Market Stats

Every conversation I have with Investing Architect clients or prospective clients these days eventually veers into the impact the oil market crash has had on the real estate market in general and investment opportunities in particular. With all the dramatic media coverage on the topic their expectation is one of a Buyer’s market with increased opportunities both in terms of options (inventory) and better deals (lower prices).

When you look at the aggregate numbers (all price segments lumped into one figure) the market has handled the effects of the crash surprisingly well. For instance, in the last six months aggregate year over year property sales were flat in June, up 7% in May, down 2% in April, down 1% in March, flat in February and flat in January. Same story with the year over year average sales price that were flat in June, flat in May, down 1% in April, down 1.6% in March, flat in February and flat in January.

Home inventories are up double digits from last year year’s drought but still averaged 3.5 months – well into Seller’s market territory. Not exactly something to write home about which I guess is a good sign on the back of 50%+ price drop oil crash.

A Tale of Two Cities

But, the reality on the ground is much more nuanced than those numbers suggest. It reminds me of Dickens’ book “A Tale of Two Cities”: It was the best of times, it was the worst of times. When you look at the data through the prism of price segmentation you get a very different and much more accurate view of what’s going in the real estate market. Take a look at the price segmentation schedule for a zip code in North Houston (Spring) prepared by my friend Ken Brand:

The price segments $0 to $300k reflects a Seller’s Market with improved selection through higher inventory in the upper limit. The price segments between 300k-600k is pretty much a balanced market entering a Buyer’s market. Finally, the price segment of $700k to $1MM+ is a strong unabashed Seller’s market.

From my experience on the ground, the numbers for this zip code are representative of what’s happening across the city. Generally speaking, it’s a Sellers market for price points up to $500k and a Buyer’s market for price points above $500k.

Price reductions on every other listing

If you dig below the surface, even in the price segments under $500k that are doing better many of the listings have been reduced in price. In a recent report covering The Woodlands area “48% of listings on the market have been reduced at least once” (cit Ken Brand). What’s happening in the Woodlands is typical of the Greater Houston area as a whole.

So how are prices being reduced at least once but average prices remain flat?

One characteristic that all hot Sellers markets share is Sellers getting away with unreasonable prices because of a buying frenzy. If one neighbor gets away with a higher price then others will follow suit even as the market shifts and balances itself. The original price when the reduction was made was often unreasonable and reflective of a hot Seller’s market that for all intents and purposes is no longer with us. The price reductions you are seeing are those Sellers coming back down to earth. Having said that, price reductions have a strong psychological effect on Sellers that leads to more leverage for Buyers in negotiations where they had none in the last few years.

Investment Opportunities

What does this mean for investors who are trying to dip their toe back into the market or get started for the first time? Well if you segment the market even further and look at the price point between $140-$200k where most investment opportunities will be found you will find an even stronger Seller’s market. Especially in the lower end of that range, it appears that the market keeps chugging along like it’s 2014: Days on market in the single digits, sometimes multiple offers, a bit more flexibility on price (but not much). We are still finding opportunities but the competition is fierce.

The rental market

On the rental side the situation is a lot brighter. In the last six months of the year, leases were up an average of 8% while rents were up and average of 1.55% year over year.

But, this tale of two cities analogy applies to the leasing market as well. Luxury rentals ($2000+/mo) have born the brunt of the impact while listings priced around the average have continued to perform well. Layoffs in oil and gas and dramatically reduced exploration budgets have meant that fewer people are moving into the area so the Tenant demand while solid, is now more balanced against supply. There has been a slight uptick in days on market and we are seeing an increase in Tenant requests for price reductions.

Note: This article was originally written on October 27, 2015 and it has been updated to reflect all data from 2015 now that it’s in. To request a full copy of the report https://investingarchitect.com/contact-us  or if you’re viewing this in your email, please hit reply. 

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“Are we here yet?”

A concerned Investing Architect client asked me that question out of the blue. In his email he sent a link to a BiggerPockets article (link in the footnotes) that warned about the risk of over saturation in certain rental markets (i.e Atlanta, GA).

In essence, over saturation occurs when there is an imbalance in the rental market caused by excessive supply. Basically, too many properties for lease and not enough tenant demand to lease them all. As a result, days on market increase significantly and there’s substantial downward pressure on rents. In these market conditions, tenants have increased leverage to negotiate lower prices (due to availability) and investors are eager to lower rents to fill vacancies. Not matter how you look at it, over saturation is bad news for long term real estate investors.

Back to the question that started it all: Is the Houston rental market experiencing over saturation? We can answer this question two different ways: 1) Blurt out a short answer that fits our existing opinions  or 2) Look at empirical data and let it answer the question unequivocally.

When in doubt, LOOK AT DATA!

Methodology and Criteria

As we set on this journey to satisfy our common deeply-held nerd cravings for numbers,  we had to use a clear methodology so the conclusions could lead us to meaningful answers.

First, we were only interested in “investment grade properties” single family homes that are zoned to great school districts, built after 2000, between 1500-3000sf, with at least 3 bedrooms and 2 baths. Further, we wanted to focus our search on properties leased for 12 months or more – so, no short term leases – and no subsidized Section 8 leases.

Next, we organized the data by school district (instead of lumping it all into one big pile) and focused our attention on four metrics: Number of units leased, Average rent, Median Rent and Days on Market.

Further, we did a side-by-side, year over year comparison for those four metrics for each month as well as on an annual basis.

Last but not least, we used the findings to project current absorption rates and inventory levels for each school district to give us forward looking perspective of the rental market in those locations.

Needless to say, the findings didn’t disappoint.

Study Results

Once we crunched the numbers, some interesting patterns emerged. Here are some of the most important ones:

1. Annually, Units Rented were up an average of 1.47%. In fact they were either higher or flat in all school districts except Katy ISD which saw an 11.5% decline. On the flipside, Klein ISD saw the sharpest increase in units leased which soared 13.2%.
2. Annually, Average Rents rose by an average of 4.27% . Median Rents rose by an average of 5.17%. In both categories, Klein and Tomball ISD properties posted the highest gains.
3. Annually, Days on Market rose by an average of 21%. Katy  and Cy-Fair ISD had the highest increase at 36% and 27% respectively.

To get a sense for how the market might behave going forward, we  “weighed” the current number of listings active on the market for each school district against the adjusted absorption rate (the number of properties leased this month last year adjusted by the annual  year over year increase or decrease in overall units leased). That provides a crucial metric for the health of a rental market (Days of Inventory) which in a nutshell tells you how many days it would take to clear out all existing inventory for lease based on last year’s adjusted absorption rate.

As of the date of this writing, there were an average of 123 listings on the market with an absorption rate of 54 properties per month. That tells us there are 72 days worth of inventory currently on the market.

Study Conclusions

So what does it all mean and what’s the answer to the question that started the nerd avalanche?

1. The Houston rental market is NOT experiencing over saturation. The fact that units leased and rents are up year over year is a testament to that simple truth.
2. Having said that, the market balance is shifting  from an overwhelmingly landlord-friendly market to a more balanced market, as more properties have become available. That is being reflected in the increase in days on market for investment grade properties for lease. This will result in more competition for tenants so rents will probably not rise at the same clip going forward.
3. The days of putting your investment property on the market and having multiple lease applications within the first week  may be behind us. Therefore, investors must adapt their expectations, and most importantly their projections, to the new market realities of longer days on market.
4. The filters we used to compile the data eliminate all properties and locations that don’t fit general “investment grade” criteria. However, the properties we present to our clients as acquisition targets are only a small fraction of this filtered list. The creme de la creme, if you will. As always, the best locations and properties outperform their less than excellent peers.
5. As much as we tried to segment the market (using school districts), I’m afraid the segmentation isn’t granular enough. For example, within Cy Fair ISD there are pockets, neighborhoods, zip codes that behave differently than other counterparts within the same district. Therefore, this analysis isn’t meant as a substitute for neighborhood level analysis that tells a clearer story about what’s going on in that neighborhood. The study is a 10,000ft view to look for general patterns – property specific market analysis is the microscope view.

We will continue to keep a watchful eye on the Houston rental market in order to provide you with the insight and strategies to make smarter long term real estate investments.

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If you’re interested in a PDF report of the study (and a Google Spreadsheet file if you’d like to play with the numbers) contact us or if you’re reading this in your email, just hit reply.

Footnotes:

The Pivotal Factor You Probably Don’t Know to Watch for in a Rental Market – http://www.biggerpockets.com/renewsblog/2015/01/19/pivotal-factor-rental-market/

BiggerPockets, January 2015

The Houston real estate market has been on fire over the past 18 months. Since the start Q2 of 2013, we have experienced double digit increases in sales as well as rising prices and rents fueled by low inventories and high demand.

The gallop has felt incessant. Just when you might expect that the market will take a breather for seasonal reasons or otherwise, it keeps sprinting forward. So, in this market climate, it’s no wonder that the hypothesis of a Houston real estate bubble has arisen reinforced by anecdotal “evidence” and largely unrelated 1980s oil crash references.

However, a couple of weeks ago, Trulia released its Bubble Watch report. Mainstream newspapers like the Houston Business Journal and the Houston Chronicle regurgitated the findings without much scrutiny and that seemingly lent some “empirical” credibility to the story.

Here’s where I got involved.

I usually dismiss market studies from companies that are best known for data inaccuracies without a second thought. After all, how much credibility can you assign to a study that finds real estate markets like Las Vegas and Chicago to be undervalued?! But I started receiving calls and forwarded links to articles from concerned clients so I decided to take an in-depth empirical look and share the findings with you here.

It’s hard to argue with anecdotes and I won’t try. I’m sorry to break it bubble proponents but the fact that your cousin’s neighbor’s house sold in 18 hours, 10% over list price to the highest bidder of 15 offers does not constitute evidence for a real estate bubble. Therefore, let’s begin by defining what a bubble is and look at some symptoms that may serve as indication for an overvalued market.

Definitions

In a 2004 Fed letter, Fed economist John Krainer and researcher Chishen Wei wrote:

We borrow from the finance literature to take a different approach. The finance paradigm holds that an asset has a fundamental value that equals the sum of its future payoffs, each discounted back to the present by investors using rates that reflect their preferences. For stocks, the payoffs requiring discounting are the expected dividends. This approach can extend to housing by recognizing that a house yields a dividend in the form of the roof over the head of the occupant. The fundamental value of a house is the present value of the future housing service flows that it provides to the marginal buyer. In a well-functioning market, the value of the housing service flow should be approximated by the rental value of the house.

A bubble occurs—in either the stock market or the housing market—when the current price of an asset deviates from its fundamental value. Right away we see that bubbles are difficult to detect because fundamental value is fundamentally unobservable. No one knows for sure what future dividends are going to be, or what discount rates investors will require on assets. Despite this obstacle, analysts still find it helpful to construct measures of fundamental value for comparison to actual valuations. One popular measure is the price-dividend ratio, which corresponds to a price-rent ratio for houses.

Wikipedia states that “in their late stages, real estate bubbles are typically characterized by rapid increases in the valuations of real property until unsustainable levels are reached relative to incomes, price-to-rent ratios, and other economic indicators of affordability.”

In summary, real estate bubbles occur when property values deviate from their fundamental value as determined by economic indicators that measure values in relation to average rents and incomes. In addition, such deviation usually happens due to rapid increases in property values that are unsustained by economic fundamentals of supply and demand.

Now that we have an idea about what a bubble is and how to identify it, let’s look at each of these factors separately and see how they apply to the real estate market in Houston Texas over the past year and a half.

Economic Indicators of Fundamental Value

There are numerous metrics (economic indicators) one can use to determine the fundamental value of an asset.  Two of the principal indicators are the price to rent ratio and price to income ratio. In the latest report on the Houston real estate market for the month of September, the average single family home price was $196,000 while average rent for the same property type was $20,988/year. Therefore the average price to rent ratio for the Houston market is 9.34. On most investment grade rental properties we analyze daily, the price to rent ratio is usually even lower at 7.5-8.2.

In comparison, the average price to rent ratios in the US is approximately 22! As in, more than double the price/rent ratio for Houston.

Now let’s take a look at the relationship between home prices and income to see if there’s an imbalance. Again the median home price is $196k according to latest HAR data while the median household income is $58,952 (Source: Forbes) so the price to income ratio is 3.32. Put a different way, the median house costs 3.32 times the median income. In comparison, the US price to income ratio was 3.76 in March 2014 (Source: Department of Numbers)

Put differently, neither price to rent nor price to income ratios point to a bubble in the Houston market. Our price to rent ratio is about half the national average and our price to income ratio is in line with the national average.

Unsustainable Rapid Increases in Property Values?

In its summary of the last confirmed real estate bubble in the US. Wikipedia states that “despite greatly relaxed lending standards and low interest rates, many regions of the country saw very little growth during the “bubble period”. Out of 20 largest metropolitan areas tracked by the S&P/Case-Shiller house price index, six (Dallas, Cleveland, Detroit, Denver, Atlanta, and Charlotte) saw less than 10% price growth in inflation-adjusted terms in 2001–2006.[65] During the same period, seven metropolitan areas (Tampa, Miami, San Diego, Los Angeles, Las Vegas, Phoenix, and Washington, D.C.) appreciated by more than 80%.” (emphasis mine).

Is something similar happening in the Houston market? Let’s look at the facts about property values and sales in Houston from 2006 to 2013.

So what do the facts tell us? During 6 out of the last 8 years, the property values in Houston have been moving sideways: Either flat or barely keeping up with inflation. Moreover, during the last two years of recovery, the market performed same as historical appreciation in 2012 and almost reached 10% appreciation in 2013.

If that’s a bubble, I’m an olympic gold medalist.

Again, you don’t have to take my word for it. Just look at the empirical evidence. In the five year period between 2001-2006, markets that were proven to be in a real estate bubble appreciated by more than 80%. That’s an average of 16% per year for 5 years! But that’s not all. Most importantly, the economic fundamentals didn’t change a bit during that period to warrant such an increase. Prices rose just because. Just because there were loose lending practices and people turned their homes into ATMs, just because people speculated that they would all become millionaires but just holding on to their homes for half a decade, just because they thought it was normal for the price on a new home to be 100k higher three months after they bought it. I’m looking at you, Las Vegas.

Unlike that situation, the economic fundamentals in Texas (generally) and Houston (specifically) are present to support a robust recovery.

Let’s start with demand. Houston didn’t just become hip overnight and now all of a sudden everyone wants to move here because we’re the new Orange County. Houston has the highest population growth in the country for two simple reasons: Jobs and low cost of living. During the 8 year period from 2005-2013 employment has grown by 18.6% in Houston compared to 1.8% nationally. Also, Houston has the lowest cost of living among 10 most populated metro areas in the country at 5.6% less than the national average.

When more people move into an area than leave, demand for housing grows. When Exxon Mobil builds a 20 building complex in North Houston that will house 10k employees (many of which have families), demand for housing in that area grows. From basic economics, what happens to prices when supply remains the same and demand rises? They must go up. It’s not speculation – It’s just how the world works.

Now add to that the fact that supply has not remained the same. During the month of June 2008 (arguably the hottest month of year for real estate sales) there were 6.6 months of inventory in the Houston real estate market. Fast forward six years later and inventory during the month of June 2014 is 2.8 months. That’s a 67% drop in available properties while demand rose at the same time! Why is supply down? There are several reasons:

1. Higher sales (demand) are depleting inventories faster
2. Foreclosures accounted for 25% of sales in 2008. They account for about 5% of sales this year.
3. Builders are struggling to fill the supply void with new home inventory

Now what happens to price when demand is up at the same time that supply is low? They rise even faster.

Basic supply and demand is at the basis of home price increases in the Houston market, not some speculative, unsustained inflation of a bubble.

Here’s a final riddle for you: If prices are supposed to decline or remain flat during a recession, what are they supposed to do during a recovery?

The answer may sound obvious, but if it is so obvious why are people screaming “bubble” after one or two years of higher than normal appreciation?

Last but not least, Trulia’s Bubble Watch report (which is basis for most bubble predictions in Houston) posts “Home Prices relative to fundamentals” as their reason for determining if a market is over or undervalued. I would love to know what “fundamentals” they are using because whatever they are, they’re certainly not price to rent and price to income ratios or median home price appreciation over the last 9 years.

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If you are interested in discussing a strategy that can build a six figure per year income stream while getting your net worth over the million dollar line , please email me or if you’re reading this from your email just hit reply.

I’ve been absent around these parts for a couple of months because let’s face it: Who wants to hear about real estate market statistics when the alternative is to carry your favorite ice cold adult beverage as you contemplate how it will take before the waves reach your  beach chair. But now that the tan is starting to fade away, it’s time to get back to business. And what better way to dive right in than to take a look at the performance of Houston’s rental market during the month of August.

Our Houston Investment Grade Rentals (HIGR) Chart brings all good news – In the high quality locations that we track, there were 727 properties leased in August. This is the second highest number of properties leased (after July’s 729) on record and year over year it represents at 14% jump. As you will probably notice from the chart, properties leased and prices typically spike during July and August due to the wave of tenants looking to get situated before kids go back to school. But even after accounting for the seasonal spike, the considerable year over year jump points to a significantly hotter market this year.

Good news also from the price front. The lease price of properties leased during August matched July’s record average of $1638. That level represents a 6.6% increase over last August.

Days on market increased slightly to an average of 22 days (last year’s DOM were 19.74) showing further proof that the larger number of properties sold and higher lease prices did not significantly impact the time properties spent on the market.

Historically, the rental market tends to take a breather during the last quarter of the year with an overall lower number of properties leased. However, rental prices tend to stay unchanged. So does this mean that you should try to time your purchases just right and take advantage of the seasonal spike in July and August?

No.

The primary reason why there are fewer properties leased out is due to the fact that there are fewer properties available for lease during these months. Read: Less competition. And most importantly, if you follow our advice and purchase high quality properties you have a built-in competitive advantage over other plain properties.

You can’t control when the right deal will come along especially in a hot market like this just like you can’t control when a property might need to be leased out again due to a tenant moving out. So, trying to get the seasonality just right can be a costly move.