TG - Fall 2021 by Texas Real Estate Research Center

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VOLUME 28, NUMBER 4 www.recenter.tamu.edu @recentertx

TIERRA GRANDE MAGAZINE TEXAS REAL ESTATE RESEARCH CENTER

5 | Hot Markets, Cool Practices Regardless of how hot the housing market is, taking short cuts to close a sale is asking for trouble. Here are tips for staying on the straight and narrow. By Kerri Lewis

2 Out of Thin Air Pros and Cons in the Search for Water Water, water, anywhere? It’s possible in the near future, thanks to technological ingenuity. And with an increasing number of Texans looking to move to parts of the state prone to less rainfall, that’s a good thing. By Harold D. Hunt

8 | Little Law, Big Deal The New Quitclaim Bill Quitclaims—the relinquishing of a claim on a property—often cause headaches for the parties involved in a transaction. Does a new law alleviate those headaches? Not entirely. By Rusty Adams

14 | Annex Marks the Spot Houston’s Suburban Gold Any treasure hunt begins with a map. For the City of Houston, limited purpose annexations have pointed the way to millions of dollars in additional sales tax revenues since 2001. By Bill Gilmer and Adriana Fernandez

18 | Oh, Deer

11 Return to Normalcy? Texas Housing Mid-Year Update Can we just forget last year already? When it comes to the state’s housing market, comparing this year with the anomaly that was 2020 is futile. Comparing it with 2019, on the other hand, is a different story. By Joshua Roberson Executive Director, GARY W. MALER Senior Editor, DAVID S. JONES Managing Editor, BRYAN POPE Associate Editor, KAMMY BAUMANN Creative Manager, ROBERT P. BEALS II Graphic Specialist/Photographer, JP BEATO III Graphic Designer, ALDEN DeMOSS Communications Specialist II, HAYLEY RIEDER Circulation Manager, MARK BAUMANN Lithography, RR DONNELLEY, HOUSTON

Heading Off a Wildlife Epidemic There’s a disease lurking where the deer and the antelope play, and it has the potential to significantly reduce the deer population. There are ways to contain it, though, and the Texas Parks and Wildlife Department has a plan. By Charles E. Gilliland

20 | Payback Predicament COVID, Mortgage Forbearance, and Repayment Affordability To paraphrase an old song, “Brother, can you spare a mortgage payment?” For some homeowners, trying to catch up on payments they missed during the pandemic is a real concern. Here’s who’s most at risk, and why. By Clare Losey

25 | Lesser Known Real Estate Leasing Tax Tips If you’re used to seeing the same list of tips for effectively managing real estate leasing activities, get ready: This article may surprise you. By William D. Elliott

28 | Practically Speaking Real Estate Questions Answered Federal law provides certain protections to FHA and VA homebuyers when it comes to low appraisals. Licensees need to understand those protections and how to properly advise their clients in such cases. By Kerri Lewis and Avis Wukasch

ADVISORY COMMITTEE: Russell Cain, Port Lavaca, chairman; Doug Jennings, Fort Worth, vice chairman; Troy C. Alley, Jr., Arlington; Doug Foster, San Antonio; Vicki Fullerton, The Woodlands; Patrick Geddes, Dallas; Besa Martin, Boerne; Walter F. “Ted” Nelson, Houston; Rebecca “Becky” Vajdak, Temple; and Barbara Russell, Denton, ex-officio representing the Texas Real Estate Commission. TG (ISSN 1070-0234) is published quarterly by the Texas Real Estate Research Center at Texas A&M University, College Station, Texas 77843-2115. Telephone: 979-845-2031. VIEWS EXPRESSED are those of the authors and do not imply endorsement by the Texas Real Estate Research Center, Mays Business School, or Texas A&M University. The Texas A&M University System serves people of all ages, regardless of socioeconomic level, race, color, sex, religion, disability, or national origin. Nothing in this publication should be construed as legal or tax advice. For specific advice, consult an attorney and/or a tax professional. PHOTOGRAPHY/ILLUSTRATIONS: Getty Images, pp. 1, 2, 3, 11, 18-19; Courtesy of James McCanney, p. 4; JP Beato III, pp. 14-15; Robert Beals II, pp. 17, 20-24. LICENSEE ADDRESS CHANGE. Log on your Texas Real Estate Commission account to change your mailing address. © 2021, Texas Real Estate Research Center. All rights reserved.

ON THE COVER: Hotel Emma at Pearl, San Antonio. Photographed by JP Beato III. FALL 2021

Water

While Texas’ rural areas could appeal to many urban residents looking to move, the shortage of potable water in those regions presents a problem. Several methods of obtaining water might offer solutions. By Harold D. Hunt lthough working from home is not a new concept, the recent pandemic has accelerated its appeal for many Texans. Past limitations are being addressed through improved efficiencies and new technology. Online shopping for almost anything is now just a click away. FedEx and UPS deliver anywhere. High-speed satellite Internet is already in beta testing in parts of the United States. When the decision is made to work from home, the next question may be where to live. Texas has a great deal of land outside urban areas. When choosing to reside in a more rural location, limitations such as available electricity and potable water may come into play. Not every part of the state is considered habitable for a residence. Unavailability of electricity in remote areas can be addressed through existing wind and solar photovoltaic technology. Back-up generators and battery systems are becoming more commonplace, providing the security of uninterrupted power. The bigger hurdle in many areas of the state could be water availability. Other factors may be considered when deciding to relocate to a rural area. Families with children might consider the quality of local school districts, for example. However, removing the constraint of insufficient potable water from the decision of where to live could be a potential game-changer for migration patterns and rural real estate markets across Texas.

Can sufficient potable water be secured for whole-house needs in areas of Texas where there is no water, very little water, or water not fit to drink? Methods such as rainwater harvesting, reverse osmosis, and atmospheric water generators may offer solutions.

Rainwater Harvesting One way to acquire water for residential use is through rainwater harvesting. However, annual rainfall varies greatly across the state. The Texas State Historical Association’s Handbook of Texas reports that El Paso receives the lowest average annual rainfall of any Texas city at just under eight inches. Much of West Texas receives only 12 to 16 inches of rainfall annually. Meanwhile, the City of Orange in East Texas averages just over 59 inches per year. In addition to showing precipitation levels, a report by the Texas Water TG

Development Board (TWDB) reveals the typical longest span of continuous days without rainfall in most of East Texas is less than 60 days. That number increases to 125 days in much of West Texas. As a result, harvesting sufficient rainwater for a residence in the driest parts of the state could be challenging. everal sources, including the U.S. Geological Survey, state the average American uses somewhere between 80 and 100 gallons of water per day. This number includes water for drinking, showering, washing clothes, and flushing toilets. Assume a family of four using 100 gallons of potable water per day per person wanted to live in an area of Texas receiving ten inches of annual rainfall and the possibility of no rain for 125 days. The amount of necessary water storage and surface capture area can be estimated using TWDB calculations. In this example, a family of four would require 50,000 gallons of water storage (400 gallons used per day x 125 possible days without rainfall). It would be prudent to have the storage tanks initially full before usage, which could mean hauling water to the site before drawing on the system. When estimating the possible amount of rainwater harvesting, the rule of thumb is 600 gallons of water collected per inch of rainfall from a 1,000-square-foot surface area. However, a 15 percent loss can be expected due to leakage and system overflows during heavy rain events. Approximately 510 gallons would more likely be captured in a one-inch rain event, or 5,100 gallons over a year, assuming ten inches of annual rainfall. A surface area ten times larger, or 10,000 square feet, would be required to capture 50,000 gallons with a 1,000 gallon additional buffer. Although roof surface areas vary, an average estimate is 1.5 times the square footage of the home. Based on that, a 2,000-square-foot house provides about 3,000 square feet of surface area for rainwater harvesting. To FALL 2021

obtain the required 10,000 square feet of surface area in the West Texas example, other outbuildings such as barns would have to be used to catch sufficient rainfall. The surface area required in East Texas would be considerably less. Assume the same family of four lives where rainfall is 50 inches per year and there are only 60 days between expected rain events. The amount of required storage would be 24,000 gallons (400 gallons per day used x 60 possible days without rainfall). At 510 gallons of water captured in a one-inch rain event per 1,000 square feet of surface area, 50 inches of rainfall provides 25,500 gallons of captured water. Again, if storage tanks were prudently filled before drawing any water, a mere 1,000 square feet of surface area should be sufficient to provide enough water to span the typically longest dry period of 60 days. Before drinking, rainwater will have to be filtered and disinfected. Furthermore, storing any water in ponds, pools, or storage containers for extended periods will require whole-house filtration systems to make the water safe for drinking.

Reverse Osmosis Reverse osmosis (RO) is a water purification process that has been in use for several decades. Units are sold today that have the capability to provide wholehouse potable water needs. RO systems could be used in areas where sufficient water is available but not fit to drink. A partially permeable membrane is used to separate water from unwanted chemicals and bacteria. Normal household water pressure forces water through the membrane. Specialized RO systems are often used in the purification of seawater or brackish water, where sea salt is removed from the water. RO has its downsides. It must be used in combination with other filtration techniques. The systems must be

backflushed, requiring disposal of the nonpotable sludge generated during the process. Anywhere from two to 20 gallons of discharge may be produced for every gallon of potable water generated, depending on water quality. The accumulated sludge cannot be used for any other purpose. The RO process removes minerals such as iron, magnesium, calcium, and sodium, which are essential to human health. This makes the water essentially tasteless. Systems are available to add minerals back to the water. RO membranes are subject to decay and clogging, lowering the quality of the treated water without proper maintenance. Most importantly, RO systems require a sufficient water source to produce the desired amount of potable water, making it impractical in areas where little or no water is available.

Atmospheric Water Generation Atmospheric water generators (AWGs) require no water source other than what’s held in surrounding air. Unlike RO systems, no discharge is generated by the process. AWGs are being looked at as one possible solution for areas with no potable water. Dr. Anjali Mulchandani, an assistant professor at the University of New Mexico, has been researching the water scarcity problem at the university’s Center for Water and the Environment. “In the U.S. Southwest, population is booming, and the water supply is diminishing,” says Mulchandani. “But there is this other reservoir we don’t even think about, and that’s the atmosphere. It actually has more water than all the rivers.” According to the Environmental Protection Agency, the most commonly used AWG systems employ condenser and cooling coil technology to pull moisture from the air in the same way a household dehumidifier does. AWGs use a blower system to draw the air from the atmosphere into the unit where filters first remove dust, dirt, and other particles. Air is then directed into a heat exchange and cooling process that causes the water to condense. The water is captured and filtered to remove any

remaining impurities or contaminants before being transferred to storage. ater production rates are highly dependent on the air temperature and the amount of water vapor (humidity) in the air. Altitude can be a factor as well, as humidity generally decreases with increases in altitude. AWG operational minimums are about 45 degrees Fahrenheit and 40 percent relative humidity. The higher the temperature and humidity, the more water produced. The volume of air passing over the cooling coil and the AWG’s capacity to cool the coil are also factors. AWGs large enough to produce sufficient water for whole-house use are relatively new and relatively rare. An Internet search of companies offering systems large enough to provide wholehouse water needs revealed few viable candidates. “There are several patents on AWGs, but it is difficult to track them to commercial devices available for sale today,” says Mulchandani. One AWG machine available for purchase by homeowners is the Maxim, manufactured by RussKap, the largest supplier of AWGs to the U.S. government. The company has more than 100 units of different sizes in use by the U.S. Marine Corps alone. “One Maxim unit can produce up to 200 gallons of potable water per day,” says Ed Russo, CEO of RussKap Holdings LLC. One or more AWG machines should supply adequate potable water for residential use in Texas, depending on environmental conditions and the volume of water required. RussKap’s AWGs use the same basic components as a home air conditioner, so unit longevity should be similar. “Homeowners could expect a useful life of about 15 years,” says Russo. “Making water from air is only one part

of the AWG system. Another important piece is keeping it safe to drink and tasting good.” AWGs are heavy energy users compared with water harvesting and RO systems. “You have to convert water from a vapor phase to a liquid phase,” says Mulchandani. “That phase change is what’s so energy-intensive. How can we sustainably supply that energy off the electrical energy grid?” James McCanney, physicist and owner of JMCC WING LLC, has spent years researching ways to reduce the energy cost to make potable water. McCanney was the winner of the Technology Innovation Achievement Award in the 2018 Water Abundance XPRIZE competition. The XPRIZE goal was to collect a minimum of 2,000 liters (about 525 gallons) of water per day from the atmosphere using 100 percent renewable energy at a cost of no more than two cents per liter, or about eight cents per gallon. “All 98 teams in the XPRIZE competition had a watermaking machine of some type,” said McCanney. “Where they stumbled was attaining that low energy cost.” McCanney married his patented JMCC WING Generator, an efficient high torque windenergy system, to his commercial AWGs to keep the energy cost down.

Alternate AWG System Under Development Scientists at GE Research are working with three U.S. universities to develop a refrigerator-size AWG unit meant to produce about 500 liters (130 gallons) of drinking water per day. Although primarily focused on providing water for military troops in the field, it could also become a source of potable water

for folks living in arid or water-stressed areas. The unit contains a dense proprietary “metal sponge” and heat exchanger that work together to soak up water from very thin air. The metal sponge sucks in the air while the heat exchanger creates condensed drops of water vapor. The water is then captured. When power is added to speed up the process, the unit can go through several water-producing cycles per day. The system is being designed to produce water in some of the driest deserts in the world. Early tests conducted in Arizona and the Mojave Desert have shown water can be harvested in regions with relative humidity in the single digits.

Once Unthinkable, Now Maybe Possible All three of these systems have their advantages and disadvantages, depending on the environment they will be operating in. However, the technical feasibility of providing sufficient potable water for whole-house residential needs in most regions of Texas looks favorable. Comparisons involving the cost, energy consumption, and efficiency of these three systems have not been discussed. A more in-depth follow-up article will provide additional insight into the systems, especially AWGs, as more research and data become available. Dr. Hunt (hhunt@tamu.edu) is a research economist with the Texas Real Estate Research Center at Texas A&M University. TG

Residential

In a highly competitive housing market, agents might be tempted to cut corners to close a sale. However, doing so can result in administrative action by TREC or even a civil suit. By Kerri Lewis

ot housing markets create a frenzy that can lead to bad decisions by buyers, sellers, and their agents. As a professional in the industry and a fiduciary, a real estate agent should keep a cool composure and be a reality check sounding-board against a buyer’s attempts to win a house at any cost or a seller’s focus only on price in a multiple-offer situation. Some hot market practices are ripe with risk. Here are some cool practice pointers for agents to reduce the likelihood of needing an attorney to defend them in a future civil suit or administrative action at the Texas Real Estate Commission (TREC).

LISTING AGENT PRACTICES Not respecting offer deadlines. One way agents handle the barrage of competing offers in a hot market is to set a deadline for offers so they can present all offers to the seller at one time. There is nothing wrong with this practice, with two caveats. First, discuss the pros and cons of this strategy with the seller, and make sure he wants offers presented in this fashion. Second, and most importantly, respect the stated offer deadlines. Do not allow your client to accept an offer before the deadline, and make sure all offers received by the deadline are presented. Failure to do this can put the agent and the client at risk of claims of unfair treatment or deceptive practices. The agent

can also be subject to discipline by the local board/ association of Realtors and TREC. Bonus practice note: Agents are required by law to present all offers, even if they are received after a stated deadline or a contract has been signed [Tex. Occ. Code §1101.557], unless the seller has stated in writing to the agent that the seller no longer wants to receive offers after a contract for their property has been signed [TREC Rule §535.156]. Not allowing inspections. If the offer guideline sheet stipulates or if the seller suggests that the buyer waive professional inspections, press pause. While this may help reduce the short-term likelihood that the buyer will come back with an amendment offer to decrease the sales price due to items found in an inspection, it is a bad idea. Preventing a buyer from using the right to inspect the property set out in Paragraph 7 of the contract (whether or not an option period is purchased) increases the seller’s and the agent’s risk of a lawsuit claiming the seller or agent withheld material information about the property’s condition. Discuss this reality with the seller and remind him that allowing a buyer to inspect the property does not obligate the seller to agree to repairs in any proposed amendment. Not allowing option periods. For the reasons stated previously, it is better to allow the buyer to have an

option period to make any independent inspections and assessments of the property the buyer deems necessary. In a hot market, it is okay for the seller to ask for more option money and a shorter option period, but an agent should caution the seller against shortening the option period to the point where it is not likely the buyer can get inspections completed. Again, this could lead to a future lawsuit claiming the seller was trying to hide a condition of the property. Disclosing informaSOLD tion only to some buyers or focusing only on SOLD price for multiple offers. Although the listing agent is a fiduciary to the seller, TREC rules require SOLD the agent treat all parties S O to a transaction fairly and LD honestly [TREC Rule §531.1 and §535.156]. Telling just some agents or parties that have submitted offers what the current highest offer is in order to create a bidding war is a clear violation of TREC rules. A best practice is to let all parties know that there are multiple offers and to submit their highest and best offer by a stated deadline. Texas Realtors has a form for this situation for members. ultiple offers can present a problem for listing agents when presenting the offers to their sellers. Be careful not to allow sellers to compare just sales prices when discussing multiple offers. Other important factors that can affect whether the contract will actually close that a seller may want to consider include other costs assigned to seller, the number of days in an option period, the number of days to get financing approved, appraisal contingency provisions, and proof of funds, especially when offers are over market price. Remember all offers need to be presented. A best practice would be to prepare a spreadsheet with all of these terms set out and discuss with your seller which they find most salient. In reality, it might be a combination of factors that leads them to choose one offer over another. Bonus practice note: Consider using a spreadsheet without identifying names of buyers, and using agent names or numbers instead. This method will help protect a seller from any claims of discrimination based on race or national origin when choosing between multiple offers.

Not tracking earnest and option money deposits. Beginning April 1, 2021, TREC promulgated contracts require option fees to be delivered to the escrow agent (generally the title company) along with the earnest money within three days after the effective date of the contract. Understand that it is not the job of the escrow agent to determine whether or not the option fee or earnest money was timely delivered. Rather, their job is to mark the date and time that it is received on the appropriate space on the contract. The listing agent should calculate the due date and track whether one or both are not delivered by midnight on that date. To do this, the listing agent will need to call or email the title company and find out the status of delivery. The agent SOLD cannot rely on the title company to proactively notify them each time SOLD funds are received or not received timely. This is SOLD important to the seller SOLD since the seller has contractual rights when the funds are not delivered timely. Revised Paragraph 5 provides that funds received from the buyer are first applied to the option fee and then to the earnest money. If either are deposited late with the title company, or if the total amount is less than the required sum for both the earnest money and the option fee, the listing agent needs to notify the seller about their choices under the contract. Paragraph 5 permits the seller to notify the buyer that the seller is terminating the contract if the seller gets that notice to the buyer after the due date of the earnest money but before the buyer delivers the full amount due to the escrow agent. In a hot market, the seller may want to do this right away, especially if a better back-up contract is waiting in the wings. If the option fee is not paid timely, no option period is created, and the buyer cannot terminate the contract using that provision of Paragraph 5. When the option fee is late, the listing agent should discuss it with the seller and let the seller decide whether to accept a late option fee payment and allow the buyer to retain an option period under the contract or hold firm to the contract terms.

BUYER’S AGENT PRACTICES Bidding over asking price. Paying over the listed price for a property is not uncommon in a hot market where demand outstrips supply. A buyer’s agent can play a big role in making sure his client understands how much he is overpaying for a home and the risks associated with it. First, a buyer’s agent should discuss the

reality of a hot market with buyers, preparing them for the multiple-offer situation, the necessity of acting quickly, and the likelihood of an offer over the asking price winning the contract. n addition, the agent should know the buyer’s motivation for buying a home and the buyer’s financial capabilities. That means the buyer should have a prequalifying letter from a lender before looking at homes and should discuss with the agent how much extra cash is at his disposal if he wants to bid over the asking price. Is now the best time for the buyer to be making a purchase? The agent should prepare a comparative market analysis for a property the buyer is interested in and discuss what happens if the lender’s appraisal comes in lower than the contract sales price. This could be reality check time for the buyer. Remember, an agent cannot predict what the value of the property will be in the future. Using the appraisal addendum incorrectly. A buyer’s agent should understand and be able to explain how each section of TREC’s Addendum Concerning the Right to Terminate Due to Lender’s Appraisal affects the buyer’s financial obligations. If Box 1 is checked, the buyer is agreeing to bring whatever cash is necessary to close the deal at the contract price, no matter what value is given in the lender’s appraisal and subsequent amounts the lender is willing to loan on the property. Box 2 is similar to Box 1, but the buyer has control over the amount he will pay over the appraised value. This option allows the buyer to set a limit on how much above the appraised value he would be willing to bring to closing. Box 3 gives the buyer an additional right to terminate, over and above the right to terminate in the Third Party Financing Addendum, if the appraised value is less than the amount inserted in the addendum. Remember, the addendum is for use only with conventional financing where a Third Party Financing Addendum is attached to the contract. It is not for use with FHA-insured or VA-guaranteed financing. Using the addendum for the latter is contrary to federal law. Making earnest money nonrefundable. Suggesting making earnest money nonrefundable to gain an advantage over other offers not only alters many remedies for the buyer under the contract, but it is the unauthorized practice of law by a license holder. The contract provides many places where the earnest money is returned to the buyer other than termination under the option period (for instance, when there is a

casualty loss, or the seller does not provide the seller’s disclosure, or any other default by seller). A better alternative is to either increase the option fee (which is never refundable) or add additional earnest money to the contract to be paid after the option period is over. Eliminating option periods or inspections. A buyer’s agent should not recommend eliminating the option period or inspections. While this may make an offer more attractive in a multiple offer situation, the buyer is committing to a buying a home that may have significant and expensive unforeseen problems, like with the foundation. When these problems are discovered after the buyer purchases the home, the likelihood of the buyer’s agent (who recommended eliminating the option period) being sued or having a complaint filed at TREC greatly increases. Remember, the buyer does not have to ask for any concessions from the seller after the inspections are completed, but at least the buyer will know exactly what he is purchasing. Not suggesting a back-up contract. A back-up contract is a good strategy for a buyer who really wants a property but is not willing to bid as high over the asking price as another buyer. Many times, the buyer in first place will realize he bid too much over, either during the option period or after the appraisal is received, and terminate the contract. If a back-up contract is signed and in place, the back-up buyer automatically becomes the new buyer. Buyers’ agents should understand how the back-up process works and explain it to their buyers. TREC’s Addendum for “Back-Up” Contract is added to a TREC promulgated contract form to create the back-up contract. Earnest money and any option fee need to be paid within three days after the effective date of the back-up contract. The buyer gets an option to back out from the time they pay the option fee until the buyer either terminates the back-up contract or after the number of days set out in Paragraph 5 once the back-up contract switches into first place. This means a buyer can keep looking for something else while in a back-up position.

THE AGENT SHOULD KNOW THE BUYER’S MOTIVATION FOR BUYING A HOME AND THE BUYER’S FINANCIAL CAPABILITIES.

Lewis (kerri@2oldchicks.com) is a member of the State Bar of Texas and former general counsel for the Texas Real Estate Commission.

Legal Issues

The New Quitclaim Bill In Texas, a quitclaim in the chain of title often creates problems that don’t go away. A new Texas statute promises to alleviate these issues, but it doesn’t eliminate them completely. By Rusty Adams

ffective Sept. 1, 2021, S.B. 885 adds only 78 words to Texas codes and barely fills half a page, yet this little bitty bill could have a significant impact on Texas real estate transactions. To understand how the changes work, one must look at the existing law relating to quitclaims. This will include a quick detour to explore bona fide purchasers. Start with the following example. In 2012, Larry owned a 500-acre ranch. In 2015, he divided it into five 100-acre tracts. Larry kept Tract 5 for himself; Tracts 1-4 were sold as follows: • Tract 1 to Ty, giving Ty a general warranty deed, which was promptly recorded. • Tract 2 to Casey, giving Casey a general warranty deed, which was not recorded. • Tract 3 to Lane, giving Lane a quitclaim deed, which was promptly recorded. • Tract 4 to Tuff, giving Tuff a quitclaim deed, which was not recorded. On Aug. 12, 2021, Larry sold the entire 500-acre ranch to Freckles, giving Freckles a general warranty deed, which was recorded on Aug. 31, 2021. Now, Larry has sold some of the same land more than once and to different people, which certainly exposes Larry to liability, but that’s a topic for another day. What happens when everyone else finds out? They end up at the courthouse, of course, and the dispute involves the concept of the bona fide purchaser.

BONA FIDE PURCHASERS Conveyances of real property definitely should be recorded in the county deed records, because they provide constructive notice of their existence. For example, Ty’s recorded general warranty deed gives constructive notice “to the world” that Tract 1 was

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conveyed to Ty. It matters not whether anyone actually checks the deed records and actually knows the deed is there. Nevertheless, a properly executed deed, delivered to the grantee, even if not recorded, is sufficient to convey title. However, Tex. Prop. Code § 13.001(a) says an unrecorded conveyance of real property is void as to a subsequent purchaser for a valuable consideration who takes in good faith and without notice of the prior conveyance. Such a subsequent purchaser is called a bona fide purchaser. An unrecorded deed is still binding on a subsequent purchaser who does not pay a valuable consideration or who has notice of the conveyance, according to Tex. Prop. Code § 13.001(b). The notice may be actual or constructive. Actual notice means the purchaser actually has personal knowledge. A person is also charged with notice of those facts that a reasonable inquiry would have disclosed. For instance, if Casey is using the land in a way that should alert Freckles to his conflicting claims, then Freckles would be on notice of the competing claim and could not be a bona fide purchaser. Constructive notice means the law imputes notice to the purchaser even if he does not have actual knowledge. The most common example of constructive notice is that given by a recorded deed. In the battle for Tract 1, Freckles cannot be a bona fide purchaser because Ty’s deed is recorded, constituting constructive notice to Freckles. Thus, Ty will prevail. In the Tract 2 lawsuit, however, Casey’s deed is unrecorded, and Freckles is a bona fide purchaser. Freckles will win on Tract 2. For purposes of the illustration, Freckles gave adequate consideration for the ranch and has no actual knowledge of the previous conveyances. To examine the cases of Tracts 3 and 4, the quitclaim deed must be introduced. TG TG

QUITCLAIMS

but does not warrant title. A quitclaim merely relinquishes the grantor’s interest, if any, to the grantee. If the Former Baltimore Orioles manager Earl Weaver once grantor has title at the time of the execution and delivery quipped, “There’s a place for the sacrifice bunt, and it’s of the quitclaim, it operates as a conveyance, but it credeep in your closet.” The same could be said for the quitates a problem in the chain of title. claim. Clients often ask lawyers for quitclaim deeds or Because a quitclaim only passes the interest presently sometimes “quick claim deeds.” In most cases, though, owned by the grantor, quitclaims “are commonly used to using a quitclaim deed is a bad idea. When should a quitconvey interests of an unknown extent or claims having claim be used in Texas? The answer is almost never. a dubious basis.” Id. at 655. Therefore, a quitclaim in The term quitclaim deed is something of a misnomer the chain of title is considered legal notice to a purchaser because it’s not exactly a deed. A deed is an instrument that another person may have a claim on the property. in writing that, when properly executed and delivered, Richardson v. Levi, 67 Tex. 359, 3 S.W. 444 (1887). This conveys title to real property. A quitclaim doesn’t doubt is never removed from the title. It stays in the title necessarily do that. The term “quitclaim,” however, is chain and is imputed to all subsequent purchasers. All appropriate. A subsequent purquitclaim does chasers take title exactly what it subject to whatsays. It quits a ever claims might claim. In other be out there. The term quitclaim deed is words, it is a disBecause the something of a misnomer because claimer in which quitclaim is the grantor it’s not exactly a deed. A deed considered releases his legal notice of a is an instrument in writing claim in favor of potential claim, that, when properly executed and the grantee. the purchaser A quitclaim in this situation delivered, conveys title to real does not estabcannot be a bona property. A quitclaim doesn’t lish title in the fide purchaser. grantee. It does If the owner of a necessarily do that. not contain prior unrecorded words of conveyinterest comes ance or warforward, the purranty. It merely chaser is at risk passes whatever of losing the propinterest, if any, erty or at least is the grantor has saddled with the at the time the quitclaim is made and delivered (unless hassle and expense of defending it. This creates an uncerthe language shows the intent to pass something other tain and unmarketable title and can make it difficult to than the grantor’s then-existing interest). Thus, if the obtain title insurance. There has never before been a good grantor has no interest in the property, the quitclaim way to fix this problem under Texas law. conveys nothing. ack in the courthouse, where title to Tracts 3 The courts determine whether an instrument is a and 4 are being litigated, the deeds from Larry to conveyance or a quitclaim based on the wording of the Lane and Tuff are quitclaims. They still operate document. If the document demonstrates an intent to to transfer Tracts 3 and 4 to Lane and Tuff. But rememtransfer the land itself, it is a conveyance. If it indicates ber, an unrecorded conveyance of real property is void as an intent only to relinquish the right, title, and interest to a subsequent purchaser for a valuable consideration of the grantor, if any, then it is a quitclaim. This is true who takes in good faith and without notice. With respect regardless of the title of the document and regardless of to Tract 4, Freckles will prevail over Tuff’s unrecorded whether it includes the word “quitclaim.” See, e.g., Porquitclaim. But Freckles will lose Tract 3 to Lane because ter v. Wilson, 389 S.W.2d 650 (Tex. 1965). Lane’s recorded quitclaim is constructive notice to Freckles. A general or special warranty deed conveys title and Now, look at the example again, but this time assume warrants the title. A deed without warranty conveys title Larry’s deed to Freckles was a quitclaim made and delivered

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on Aug. 12, 2021, and recorded on Aug. 31, 2021. Freckles is back in the courthouse fighting over the title. The quitclaim is effective to transfer title to Tract 5 from Larry to Freckles. After all, Larry did own it, and he quitclaimed it directly to Freckles. Note, however, that no one claiming Tract 5 under Freckles in the future may be a bona fide purchaser. As to Tracts 1-4, Freckles cannot be a bona fide purchaser because the quitclaim itself is notice. No one claiming under Freckles in the future can ever be a bona fide purchaser in this scenario. The Commission of Appeals lamented the sometimes harsh results of this rule: We therefore regard the question as settled in this state until such time as the legislative branch of the government may deem it in the interest of public policy to change the rule by statute. Houston Oil Co. of Texas v. Niles, 255 S.W. 604, 610 (Tex. [Comm’n Op.] 1923). That time is now.

The New Law Almost 100 years later, after several previous attempts, the 87th Texas Legislature passed S.B. 885, a new law that changes the way quitclaims are treated effective Sept. 1, 2021. First, the bill adds three words to Section 16.025(b) of the Texas Civil Practice and Remedies Code, providing that the five-year adverse possession statute does not apply when a claim is based on a quitclaim deed. As Chief Justice Robert W. Calvert observed in a dissenting opinion in Porter, the words of that statute do not exclude quitclaim deeds from its operation. Nevertheless, it is already settled law in Texas courts that a quitclaim deed will not support an adverse possession claim under the five-year statute. Therefore, this seems to be a nonsubstantive clarification rather than a change in the law. econd, and more importantly, the bill adds Section 13.006 to the Texas Property Code. This section provides that once a quitclaim deed has been recorded for four years, it does not affect the question of the good faith of a subsequent purchaser or creditor and is not notice to a subsequent purchaser or creditor of any unrecorded conveyance, transfer, or encumbrance. In other words, once a quitclaim has been recorded for four years, it is not automatically notice that another person might have a claim, and it can allow a buyer to be a bona fide purchaser when there is a quitclaim in the chain of title. This law applies only to a quitclaim deed recorded on or after Sept. 1, 2021. Act of April 21, 2021, 87th Leg., R.S., ch. 94, §§ 3-4, 2021 Tex. Session Law Serv. (S.B. 885) (Vernon’s) (codified at Tex. Prop. Code § 13.006). It is important to note that while the law only applies to a quitclaim recorded on or after Sept. 1, 2021, that language did not make it into the code.

10 10

Notice that even under the new law the result is the same because the quitclaim was recorded on Aug. 31, 2021. Now change the facts a little bit to illustrate the effect of the new law. What if, instead, the same quitclaim from Larry to Freckles is recorded a day later, on Sept. 1, 2021, and then, just over four years later, Freckles sells the ranch to Charmayne on Sept. 2, 2025, giving her a deed (not a quitclaim)? What a difference a day makes. In a dispute between Charmayne and Ty over Tract 1, Ty wins this go-round. The quitclaim from Larry to Freckles, recorded on Sept. 1, 2021, and of record for four years, is not a problem for Charmayne. However, Charmayne cannot be a bona fide purchaser because Ty’s deed was recorded. It is still constructive notice of a conflicting claim, and it is not extinguished by the quitclaim under the new statute. harmayne outruns Casey for Tract 2. Charmayne is a bona fide purchaser. Casey’s deed is not constructive notice because it was never recorded. Previously, Larry’s quitclaim to Freckles would have precluded Charmayne’s bona fide purchaser status. But under the new statute, Larry’s quitclaim is not constructive notice to Charmayne because it was recorded on or after Sept. 1, 2021, and has been of record for more than four years. In the (fictitious) case of Charmayne v. Lane, with respect to Tract 3, Lane wins. Charmayne is not a bona fide purchaser. Under the new statute, Larry’s quitclaim to Freckles is not constructive notice. However, Lane’s previous quitclaim is of record, and its constructive notice to Charmayne is not affected by the new statute because it was recorded prior to Sept. 1, 2021. Charmayne runs away from Tuff with Tract 4. Charmayne is a bona fide purchaser. Larry’s quitclaim to Freckles has been recorded for more than four years and is, therefore, not constructive notice under the new statute. Tuff’s quitclaim is not notice because it was never recorded. As for Tract 5, not only is Charmayne the owner, but future purchasers claiming through her may be bona fide purchasers. The only quitclaim in the title chain of Tract 5 was recorded on Sept. 1, 2021, and has been of record for more than four years. As these examples show, quitclaims in the chain of title can still be the proverbial fly in the ointment. But this new legislative enactment, no matter how small, has the potential to change the landscape of real estate transactions on properties with heretofore unmarketable titles. The examples in this article are fictitious and for illustrative purposes only. Nothing in TG should be considered legal advice. For advice on a particular situation, consult an attorney.

Adams (r_adams@tamu.edu) is a member of the State Bar of Texas and a research attorney for the Texas Real Estate Research Center at Texas A&M University. TG TG

Residential

RETURN TO NORMALCY?

Texas Housing Mid-Year Update The Texas housing market is still feeling the effects of the COVID-19 pandemic, but indicators such as an increase in listings of existing homes suggest a return to normalcy. By Joshua Roberson

FALL 2021

he 2021 housing season is almost over, and the year-toyear comparisons are in full swing. However, sizing up this year against last year may not be as helpful as usual for projecting what’s ahead. Home sales from the first half of 2020 were heavily influenced by the one-and-a-half-month shutdown during part of March and all of April. Comparing 2021 to two years ago, meanwhile, reveals year-to-date sales currently have an almost 25,000-unit lead over 2019’s then record-setting year. The second half of 2021 will likely look completely different from 2020’s second half. Sales ramped up during summer 2020 and didn’t let up in the fall like in other years. For that reason, topping last year’s July and August numbers is far from certain even though June 2021 sales were 7 percent higher than June 2020 sales.

The Listings Gap One sign of this is pending listings. Going into July, they were down around 8 percent, a significant gap that may be too much to overcome. Still, given the strong housing activity so far, year-end sales figures should be nothing to shrug at even if they fall short of 2020 (Figure 1). The improvement in housing inventory bodes well for sales this year. The statewide month’s inventory level may have bottomed out in May at 1.3 months, but then it improved to

300 50

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Figure 2. Statewide New Listings

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Source: Texas Real Estate Research Center at Texas A&M University

almost 1.4 months in June. Although small, it’s a change in the right direction. The turnaround in inventory has been fueled by a bounceback in new listings (the flow of new homes into the market), which more closely resembled 2019 than 2020 (Figure 2). Still, there is a significant gap in the number of active listings (current level of homes on the market) between 2021 and previous years. The June 2021 count of statewide active listings was close to 50,000, compared with 85,000 the year before. Until that gap narrows, the pressure on home prices will likely continue.

A New Phenomenon Emerges

ome price appreciation is currently through the roof. According to the Texas Real Estate Research Center’s Home Price Index, the statewide index grew 13 percent year-over-year in second quarter 2021. The rapid growth has resulted in a new phenomenon in the market. For probably the first time ever, at least half of Texas home sellers this year were able to sell their homes for their starting asking price or more (see table). To put that into perspective, in 2019 only around a quarter of Texas sellers received at least their asking price. Before that, the highest rate was in 2015, and even that was below 30 percent. Sellers currently have a remarkable amount of control over the market. Aggressive bidding wars in markets such as Austin and Dallas are not new, but other markets have recently experienced intense buyer skirmishes that would have turned heads two years ago. Markets such as Killeen-Temple have benefited from their strategic location within the Texas Triangle (the region between Houston, San Antonio, and DFW) and proximity to Austin, while cities such as El Paso and Lubbock show home price growth is reaching even the more remote markets.

Construction Shakeup The new-home market also had a bit of a shakeup last year as a result of the COVID shelter-in-place mandates. Comprehensive data from the U.S. Census Bureau’s Survey of Construction reveal just how wild 2020 was for homebuilders. Texas accounted for 81.6 percent of total single-family permits in 2020. In addition, the same year brought a massive

New Listings (Thousands)

YTD Sales (Thousands)

Figure 1. Texas Existing Single-Family Home Sales

20 10 0

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Source: Texas Real Estate Research Center at Texas A&M University

Ratio of Sale Price Over Asking Price, Top Texas MSAs in First Half of 2021 Austin-Round Rock Dallas-Fort Worth-Arlington Killeen-Temple El Paso San Antonio-New Braunfels Wichita Falls Lubbock Tyler Houston-The Woodlands-Sugar Land Sherman-Denison

1.0768 1.0138 1.0103 1.0053 0.9979 0.9904 0.9900 0.9884 0.9877 0.9871

Note: A ratio of 1 indicates seller received asking price. Over/under 1 indicates seller received more/less than asking. Source: Texas Real Estate Research Center at Texas A&M University

spike in new single-family detached home sales for the West South Central region, which includes Texas and neighboring states such as Oklahoma, Arkansas, and Louisiana. Between 2019 and 2020, new-home sales increased nearly 25 percent, totaling 148,000 new homes in the region. Like existing-home sales, new-home sales began to escalate over the summer and extended throughout the remainder of the year. The last time Texas had sales of this magnitude was just before the mid-2000s housing crash. However, despite hot demand in 2020, new-home sales didn’t surpass the 169,000 homes sold in all of 2006 (Figure 3). The massive jump in sales put the new-home market to the test. Combined with labor and material shortages, the industry has had its work cut out to fulfill orders in a timely fashion. On paper, most spec homebuilders (those who build homes without a sales contract in place) in 2020 maintained a start-to-finish building window of six months, comparable to the pre-COVID market. The timeframe in southern states, TG

Figure 3. New Single-Family Home Sales West South Central Division

18 Monthly Sales (Thousands)

16 14 12 10 160

150 140

4 1999 2001 2003 2005 2007 2009 2011 2013 2015 2017 2019 2021 Sources: U.S. Census Bureau and Texas Real Estate Research Center at Texas A&M University

Figure 4. New Home Starts West South Central Division

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Starts (Thousands)

13 12 11 10 9 8 7 6 5 4 3 2 1 0

Price Index 2005 = 100

Figure 5. National New Construction Single-Family Price Index

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2018

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2019

2020

Sources: U.S. Census Bureau and Texas Real Estate Research Center at Texas A&M University

including Texas, was closer to five months. However, this trend clearly doesn’t square up with what’s going on right now. What happened? ew homes uncharacteristically broke ground later and later into 2020, creating a massive backlog. November and December of 2018 each had 4,000 new-home starts. In the same months of 2020 that number was closer to 9,000 (Figure 4). Because of that, the Census Bureau’s Survey of Construction will likely show 2021 was the year that revealed market strain on output. Additionally, while spec homes overall turned around quickly, custom homes did not because of increasing labor and supply shortages. Price pressure, on the other hand, did show up in the 2020 data. Between 2019 and 2020, the average price of a new singlefamily home rose $21,000, or 6 percent, to $337,000. The priceper-square-foot increased more than 5 percent to $130. On the surface, 2020’s average lot price did not change from $56,000, but lot sizes got smaller as the year progressed, which explains

FALL 2021

why lot price per square foot increased from $7.80 to $8.09 in 2020. During the 2006 housing boom, lots were around $4 per square foot. While prices increased according to the Survey of Construction’s 2020 sample, the magnitude was muted compared with prices in the existing-home market. A more frequently updated Census Bureau series, the Construction Price Index, reveals a national price surge comparable to the existing-home market starting in third quarter 2020 and persisting into first quarter 2021 (Figure 5).

Signs of Normalcy The Texas housing market is still caught up in the initial impact of the COVID-19 pandemic, but signs of normalcy are emerging, even if minimal. New listings in the existing-home market are returning in numbers similar to 2019. If the latter half of 2021 cools like in most years, that should help recharge housing inventory levels and provide some relief to housing. The new-home market saw a similar price surge that started in the second half of 2020. At this point, it’s difficult to tell when the supply side of this market will sort itself out. The construction business has many moving parts, including input costs and labor, to name just a couple. On the demand side, overall optimism among builders is still high according to the National Association of Homebuilders. Judging by the record pace of single-family building permits in 2021—25,000 more than mid-year 2019 and mid-year 2020—it will be awhile before that sector cools off. Roberson (joshuaroberson@tamu.edu) is a senior data analyst with the Texas Real Estate Research Center at Texas A&M University.

Taxes

suburban contentment with current services, the city’s poor handling of past annexations, and concern about city finances and debt levels.

MUDS, Annexations, and Changing Rules The MUD is the chief vehicle that makes Texas annexation work. It is often in a municipality’s extraterritorial jurisdiction (ETJ), which, for a large city like Houston, is a five-mile ring of land outside the city limits. Narrowly conceived as water districts in the 1920s and given modern form in 1971, the MUD is a parcel of land that prepares the way for future annexation by creating a land development company to provide water, sewer, drainage, and streets and roads. The MUD can finance development through bonds, fees, and property taxes. It is authorized and regulated under state law, but if located in a municipality’s ETJ, that city’s consent is required. The city imposes conforming municipal rules for land development intended to smooth the path for future general annexation. In 1994, Houston’s Kingwood subdivision was made up of three MUDs comprised of 15,000 acres and 53,000 residents. The City of Houston proposed general annexation, a process that at the time left Kingwood with little local input or legal recourse, but which local residents still turned into a bitter two-year public relations and legal battle. While Houston successfully completed the annexation in December 1996, the long-run fallout changed the course of Texas annexation law and ultimately proved costly to

Dollars (Millions)

n 2019, the City of Houston collected $706.9 million in sales tax revenues, with $120.7 million (17.1 percent) collected from 230 suburban Municipal Utility Districts (MUDs) located outside the city limits. Figure 1. Houston Sales Tax Revenue With/Without LPAs This extraterritorial growth began 200 in 2001 and continues to add new tax monies to the city’s coffers today 180 (Figure 1). How did these extrater160 ritorial collections come about, and what was their rationale under Texas 140 annexation law? The suburban revenues result 120 from limited purpose annexations (LPAs), which—as used by the 100 City of Houston—are potential general annexations suspended in 80 mid-stream, but which are capable of generating city tax revenue for 60 decades while the city provides no 1999 2001 2003 2006 2008 2010 2012 2015 2017 services to the suburbs. This use of City of Houston City + LPAs LPAs has been made necessary by Note: Dollar amounts are seasonally adjusted. changes in Texas annexation law,

2019

Source: City of Houston

FALL 2021

the city. It was costly in that politically savvy Kingwood residents demanded and received sustained high service levels, cutting into any of Houston’s revenue windfall. But in 1999, partly in response to Kingwood, the Texas legislature required a three-year planning period for statewide general annexation, implementation of a joint strategic planning agreement (SPA) to merge services and finances, and remedies by law or arbitration if no agreement was reached. Finally, in 2017, the Texas legislature passed a bill to allow affected residents to vote on proposed annexation.

LPA as envisioned by the city, however, sees no city services provided except limited authority over planning, health, and safety, while MUD services continue unaffected. The city receives permission from the MUD to collect its one-cent municipal sales tax within MUD boundaries and turns half this money over to the MUD as a supplement to property taxes. The MUD must use these new funds for the same purposes as property taxes (water, sewage, streets, etc.). This “interim” SPA and a promise of no general annexation typically remains in force for 30 years, at which point the SPA can be renewed or terminated, or general annexation can be imposed. The reviews of Houston’s LPAs have been widely mixed. Houston itself claims this is a commuter tax and frames the issue in terms of fairness: suburban commuters drain city services by day but add nothing to the tax base. The Kinder Institute broadly favors metropolitan annexation and

Special Purpose Annexation

ost-Kingwood, there has been no significant generalpurpose annexation in Houston. The cost of providing services to the suburbs has proven high and the net revenue gains from general annexation small. But the suburban revenue target still remained tempting for Houston. The Kinder Institute at Rice University estimates that in Figure 2. LPAs’ Impact on Houston Sales Tax Growth 2015 the combined MUDs in Sales Tax Growth With/Without LPAs LPAs’ Addition to Sales Tax Growth Houston’s ETJ were compa-

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8 2.5 rable in size to the City of 6 San Antonio, containing 1.5 2.0 million residents, 400 square 4 miles, and 550,000 housing 1.5 2 units. The LPA proved to be the map the city needed to 0 1.0 find this suburban treasure –2 chest. 0.5 –4 Here’s an example of how 0.0 an LPA is usually intended –6 to work. A Texas city agrees to future general annexation with a MUD located in City of Houston City + LPAs LPA addition to growth After MUD split its ETJ, and they enter into City after split a strategic partnership and Source: City of Houston an interim three-year partial annexation to blend service levels and finances. Both sides consolidation of MUDs into Houston and sees these agreework toward an agreement where the city will match public ments—which are not subject to a vote when they end—as service levels prevailing in the MUD before annexation, perhaps the last and best hope for general regional annexaand the MUD accepts city water and sewage services, rates, tion. In contrast, former Harris County Judge Ed Emmett and fees. Meanwhile, interim changes can be demanded. said, “I think at their heart, they’re a money grab by the For example, the city is concerned about high debt levels in City of Houston . . . and they get the MUDs involved on the the MUD and demands debt be paid down by immediately basis of ’We promise not to annex you.’” imposing a 1 percent sales tax within the MUD. Once the City of Houston LPAs Today SPA is in place, general annexation proceeds. The Texas municipal code for SPAs was meant to be LPAs spread mostly to the fast-growing suburbs north and flexible, and the City of Houston has stretched its limits northwest of Houston (see map). In 2019, just before the to arrive at a very different outcome. Houston approaches pandemic began, the City of Houston collected $120.7 local MUDs seeking a strategic partnership while advertismillion in taxes from 230 MUDs operating under LPAs and ing a preference for limited over general annexation. The then split half these funds with participating MUDs.

LPA Spread to North, Northwest of Houston, 2017

Is Houston’s tax on SPAs a commuter tax? If so, it is poorly structured. A good commuter tax usually targets nonresident workers through a payroll tax on local businesses or by taxing autos entering the region. Only about 60 percent of Fort Bend commuters and 40 percent of Montgomery County commuters enter Harris County. The SPAs are a broader-based tax on suburban consumers.

The Woodlands Tomball

Spring

290

INTERSTATE

Atascocita

Cypress Jersey Village

It is the vehicle required by law for partial annexation. As used by the strawman LPA in this article, it is a quick and highly efficient means for a municipality to raise funds for short-term pre-annexation goals. In contrast, the City of Houston has made it a 30-year longterm supplement to its sales tax revenue.

INTERSTATE

8 INTERSTATE

10 Cinco Ranch

Why collect 1 percent and rebate half to MUDs? Why not just collect half?

INTERSTATE

610 Clear Lake City Fresno

Houston ETJ LPAs (FY 2017) MUD Non-MUD Source: Kinder Institute, Rice University

ompared with sales tax collected only within City of Houston boundaries, the new LPAs boosted total revenue growth by an additional 1.5 to 2 percent each year from 2004 to 2010, although that amount is cut roughly in half after MUD payments are subtracted (Figure 2). This revenue growth has been slowing for some time, however. Leading this early surge in LPA revenue was the ability to target large numbers of existing MUDs, with a peak of 30 new LPAs added in 2003. But as the backlog of MUDs was exhausted, the number of new LPAs steadily slowed to only one or two LPAs each year after 2014. Fewer new LPAs and ongoing MUD payments mean suburban collections will add only half a percentage point to future city sales tax growth. However one feels about these LPAs, they are legal, and the Texas Municipal Code allows no judicial review of the rationale behind any annexation. Short of legislative change, SPAs will be in place for some time to come, but perceptions of fairness still count and certainly deserve further thought. Dr. Gilmer (rwgilmer@Central.UH.edu) is director with the University of Houston Bauer Institute for Regional Forecasting, and Fernandez (Adriana.Fernandez@tsu.edu) is with the Accounting/Finance Department, Jesse H. Jones School of Business, Texas Southern.

FALL 2021

Why a sales tax?

With the threat of a general annexation waning, tax rebates become the carrot for MUD participation in SPAs that replace the annexation stick. While the rebate must be spent by the MUD for the same purposes as property taxes, extra revenue provides management new flexibility to reduce rates and fees, expand existing services, or add new ones.

Is the SPA tax fair: Horizontal equity? Horizontal equity occurs if two similarly situated consumers face the same tax obligations. In this case, if two consumers buy the same basket of goods, do they pay the same amount in sales taxes? Since the 1980s, Houston has had a 1 percent sales tax that the suburbs had escaped. As the city has pushed its sales tax widely into the suburbs, it has increased horizontal equity across the region.

Is the SPA tax fair: Vertical equity? Vertical equity requires that two taxpayers with the same income face the same tax obligations. The Texas sales tax is widely regarded as falling too heavily on the poor. But equally ill-structured property and franchise taxes are the chief Texas alternatives for broad-based tax collection and bring their own equity issues.

Is the City of Houston disproportionately burdened by the urban poor? There is little question on this score. The U.S. Census Bureau measure of median household income from 2015 to 2019 is $52,338 for Houston, while Montgomery County and Fort Bend County (the region’s largest suburban counties) show $80,903 and $97,743, respectively. The poverty rate in the city is 20.1 percent versus 8.9 (Montgomery County) and 6.6 percent (Fort Bend County). But is the SPA the best way to deal with this problem? It raises revenue but fails to target the poverty problem meaningfully and specifically.

Rural Land

Landowners in certain parts of the state need to be aware of chronic wasting disease, which can greatly reduce the number of deer. While there are no known cures or ways to eradicate the disease, the Texas Parks and Wildlife Department is taking measures to reduce its spread. By Charles E. Gilliland

multitude of risks threaten to undermine Texas landowners’ efforts to manage their land. Some of those spring from past activities but can leave invisible living legacies behind. Anthrax, for example. An outbreak of anthrax in livestock leaves a scattering of spores across the countryside that can activate and infect replacement herds. Chronic wasting disease (CWD) in wildlife poses a similar potential problem for landowners in certain parts of Texas. CWD infects members of the Cervidae family, namely deer, elk, moose, etc. CWD does not pose dangers to livestock, and scientists have not found evidence of the disease infecting humans. However, it is always fatal to stricken wildlife, threatening a destructive wave of infections among deer herds where the disease has spread. Therefore, CWD poses a direct threat to one of the primary motives for owning rural land: wildlife herd management.

Profiling CWD CWD belongs to a family of disorders known as prion diseases, or transmissible spongiform encephalopathies (TSEs). It includes Creutzfeldt-Jakob disease in humans and bovine spongiform encephalopathy, or mad cow disease, in cattle. The Centers for Disease Control and Prevention describes these maladies in detail:

The causative agents of TSEs are believed to be prions. The term “prions” refers to abnormal, pathogenic agents that are transmissible and are able to induce abnormal folding of specific normal cellular proteins called prion proteins that are found most abundantly in the brain. The functions of these normal prion proteins are still not completely understood. The abnormal folding of the prion proteins leads to brain damage and the characteristic signs and symptoms of the disease. Prion diseases are usually rapidly progressive and always fatal. CWD symptoms include dramatic weight loss, stumbling, listlessness, decreased social interaction, loss of fear of humans, and excessive salivating. However, animals typically exhibit no symptoms until 18-24 months after contracting the disease. In addition, these symptoms could be caused by other conditions, so formal testing is needed to reliably diagnose CWD. Obviously, an infected animal may spread the disease to other members of the herd during the nonsymptomatic phase of infection. Perhaps even worse, the body casts off prions, so an infected animal will cast off diseased prions. Therefore, an infected herd can

leave infection in the soil and remain infectious to host animals, much like anthrax.

CWD Comes to Texas Scientists first identified CWD in mule deer in Colorado in 1967. Since that time, CWD has spread to Wyoming, Montana, Wisconsin, Pennsylvania, and other states. CWD first appeared in Hudspeth County in 2012 in free-ranging mule deer. In 2015, the Texas Parks and Wildlife Department (TPWD) found CWD in white-tailed deer in captive facilities in Medina County. By 2021, a total of 224 cases had been identified in 13 counties. Tests confirmed cases in two red deer, four elk, 49 mule deer, and 169 white-tailed deer. See the TPWD website for details (use QR code to access). Texas A&M AgriLife Extension provides TG

a good overview of the disease in A Guide to Chronic Wasting Disease (CWD) in Texas Cervids (use QR code to access).

Containing the Spread

urrently, there is no known cure for the disease nor any mechanism to eradicate it. Therefore, TPWD management of CWD seeks to contain the spread to areas of confirmed infections. The plan has established five CWD zones with confirmed infections: Kimble County Zone, Trans-Pecos Zone, South Central Zone, Panhandle Zone, and Val Verde County Zone. The latest edition of the TPWD Outdoor Annual (use QR code to access) provides maps of each zone indicating official stations performing testing for CWD. All FALL 2021

hunters harvesting animals in these zones must take them to one of these stations to have them tested for CWD within 48 hours of the harvest. In addition, hunters can transport carcasses out of the zones only after all brain and spinal cord tissue have been removed. TPWD will provide a receipt for the sample. Because the spread of CWD is evolving, regulations can change quickly. Therefore, anyone involved in hunting activity should consult the most recent Outdoor Annual for the latest regulations. To reduce the chances of spreading the disease, TPWD regulations also restrict the movement of live deer from CWD zones.

Impact on Rural Landowners CWD poses a significant threat to the future of hunting in Texas. Deer population declines of 45 and 50 percent have been documented in Colorado and

Wyoming. A broad infection of Texas deer populations resulting in similar population impacts would inflict severe economic damage to rural communities and could negatively impact land markets. Specifically, those landowners seeking to establish a thriving herd of deer could avoid buying in areas with confirmed CWD infections. As they do with anthrax-susceptible properties, land brokers may find it advisable to inquire about the status of CWD infections on properties that they present for sale. Prospective buyers should also investigate the status of the wildlife on prospective properties. In addition, existing landowners should monitor developments as TPWD crafts management strategies to identify and contain this deadly disease. Dr. Gilliland (c-gilliland@tamu.edu) is a research economist with the Texas Real Estate Research Center at Texas A&M University.

Residential

Payback Predicament COVID, Mortgage Forbearance, and Repayment Affordability

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conomic downturns indicate significant turmoil in the labor market, often resulting in rises in unemployment and accompanying losses in household income. This threatens consumers’ ability to afford even necessary expenditures, including monthly mortgage payments. The COVID-19 recession was no exception. In the initial wake of the pandemic, the national mortgage delinquency rate surged to nearly 10 percent but has since declined considerably, largely due to the federal government’s broad-reaching mortgage forbearance program. An estimated 70 percent of existing homeowners qualify for temporary relief in their mortgage payments. Although mortgage forbearance largely prevents massive mortgage default and foreclosure, a loss in income can significantly affect a borrower’s ability to repay his mortgage.

Homeowners who qualified for temporary relief from mortgage payments in the wake of the COVID-19 recession will eventually have to repay any missed or reduced payments. Their ability to do so is largely a function of their age and length of time working. By Clare Losey

Maintaining Homeownership During COVID-19 Housing affordability generally falls into two categories: purchase or repayment affordability. Federal housing policy predominately aims to facilitate purchase affordability—a household’s ability to buy a home. Such policy is largely predicated on the perceived financial and social benefits of homeownership (i.e., wealth accumulation and neighborhood stability). Repayment affordability, on the other hand, denotes an existing homeowner’s ability to maintain monthly mortgage payments. As unemployment spikes during economic downturns, spurring potentially substantial declines in household income, federal housing policy largely shifts to facilitating repayment affordability. TG

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COVID-19, which completely upended the nation’s labor market, resulted in massive losses in jobs and income/wages, leaving millions of American homeowners unable to afford their monthly mortgage payments. Anticipating massive mortgage defaults and foreclosures, the federal government extended, through the Coronavirus Aid, Relief, and Economic Security (CARES) Act, a mortgage payment forbearance option to all borrowers who either experienced a financial hardship due to COVID-19 or have a federally-backed mortgage (i.e., HUD/FHA, VA, USDA, Fannie Mae, or Freddie Mac loans). For borrowers with HUD/FHA, VA, or USDA loans, the deadline to apply for mortgage forbearance was Sept. 30, 2021. There is currently no application deadline for borrowers with loans backed by Fannie Mae or Freddie Mac. ortgage forbearance allows the borrower to pause or decrease their monthly mortgage payments for a set amount of time. In the instance of the CARES Act, homeowners enter forbearance for an initial period of 180 days, but they may extend it by another 180 days or up to 18 months in total. However, borrowers will still be obligated to repay the missed or reduced payments. More information on the mortgage forbearance provided under the CARES Act is on the Consumer Financial Protection Bureau’s website (use QR code to access). L

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What Affects Repayment Affordability? Mortgage financing plays a crucial role in a household’s ability to both attain and maintain homeownership. In 2020, 87 percent of U.S. households used mortgage financing to purchase a home. Because of the general structure of a mortgage loan— 30-year, fully-amortizing, fixed-rate—the average borrower can expect to make constant monthly payments over three decades. Income, wealth, and credit—as measured through the debtto-income (DTI) ratio, loan-to-value (LTV) ratio, and credit score—primarily determine purchase affordability. Repayment affordability is largely a function of income and/or wealth, but it depends heavily on the borrower’s age and tenure in the labor force. Income is a more important indicator of repayment affordability among younger borrowers, who tend to have less wealth, while wealth is more important among older borrowers, who tend to have more wealth but are perhaps no longer working. he DTI ratio represents the proportion of household income devoted to total household debt payments, including credit card, student loan, auto, and mortgage debt. For example, a DTI ratio of 25 percent indicates that one-quarter of a household’s income goes toward total household debt payments. Younger borrowers, who generally have less income, wealth, and credit than older borrowers, tend to receive loans with higher DTI and LTV ratios. On average, DTI ratios measure lower for conventional loans and higher for FHA and VA loans. In 2020, the average DTI ratio for FHA loans—originated primarily to first-time and low-income homebuyers—was 43 percent. The correlation between the maximum home price affordable to a particular household and the corresponding DTI ratio differs between purchase and repayment affordability. All other conditions remaining the same, the DTI ratio is generally positively correlated with purchase affordability but negatively correlated with repayment affordability. Higher DTI ratios allow for higher monthly mortgage payments, translating into a higher maximum affordable home price and thereby easing purchase affordability. However, the DTI ratio generally bears a negative association to the borrower’s ability to repay his mortgage. A higher DTI ratio dictates a greater proportion of the borrower’s income be devoted to the monthly mortgage payment. As such, a decline in household income is more likely to diminish the ability of a household with a higher DTI ratio to continue to make monthly mortgage payments. For more information on the relationship between the DTI ratio

UTILITY BILL

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Table 1. Total Monthly Mortgage Payment by Income, Debt-to-Income Ratio

and home price affordable to a borrower, see “Downsized: Pandemic Diminishes Homebuying Ability” (use QR code to access).

Effects of Household Income Loss on Repayment Affordability

Debt-to-Income Ratio

Household Income

20%

25%

30%

35%

40%

45%

50%

55%

60%

$25,000 $30,000 $35,000 $40,000 $45,000 $50,000 $55,000 $60,000 $65,000 $70,000 $75,000 $80,000 $85,000 $90,000 $95,000 $100,000

$417 $500 $583 $667 $750 $833 $917 $1,000 $1,083 $1,167 $1,250 $1,333 $1,417 $1,500 $1,583 $1,667

$521 $625 $729 $833 $938 $1,042 $1,146 $1,250 $1,354 $1,458 $1,563 $1,667 $1,771 $1,875 $1,979 $2,083

$625 $750 $875 $1,000 $1,125 $1,250 $1,375 $1,500 $1,625 $1,750 $1,875 $2,000 $2,125 $2,250 $2,375 $2,500

$729 $875 $1,021 $1,167 $1,313 $1,458 $1,604 $1,750 $1,896 $2,042 $2,188 $2,333 $2,479 $2,625 $2,771 $2,917

$833 $1,000 $1,167 $1,333 $1,500 $1,667 $1,833 $2,000 $2,167 $2,333 $2,500 $2,667 $2,833 $3,000 $3,167 $3,333

$938 $1,125 $1,313 $1,500 $1,688 $1,875 $2,063 $2,250 $2,438 $2,625 $2,813 $3,000 $3,188 $3,375 $3,563 $3,750

$1,042 $1,250 $1,458 $1,667 $1,875 $2,083 $2,292 $2,500 $2,708 $2,917 $3,125 $3,333 $3,542 $3,750 $3,958 $4,167

$1,146 $1,375 $1,604 $1,833 $2,063 $2,292 $2,521 $2,750 $2,979 $3,208 $3,438 $3,667 $3,896 $4,125 $4,354 $4,583

$1,250 $1,500 $1,750 $2,000 $2,250 $2,500 $2,750 $3,000 $3,250 $3,500 $3,750 $4,000 $4,250 $4,500 $4,750 $5,000

otal monthly mortgage Source: Texas Real Estate Research Center at Texas A&M University payment is shown as a function of the borrower’s income and the DTI ratio Table 2. Monthly Residual Income After Deducting Total Monthly Mortgage Payment in Table 1. Payment increases Debt-to-Income Ratio Household as the DTI ratio increases. For Income example, a borrower earning 20% 25% 30% 35% 40% 45% 50% 55% 60% $50,000 annually can afford a $25,000 $1,667 $1,563 $1,458 $1,354 $1,250 $1,146 $1,042 $938 $833 total monthly mortgage pay$30,000 $2,000 $1,875 $1,750 $1,625 $1,500 $1,375 $1,250 $1,125 $1,000 ment of $833 with a DTI ratio $35,000 $2,333 $2,188 $2,042 $1,896 $1,750 $1,604 $1,458 $1,313 $1,167 of 20 percent, but $2,083 with a $40,000 $2,667 $2,500 $2,333 $2,167 $2,000 $1,833 $1,667 $1,500 $1,333 DTI ratio of 50 percent. $45,000 $3,000 $2,813 $2,625 $2,438 $2,250 $2,063 $1,875 $1,688 $1,500 While a higher DTI ratio $50,000 $3,333 $3,125 $2,917 $2,708 $2,500 $2,292 $2,083 $1,875 $1,667 eases purchase affordability, $55,000 $3,667 $3,438 $3,208 $2,979 $2,750 $2,521 $2,292 $2,063 $1,833 providing the borrower access to $60,000 $4,000 $3,750 $3,500 $3,250 $3,000 $2,750 $2,500 $2,250 $2,000 a higher-priced home, it erodes $65,000 $4,333 $4,063 $3,792 $3,521 $3,250 $2,979 $2,708 $2,438 $2,167 the monthly residual income $70,000 $4,667 $4,375 $4,083 $3,792 $3,500 $3,208 $2,917 $2,625 $2,333 (Table 2). $75,000 $5,000 $4,688 $4,375 $4,063 $3,750 $3,438 $3,125 $2,813 $2,500 For a borrower earning $80,000 $5,333 $5,000 $4,667 $4,333 $4,000 $3,667 $3,333 $3,000 $2,667 $50,000 annually, the monthly $85,000 $5,667 $5,313 $4,958 $4,604 $4,250 $3,896 $3,542 $3,188 $2,833 residual income amounts to $90,000 $6,000 $5,625 $5,250 $4,875 $4,500 $4,125 $3,750 $3,375 $3,000 $3,333 at a DTI ratio of 20 per$95,000 $6,333 $5,938 $5,542 $5,146 $4,750 $4,354 $3,958 $3,563 $3,167 cent and $2,083 at a DTI ratio $100,000 $6,667 $6,250 $5,833 $5,417 $5,000 $4,583 $4,167 $3,750 $3,333 of 50 percent. In other words, Note: Calculations are on a before-tax basis. On an after-tax basis, the effective DTI is greater and residual income is lower. the amount remaining to cover Source: Texas Real Estate Research Center at Texas A&M University additional necessary expenses— food, clothing, transportation, health care, etc.—decreases as According to the Congressional Research Service, a higher the DTI ratio increases. Borrowers with higher incomes generproportion of lower-income households saw employment ally have higher residual incomes. income drop during the pandemic. Nearly two-thirds (65 A borrower’s monthly income based on percent declines in percent) of households that have children under 18 and that annual household income is shown in Table 3. For example, if earn less than $25,000 reported losses in employment income, a borrower’s $25,000 annual household income declined by 50 compared with less than one-third (30 percent) of those earning percent, his monthly income would drop from $2,083 to $1,042. $200,000 or more.

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Table 3. Borrower’s Monthly Income Based on Decline in Annual Household Income Adjusted Monthly Income Based on Percent Decline in Annual Household Income

Household Income

-10%

-20%

-30%

-40%

-50%

-60%

-70%

-80%

-90%

$25,000 $30,000 $35,000 $40,000 $45,000 $50,000 $55,000 $60,000 $65,000 $70,000 $75,000 $80,000 $85,000 $90,000 $95,000 $100,000

$2,083 $2,500 $2,917 $3,333 $3,750 $4,167 $4,583 $5,000 $5,417 $5,833 $6,250 $6,667 $7,083 $7,500 $7,917 $8,333

$1,875 $2,250 $2,625 $3,000 $3,375 $3,750 $4,125 $4,500 $4,875 $5,250 $5,625 $6,000 $6,375 $6,750 $7,125 $7,500

$1,667 $2,000 $2,333 $2,667 $3,000 $3,333 $3,667 $4,000 $4,333 $4,667 $5,000 $5,333 $5,667 $6,000 $6,333 $6,667

$1,458 $1,750 $2,042 $2,333 $2,625 $2,917 $3,208 $3,500 $3,792 $4,083 $4,375 $4,667 $4,958 $5,250 $5,542 $5,833

$1,250 $1,500 $1,750 $2,000 $2,250 $2,500 $2,750 $3,000 $3,250 $3,500 $3,750 $4,000 $4,250 $4,500 $4,750 $5,000

$1,042 $1,250 $1,458 $1,667 $1,875 $2,083 $2,292 $2,500 $2,708 $2,917 $3,125 $3,333 $3,542 $3,750 $3,958 $4,167

$833 $1,000 $1,167 $1,333 $1,500 $1,667 $1,833 $2,000 $2,167 $2,333 $2,500 $2,667 $2,833 $3,000 $3,167 $3,333

$625 $750 $875 $1,000 $1,125 $1,250 $1,375 $1,500 $1,625 $1,750 $1,875 $2,000 $2,125 $2,250 $2,375 $2,500

$417 $500 $583 $667 $750 $833 $917 $1,000 $1,083 $1,167 $1,250 $1,333 $1,417 $1,500 $1,583 $1,667

$208 $250 $292 $333 $375 $417 $458 $500 $542 $583 $625 $667 $708 $750 $792 $833

2019 was $5,300. However, this value varied considerably by the householder’s age. Younger householders had less savings than older householders. The median value of savings accounts of householders younger than 35 was Source: Texas Real Estate Research Center at Texas A&M University $3,200. Of householders at least 75 years of age, it was $9,300. Table 4. Number of Months Borrower Could Maintain Mortgage Payments The number of months a with $1,000 in Savings borrower could maintain the Debt-to-Income Ratio Household monthly mortgage payment Income depends on his savings bal20% 25% 30% 35% 40% 45% 50% 55% 60% ance, income, and DTI ratio. $25,000 2.4 1.9 1.6 1.4 1.2 1.1 1.0 0.9 0.8 Tables 4, 5, and 6 compute the $30,000 2.0 1.6 1.3 1.1 1.0 0.9 0.8 0.7 0.7 number of months based on $35,000 1.7 1.4 1.1 1.0 0.9 0.8 0.7 0.6 0.6 savings of $1,000, $5,000, and $40,000 1.5 1.2 1.0 0.9 0.8 0.7 0.6 0.5 0.5 $10,000, respectively. These $45,000 1.3 1.1 0.9 0.8 0.7 0.6 0.5 0.5 0.4 tables assume the borrower $50,000 1.2 1.0 0.8 0.7 0.6 0.5 0.5 0.4 0.4 loses all income and does $55,000 1.1 0.9 0.7 0.6 0.5 0.5 0.4 0.4 0.4 not dip into other sources $60,000 1.0 0.8 0.7 0.6 0.5 0.4 0.4 0.4 0.3 of wealth, such as gifts from $65,000 0.9 0.7 0.6 0.5 0.5 0.4 0.4 0.3 0.3 family or friends or his retire$70,000 0.9 0.7 0.6 0.5 0.4 0.4 0.3 0.3 0.3 ment account. However, the $75,000 0.8 0.6 0.5 0.5 0.4 0.4 0.3 0.3 0.3 structure of the computation is $80,000 0.8 0.6 0.5 0.4 0.4 0.3 0.3 0.3 0.3 such that any individual value $85,000 0.7 0.6 0.5 0.4 0.4 0.3 0.3 0.3 0.2 (i.e., $1,000, $5,000, or $10,000) $90,000 0.7 0.5 0.4 0.4 0.3 0.3 0.3 0.2 0.2 could denote either that $95,000 0.6 0.5 0.4 0.4 0.3 0.3 0.3 0.2 0.2 entire amount in savings or, $100,000 0.6 0.5 0.4 0.3 0.3 0.3 0.2 0.2 0.2 for instance, $500 in residual Note: Red indicates borrower could not afford even one month's mortgage payment. income and $500 in savings Source: Texas Real Estate Research Center at Texas A&M University for a total of $1,000. Additionally, although the computation assumes the borrower loses all Households facing unemployment and/or a reduction in income, the results reflect repayment affordability for borrowwages or income are more likely to tap into savings to cover ers of varying income as the monthly mortgage payment itself necessary expenditures. While households typically invest in a is a function of the borrower’s income. variety of assets, including retirement accounts, stocks, bonds, Obviously, borrowers with less in savings cannot maintain and real estate, a savings account is the most liquid source monthly mortgage payments for as long as borrowers with of wealth. According to the Survey of Consumer Finances, more in savings. The majority of borrowers with $1,000 in the median value of savings accounts of U.S. households in FALL 2021

Table 5. Number of Months Borrower Could Maintain Mortgage Payments with $5,000 in Savings

savings could not afford to make even a single monthly mortgage payment (as depicted in red in Table 4). Borrowers with lower DTI ratios fare better than borrowers with higher DTI ratios, regardless of the savings balance. For instance, a borrower with $5,000 in savings who makes $25,000 could afford to finance his mortgage for 12 months with a DTI ratio of 20 percent, but for only four months with a DTI ratio of 50 percent (Table 5). The precipitous spike in unemployment or a reduction in hours or income/wages in the wake of the COVID-19 pandemic left millions of homeowners unable to maintain monthly mortgage payments. According to the U.S. Census Bureau, 14.1 percent of Texas homeowners were behind on their mortgage payments in the initial wake of the pandemic. By September 2021, that number had dropped to 12.5 percent. The mortgage forbearance program enacted by the CARES Act (which includes over $840 million in relief funds to Texas homeowners through the Texas Department of Housing and Community Affairs) considerably diminishes the potential for widespread mortgage default and foreclosure. However, understanding the effects of declines in income on repayment affordability remains a salient topic for consumers, professionals, and policymakers. Dr. Losey (clare_losey@tamu.edu) is an assistant research economist with the Texas Real Estate Research Center at Texas A&M University.

Debt-to-Income Ratio

Household Income

20%

25%

30%

35%

40%

45%

50%

55%

60%

$25,000 $30,000 $35,000 $40,000 $45,000 $50,000 $55,000 $60,000 $65,000 $70,000 $75,000 $80,000 $85,000 $90,000 $95,000 $100,000

12.0 10.0 8.6 7.5 6.7 6.0 5.5 5.0 4.6 4.3 4.0 3.8 3.5 3.3 3.2 3.0

9.6 8.0 6.9 6.0 5.3 4.8 4.4 4.0 3.7 3.4 3.2 3.0 2.8 2.7 2.5 2.4

8.0 6.7 5.7 5.0 4.4 4.0 3.6 3.3 3.1 2.9 2.7 2.5 2.4 2.2 2.1 2.0

6.9 5.7 4.9 4.3 3.8 3.4 3.1 2.9 2.6 2.4 2.3 2.1 2.0 1.9 1.8 1.7

6.0 5.0 4.3 3.8 3.3 3.0 2.7 2.5 2.3 2.1 2.0 1.9 1.8 1.7 1.6 1.5

5.3 4.4 3.8 3.3 3.0 2.7 2.4 2.2 2.1 1.9 1.8 1.7 1.6 1.5 1.4 1.3

4.8 4.0 3.4 3.0 2.7 2.4 2.2 2.0 1.8 1.7 1.6 1.5 1.4 1.3 1.3 1.2

4.4 3.6 3.1 2.7 2.4 2.2 2.0 1.8 1.7 1.6 1.5 1.4 1.3 1.2 1.1 1.1

4.0 3.3 2.9 2.5 2.2 2.0 1.8 1.7 1.5 1.4 1.3 1.3 1.2 1.1 1.1 1.0

Source: Texas Real Estate Research Center at Texas A&M University

Table 6. Number of Months Borrower Could Maintain Mortgage Payments with $10,000 in Savings Debt-to-Income Ratio

Household Income

20%

25%

30%

35%

40%

45%

50%

55%

60%

$25,000 $30,000 $35,000 $40,000 $45,000 $50,000 $55,000 $60,000 $65,000 $70,000 $75,000 $80,000 $85,000 $90,000 $95,000 $100,000

24.0 20.0 17.1 15.0 13.3 12.0 10.9 10.0 9.2 8.6 8.0 7.5 7.1 6.7 6.3 6.0

19.2 16.0 13.7 12.0 10.7 9.6 8.7 8.0 7.4 6.9 6.4 6.0 5.6 5.3 5.1 4.8

16.0 13.3 11.4 10.0 8.9 8.0 7.3 6.7 6.2 5.7 5.3 5.0 4.7 4.4 4.2 4.0

13.7 11.4 9.8 8.6 7.6 6.9 6.2 5.7 5.3 4.9 4.6 4.3 4.0 3.8 3.6 3.4

12.0 10.0 8.6 7.5 6.7 6.0 5.5 5.0 4.6 4.3 4.0 3.8 3.5 3.3 3.2 3.0

10.7 8.9 7.6 6.7 5.9 5.3 4.8 4.4 4.1 3.8 3.6 3.3 3.1 3.0 2.8 2.7

9.6 8.0 6.9 6.0 5.3 4.8 4.4 4.0 3.7 3.4 3.2 3.0 2.8 2.7 2.5 2.4

8.7 7.3 6.2 5.5 4.8 4.4 4.0 3.6 3.4 3.1 2.9 2.7 2.6 2.4 2.3 2.2

8.0 6.7 5.7 5.0 4.4 4.0 3.6 3.3 3.1 2.9 2.7 2.5 2.4 2.2 2.1 2.0

Source: Texas Real Estate Research Center at Texas A&M University TG

Taxes

LESSER KNOWN REAL ESTATE LEASING TAX TIPS

When planning real estate leasing activities, decide whether the activity is an investment or business, plan for all taxes, carefully choose the form of the entity, maintain a corporate record book, and plan for whether the activity is passive or nonpassive. BY WILLIAM D. ELLIOTT

rticles on tax tips for real estate leasing often lull readers into expecting a laundry list of topics such as keeping good records to substantiate travel and entertainment expenses. As any Internet search would reveal, this is the norm in tax literature. The tips presented here touch on subjects not usually covered in a typical tax article. Consider them when planning real estate leasing activities.

TIP 1: DECIDE WHETHER ACTIVITY IS AN INVESTMENT OR BUSINESS

A discussion of tax issues involving real estate in general and real estate leasing in particular must focus on the great divide in taxation: capital gain versus ordinary income. This bifurcation between capital and ordinary income lurks behind just about every tax topic and business decision. President Biden’s tax plan hit this issue hard by effectively proposing to eliminate FALL 2021

the capital gains tax, at least for many. The proposal has not yet become law, so ordinary income is still taxed at a much higher rate than capital gain income. For the real estate investor or professional—indeed, for just about any taxpayer who is serious about investing or operating a business—the ordinary income versus capital gain divide looms large in planning. or those in real estate, the ordinary income versus capital gain division often turns on the question of whether one is an investor or in the real estate business. The investor achieves capital gain income while the one in business pays ordinary income tax on earnings and gains. Conversely, one who experiences losses can either deduct the loss against all other income (ordinary loss) or offset the loss against capital gains (capital loss), subject to the passive loss limitations, which will be discussed later. The differences in tax rates between capital gain and ordinary income are material. Seven tax rates are in effect for both 2020 and 2021: 10 percent, 12 percent, 22 percent, 24 percent, 32 percent, 35 percent, and 37 percent. The 2021 tax brackets were adjusted to account for inflation, which means that in 2021 a taxpayer could end up in a different tax bracket than they were in in 2020. Another factor for determining tax brackets is filing status. For example, a 22 percent tax bracket for 2021 begins at $40,526 and ends at $86,375 for single taxpayers, but begins at $54,201 and ends at $86,350 for headof-household filers. President Biden has proposed increasing the 37 percent tax rate to 39.6 percent, which would apply to single filers with taxable income over $452,700 and joint filers with taxable income exceeding $509,300. For the year 2020, the tax rate for capital gain is generally 15 percent for those with incomes up to $441,450 (single filers) and 20 percent for those with higher incomes. For 2021, the 15 percent tax rate applies to incomes up to $445,850 (single filers) and 20 percent for higher incomes. Also, capital gains are computed by deducting the tax basis of the asset from the amount realized on sale. Ordinary income is paid on all income. Another factor in the ordinary income/capital gain divide is whether one makes or loses money. The higher tax rate for ordinary income means losses are more valuable if they are ordinary losses. An ordinary loss reduces ordinary income taxed at the higher tax rates, as opposed to capital losses, which reduce capital gain income.

This capital gain/ordinary income (or investor versus being in the real estate business) division is ever-present. The following tax issues are affected by whether the taxpayer is an investor or in the real estate business: • Section 199A, 20 percent deduction allowed against income from a pass-through business. • Limits imposed on deductions for business interest, but not applicable to small business. • Deduction for investment interest limited to net investment income. Investment interest does not include passive activity and, therefore, does not include real estate rental activity. • The character of gain or loss from a sale of the property. The capital gain for sale of real estate property held for more than one year applies only to the property used in a trade or business. • The net investment income tax. The premium, add-on tax for investment income does not apply for real estate rental activity that is nonpassive and rises to the level of a trade or business. • The excess business loss limitation. Taxpayers not operating in corporate form can use up to $250,000 of net losses ($500,000 if married, filing jointly) to offset nonbusiness income. If real estate rental activity is not a trade or business, net losses from rental activity are not limited by this rule. • Treatment of joint interests as a separate entity. Joint interests can be treated as a separate entity for tax purposes if the people carry on a trade or business and divide the profits from the activity. • The excess passive investment income tax. S Corporations pay an entity-level tax if more than 25 percent of the corporation’s gross receipts are from passive investment income. • Net operating losses. Nonbusiness deductions are taken into account when computing net operating losses. • Form 1099 filing requirements. Businesses are required to issue Forms 1099 to each noncorporate service provider.

TIP 2: PLAN FOR ALL TAXES, INCLUDING THE ESTATE TAX

When planning for real estate leasing, plan for all taxes, not just income taxes. Remember, especially, estate taxes. The large lifetime estate and gift tax exemptions have relaxed everyone, but the potential for an estate tax is a real economic risk. First, Congress might enact President Biden’s tax proposals, which in brief reduce the estate tax exemption to $3.5 million ($7 million for couples) from the current $11.7 million. Second, even if Congress does not enact those tax proposals, the exemption is already scheduled to drop to $5 million (adjusted for inflation) at the end of 2025. TG

TIP 4: MAINTAIN A CORPORATE RECORD BOOK, AND MAINTAIN IT WELL

The time for considering the risk of an estate tax is now. Some key strategies in estate planning are: • transfer assets to your family before those assets’ intrinsic value is realized; • organize assets you are considering transferring to take advantage of valuation discounts, such as in a family partnership; • make low-interest loans to your family to enable them to purchase new assets instead of you purchasing them; • avoid outright transfers, but use a generation-skipping trust; and • before gifting to your family, be certain you have retained sufficient assets to support you and your spouse.

TIP 3: CAREFULLY CHOOSE THE FORM OF ENTITY

One of the most important first decisions for your real estate business or investments is choosing the form of entity. The prime consideration when selecting an entity—apart from taxes—is how to best manage liability risk. The goals are to keep the risk of potential liability that is inherent in real estate leasing from threatening your other assets and to keep other liability risk from impairing your real estate leasing assets or activities. One approach is to select a form of business entity that limits liability, then compartmentalize liability risk so the liability risk exposes only the assets involved in the activity. Consider these points when selecting an entity. • A pass-through entity is usually favored, which narrows the choice to a limited liability company (LLC) or Subchapter S corporation. A pass-through entity avoids double taxation of the regular corporation. • Practically speaking, accountants tend to favor Subchapter S corporations while tax lawyers generally prefer LLCs. The S Corporation offers some relief from the self-employment tax, but S Corporations are tricky to start and maintain, and their rigid operational rules are easily violated. Mistakes with an S Corporation can result in loss of the S election, which can be painful. Further, S Corporations offer little flexibility in estate planning. LLCs, on the other hand, offer flexibility in estate planning but require more subtlety on self-employment taxes. FALL 2021

Keeping a corporate record book will perhaps strike many as an outdated idea. Those black binders sit on the shelf, but who ever opens them? However, the corporate record book belongs on the list of most important goals of operating any business or investment activity, especially real estate leasing. It’s on par with keeping a good set of accounting books. The advantages of a well-maintained corporate record book are subtle but real: • When selling the real estate leasing business or investment, purchasers (or their lawyers) will ask to see the corporate record book. A well-maintained one will ease the sales transaction. Further, it can enhance a purchase price on sale of assets. When presenting a purchaser of a business with a seller’s well-maintained corporate record book, purchasers (or their lawyers) become more willing to bend on other issues. • A well-thought-out corporate record book documents clear and logical business decisions as well as the reasoning supporting those decisions. Basically, it’s a business diary. • Maintaining a corporate record book will bring business discipline to one’s real estate leasing activity. It organizes thoughts. • The IRS will often ask whether a transaction or activity has a business purpose. Good accounting books help support the tax consequences of one’s decisions. The same goes for the corporate record book. A well maintained corporate record book is a business advantage. It is the secret sauce.

TIP 5: PLAN FOR WHETHER THE ACTIVITY IS PASSIVE OR NONPASSIVE

Passive loss rules are pervasive. In brief, passive activity rules force taxpayers to lump their activities into boxes. Inside the passive activity box, losses derived from passive activities (passive losses) can be offset only on gains from passive activities (passive gains). Inside the nonpassive box, losses from nonpassive activities can be offset against any income. The IRS has decided that real estate rental activity is generally passive, but with important exceptions. Most try to fall within the exceptions. For more on passive activity, read TG article “Rental Tax Issues Worth Watching” (use QR code to access). Elliott (bill@etglawfirm.com) is a Dallas tax attorney, Board Certified, Tax Law; Board Certified, Estate Planning & Probate; Texas Board of Legal Specialization; and Fellow American College of Tax Counsel.

Q. Can a license holder use TREC Form 49-1 Addendum Concerning Right to Terminate Due to Lender’s Appraisal for a A.

Federal Housing Administration (FHA) or Veterans Administration (VA) loan buyer?

No. TREC Form 49-1 specifically notes under the title that it cannot be used for “FHA-insured or VA-guaranteed financing,” because federal law dictates how and when an FHA or VA buyer can terminate due to a low appraisal. A license holder should never use the Appraisal Addendum for a VA or FHA or for any reason write an appraisal contingency into Paragraph 11 of the contract. This would be considered the unauthorized practice of law.

Q. Can a party to the contract use TREC Form 49-1 Addendum Concerning Right to Terminate Due to Lender’s A.

Appraisal or use language supplied by the lender for an FHA or VA loan buyer?

No. Since TREC Form 49-1 specifically notes under the title that it cannot be used for “FHA-insured or VA-guaranteed financing,” any party who signs the form is affirming that those types of loans are not involved. Further, even if the parties wrote some language in Paragraph 11 waiving the appraisal contingency, it would not be effective.

What the Law Says Pursuant to federal regulations and underwriting guidelines put in place for FHA and VA loans in 1978, a form containing a prescribed clause (known as the Amendatory Clause) must be given to an FHA or VA purchaser or included in the sales contract when the purchaser has not been informed of the appraised value before signing the sales contract. In Texas, the Amendatory Clause language is contained in the body of Paragraph 4 of the Third Party Financing Addendum and provides, “It is expressly agreed that, notwithstanding any other provision of this contract,

the purchaser (Buyer) shall not be obligated . . . ” to complete the purchase or forfeit earnest money if the appraised value is below the amount assessed by FHA or VA for the value of the home (emphasis added). The “notwithstanding” language makes clear that the purchaser cannot waive the appraisal contingency even if other provisions of the contract attempt to waive it. However, an FHA or VA buyer can elect to pay more than the appraised value after the appraised value is known in accordance with federal guidelines as set out in subsections A-C of Paragraph 4.

For Example Maria Delgado, a decorated veteran helicopter pilot, wants to purchase a home using her VA eligibility. She found an online lender who has told her she can get her approved for VA financing in just a few days. The market is driving prices up at a rapid pace. Maria wants to guarantee she can get a particular home her agent showed her. The agent knows Maria will have to offer more than what the seller is asking to get this property under contract, and the house may appraise for less than that

sales price. The online lender recommends language to Maria for the contract that waives any right Maria has to back out of the contract if the property does not appraise. The agent for Maria points out the language in Paragraph 4 of the Third Party Financing Addendum, which conflicts with the recommendation of the online lender, and recommends Maria consult an attorney regarding the validity of the lender’s recommended language.

Best Practice

Keep in mind an agent is a fiduciary. Be aware of the protections federal law has given to FHA and VA buyers regarding low appraisals. Help your buyers and sellers understand these protections exist for good reasons. Do not use TREC Form 49-1 for an FHA or VA buyer. If language is added waiving the appraisal contingency, the listing agent should point out to the seller that it conflicts with Paragraph 4 of the Third

Party Financing Addendum, and the seller should consult an attorney regarding the enforceability of the waiver language. Remind clients an FHA or VA buyer can still elect to put in more money if needed after the appraisal is received, or the sales price can be renegotiated after the appraisal is received, if the parties want to proceed to closing.

Bonus Question Q. What amount is put in the blank in Paragraph 4 of the Third Party Financing Addendum regarding the appraised value for an FHA or VA loan?

A. Generally, the sales price goes in this blank. Keep in mind that many FHA or VA loans require no money down, so the purchaser wants the property to appraise for the full sales price.

Nothing in this publication should be construed as legal advice for a particular situation. For specific advice, consult an attorney. Lewis (kerri@2oldchicks.com) is a member of the State Bar of Texas and former general counsel for the Texas Real Estate Commission (TREC). Wukasch (avis@2oldchicks.com) is a broker and former TREC chair.

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TG - Fall 2021

Articles inside

Lesser Known Real Estate Leasing Tax Tips

Hot Markets, Cool Practices

Payback Predicament

Practically Speaking

Little Law, Big Deal

Annex Marks the Spot

Oh, Deer