Housing price dynamics within metropolitan areas

Housing Price Dynamics within a Metropolitan Area

One of the most dramatic features of the current recession is the impact that it has had on housing prices. Rather than viewing houses primarily as homes, many Americans have long considered houses to be their largest financial investments. In addition, real estate had been a fairly secure financial investment for a significant period of time. In fact, in many areas real estate was not only a secure investment, but one of the safest speculative markets, because of rapid appreciation. Between the late 1990s and the mid 2000s, real residential property prices appreciated by over 80% in the United States (Guerrieri, Hartley, & Hurt, 2009). This rapid appreciation of housing prices does not even convey the entire story about the boom housing market, because many areas had very little appreciation in housing prices, while other areas saw dramatic, even ridiculous, increases in housing prices. The ability to double or triple one's investment in a relatively short period of time transitioned real estate from a safe and stable investment to a major money-making opportunity. Real estate investment became something that the average investor could use as a means of rapid wealth accumulation.

Moreover, while other forms of investment still required substantial amounts of start up money in order to make substantial profits, real estate investing was a money-making opportunity that people could access because of loosened qualifications for mortgages. The subprime market, which was initially developed to assist first time and minority buyers, began to expand to other markets. Not only were Americans investing money in their own homes, they were also using real estate as a way of making money, and diverting capital from other investments into real estate. However, since the mid 2000s, nationwide housing prices have dropped roughly 40% (Guerrieri, Hartley, & Hurt, 2009). Therefore, when the bottom fell out of the housing market, many Americans were left in incredibly financially vulnerable positions. Their secured debts were no longer secure.

The fallout from the burst housing bubble was both immediate and chronic. The first impact was a wave of foreclosures that, to many, seemed as if they would only impact those who had foolishly borrowed money for unaffordable mortgages, under the hopes that appreciation would pay off for them. However, the reality is that the crashing housing market had an impact that went well beyond the impact on irresponsible lenders. First, foreclosures meant that banks were not getting the money that they thought they would get from each loan. This greatly contributed to the bank crisis. Federal money, which is tax money collected from Americans, was used to help bail out those banks. The actual financial cost to the average American was nominal for the bank bail outs, but the chronic impact of the bubble burst has had a larger impact on many Americans. As a general rule, foreclosed houses sell for less than owner-sold houses. The sale value of comparable homes helps determine house prices for a particular area, so even a single foreclosure in a neighborhood can have a detrimental impact on home value in that area. When housing prices begin to fall, more people may be encouraged to place their homes on the market, thus increasing both available supply and the price one can demand for the house in question.

While the housing bubble and bust impacted almost every major metropolitan area in the United States, it does not seem to have had the same impact on Houston, Texas. This paper examines housing prices in Houston and why Houston seems immune to the housing price cycles that impact the rest of the nation. The paper also acknowledges that, while Houston has escaped the extremes that the rest of the nation has faced, it has eventually felt the same sting as much of the U.S. housing market. The paper looks at why Houston, with its unique housing market and relatively strong economy, could not remain permanently immune from the housing boom and bust cycle.

Houston, Texas

Many Texans are boastful of the fact that they are from Texas and maintain that this makes them both different and better than other Americans. Whether or not that is true of individual Texans, it does seem to hold true for the housing market in Houston, Texas' largest city and the fourth largest city in the United States. Houston has had a strong housing market, even during the recession. Furthermore, while Houston has certainly felt the impact of the recession and has experienced falling house prices as a result of the economic downturn, it has managed to weather the recession in a way that other cities have not. In fact, looking at the Houston metro area as a whole, "prices held steady for Houston's overall single-family housing market in 2009. An annual study showed that 52,100 homes changed hands last years, a seven percent drop from the 56,012 sales in 2008. The median price per square foot fell to $72.58, a 0.2% change from the median of $72.71 in 2008. The median sales price increased slightly to $154,900" (Real Estate Center at Texas a&M University, 2010).

While housing prices remained relatively steady, Houston was not completely immune from the housing crisis. "The strained energy industry, a devastating hurricane and the trickle-down effects of the national economy have teamed to squeeze Houston's real estate market, which at times has seemed immune from the national downturn" (Thai, 2009). While the rest of the country was beginning to feel the squeeze of a tightening economy, Houston was experiencing job growth and was actually experiencing an increase in property values. However, when Hurricane Ike arrived, it devastated a huge part of the Gulf Coast area. Suddenly, homeowners became renters, commercial property lost its money-making potential, and home building in other areas was delayed because of a lack of supplies and the fact that rebuilding efforts were directed towards the coast. This led to an immediate decrease in home values in the Houston area. Hurricane Ike hit in September, and by January, "median sales prices dropped by more than $25,000" (Thai, 2009). While Houston may not have experienced the same level of problems as the rest of the nation, it was not actually immune to the housing bust.

However, some features of Houston's economy certainly make it seems as if it will weather the current economic crises better than many other major metropolitan areas. Some of this may be due to the fact that Houston simply did not experience the housing bubble in the same way as other cities. Because housing prices were never significantly artificially inflated, there is not a tremendous risk when the market self-corrects, which is what occurs when a bubble bursts.

Most major metropolitan areas in the United States experienced significant appreciation during the housing bubble. Not only did housing prices increase, but they increased in a way that made housing unaffordable for many people. This factor helped drive subprime lending; to have livable housing, many people almost had to choose complex mortgages schemes that left them very vulnerable to fluctuations in the housing market. However, Houston, Texas seemed almost immune from the housing appreciation mania that hit the United States in the late 1990s and early 2000s. Part of this is due to Houston's vast size. While many major metropolitan areas are growth-constricted because of nearby metropolitan areas, Houston is a fairly isolated major city. The closest metropolitan areas are Austin, San Antonio, and the Dallas-Fort Worth metroplex and the outlying neighborhoods in each of these areas are still at least 100 miles away from the center of Houston. This means that Houstonians have area to expand. Rather than engaging in fierce competition for existing housing, Houstonians can move to the suburbs. In fact, Houston might be characterized by its suburban nature more than any other area. The Houston suburbs expand north almost to Conroe, Texas, to the west out to the Richmond/Rosenberg/Katy area, and to the South to Galveston Island. The Houston metro area is literally larger than some states on the Eastern seaboard. This has meant that Houston's housing market has not followed national trends.

One of the things that placed Houston outside of the national trend was its tremendous growth in the last decade. Not only did Houston's population grow, but so did its number of job opportunities. In fact, in the early stages of the recession, many Texans believed that Texas would weather the recession with little impact, largely because of the job opportunities available in Houston. As in other boom-cycle economic trends, Houston seemed poised to be a success, because the high oil and gas prices that were crippling much of the rest of the nation's economy meant income and opportunities in Houston. "Given that Houstonians had access to the same new types of mortgages as the rest of the country and that Houston has had greater population growth than other large metros, we might expect price appreciation to be stronger in Houston than elsewhere. However, the opposite has been true. Houston's large supply of land means that demand growth primarily results in more construction, not higher prices" (McCullagh & Gilmer, 2008).

However, it is important to realize that land supply is only one part of the reason that new home construction formed such a large part of the Houston housing market. Yes, Houston has more available surrounding land than almost any other major metropolitan area in the United States, but it also applies different rules to its surrounding areas, making development more of a possibility than in other areas:

In Houston, developers can create a munici-pal utility district, or MUD, to provide these [water, sewage, and drainage] services on their properties and can finance these with tax-free bonds. Houston requires developers to build MUDs in such a way that they eventually could be connected to the city's corresponding infra-structure, but they begin as self-sufficient enterprises.

In other cities, develop-ments must be connected to the city's water and sewer lines, confining new projects to nearby or adjacent land since the cost of building lengthy lines is prohibitive. In metro Houston, by contrast, virtually any large parcel of land can become a new suburb, espe-cially given the metro's expan-sive highway system. Experience bears out this conceptual frame-work, with significant Houston suburbs like Katy and Spring developing and prospering before many closer-in areas.

But Houston does not just have a larger supply of available land on its outskirts. Unlike all other large U.S. cities, Houston lacks zoning laws restricting industrial, commercial and resi-dential construction to specific neighborhoods. Many inner-city Houston neighborhoods protect property values through deed restrictions diligently enforced by private neighborhood asso-ciations, and the large, planned suburban communities oper-ate similarly. But much of the land in metro Houston is not assigned a specific use (McCullagh & Gilmer, 2008).

All of these factors meant that Houston could have a housing boom that had nothing to do with falsely inflated home values and everything to do with a boom in available new construction. As long as Houston does not lose the jobs that brought new people to the area in the first place, the impact of the housing bust should be minimal.

Moreover, it is interesting to note that there is a linear relationship between income and housing prices in Houston, which is not necessarily in existence in other areas of the country. The slope of the line might change, but the correlation between housing prices and income always remains strong. "House prices can rise either due to a movement along the income-house price line or due to a shift in the line. Rises that are attributable to the latter are of potentially greater concern to policy makers" (Gan & Hill, 2008). What this means is that, not only did Houston manage to basically escape the boom and bust that impacted most major metropolitan areas over the last decade, but that its pricing structure will probably ensure that it will escape future housing booms and busts.

Why Home Prices Matter

Some people might suggest that home pricing is not that important because fluctuating house prices impact investors in a more significant manner than they impact the average homeowner. This statement is both true and misleading. Taken as a whole, the fluctuating real estate market may have a greater impact on the net worth of investors. However, these investors are also more likely to have sufficient financial resources to weather financial ups and downs. While individual home owners might not face the same degree of financial risk, they do risk their personal financial futures. Furthermore, individual homeowners may buy houses in order to live in them with no plans of selling those houses, but the changing circumstances that prompt home sales, which can include job changes, deaths, births, divorces, and marriages, are the same kinds of life changes that require selling a home. Fluctuating house prices can make it impossible for the average homeowner to prepare for these types of life changes. Therefore, whether for investors or homeowners, the consequences of a fluctuating housing market can have a major financial impact. As a result, it is clear that, "understanding the future path of house prices in relation to economic stresses such as oil price shocks, financial market distress, household income, and others is critical to successful strategic planning and risk management" (Deng, Moon, & Wu, 2010). Moreover, it is critical for all types of homeowners. For example, understanding housing prices can help the average homeowner determine whether home ownership or rental is a more appropriate short-term choice.

The Role of Mortgages

Obviously, people who hold mortgages on property face greater financial risks than people who do not hold mortgages, because they may find themselves upside down in a loan, and unable to sell a property and cover the outstanding loan amount. Oftentimes these people are the ones who default on their mortgages, because of an inability to sell their homes. People who own the property outright may not be able to recover the payment price for the house, but they will at least have the ability to sell a house at a loss without damaging their credit. However, it is interesting to know that not all mortgages have the same degree of default risk. Complex mortgages are riskier than simple mortgages, and complex mortgages proliferated in the late 1990s and early 2000s:

The focus on initial loan affordability might motivate households to borrow too extensively and to underestimate refinancing risk, which is exacerbated by historically short reset periods and recasting of negative amortization loans. After controlling for observable characteristics including the FICO score and income, we find that households with complex mortgages are more likely to default. This holds true after the set of controls is expanded to include time-varying LTV, which suggests that higher complex mortgages defaults are not due exclusively to higher ex-post leverage (Amromin et al., 2010).

Furthermore, it is important to understand what role mortgages play in America's inner economic structure. Americans are known to be borrowers rather than savers, purchasing things on credit rather than saving money for desired purchases. While America is a debtor society, it is important to realize that mortgages make up the bulk of that debt. While many Americans may have carried unsecured consumer credit, borrowing was mainly to finance home purchases. Furthermore, as the credit market expanded, home ownership was a possibility for groups that had traditionally been excluded from the home ownership marketplace. "For example, mortgage debt dwarfed consumer debt by fourfold in the first quarter of 2005 according to the American Bankers Association (ABA). Part of this growth can be attributed to the proliferation of nontraditional mortgage products such as interest-only loans and loans with little or no documentation of down payment sources or income. In addition, the growth of the subprime mortgage market has helped introduce credit constrained households to the mortgage debt market" (Pennington-Cross & Ho, 2006). This fact has a major implication for homeowners, especially non-investor home owners. While they may carry a high debt burden, if most of that debt burden is linked to mortgages, it is a burden that becomes more difficult to escape. Unsecured consumer debt can be stressful for a borrower, but is ultimately escapable through bankruptcy. While a bankruptcy will impact a borrower's credit score, it essentially allows a debtor to be free from a debt for pennies on the dollar. In contrast, mortgages, because they are secured by real property, are not escapable in the same way. Not only will a mortgage default impact a consumer's credit, but it will also impact the consumer's financial bottom-line.

Home prices matter in Houston because they are a large part of the city's draw for new residents. People can home two or three times the home in Houston that they can in other metropolitan areas, such as Boston. This is significant because Houston's salaries are not two to three times less than salaries in Boston. While other factors, such as the cost of groceries and fuel, impact the cost of living, the relative affordability of housing means that Houstonians, in general, experience a greater standard of living than residents of many other parts of the country, despite having lower incomes. The availability of affordable land also makes Houston a draw for new industry, and commercial land values are linked to residential land values. Therefore, home prices in Houston remain critical to the health of Houston's overall economy.

Impact of Frequent Resales

One of the problems with tracking home retail value is that it is difficult, if not impossible, to determine how a house has fared in between sales. A house could have received substantial improvements between sales. This might be the case in a neighborhood that is undergoing gentrification, where individual owners and investors alike might purchase a dilapidated property and make improvements to it, with the hope of netting a handsome profit upon resale. The term for this process is flipping, and the availability of cheap housing, cheap mortgages, and rising property values made flipping a way to earn money for many people during the housing boom. Likewise, a house could have depreciated significantly between sales because of neglect and disuse. This could be the case when someone has purchased a home in good condition and used it as a rental property, because rental properties are routinely subjected to harder use than owner-occupied properties. Both flipped property and investment real estate would be expected to change hands more frequently than owner-occupied properties. There has been speculation that homes that are bought and sold frequently might have a different appreciation path than other homes. However, that does not seem to be the case. Properties that are frequently bought and sold do not appear to have different appreciation paths than properties that are not frequently bought and sold (Federal Housing Finance Agency, 2011). Because so much of Houston's home market is based on the buying and selling of new construction, this might not appear to be salient to the Houston home market. However, in the actual city of Houston, property values are much higher than in most surrounding neighborhood areas, with properties in nice neighborhoods inside Houston's "loop" area selling for several times more per square foot than similar properties in Houston's suburbs and exurbs. Whole Houston neighborhoods have been gentrified, and flippers were responsible for many of the improvements to homes in these older neighborhoods. However, while these sellers may have made profits on individual homes, if Houston follows the national trend, these sales actually have little impact on the area's overall housing market.

Of course, it is impossible to know, with any certainty, what type of changes a house has undergone between two sales. While that might be possible to examine on an individual basis, it is simply too complex to process on a larger-scale basis. Take for example, the Standards & Poor Price Index:

To calculate [for the Standards & Poors Price Index], the indices, data are collected on transactions of all residential properties during the months in question. The main variable used for index calculation is the price change between two arms-length sales of the same single-family home. Home price data are gathered after that information becomes publicly available at local recording offices across the country. Available data usually consists of the address for a particular property, the sale date, the sale price, the type of property, and in some cases, the name of the seller, the name of the purchaser, and the mortgage amount (Standards & Poors).

Therefore, what those numbers reveal is the change in the home prices, but they cannot reveal the changes in the home's condition.

Housing in Urban Areas

One of the interesting features about urban housing markets is that these urban markets are interrelated to one another, and cannot be treated as stand-alone markets. Obviously, in an urban area like Houston, Texas, pricing in the city is going to be linked to prices in the suburbs. However, it is important to realize that housing price correlations are not limited to neighboring geographic areas. On the contrary, there certainly appears to be a link between housing markets in different areas. This explains why housing booms seem to impact more than a single area, and, why, even in boom economies there are areas experiencing busts. For example, though much of the late 1990s and early 2000s was characterized by housing booms in much of the nation, there were some areas, most notably Detroit, which were experiencing housing busts, with rapid property devaluation and migration away from the city. Of course, when one considers demographics, this phenomenon makes sense. If a city is experiencing an influx of purchasers, these new buyers must be coming from somewhere.

However, migration from one city to another is the only way in which cities are impacted by the growth cycles of other cities. Basically, there are two reasons that housing markets might be linked: "the first is migration patterns, and the second is interurban industrial linkages. There is much evidence in the literature about the importance of earlier migrants moving from one specific location to another in influencing future generations to make the same move. For this reason, conditions in one city that change the demand for migration may be linked to the housing market in the other city. Increased out-migration in one place may mean a fall in origin house prices and a rise in destination house prices" (Yu & Wenz, 2009). Moreover, people may contemplate moves that do not seem logical. For example, Detroit's economy was driven by automobile manufacturing, and there are not enough automobile manufacturing plants to absorb those former auto workers. Therefore, these former auto workers have had to find jobs in other industries. Some of them may have relocated to areas like the Houston area, where blue collar workers can still make living wage incomes because of oil refinery work. This would not be an easily predictable move, but may be a logical move based on the modern economy.

The fact that markets are inter-linked may help explain why it is difficult to forecast housing prices in metropolitan areas. Regional econometric housing forecasts are not nearly as predictive as they should be (Fullerton & Kelley, 2008). This is because regional housing forecasts look at regional economic details like job markets, cost-of-living, and similar standard-of-living measures. However, homeowners do not consider these factors in isolation. A low cost-of-living may not be enticing if it means a low standard-of-living. Moreover, people are going to consider how these same factors impact living in other areas. While many Americans still live within 50 miles of where they were born, the fact is that Americans no longer make their housing and living decisions based on where they were born. Families are literally spread across the United States. Therefore, a low cost-of-living combined with a high standard-of-living in a boom economy like Houston's might impact the housing market of other major metropolitan areas. Moreover, Houston's troubled educational system might prompt some residents to consider other areas, such as the Dallas-Fort Worth metroplex, with similar attributes and superior school districts.

Gentrification

One of the interesting aspects about urban real estate markets is how prices can vary so wildly within a single metropolitan area. The above example of school districts is an important one. In Houston, for example, the suburbs are known to have better school districts than the city. Fort Bend ISD, Katy ISD, and Lamar Consolidated ISD are all known for their superior school districts. However, people have flocked to west Harris County and Fort Bend County because of the reputation of those school districts, causing such tremendous and rapid growth that the school districts have been unable to keep up with demand. While those districts remain competitive, they are now being outperformed by school districts in other Houston suburban communities. Moreover, some areas in cities have more elastic pricing, while others have more stable prices.

Houston's premier neighborhood is River Oaks, a neighborhood of mostly moderate-sized homes for high income people. While the suburbs of Houston feature larger, more ostentatious homes, River Oaks has been able to maintain its high property values, through several boom and bust cycles, because the homes are located in close proximity to Houston's Downtown and Uptown areas, as well as within easy distance of Houston's medical center, zoo, and museum districts. However, not all neighborhoods in Houston have been able to maintain the same consistency in property pricing. What is counterintuitive is that housing prices in wealthier areas remain more stable than housing prices in poorer areas. This is due to the phenomenon known as gentrification.

A housing demand shock will cause the rich to expand into areas previously occupied by the poor. As this happens, house prices in rich neighborhoods are not affected, while house prices in gentrified neighborhoods are driven up due to the neighborhood externality…within a city, low price neighborhoods appreciate at a faster rate than high price neighborhoods. Moreover…the low income neighborhoods directly abutting the rich neighborhoods are the ones that are more price elastic. This is due to the fact that, after a demand shock, rich households will expand in locations as close as possible to the rich neighborhoods, in order to enjoy the highest level of externality (Guerrieri, Hartley, & Hurt, 2009).

At first blush, gentrification seems as if it would be beneficial to a neighborhood. After all, gentrification means that people are investing time and money in financially depressed neighborhoods. Not only do homeowners make improvements to their owner properties, but they also push for improvements to public spaces, like parks, and to community resources such as libraries and schools. However, it is critical to view gentrification as a whole. While gentrification can be very positive for some people in a neighborhood, it can also have a crippling impact on the neighborhood. While the current nationwide housing market bust may be worse than anything seen in American history, it is erroneous to assume that it is unprecedented. In the 1980s, Massachusetts, particularly the Boston area, experienced a dramatic increase in housing prices, with the value of housing in the poorest 10% of ZIP codes increasing by more than 165% (Case & Marynchenko, 2001). However, a statewide recession led to a decline in the housing market in the late 1980s and early 1990s. While the low-income part of the market experienced the greatest appreciation during the Boston boom, it also appreciated the most dramatic decline. When the market crashed, "real declines [in property value] exceeded eight percent in the bottom quintile but were only 6.7% in the highest decile" (Case & Marynchenko, 2001).

What makes it even more difficult to discern the true impact of gentrification is that most studies have focused on local neighborhoods, rather than city-wide regions. However, when one considers a major metropolitan area, it becomes clear that the housing market for a potential buyer is far greater than a single neighborhood, or even a small set of neighborhoods. Looking at a city the size of New York City, for example, a person wanting to purchase a home in the New York City metropolitan area could actually purchase a home in New York, New Jersey, or Connecticut. Factoring in super commuters, those who are willing to live in distant suburbs and commute to New York City, upstate New York, Pennsylvania, and a large section of the Eastern Seaboard become housing possibilities. When the radius for potential housing choices grows to encompass several states for a single metropolitan area, it becomes clear that changes in even a single neighborhood can impact prices around the region. What makes this fact even more complex is that gentrification is a changing process, and those changes have yet to be revealed by local studies (Hackworth, 2001).

In Houston, with its general lack of zoning restrictions, gentrification is generally possible. However, the fear is that gentrification will change the feel of a neighborhood. A great example of this is the small city of Bellaire, which is literally surrounded by the city of Houston. In Bellaire, a neighborhood of formerly modest-size homes on mid-sized lots, many homeowners have completely razed existing structures to build mini-mansions. The feeling and tone of the neighborhood changed from that of a bedroom community to that of an exclusive enclave. These changes have been reflected in the attitude of some people in Bellaire. While Bellaire is known as a safe city with a remarkably short 9-11 response time and excellent community resources, its police force also has a reputation as racist, and a black man was recently shot in his own driveway by a member of the police force. All of these factors help determine home value, elevating it for some, but making the neighborhood undesirable for others.

Not all neighborhoods embrace gentrification, even if it does bring in a substantial influx of dollars. Houston Heights, a historic area of Houston located near downtown, is an example of a neighborhood that has resisted gentrification. The Heights has long been associated with the arts in Houston. Moreover, at least since the 1960s, the Heights, along with the Montrose area, have been considered a good location for Houston's gay and lesbian communities. However, the location of the neighborhood makes it a perfect candidate for gentrification. The problem is that gentrification would destroy the very nature of the neighborhood, because it is a historic neighborhood. The residents have managed to avoid much of the impact of gentrification with deed restrictions. As a result, the Heights are still characterized by Victorian houses and Craftsmen bungalows. However, many of those homes have been extensively remodeled inside. Housing prices in the area are high, despite the fact that the character of the neighborhood has not been substantially changed.

Depreciation

While gentrification may result in seemingly-artificial increases in housing prices, it is important to understand that other factors can drive down housing prices, and that these decreases may not be linked to economic factors. When purchasing a home, many buyers look at factors like school districts, ease of commute, proximity of shopping, and other seemingly intangible factors that might have an impact that is even greater than external economic forces. These elements factor into the idea of depreciation, which can impact an entire neighborhood, not just a single house. One of the issues that can help lead to depreciating property values has to do with pollution and other forms of environmental degradation. Moreover, what is interesting is that environmental degradation seems to have a longer lasting impact than was previously assumed. Different neighborhoods respond in different ways to post remediation efforts, but, in some areas, the impact of remediation seemed to take longer than one might have assumed. Interestingly enough, Aydin and Smith looked at remediation efforts in Houston, Texas, the city studied in this paper. What they found was that "in the case of Houston Environmental Protection Agency Superfund sites that, while the direct value impacts of proximity to toxic waste sites was significantly reduced after remediation, the indirect effects associated with induced demographic changes were much slower to reverse, producing a housing market inertia that stifled full home value recovery" (2008).