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Housing Bubbles Are A Local Issue

“Housing Bubbles Are A Local Issue”

Hugh Pavletich FDIA
Performance Urban Planning
New Zealand

May 25, 2009

A recent Wall Street Journal article by Nick Timiraos “Why Didn’t the Housing Bubble Mess With Texas?” (CBS News version) suggests Americans are belatedly waking up - realizing that Texas did not experience a housing bubble – and are now asking – why?

While Texas housing stayed at around 2.5 times annual household income through the recent era of easy money (as did most of middle North America – including Canada), California housing for example, blew out to near 9.0 times household income, triggering the global financial crisis.

To compete – financial institutions within California and other bubble markets were forced to engage in distorted and destructive lending up to eleven times earnings. For example, those on annual household income of $US90,000 in California were borrowing a million dollars, as explained within the Herb Greenberg article - Mortgage Mess.

The politically created scarcities and ever inflating bubble values, were supposed to “save” both lenders and borrowers. The consequences were never considered.

There are many other “bubble markets’ where housing exceeds the affordability threshold of 3.0 times annual household earnings - as illustrated by this year’s Annual Demographia International Housing Affordability Survey of the 265 major urban markets of the English speaking world.

Within a recent New Geography article “ We May Have Reached Bottom, But Not Everywhere” (refer also Los Angeles Times), Wendell Cox, the co author with the writer of the Annual Demographia Survey’s illustrates (refer Table 1) how the urban markets of California have been thrashed.

In percentage and quantum dollar terms - median housing prices have collapsed to date in Riverside – San Bernardino by 57.7% or $US235,600, Sacramento by 56.5% or $US219,600, San Francisco by 52.5% or $US444,800, Los Angeles by 48.8% or $US286,400 and San Jose by 48.0% or $US415,000.

But even as the housing bubbles were inflating in California, the reality was that those involved in residential development and construction were likely losing money – as Skip Preble, an experienced building industry consultant (posting 1.53pm, May 1, 2009) explains within the comments section of the Wall Street Journal article “Why didn’t the housing bubble mess with Texas?” –

“I live in Texas, but the bulk of my real estate consulting work has been on the coasts over the past 8 or 9 years. As a result, I had a ringside seat to watch the disaster unfold. During this time period, the debt and equity capital environment in Texas was generally pretty uncomplicated, and it bordered on the absurd (actually in many cases it was the absurd) during the same period on both coasts (and also in Chicago to be fair). And why was this? Simply put, the perception among investors was that the profit margins in the Texas real estate industry were too slim relative to those being enjoyed in what we now refer to as the “bubble markets”. As a result, investment capital kept pursuing the higher marginal returns of increasingly overpriced markets and (fortunately) ignored markets like Texas, where homebuilder margins were kept in check by competitive conditions.”

“The funny thing is, during this period very few of the builders on either coast were still making profits on their building operations. I would estimate that 80 – 89% of their profit was in the “appreciation” which of course by definition is all in the land. In fact, many of these builders were actually reducing their overall return by building on their lots. They would have made better returns with far less risk by selling their lot inventory. So now this speculative excess has to be wrung out of their respective markets, and the surviving builders are going to have to re-learn how to make money building homes. And I believe this is a good thing.

“The fact is that much of this speculative money skipped over Texas during the boom years, because it didn’t see the opportunity for above average returns on investment. So you could make the argument that the same competition that kept homebuilding profit margins at normal levels during this period, is in large part the reason why Texas is not having the same problems as the bubble markets. If you don’t go on a drunken binge, you don’t have to worry about the hangover.”

The reality too is that these builders and developers operating within these “bubble markets” were required to equity and debt finance their operations as the bubbles were inflating – and forced to pay tax on the illusory profits. If this didn’t send them broke – the deflating bubbles did – as their often politically induced un-marketable and poorly located stock collapsed in price.

In some inland areas of California, it proved to be more economic to tear them down.

Too many ill informed economists and housing commentators are treating this “bubble rubbish” as surplus residential stock. There is a world of difference between the surplus well located stock on the fringes of affordable Atlanta, Dallas Fort Worth and Houston and the “bubble rubbish” in California’s inland empire, as one example of a bubble market.

Much of the other political and planning induced dense development should be considered “bubble rubbish” as well.

Within a recent Reason on Line interview The Housing Boom and Bust ( Sowell article) the eminent economist Dr Thomas Sowell explains how these housing problems are “local issues” – stating –

“ ‘Affordable housing’ covers a number of things. There was the sense in Washington that the cost of buying a house had become a nationwide major problem which would require a federal answer as opposed to a local answer. All the data say that was not true. People weren’t paying a higher percentage of their income nationwide for housing than they had a decade earlier. In fact it was a somewhat lower percentage in some areas. Now in some areas, including California – coastal California – people were paying half their family income to put a roof over their head. That in turn was a result of local political people putting all sorts of restrictions on building.”

Dr Sowell and other leading United States economists dealing with these housing issues, such as Professor Edward Glaeser, Professor Paul Krugman and Professor Robert Shiller, to name just a few, have yet to “spell it out clearly” to policymakers and the wider American public, that these housing bubbles are “local issues”.

Further to this – what policy initiatives need to be put in place within these problem markets – to ensure that going forward, housing does not exceed three times household income. To achieve this – the fringes – being the supply or inflation vents – must be “allowed” to provide new starter housing at 2.5 times the gross annual median household income of specific urban markets.

Houston (gross annual median household income $US55,600 refer Demographia Survey) - for example - is supplying fringe new starter housing of 235 square metres (2,529 square feet) on 700 square metre (a fifth of an acre) comprising 4 bedrooms, master en-suite, separate dining, ducted air conditioning and double garage for $US140,000 - $US30,000 for the serviced lot and $US110,000 for the actual house construction (a Median Multiple of 2.5).

These are sound and sustainable Development Ratios of approximately 20% serviced lot – 80% actual house construction.

Houston is also supplying fringe manufactured housing of 160 square metres (1,722 square feet) on large lots for $US73,000 - $US20,000 for the serviced lot and $$US53,000 for the manufactured house (a Median Multiple of 1.31).

The simple questions are – firstly, why isn’t fringe starter housing currently being supplied at these prices and multiples of California’s coastal urban markets and other bubble markets as identified by the Annual Demographia Surveys – and secondly - when will Federal / National and State Governments start requiring local governments to meet their community obligations and “allow” affordable housing to be built?

Indeed – within an excellent City Journal article “Obsessive Housing Disorder” Steven Malanga, senior editor and a senior fellow with the Manhattan Institute spells out in clear terms, the litany of disasters of Federal involvement in housing issues. In concluding he states –

“At the same time, governments should do no harm, especially when it comes to the cost of housing. One reason politicians and policymakers continue to feel that they must subsidize mortgage rates and launch ownership campaigns is that since the 1970’s local housing and zoning regulations have raised the price of home construction – sometimes by hundreds of thousands of dollars – as economist Randall O’Toole has shown – and thereby reduced the supply of affordable housing. Half a century ago, Americas cities boasted a rich stock of affordable housing, even as their populations grew. Today, even shrinking cities complain of a lack of it. One solution is for the federal government to tie aid to states to local regulatory reforms that reduce the cost of construction and encourage additional building.”

It is generally now well understood that the performance of the economics profession with respect to these housing bubbles has been “woeful” – as I explained earlier this year within an article “Housing Bubbles & Market Sense”.

The media has an important role to play in asking politicians, planning authorities and public commentators on housing, for their suggested solutions in how these local issues should be dealt with. And particularly –exactly what steps they will be taking – and when – to allow affordable housing to be built.

Of the six countries covered by the Annual Demographia International Housing Affordability Surveys – New Zealand is clearly leading the way – as illustrated by the public statements this year by Prime Minister John Key, Housing Minister Phil Heatley, Environment Minister Nick Smith and Deputy Prime Minister and Infrastructure Minister Bill English (NZ Sunday Times "Cheaper borrowing for local authorities").

One of the major reasons why Local Government has difficulties ensuring the provision of affordable housing – is because of the inappropriate methods infrastructure is currently being financed. Deputy Prime Minister Bill English stated earlier in the year that there is much work required in “capacity building” the skill levels in the local government sector.

Within the recent Wall Street article “You can’t spend your way out of a crisis”, New Zealand Prime Minister John Key said –

“We don’t tell New Zealanders we can stop the global recession because we can’t. What we do tell them is that we can use the time to transform the economy to make us stronger, so that when the world starts growing again, we can be running faster than other countries we compete with.”


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