Sunday, May 8, 2011

1980s Texas Housing Bubble Myth - A Reply

Recently the debate on the price impacts of planning regulations has been a hot topic here and elsewhere. Leith van Onselen at Macrobusiness is one of the more sophisticated proponents of supply side impacts on home prices and recently responded to a comment of mine about Houston Texas. My comment was that if Houston is an example of how responsive supply can help cities avoid house price volatility, why did Houston experience a house price bubble in the 1980s?

Leith argued that Houston's apparent price bubble was a mere mild blip, especially on the grounds of price to income multiples. In his typically evenhanded fashion Leith does note many of the demand side factors at play during that time - the oil boom, liberalisation of loan standards and population growth. He brings together these points with the following conclusion.

What makes Texas’ home price performance in the early 1980s particularly impressive is that prices managed to remain relatively stable in the face of significant demand-side influences that should have caused home prices to rise significantly and then crash.

An additional point is made that Houston has managed to avoid the 2000s property bubble infecting most of the rest of the US, and much of the world.

My reply.

Houston prices declined around 40% in real terms following the 1982 market peak - that is indeed volatile - and it took 15 years for prices to recover in nominal terms.  The Case-Shiller 10 city index has dropped by a similar amount since the US peak in 2006 (30.5% nominally) - so much for the volatility aspect.

But why do prices in Houston still appear so dramatically affordable?

One major reason is the relatively high property tax rate.

Property tax rates in Houston more that doubled from 1984 to 2007 becoming one of the highest rates in the US. Depending on your area you can pay between 2-3% of your properties improved market value in annual State taxes, while the US National average is 1.04%.

One would expect areas with higher property taxes to have structurally lower prices, reduced price volatility, and much lower price to income ratios.

An illustrative example is shown below. The three comparisons are intended to roughly represent the early 1980s, the early 2000s and today. The Houston property tax rates increase from two to three percent, while the comparison taxes increase from half to one percent. Interest rates also represent mortgage rates at the time.

From these examples we can see that from just this single factor, the property tax differential, we should expect prices in Houston to currently be structurally around 30% lower than national averages (more on the impact of the property tax differential here).

An important factor at play in this example is that at lower interest rates a fixed percentage property tax leads to greater price differences. Therefore, over time, we would expect Houston to home prices to be a smaller fraction of comparable homes elsewhere as the property tax differential has a greater price impact at lower interest rates. Remember in the table above, rents and returns are the same for each comparison - only the tax rate is different.

Of course, this does not mean that housing is lower cost. It just means that cost of housing is borne by annual tax obligations rather than capitalised in the price. A far better comparison of whether housing is structurally cheaper in Houston would be to compare quality-adjusted rents to incomes over time and across cities.

Perhaps once the property tax differential and other demand side factors are properly considered we will see Houston's supply-side impact on housing prices diminish to zero.

Lastly I would add that the memory of such a deep and prolonged property price slump would be motivation enough to dampen speculative housing demand in Houston. Who in their right mind would bid up prices in Houston knowing that increased tax liability and the history of dramatic losses on the property market?

Evidence of supply-side effects on home prices remains elusive.  

3 comments:

  1. Cameron,

    I strongly agree that property taxes are a better component of a broad-based tax system, than income taxes, and the more a nation/region/city abates income taxes by using property taxes instead, the better I would expect their economic performance to be.

    But there is still NO CORRELATION when one examines the whole Demographia Survey results, between property taxes (or any other kind of tax) and the absence of a house PRICE BUBBLE. Houston was far from the only city to avoid a price bubble - there are between 90 and 150 others to examine. The ONLY factor that DOES correlate is "elastic supply".

    The obvious reason that Houston, Dallas and Atlanta are focused on by people like Leith Van O and Hugh P and Alan Moran, is that they have had MASSIVE population growth and have supplied tens of thousands of new homes to stay ahead of demand.

    You say: "Evidence of supply-side effects on home prices remains elusive."

    That last word is wrong, it should be "conclusive". The evidence that any OTHER factor is THE common denominator in the worldwide house price bubble epidemic, is truly elusive. YOU start trying to prove one of them, I dare you.

    By the way, Houston house prices inflated from an average of $100,000 to $130,000, and then dropped, over a few years, 40% to $78,000; REAL economic recovery followed rapidly, with a booming productive sector. There is no overhang whatsoever to this crisis today; all the "overstock" of houses were full of tenants and owners within a few short years; and as I say, tens of thousands more homes have been supplied without prices going either too high or too low.

    Contrast this with California, or Britain. House prices, while Houston's were going from $100,000 to $130,000; were more like going from $200,000 to $390,000 AT THAT TIME; dropping from that, to $190,000; rising again to $500,000; and dropping from that to $280,000.

    WHOSE economic performance is going to be the winner in these comparative cases? Is your Green "urban growth constraint" policy designed to successfully reduce emissions, conserve resources, etc, by collapsing economies and throwing people out of work, and acting like de facto fascist eugenics policies because people can't afford to have kids any more?

    By the way, is Obakesan your mother?

    - Wodehouselee

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  2. I just discovered, Cameron, that on a blog called "Popping Bubble", a guy called "Raveswei" said THIS in response to an argument from YOU:

    "......In Texas, place that you like to use as an example, less new homes was built (1.05m homes between 2001-2006 on 2.4 million new residents) than in Australia (940k new homes 2001-2006 on population increase of 1.3m new residents) or California (1.06m new homes on 2.1m new homes during the same period), still prices in Texas remained steady during this period compared to huge gains in Australia or California. Why? Well, I think that the reason is not how many new homes are built or how much of the new land was developed, but the way how it is done. In Texas almost everybody can buy agricultural land, develop it and build a house. None can sell a new home with large profit because there is alternative for everybody to do it by themselves. That’s why new home prices are just slightly higher that cost of development. In Australia and California regulation is different and residential development business is highly manipulated and done by privileged business in cooperation with the local councils. People are forced to pay price they ask because it is almost impossible to do it yourself. Price of a new home is significantly higher that cost of development. That’s why lend developers and local councils are earning huge profits from new housing developments......."

    He is SOOOO right. It is refreshing to find the rare individual who "gets it" so well.

    - Wodehouselee

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