Thursday, April 23, 2009

Where will they live? What will it cost to live there?

Based on current census bureau statistics, there is a large immigration going on. People are moving to Texas! Dallas, Houston, San Antonio and Austin are continuing to add population at high levels. How does this impact changes in rents and real estate pricing in the current economic strife?

Everyone has been feeling the impact of the bubble which burst, a bubble created by cheap credit and real estate speculation. Everyone seems to have forgotten the traditional measures which control economic drivers, the actual supply and demand of real houses and people to live in them. The question I kept asking myself was why did the price of real estate go up 20% per year in Phoenix when there was no shortage in the supply of houses? These valuation increases, the types of which are normally created by scarcity, made no sense as they were filling homes as fast as they could build them.

The supply and demand issue which created the housing bubble was the supply of easy credit and the demand to leverage this credit into accumulation of the physical asset of real estate. This equation ignored the actual use of the improved land to support the needs of the population for housing and the additional supporting commercial uses of office space for jobs and the retail space to support shopping.

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To look beyond the current crisis and see the other side; let’s get back to basics. The basics include, where are people choosing to live and where will the jobs be which can support an expanding economy. The facts are that there are specific areas of the country which have a current oversupply of housing and other areas which have an adequate supply or may actually be looking at an impending shortage. The oversupply exists for one of two reasons; either the area was overbuilt in anticipation of greater population growth then actual, or the areas suffered from a loss of population and jobs.

The Sun Belt real estate crash resulted from overbuilding and today there is too much housing. These areas include Phoenix, Las Vegas, Southern Florida and the inland valleys of California. The crash would not be as severe if the population and job growth had developed at the hyper levels required to sustain the rate of new home construction which existed from 2002-2007. You cannot blame the whole crash on easy credit. Part of the reason for the crash is the people who were loaning money to builders failed to properly forecast consumption.

There are now houses in these overbuilt areas which can be purchased for less than the cost to build a new home. These can be a bargain and should be purchased if you can find a use for the house. This means you have to live in the house to make it productive or you must be able to place a paying tenant in the home to offset the acquisition costs. People still move into these areas, so if and when jobs are created, this is where you might want to own real estate.

There are areas of the country where the oversupply has been created by emigration as people move out of the area. Small towns throughout the country have long experienced a stagnant real estate market as the young people grow up and move away to the bigger cities. The situation in many cities in Rust Belt states is uniquely severe, not only do the people leave, but the jobs leave as well. Detroit is the textbook example. This area, once the fourth largest in the country, is now only number eleven in large part because of emigration. The diminishing status is not just because Dallas area has grown to be the new number four, but Detroit has shrunk to half its largest population. There are houses in Detroit which burned during the riots of 1967 and were never torn down because the land was never needed for anything else. The price of houses in Detroit are far below what it would cost to rebuild, but there is no light at the end of the tunnel because there is no projected need for significant additional housing. Phoenix is expected to recover, adding jobs and people in the future, and at some point the housing market should reach a situation where all existing stock is absorbed and a demand is created for new construction.

Texas is the current shining light in this economic downturn. I would call it a dim light, but it beats the black gloom hanging over Las Vegas and Southern Florida. The immigration into Texas cities continues to be strong and the need for additional housing stock still exists. The housing need is being met, so far, by a greater number of apartment complexes being built. There has been minimal job loss in the major metro areas, and Austin has experienced a net job gain over each of the past two months. There have been layoffs in Dallas, but there continue to be new job opportunities to replace the lost jobs. These new Dallas area jobs are usually at the expense of other parts of the country as employers continue to move jobs to Texas.

The inventory of resale homes in DFW is currently at 5.5 months, well within the normal range of 3-6 months. The issue people are failing to consider is that Dallas usually has a 3-6 month inventory and at the same time there are a large number of new homes under construction. The second piece of this equation, new homes, is largely missing. When this recession ends the need for housing will expand and it will take quite a while for builders to re-engage their construction teams and get new homes rolling out to the public. The cost of new construction is anticipated to be higher, since much of the economy of scale will be lost as new projects are started on a smaller scale than in the past.

I predict Dallas is sitting on a potential shortage of housing once the economy (and job growth) recovers. We see some of this shortage in the rising rents and lower vacancy in the DFW area. Phoenix, on the other hand, will be able to handle expanding immigration and a recovering economy for a couple of years without asking its new home builders to get ramped up. The same house (similar age, configuration, neighborhood demographics) which receives $800/month in Phoenix is receiving $1,200/month in Dallas and $1,300/month in Austin. The price difference in rents is created by the traditional forces of supply and demand for housing.In order to see price appreciation in residential real estate we are waiting for two things to happen 1) the restarting of job growth and 2) the ability of banks to once again lend money for real estate. When these things happen there will eventually be a shortage on the supply side, which will first appear in Texas, then later in the other areas which add population and jobs. This shortage will drive up the value of real estate over today’s prices which will mimic the shortage there currently exists in our markets for single family rentals.

There is no telling what will be required to make the fuller economy recover, but until then the market forces of increasing population in some markets and tight credit are forcing more people to be renters and it continues to make this a good market to be a landlord in Texas. Texas is also where I first expect upward price pressure for real estate valuations. I never expected Texas real estate to increase in value at the 10/20/30% per year which other markets experienced in the bubble years, but that is not what I am look for. Because my real estate is leveraged, all I need for good return, with my rent/value ratios, is 3% increase in value per year and I get an excellent return with 4-5% per year.

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