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JANUARY 2012

JOURNAL OF THE REAL ESTATE CENTER AT TEXAS A&M UNIVERSITY


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JANUARY 2012

VOLUME 19, NUMBER 1

TIERRA GRANDE JOURNAL OF THE REAL ESTATE CENTER AT TEXAS A&M UNIVERSITY

14 Beyond a Reasonable Drought Texas’ record-breaking drought isn’t the only thing pounding the agricultural sector. Changes in national farm policy aimed at deficit cutting pack a punch, too.

Director, GARY W. MALER Chief Economist, MARK G. DOTZOUR Senior Editor, DAVID S. JONES

BY JOE OUTLAW AND CHARLES E. GILLILAND

Managing Editor, NANCY MCQUISTION Associate Editor, BRYAN POPE Assistant Editor, KAMMY BAUMANN Art Director, ROBERT P. BEALS II Graphic Specialist/Photographer, JP BEATO III Circulation Manager, MARK BAUMANN Lithography, MOTHERAL PRINTING, FORT WORTH

ADVISORY COMMITTEE: Joe Bob McCartt, Amarillo, chairman; Mario A. Arriaga, Spring, vice chairman; Mona R. Bailey, North Richland Hills; James Michael Boyd, Houston; Russell Cain, Port Lavaca; Jacquelyn K. Hawkins, Austin; Kathleen McKenzie Owen, Pipe Creek; Kimberly Shambley, Dallas; Ronald C. Wakefield, San Antonio; and Avis Wukasch, Georgetown, ex-officio representing the Texas Real Estate Commission. TIERRA GRANDE (ISSN 1070-0234) is published quarterly by the Real Estate Center at Texas A&M University, College Station, Texas 77843-2115. Telephone: 979-845-2031. SUBSCRIPTIONS free to Texas real estate licensees. Other subscribers, $20 per year. Subscribe online at http://recenter.tamu.edu/store. VIEWS EXPRESSED are those of the authors and do not imply endorsement by the Real Estate Center, Mays Business School or Texas A&M University. The Texas A&M University System serves people of all ages, regardless of socioeconomic level, race, color, sex, religion, disability or national origin. PHOTOGRAPHY/ILLUSTRATIONS: Erin Pope, p. 1; Real Estate Center files, pp. 2–3, 13, 28; Robert Beals II, pp. 4–5, 10 (illustration), 22, 25; JP Beato III, pp. 6 (illustration), 14–15, 16–17, 18–21 (illustrations), 26.

2 Texas Sails On

Nation Battles Headwinds This year looks to be a better one for Texas’ economy, but the United States as a whole is still attempting to overcome serious obstacles to recovery. BY MARK G. DOTZOUR

© 2012, Real Estate Center. All rights reserved.

Transfer Fees Outlawed Those fees have only been around since 2007, but the law creating them was repealed in 2011. Even grandfathered transfer fees must meet strict requirements to comply with the law. BY JUDON FAMBROUGH

10 Dialing Down Debt

Road to Recovery Begins at Home Record 14-inch snowfall, Feb. 12, 2010, at Hart Farms, Ellis County

PHOTOGRAPHER W. Clay Jones

When to Toss Old Tax Records Some people never throw tax records away. Others don’t keep them long enough. Knowing what to hang on to, why you need it, and for how long can save both storage space and headaches.

BY JERROLD J. STERN

18 The Trouble with Troubled Assets

6 Terminated

ON THE COVER

16 For the Record

Although the ongoing debate over the national deficit accounts for much of the shouting going on in Washington, the truth is that American households need to pay off their debt, too. BY GERALD KLASSEN

Investors are still expecting a deluge of distressed commercial real estate to pour into the market. The question remains, “When?” BY HAROLD D. HUNT

22 The Great Recession

Why Intensity and Duration Varied Yes, the recession was awful. But exactly how awful and how long the pain lasted depended on where you live in Texas. Here’s what made a difference.

BY ALI ANARI

26 Vested Rights

Project Protection for Developers Conventional wisdom says changing the rules in the middle of a game is a no-no. Texas law backs this up. Once a project permit application is filed, most new land use regulations don’t apply. BY REID C. WILSON

JANUARY 2012

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Texas, U.S. Economies

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The new year is upon us. Business owners, investors and households are trying to anticipate what the economy will look like in the months ahead. While there are no doctoral degrees in clairvoyance or fortune telling, it’s not difficult to understand why weather forecasters and economists would be interested in acquiring those skills. Both professions have one thing in common: hundreds of variables interact to create changes in the weather and in the economy. When most of these variables are stable and predictable, forecasting is rather easy. But when they are in a frenzied state, forecasting the outcome of their interaction becomes challenging. Ultimately, weather forecasters and economists attempt to discern patterns out of chaotic data.

Leading Indicators Suggest Direction

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conomic indices of leading indicators were created specifically for the purpose of anticipating future business activity. The Leading Figure 1 Index for the United Leading Index for the United States States (Figure 1) is U.S. Recessions just such a measure. August 1994 The index is hinting 2.71 at modest positive economic growth in October 2011 1.53 the next 12 months. It has been oscillating between 200 and 400 for most of 2011, January 1982 –2.00 which is about where March 2009 it was from 2003 –3.85 through 2006, when Source: Federal Reserve Bank of Philadelphia the economy was and 2011 research.stlouisfed.org expanding at a modest clip. The current level is slightly less than in the late 1990s when the economy was expanding much more rapidly. JANUARY 2012

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The Texas Index of Leading Indicators (Figure 2) shows a much more robust economic outlook for 2012 compared with the national economy. The Center’s Monthly Review of the Texas Economy (recenter.tamu.edu/econ) Figure 2 documented how Texas dramatiTexas Index of Leading Indicators cally outperformed the United States in 2011, with positive job June 1999 124.2 August 2011 growth not only in the energy 119.6 industry, but also in construction, manufacturing, retail, transportation, professional April 2009 business services, health care 102.0 and hospitality. Only the govSource: Federal Reserve Bank of Dallas ernment sector and the information industry declined. Texas has a lower cost of living and a lower wage structure than many states. This allows Texas businesses to be more competitive in the global market and keep jobs in America. For example, General Electric recently announced it will build a $95 million mining equipment plant in Fort Worth to build electric drive systems for huge off-road vehicles. In the current economic environment, this is a huge accomplishment. The Texas Index is currently in the range of 120 to 123, similar to that of 2004–05, when the previous economic recovery occurred. Job growth is occurring in nearly all Texas metro areas and is likely to continue into 2012, Figure 3 Total Private Construction Spending: Residential albeit at a modest pace. Over 11 million people in (Millions of Dollars) Texas have jobs. This number is March 2006 $676,412 higher than it was in 2008 when the recession started. The state U.S. Recessions has fully recovered all the jobs lost during the recession. By comparison, for many states, full recovery could be years away. January 1993 $194,150

October 2011 $238,990

Sources: U.S. Department of Commerce: Census Bureau and 2001 research.stlouisfed.org

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Problems Yet to Solve If this was a typical recession, we would expect the U.S. economy

to expand at a faster rate after three years of decline. Unfortunately, this is not a typical recession. Four key drags to the economy haven’t yet been remedied. First, we haven’t seen the normal rebound in housing construction that typically leads the economy out of recession. Normally, a recession brings lower interest rates, which make housing look attractive, so people start to buy and build homes. So far, that hasn’t happened. Residential construction has virtually collapsed and shows no sign of rebounding (Figure 3). everal things have to happen before significant increases in housing construction will occur. First, somewhere between 4.5 and 6 million more foreclosures need to occur. Until this happens, people will be skittish about buying, fearing a price decline when these homes are sold. The foreclosure process is scaling up, but the Office of the Comptroller of the Currency estimates it could take 50 months to move these homes back into the hands of homeowners or investors. Again, Texas is an exception. Foreclosure activity is much lower here than in other parts of the country. The second headwind slowing recovery is that Americans have borrowed too much in the past five years and now they have to pay it back (Figure 4). Sixty-five to 70 percent of the U.S. economy is based on consumer spending. When credit increases, people spend more. When credit contracts, they spend less. Until credit starts to expand again, economic growth will be subdued. Outstanding credit in America has never declined in the past 60 years, until just recently. This is why the U.S. economy will experience only modest job growth for the next several years.

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Until Americans get their debt levels down to manageable levels, they will save more and spend less. The third headwind is that the banking system is still struggling with solvency. While banks have written off Figure 4 some bad debt, significant losses Houshold Sector: Liabilities; have yet to be recognized. First Household Credit Market Debt Outstanding mortgage loan losses and losses (Percent Change from Year Ago) on second mortgages and home October 1952 equity lines of credit will have 14.8 to be dealt with in the future. Until this process is completed, the U.S. banking system will April 2011 limp along, with many bankers –1.3 and bank regulators extremely Sources: Board of Governors of the Federal Reserve System averse to taking on risk with and 2011 research.stlouisfed.org new loans. In Texas, banks appear to be much stronger than their cousins in other states. However, Texas banks are subject to regulation by the same people who regulate banks all over the country. And those regulators are not encouraging loan expansion at this point. The fourth headwind to a more rapidly growing economy is that small business owners in America are still reluctant to hire (Figure 5). Figure 5 Even though profits are good, Small Business Outlook “Planning to Hire People in the Next Six Months” cash flow is good and $2 tril(Net Percent of Respondents) lion in cash is sitting on their January 1998 balance sheets, they are so 19 baffled by the current economy and regulatory environment October 2011 that they aren’t yet interested 3 in hiring. This is the key to the U.S. economy’s rebound. BusiMarch 2009 –10 nesses must begin to hire again. Source: National Federation of Independent Business The monthly survey from the National Federation of Independent Businesses, which represents small business owners, shows that the number of business owners who say they are going to hire in the next six months has been hovering around zero for the past three years. JANUARY 2012

Can Congress create an environment that will encourage businesses to begin to expand and hire again? If they do, the American economy will hum with enthusiasm. In the meantime, the U.S. economy is likely to struggle to generate jobs again in 2012, because so many important issues that powerfully impact business owners and investors will not get resolved until after the 2012 election. Because of the pent-up demand from businesses and investors and families who have been postponing economic decisions for three years now, the economy appears to be “spring loaded.” ortunately, Texas is poised to outperform the U.S. averages. Home sales volume in Texas should show modest improvement over 2011, and prices should be stable throughout 2012. Americans do not tolerate deferred gratification for very long. We have dreams and we want to live them out. Once the federal government creates a positive environment for business owners, we might be pleasantly surprised at the vigor of the recovery.

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Dr. Dotzour (dotzour@tamu.edu) is chief economist with the Real Estate Center at Texas A&M University.

THE TAKEAWAY Texas’ economic outlook for 2012 is positive, with job growth occurring in several sectors and low cost of living enticing businesses to move here. It will be tougher going for the nation, however, because the housing market needs to clear a huge number of foreclosures, consumers need to pay off their debt, the banking system needs to write off bad debt, and small businesses need to start hiring again.

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Development Issues

A new statute voids all future private transfer fee obligations created in Texas after June 17, 2011, and terminates existing transfer fees that do not comply with specific future obligations.

Payments Not Considered Transfer Fee Obligations

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he Texas Property Code lists ten payments associated with the transfer of real property that are not considered private transfer fee obligations and thus are not prohibited (Section 5.202). They are: • Consideration paid to the seller for an interest in land including any mineral interest and additional consideration paid for appreciation, development or sale after the interest has been transferred to the purchaser, as long as it is paid only once and is not binding on successors in interest. • Commission paid to a real estate broker under a written contract of sale that includes any additional commission

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paid for the property’s appreciation, development or sale after the property is transferred to the buyer. • Any interest, fee, charge or other type of payment made to a lender pursuant to a loan secured by a mortgage on the property. This includes any payment for an assumption of the loan or transfer of the property subject to the loan; an estoppel letter or certificate; shared appreciation or profit participation; or any other consideration payable to the lender in connection with the loan. • Payment to a landlord under a lease agreement such as rent, reimbursement, fee, charge or other types of payments to a lessor for the right to assign, sublease, encumbrance or transfer of the lease. • Payment to waive, release or for not exercising the right of first refusal or similar interest upon transfer of the property. TIERRA GRANDE


• Fee imposed by or payable to a governmental entity for recording the transfer (a recording fee). • Dues, fees, charges, fines, assessments and other types of payments made to a homeowners’ association or similar organization under a declaration, covenant or under law. With certain exceptions, these include such things as charges for entering a change of ownership on the records, an estoppel letter or resale certificate. • Dues, fees, charges, assessments, fines, contributions or similar types of payments for transfer of a club membership related to the property. • Fee imposed by or payable to the Veterans’ Land Board for consent to assume or transfer a contract of sale and purchase. • Dues, fees, charges, assessments, fines, contributions or similar types of payments made to organizations exempt from federal taxation under Section 501(c)(3) or 501(c)(4) of the Internal Revenue Code as long as the organizations use the payments to directly benefit the encumbered property by:  supporting or maintaining the property and no other;  constructing or repairing improvements on the property and no other;  providing activities or infrastructure that supports the quality of life such as cultural, educational, charitable, recreational, environmental and conservation activities and infrastructure that directly benefit the property. The statute qualifies the requirement that the activities or infrastructure must directly benefit the encumbered property. The benefits may collaterally benefit a community located next to the property or whose boundary lies within 1,000 yards of the property. Likewise, an organization may provide a direct benefit by meeting three qualifications: • The organization provides activities or infrastructure to the general public. • The activities or infrastructure substantially benefit the encumbered property as well as the general public. • The governing body of the organization is controlled by the owners of the encumbered property and approves the payments for the activities or infrastructure annually. Also, the organization may provide activities or infrastructure at no charge to another organization exempt from federal taxation under Sections 501(c)(3) or 501(c)(4) for small or insignificant usage without violating the requirement.

Fee Obligation” on or before Jan. 31, 2012. The notice must be filed in the real property records of each county in which the property is located. If there are multiple payees of the fee, the notice must designate one person as the payee of record to receive the fee. he notice must be printed in at least 14-point boldface type and state the amount of the fee and the method used for its determination. In addition, the notice must contain the: • date or circumstances under which the fee obligation expires, if any; • purpose for which the fee will be used; • name of each payee and his or her contact information even though only one person has been designated the payee of record; • name and address of the payee of record to whom the fee must be sent; • legal description of the property subject to the fee; and • signature and acknowledgment of each payee or his or her authorized representative.

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A person or persons entitled to receive a transfer fee payment must file a “Notice of Private Transfer Fee Obligation” on or before Jan. 31, 2012.

Requirements for Existing Transfer Fee Obligations to Continue Although the statute grandfathers existing transfer fee obligations, it includes several requirements for their continued existence. Notably, a person or persons entitled to receive a transfer fee payment must file a “Notice of Private Transfer JANUARY 2012

Refiling and Amending the Notice

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fter the initial notice has been filed on or before Jan. 31, 2012, the payee of record must file the notice every three years thereafter. In particular, it must be filed no sooner than the 30th day before the expiration of the third anniversary date of the original filing. In addition to filing the notice every third year, an amendment must be filed each time a payee changes. The amendment must be filed within 30 days after the change. The amendment must contain the information found in the original notice, the legal description of the property and the name and contact information of the new payee.

Failure to File Required Notices or Receive Payments If the required notices are not filed on time, the transfer fee terminates. The statute states that if the person required to file the notices fails to do so, the following three things occur:

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• payment of the private transfer fee may not be required for the conveyance of an interest in the property to a subsequent purchaser; • the property is no longer subject to the private transfer fee obligation; and • the private transfer fee obligation becomes void. The statute also addresses the timely acceptance of the payment. If the payee of record fails to accept the private transfer fee within 30 days after being tendered, a similar fate awaits both the fee and the obligation. In that case: • payment must be returned to the payor; • payment of the fee is no longer required for a subsequent conveyance of an interest in the property; and • property is no longer subject to the private transfer fee obligation.

If the payee of record fails to accept the private transfer fee within 30 days after being tendered, the property is no longer subject to the private transfer fee obligation. New Contractual Requirement

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tarting Jan. 1, 2012, the seller of real property that is or may be subject to a private transfer fee obligation must provide written notice to a potential purchaser that the obligation may be governed by Subchapter G of the Property Code. The statutory heading to this requirement indicates that the notice must be placed in the contract for sale. However, the text (or body) of the law does not indicate exactly how the notice must be conveyed. The language simply states the potential purchaser shall receive written notice of this fact. Even more importantly, nothing in the statute addresses the legal consequences for failing to provide this written notice to a potential purchaser.

Waivers and Enforcement The statute clearly discourages any attempts to waive its provisions. Any provision that purports to waive any rights given a purchaser under the statute is void. The statute ends by giving the attorney general and the courts certain rights to enforce and punish those who violate its provisions. First, the attorney general is empowered to file an injunction or declaratory relief to restrain the violation of the statute. Second, the attorney general may institute an

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action for civil penalties against a payee or the payee of record for failing to file the required notices. The civil penalty may not exceed twice the amount of the fee charged or collected. inally, if there is a pending action against a payee or the payee of record by the attorney general for failing to file the notices, and the court finds that the violations are so frequent that they constitute a pattern or practice, the court may assess a civil penalty no greater than $250,000. If this is the case, the statute disallows the attorney general from collecting the civil penalty noted above. All the penalties collected must go to the comptroller and be deposited in the general revenue fund.

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Unanswered Questions The new statute raises several questions. For one, who checks compliance? If the payee fails to file an amendment within the required 30 days, who will know? Must an amendment be filed if there is a change in the contact information of a payee, but the payee remains the same? If the payee of record fails to accept the payment within 30 days after being tendered, how is this monitored and how are the 30 days calculated? Must the required tender occur by mail or in person? What about the disclosure regarding the use of the payment? What are the consequences of giving false information? Does fraud affect the status of the transfer fee payment? What are the consequences for failing to inform a potential purchaser that the property may be subject to the new statute after Jan. 1, 2012? The statute imposes rather stiff penalties on other violations, but it is silent on this one. What happens if the payee does not file the Notice of Private Transfer Fee Obligation within the prescribed three-year period? Is the title company liable for withholding the transfer fee even though it has been statutorily terminated? Or, does the duty to check on the required filings fall on the potential purchaser? Finally, why is no private right of enforcement given to individuals? The only enforcement power mentioned in the statute belongs to the attorney general and the courts. And, if a failure to file a required notice terminates the transfer fee, why impose civil fines and penalties thereafter? Fambrough (judon@tamu.edu) is a member of the State Bar of Texas and a lawyer with the Real Estate Center at Texas A&M University.

THE TAKEAWAY Transfer fees, money paid for transferring interest in real property, were implemented in 2007 legislation. Four years later, that law was repealed, prohibiting any future transfer fees and terminating existing fees that do not comply with the new statutory requirements. TIERRA GRANDE


JANUARY 2012

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U.S. Economy

It is time for an honest discussion about household debt levels in the United States. How much debt are households carrying? Will they be able to pay it back? What happens if they can’t? How will it impact banks? 10

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ank expectations of future losses are reflected in the level of loan loss provisions made on their financial statements. Banks have so aggressively released loan loss reserves in the past year that the positive impact on earnings has covered the weakness from revenue declines caused by falling loan balances. The FDIC’s Quarterly Banking Profile for first quarter 2011 reports banks reduced loss reserves by $30.9 billion, or nearly 60 percent, in the prior 12 months. Total provisions for losses are now at $20.7 billion, the lowest level since third quarter 2007. Current household debt is very high by historical standards. Do banks really think households will successfully pay down their current debts? If households can’t pay, is $20.7 billion enough to absorb all the losses that might occur? TIERRA GRANDE


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Figure 1. St. Louis Financial Stress Index

140 Real Estate Bubble

120

Tech Bubble Baby Boomers turn 40. Strong Income Growth Ahead!

80 Tax Act of 1981 Spurs Growth

60 1972

2

87.5%

Economic Recovery

Mar. 09 3.290

4 Index

Figure 3. Household Debt-to-Income Ratio

100

U.S. Recessions

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that explain why debt increased significantly and drove massive economic growth (Figure 3).

Percent

n earnings calls, senior bank executives continue to report improving credit quality. Few investors have questioned this judgment, just as they didn’t question earnings quality back in 2006 and 2007. But if all is well for banks, why has the St. Louis Fed’s Financial Stress Index (Figure 1) hit the same level as before the 2008 financial crisis? Are financial markets telling us something different than bank executives?

Nov. 11 0.998

1982

Income-Based Asset-Based Borrowing Borrowing

1992 992

2002

2012 2

Sources: Federal Reserve Flow of Funds, Bureau of Economic Analysis and Real Estate Center at Texas A&M University

0

Dec. 93 –0.458

The Economic Recovery Act of 1981 significantly spurred growth in household debt by lowering personal taxes, making 2000 2006 2012 more disposable income available to service debt. The strong Source: Federal Reserve Bank St. Louis growth in debt moderated by 1986 but grew steadily for the next decade. Household debt levels can be examined from three different In 1986, the first Baby Boomers turned 40 with their highperspectives: est earning years ahead of them. They justified taking on more • Household debt-to-income ratio, debt by anticipating that their incomes would “grow” into • Household debt-to-asset ratio and it. This growth in debt fueled a surge in economic activity as • Household mortgage debt-to-GDP ratio. Boomers purchased bigger homes, minivans and vacations for All three measures indicate U.S. households are in uncharted their growing families. territory. The current level of household debt truly is unparalIn 1996, the Tech Bubble took hold and propelled houseleled. If household credit growth drives economic recoveries, hold debt to a new level. Prior to 1996, borrowing was fueled this recovery will be like nothing we’ve seen since the Great primarily by current income and expected income growth. Depression. It is time to take the blinders off and scrutinize the After 1996, U.S. households became comfortable with assetimplications for the financial system and the economy for the driven borrowing. They expected to fund their retirement next ten years. years through stock price appreciation rather than traditional savings. Growing stock portfolios gave Americans the confiHousehold Debtdence to save less and redirect their discretionFigure 2. Household Debt-to-Income Ratio to-Income Ratio ary income to servicing new debt. The resulting 150 growth in debt fueled strong economic growth. The ratio of household Q3 2007 130.2% When the Tech Bubble ended in 2001, debt to income remained households turned their lust for collateral to relatively stable from 110 the homes in which they lived. The rallying cry 1965 to 1985, fluctuatQ2 2011 114.3% of “My house is my retirement plan” could be ing in a range around 60 heard in the hottest real estate markets across percent (Figure 2). Then 70 the country. Asset-based borrowing fueled in 1986, a fundamental further growth in household debt, which rose to change occurred. AmeriQ1 1952 –34.9% a historically stratospheric level of 130 percent cans became increasingly 30 of income. comfortable with debt. 1952 1964 1976 1988 2000 2012 The widespread use of partially amortizing A closer look at key events from 1986 to 2006 Sources: Federal Reserve Flow of Funds, Bureau of Economic Analysis loans added to the debt level taken on by houseand Real Estate Center at Texas A&M University holds. At the peak in 2008, U.S. households reveals important changes Percent

–2 1994

JANUARY 2012

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Figure 4. Household Debt-to-Asset Ratio 25 20 Percent

First Quarter 2009–22%

2011 Q2 Household Assets: $72.3 Trillion

$4.7 trillion decline in assets 18% necessary to reach pre-tech 15 bubble ratio of 15 percent 15%

Second Quarter 2011–18%

10 5 First Quarter 1952–7%

0 1952

1964

1976

1988

2000

2012

Sources: Federal Reserve Flow of Funds and Real Estate Center at Texas A&M University

were straining under the burden of $13.9 trillion dollars in debt, equivalent to 96.6 percent of GDP. When the real estate bubble burst, the age of deleveraging commenced. Not since the Great Depression have U.S. households exhibited such an adverse attitude toward debt. Yet the primary actions of Congress and the Federal Reserve to stimulate economic recovery have revolved around enticing Americans to take on additional debt. Is it any wonder their efforts are failing? The economy will not recover until households have reduced their debt to long-run “normal” levels. Many have asked how long it will take for the economy to recover. Like children in the back seat of the car during a long family vacation, households repeatedly ask “Are we there yet?” A simple ratio analysis demonstrates that there is a long way to go. If we assume that the “normal” debt-to-income ratio is 87.5 percent (harkening back to the last time borrowing was income-based), households should be expected to reduce their total debt level to $10.1 trillion based on current income levels (the long-run average ratio is approximately 80 percent). If we compare the amount of net debt extinguished to date with the “normal” level, deleveraging is 21 percent complete with $3.1 trillion left to go (Table 1). This debt will be extinguished through repayment or default. The level of debt households can support based on their disposable income after taxes will be a hotly debated topic in the Table 1. How Much Deleveraging to Go? Normalized Debt-to-Income Ratio Debt Level Supported by Income Debt Level as of 2011 Q2 Debt to Be Extinguished Peak Household Debt Level Net Debt Extinguished to Date

87.5% Billions $10,150 $13,258 $3,108 $13,900 $641

Source: Real Estate Center at Texas A&M University

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coming years as we wait for deleveraging to end. Those who argue that a higher total level of debt can be supported point to lower interest rates that reduce debt service costs. Rates are currently low so households should be able to support this higher level of debt without defaulting. What if interest rates rise? Four arguments can be made to show the current level of debt is not sustainable: • Baby Boomers are entering a period of secular income decline as the first of this cohort turns 65 in 2011. They will have less income available in the future to service debt as they begin to retire. • Increased household savings because of lower expected return on assets means less income available to service debt. When bond and CD yields are so low, all households recognize the need to save more for retirement. • Echo Boomers won’t hit strong earnings growth until 2020 (assuming the cohort began in 1980). Of course, this assumes their spending habits and attitude toward debt will be the same as their parents. • Future tax increases to reduce the budget deficit will have the exact opposite effect on household debt that the Economic Recovery Tax Act of 1981 had when taxes decreased. For these reasons, expect the deleveraging process to be prolonged and the economic recovery to be delayed.

Household Debt-to-Asset Ratio

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he household debt-to-asset ratio provides insight into how households will extinguish their debt. One way to analyze households is to look at their balance sheets. Every household has assets, liabilities and equity. The process of deleveraging means households are reducing their liabilities. They do this by making payments out of their income or liquidating assets (for example, selling their home, foreclosure, or drawing down savings). The current debt-to-asset ratio is 18 percent compared with the “normal” debt-to-asset ratio of 15 percent in 1996 (Figure 4). If the normal sustainable household debt level is $10.1 trillion and the normal debt-to-asset ratio is 15 percent, the market value of household assets needs to decline by $4.7 trillion to retain the “normal” relationship between debt and assets (Table 2). Table 2. Impact on Household Asset Values Normalized Debt-to-Asset Ratio

21% Complete

Target Household Debt Level Target Household Asset Level Current Household Assets Asset Reduction to Reach Normal Ratio

15% Billions $10,150 $67,669 $72,326 $4,657

Source: Real Estate Center at Texas A&M University TIERRA GRANDE


FORECLOSURE IS ONE METHOD of reducing excessive household mortgage debt. Eliminating high mortgage payments enables households to find more affordable housing, resume reasonable consumption and direct excess funds to savings.

Rather than delaying foreclosures and continuing to extend and pretend, the more appropriate action is to accelerate debt extinguishment Household assets will be reduced through: through foreclosure and bankruptcy. This will free households from excessive debt and give them the flexibility to rearrange • Selling vacation homes, boats and RVs, their finances and return to a responsible level of borrowing • Selling second and third cars and other used belongings, and consumption. Some of these foreclosed homes will become • Selling investments (stocks, bonds), rental property for investors. • Withdrawing money from retirement accounts, Only when the debt extinguishment process is complete will • Selling their primary residence and becoming renters, confidence in the quality of bank assets be restored. Until that • Declaring bankruptcy, time, bank managers and regulators will make nuanced state• Foreclosure and ments about the adequacy of loss provisions while markets • Declining market value of assets. contradict them through various measures of financial stress. Household Mortgage Debt-to-GDP Ratio Worst of all, everyone will wonder why banks aren’t lending xamining the ratio of mortgage debt to GDP provides more even though they profess to be healthy. corroborating evidence that deleveraging will be sigIt is highly probable that the loss provisions at many banks nificant. Figure 5 are inadequate. An industry total of Figure 5. Household Mortgage Debt-to-GDP Ratio illustrates the current and $20 billion in provisions is not going First Quarter normal ratios of mortgage 80 to get the job done. 2008–74.4% debt to GDP (assuming We must accept that a significant Second Quarter 66% 2011–66.2% 1996 is normal). amount of household debt currently 60 $3.3 trillion decline in mortgage debt require For the ratio to return to outstanding will be extinguished to reach pre-tech bubble ratio of 44% 1996 levels, approximately 44% through default. While foreclosure is 40 $3.3 trillion of mortgage painful to both borrower and lender, it debt needs to be extinis a necessary process. Our parents and 2011 Second Quarter 20 GDP: $14.99 trillion guished. This is slightly grandparents have survived difficult First Quarter more than the $3.1 trillion 1952–15.1% times like this. So can this generation. 0 indicated by the debt-toThe housing market will begin a real 1952 952 1964 1976 1988 2000 2012 income ratio, but it is in recovery cycle when the foreclosure Sources: Federal Reserve Flow of Funds, Bureau of Economic Analysis the ballpark. process nears completion. It has to and Real Estate Center at Texas A&M University The implications for this happen sometime. The sooner the betlevel of decline are clear and significant for those involved in ter for the economic future of our country. mortgage origination and servicing. A nation with fewer homeKlassen (gklassen@tamu.edu) is a research analyst with the Real Estate Cenowners needs fewer mortgages. New funds will be needed by ter at Texas A&M University. investors who purchase foreclosed homes for rental property. Percent

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Facing Reality To take the right steps toward economic recovery, the problem of household debt must be confronted realistically. Household debt will not increase and drive economic growth until it has first decreased to its long-run average. The reversion process is especially painful because it must overshoot the average before it can return to average. The overshoot is necessary because household debt has been above the average for so long. JANUARY 2012

THE TAKEAWAY It will hurt, but American households will have to liquidate their assets and reduce debt if they want the economy to recover. This means selling luxury items including vacation homes, boats and RVs, as well as liquidating investments, declaring bankruptcy or suffering through foreclosure.

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Land Markets

R

ecently, Center staff had a conversation with noted agricultural economist Dr. Joe Outlaw concerning the state of Texas agriculture. This is a summary of his insights.

?

How has the drought affected Texas farmers

Some producers will be relatively okay because they purchased multiperil insurance on their crops. That insurance paid off when crops failed completely. Because of changes in the price of cotton late in the 2011 season, farmers with insurance actually made more money from the payments they received than they would have made on a crop sold at prices prevailing at harvest time.

14

However, producers who did not buy insurance will face serious problems in repaying operating loans and negotiating loans to put in this year’s crop. Lenders are going to insist that they pay something on the outstanding debt and be able to make enough to pay the new loan off.

What impact will these circumstances have on local economies in rural Texas

?

Farmers still spend a lot of money locally. In the major agricultural areas, there is an infrastructure that relies on farmers buying things such as tractors, fertilizer and seed, or hiring a flying service. Following a drought, everyone becomes a penny pincher. That affected the 2011 TIERRA GRANDE


round bale of hay. It is difficult to put the pencil to paper and make that money up. Because of the sell-off, herd numbers in Texas are really low. Many acres that were taxed based on agricultural value for grazing are vacant now. To avoid paying much higher taxes, owners will have to find another qualifying agricultural use. In addition to these issues, no one pulled the cattle off the land before it was damaged by lack of rainfall. It will take pastures years to recover and will be expensive to restock when the drought ends.

What are the latest developments in agricultural policy nationally

W

crops because there was no reason to apply defoliant or fertilizer on crops that didn’t come up. Those service business owners suffered last year and will face customers who are belt tightening this year as well.

What about livestock operators

T

?

his is a multifaceted situation. For the first time in my memory, we’ve had a drought during which beef prices were pretty good. Some producers are facing high tax bills after selling mother cows for more than they paid for them because they didn’t want to pay the high cost of hay. Those producers that weren’t able to sell or didn’t want to sell are paying more than $100 for a

JANUARY 2012

?

?

What is driving current commodity prices, and how long will that likely continue

E

thanol is driving commodity prices. It has been a significant driver of corn prices and that impacts everything else. It increases feed costs and influences crop decisions that in turn affect other commodity prices. The government has mandated use of ethanol in gasoline and subsidized it with a blender’s tax credit that expired at the end of 2011. Poultry, swine and livestock producers are trying to end the mandated use as well because of ethanol’s impact on corn prices, but the mandate is still in place. As a result, corn prices are likely to be high for the foreseeable future.

e are currently analyzing 12 potential scenarios for Congress to assist in setting up the Is there a bubble agricultural safety net for crop producers over the next five years. The four in cropland prices principals on the agriculture committees I do think we are in a bubble. The curresponded to the now disbanded Super rent farm program has supported good Committee by agreeing to cut $23 bilproducer returns, and that has driven lion out of the ag baseline budget, with land prices up. Direct payments from $15 billion coming out of commodity that program have been capitalized into programs over ten years. The rest will current land prices. Those are going come as a $3 billion cut from food proaway, and it’s going to be difficult to grams and $5 billion from conservation explain the impacts when the new farm programs. Currently, we spend about policy comes out. $80 billion on food programs, about $6 Investors will have to do some seribillion on commodity programs and ous pencil pushing to see if farmland roughly the same on conservation proinvestment is a good idea for them. The grams each year. That makes the relative reduced safety net is going to be a lot cut to commodity programs a big deal. less. This increased uncertainty is likely Conversations in Congress indicate to make investors pause before aggresthat the direct, fixed payments to owners sively buying cropland. of base acres (land with eligible historic Dr. Outlaw (joutlaw@tamu.edu) is a profescrop production enrolled in Farm Service sor and extension economist and co-director of Agency commodity programs) will probthe Agricultural and Food Policy Center in the ably end. That means those who bought Department of Agricultural Economics at Texas land hoping to use that money to pay A&M University, and Dr. Gilliland (c-gilliland@ for it are out of luck. The money will tamu.edu) is a research economist with the Real be reallocated to cover shallow losses, Estate Center at Texas A&M University. which are those paid by crop insurance before losses become serious. In other words, it won’t THE TAKEAWAY take much to trigger a payment, but the payment Farmers, ranchers and service businesses that will be small. Texas has support them are suffering negative effects of this had deep losses, and once year’s drought. To make matters worse, federal claimants get past shalagricultural programs are on the chopping block to low losses there will be no reduce the deficit. protection.

?

15


Income Taxes

16

TIERRA GRANDE


H

How long should tax records be kept? The answer depends on the type of records and other circumstances. There are tax and nontax reasons for keeping records. For tax purposes, income sources and amounts need to be identified through W-2 wage statements, Forms 1099 (interest income, mutual fund income, stock transactions) and other documentation. Records also may be needed for insurance purposes or to obtain a loan. Individuals should compare annual earned income with the earnings shown on their annual Social Security statements (for workers older than 25). Expenses need to be documented to support deductions in the event of an IRS audit. Documentation can be in the form of a cash receipt, credit card statement or cancelled check. Interest and penalties may be levied if deductions are disallowed for lack of records. Keeping tax returns is helpful to guide the preparation of future tax returns and

exceeds 25 percent of gross income results in a six-year statute of limitations. For example, assume a taxpayer has $100,000 gross income from real estate commissions. If the Realtor withdrew $30,000 of taxable funds from a pension plan (either the taxpayer’s or an inherited plan) and unintentionally neglected to include that income on the tax return, the six-year statute of limitations would apply. As long as the omission was unintentional, a “negligence” penalty of 20 percent of the tax due, plus interest, would have to be paid. Assume the Realtor is in the 28 percent tax bracket. The additional tax would be $8,400 ($30,000 × 28 percent). A $1,680 penalty also would have to be paid ($8,400 × 20 percent) plus interest on both the tax and the penalty. Fraud is another matter. Fraud exists if there is a deliberate attempt to evade tax. Typically, fraud exists when large amounts of taxable income are not included on the tax return.

Statutes of Limitations IF you . . .

THEN the period is . . .

1. Owe additional tax and (2), (3), (4) and (5) do not apply to you 2. Do not report income that you should and it is more than 25% of the gross income shown on your return 3. File a fraudulent return 4. Do not file a return 5. File a claim for a loss from worthless securities

Three years Six years No limit No limit Seven years

Source: IRS Publication 552 - Recordkeeping for Individuals

for filing an amended tax return. The IRS can furnish copies of your prior-year tax returns if necessary. Records should be kept to document the cost (basis) of real and personal property. In particular, the cost of improvements to real estate increases the basis of the property and, thus, decreases the amount of taxable gain when the property is sold. Such records are also necessary to support insurance claims and casualty loss deductions, as well as depreciation deductions for business and investment structures and improvements. Records associated with tax returns should be kept at least until the statute of limitations runs out. The statute of limitations is the time during which the IRS is allowed to audit a tax return. The table above shows various lengths of statutes of limitations. The minimum, which applies to most people, is three years. Statutes of limitation periods and associated penalties for errors vary. As indicated in the table, omitted income that JANUARY 2012

Fraud can be found to be a criminal act depending on the circumstances. For example, famed baseball player Pete Rose did not report sizeable amounts of income from gambling and sales of memorabilia. He served five months in prison for criminal fraud. For most people, tax records other than those pertaining to assets (real estate and securities, for example) could be discarded after three years. Even so, a longer period — seven or more years — would be prudent. Dr. Stern (stern@indiana.edu) is a research fellow with the Real Estate Center at Texas A&M University and a professor of accounting in the Kelley School of Business at Indiana University.

THE TAKEAWAY At a minimum, tax records should be kept three years. However, a period of seven or more years is recommended. Tax and nontax factors play a role in the decision.

17


Commercial Markets

the trouble with troubled

assets

by harold d. hunt

Overall, commercial real estate sales are on an upswing. According to Real Capital Analytics, national sales volume for 2011 should top out near the $200 billion mark. Although that is only a third of the 2007 peak, it is significantly higher than 2010’s $120 billion. Meanwhile, signals regarding the sale of distressed commercial property are more mixed. A variety of factors are affecting sales volume, including property location, type and the availability of financing. To understand the dynamics of this sector, the Center consulted several Texasbased commercial real estate professionals.

Distressed Asset Flow

I

nvestors have been raising money for several years in anticipation of the next “RTC event.� Expectations were that bank regulators would flush distressed properties out of the banking system, selling them at steep discounts. This has not occurred. The FDIC did conduct several auctions and a large number of structured sales during 2010. Structured sales are joint ventures or partnerships between the FDIC and private sector investors designed to facilitate the disposal of assets from failed banks and thrifts. The FDIC retains a financial interest in the assets after their sale while

18

TIERRA GRANDE


transferring day-to-day management responsibilities to the private sector. “The FDIC was able to unload more than 5,400 commercial loans with a total unpaid balance of almost $7 billion in structured transactions during 2010,” says Bruce Nelson, chief operating officer for the Houston-based Situs Companies, a full-service real estate advisory firm. “But the flow of assets out of the FDIC slowed considerably in 2011.” ussell Ingrum, managing director of investment sales in the CB Richard Ellis Houston office, notes that a consistent 22 to 23 percent of their company’s commercial valuations have been for distressed properties, but that has not translated into sales. “CB completed about $12 billion in sales during the first half of 2011. However, less than $1 billion of those properties were distressed,” says Ingrum. Nelson says he is seeing an increase in sales from both troubled and healthy banks offering a select number of assets culled from their loan portfolios. “Although these portfolios are smaller than some of those marketed by the FDIC, we are now beginning to see a more steady flow of deals,” says Nelson. “I expect that trend to continue in 2012.” “For the more institutional-grade properties our company deals in, we haven’t really noticed an increase in volume,” says Dallas-based Sam Gillespie, executive vice president and chief operating officer of Behringer Harvard Opportunity REIT I & II. “We have noted that the quality of distressed properties coming up for sale has improved.” “What I’ve seen in 2011 is a bit different from the three or four previous years,” says Carlos Vaz, president and founder of Conti Organization Real Estate Investments. Vaz’s company deals exclusively in distressed Class B and C multifamily properties in the major Texas metros. “Much more capital has become available, both equity

R

JANUARY 2012

and debt,” he says. “As a result, more investors are competing for distressed assets, even in Class-C properties.” Vaz also believes that the special servicers working with distressed CMBS (commercial mortgage-backed security) properties are now starting to part with some of their worstperforming properties. “They are a huge liability,” says Vaz. “They realize they must feed these properties like crazy if they hold them.” “In the CMBS world, liquidations of distressed loans have begun increasing while loss severity is starting to trickle downwards,” says Nelson, whose firm also acts as a CMBS special servicer. “However, modifications and extensions are still about 70 percent of current resolutions. So you are seeing more product from the bank sector and less from the FDIC. With more loan maturities coming and originally modified loans not being able to get refinanced, we can expect more distressed opportunities coming from CMBS.” ost of the lenders I deal with are commercial banks,” says Reid Wilson, attorney with Wilson, Cribbs & Goren P.C. and CRE, Houston. “Healthy banks are being more aggressive in removing their bad loans. The stronger the bank, the tougher they are on their borrowers. They also are feeling pressure from their regulators. Alternatively, struggling banks are continuing to extend and pretend because they just can’t take the losses.” “One thing to note is about a third of loans held by CMBS special servicers are experiencing maturity default and not monetary default,” states Will Holshouser, commercial mortgage banker with San Antonio-based Trinity Mortgage Finance. Maturity default occurs when an owner cannot secure refinancing. “They are unable to meet their loan maturity balloon payments, and it is taking a great deal of time and effort to find a replacement lender,” Holshouser explains. “As a result, some borrowers are being forced to accept terms they really don’t want.”

“M

Distressed Property by Type Multifamily properties have been one of the most prevalent property types in CMBS transactions. Though they were thought to be safer than some other property types, they are now showing up in distressed sales. “Multifamily deals, particularly ClassC apartments financed through CMBS, were having performance issues before this recent crash even began. So it’s no surprise that we have seen a lot of apartments,” says Nelson. “We are also seeing a lot of distressed land on the books of banks. In CMBS, distressed loans are more or less evenly split between multifamily, retail and office with a lesser amount in hospitality.” “Land is where many assets have decreased in value, and owners are having to feed them,” says Ingrum. “So they have to make a decision to keep feeding until the market comes back or let the property go because land generates no income.” Ingrum adds, “A vacancy event will often trigger a default in retail

19


properties. Losing an anchor tenant can be catastrophic in retail. Luckily, there has been comparatively little distressed industrial space because it is largely a low-leverage product.”

Distressed Asset Pricing

T

he prices that FDIC received for distressed assets early on were quite low. According to Nelson, one early FDIC bulk transaction traded in the 20-cent range while several others were in the high 30s on the dollar. Prices have gone up since then, although the price can vary greatly depending on the composition of the pool. “On the one-off FDIC deals, we are seeing an extremely wide range of prices,” Nelson continues. “CMBS assets that have actually been liquidated are experiencing losses in the 40 to 50 percent range. That’s consistent with losses occurring in auctions as well.” Vaz states that in the last three months, “The market has changed more than in the last two years. There are deals that we have made that were maybe 20 percent of the note value. You just don’t see that discount anymore. That gap is closing.” Location is also a factor. “During 2011, I know of four Dallas transactions that sold lower than a five-cap. That’s never happened before,” says Vaz. “I had someone in New York ask why I would want to go to Texas to pay a five-cap. So something will need to adjust, but I don’t know how it’s going to happen.” A large disconnect has occurred between the way distressed and nondistressed commercial real estate is being priced. “I see two distinct valuation scenarios depending on whether the property is distressed or not,” says Pat O’Connor, MAI and president of O’Connor & Associates, Houston. “For non-distressed assets, pricing is based on the property’s capitalization rate. You are looking at how much money you could have put in the bank in the last three months or the last year. So trailing three- or 12-month income is what’s being used to calculate the price.” O’Connor believes that pricing for distressed assets is now being done “by the pound.” In this case, by the pound means buying small quantities at the cheapest price possible.

“In CMBS, distressed loans are more or less evenly split between multifamily, retail and office with a lesser amount in hospitality.”

20

“Appraisal theory generally doesn’t apply in price-per-pound deals,” he says. “Sales price is determined by how desperate a particular owner is to sell. So pricing is determined on a caseby-case basis.” O’Connor notes that some of the distressed prices being paid are extremely low. “I have seen as little as $4k to $8k per door paid for ClassC distressed apartments in Houston. A combination of tight financing and limited buyers was most likely the reason,” he says.

Investor Expectations Economic conditions affect investor expectations, and the Texas economy continues to outperform much of the country. “It’s important to distinguish between the Texas recovery and the national recovery,” says Vaz. “Interest is high from outsiders. For distressed Class-A and -B multifamily properties in Texas, I am seeing local, national and international buyers.” “Texas is doing better, but we are still in a riskaverse environment,” notes Ingrum. “In 2007, loan committees might meet for 15 minutes on a large deal. Today, they are spending much more time understanding all the ways they could lose money on an investment.” Ingrum states that “gateway” markets such as Washington, D.C., or New York all have significant barriers to entry. “Coming out of the recession, you want to look at markets that have shown a proven ability to grow, and Texas fits that description well.” There is still more capital and more aggressive bidding for distressed assets than any other property profile. “I see a definite bifurcation between highquality core properties, opportunistic distressed properties and the vast wasteland of assets in the middle that nobody is interested in at the moment,” says Gillespie. “It is truly mind-boggling to see cases where high-performing assets are trading for less than a building that is half-leased. Some distressed buyers are TIERRA GRANDE


obviously purchasing the hope that they can do a better job than previous management did.” “There is always the question of whether now is a good time to sell,” says Vaz. “Owners of Class-A or -B assets may want to consider holding out for a better price. In the Class-C distressed apartment segment, our main objective is to secure cheaper debt for a future sale. “Fannie Mae recently offered us 5.25 percent nonrecourse money for ten years on a refinance deal. The loan was also assumable. Depending on what happens to inflation, two years from now you may not find such attractive debt financing being offered. So we are hoping to earn a premium for our assets that have secured cheap debt,” Vaz notes.

Financing Distressed Assets Bridge financing is making a comeback because of the comparatively low loan-to-value (LTV) ratios available today. “We are seeing mezzanine financing being offered again,” says Ingrum. “However, this time around the money is coming from hedge funds or debt funds that are much more sophisticated than in the past. They are only offering funds if they really like an asset.” David Carter, principal with Colliers International in Houston, is also seeing the return of mezzanine and second loan financing. “If you have a 60 percent LTV, you need the gap filled,” he says. “However, mezzanine funding rates are 12 to 15 percent right now. So it’s not cheap.” Vaz explains that his firm generally needs bridge financing to obtain enough debt until it can improve the properties enough for Fannie’s financing standards. “High LTVs are rare for Class-C distressed apartments,” he says. “A key factor driving the increase in available financing during 2011 was the increase in overall sales,” says Holshouser. “This provided lenders with more information about where commercial values are. And that has made lending easier.”

Challenges with Distressed Assets “The biggest challenge today is getting a deal done,” says Ingrum. “The trick is to pursue deals that result in a market sale. About 20 percent of time but only 8 percent of revenue is coming from distressed deals out of my office. “Timelines for everything (such as due diligence and loan agreements) are compressed with distressed assets, mainly because of the level of competition for them. This is especially true for properties greater than $10 million in value.” JANUARY 2012

Carter agrees. “Funding is generally not an issue if you are bidding. It’s mainly timing and due diligence. You need to move quickly. Sellers demand that you do your homework ahead of time. And once the contract is signed, they are not allowing changes.”

What Lies Ahead

R

eal Capital Analytics reports that about $1.2 trillion in commercial real estate assets were traded nationally between 2005 and 2007. “For the most part, these assets are still being held by those purchasers,” says Ingrum. “As a result, many of them will come up for sale in the next four years, depending on holding period, market conditions, and so on.” These properties could represent $200 billion per year in transactions. Many of them will be in the distressed category because of when they were purchased. “If you are a broker, you should consider focusing on what traded back then,” says Ingrum.

“In 2007, loan committees might meet for 15 minutes on a large deal. Today, they are spending much more time understanding all the ways they could lose money on an investment.” The quicker distressed assets get resolved, the better. “They tend to slowly deteriorate due to lack of tenant improvements and deferred maintenance,” notes Ingrum. “You can defer for one to two years, but after four or five years, it’s too long. We are pretty near that five-year window for a significant amount of product based on the 2007 start of this downturn.” Dr. Hunt (hhunt@tamu.edu) is a research economist with the Real Estate Center at Texas A&M University.

THE TAKEAWAY The volume of distressed property sales was expected to be much higher by this time. So far, everyone is still waiting. But according to commercial real estate insiders, distressed sales are on the way up.

21


Texas Economy

The Great Recession Why Intensity and Duration Varied By Ali Anari

Almost all Texas metropolitan areas had output and job losses during the Great Recession. But the extent to which local economies were negatively affected by the intensity and duration of the recession varied considerably. 22

I

n this study, recession intensity was measured in terms of the largest annual decline rate (negative growth rates) of employment, aggregate income and aggregate output. Recession duration was measured by the number of months or quarters of decline in rates of employment, aggregate income or output. Employment data was used because of its availability for all the metro areas.

Location Was Everything Recession intensity varied widely across Texas metro areas, from less than 1 percent for College Station-Bryan to 10.3 percent for Odessa (table and Figure 1). Recession duration varied from as few as four months for College Station-Bryan to 28 months for Wichita Falls (table and Figure 1). The smaller Texas metro areas are currently experiencing a fragile recovery. Abilene (Figure 1.1), Brownsville-Harlingen (Figure 1.5), San Angelo (Figure 1.18), Sherman-Denison (Figure 1.20), Texarkana (Figure 1.21) and Wichita Falls (Figure 1.25) are in a double-dip recession. Economic recovery in Odessa and Midland depends heavily on higher oil prices. However, larger metro areas such as Austin-San MarcosRound Rock (Figure 1.3), Dallas-Fort Worth-Arlington (Figure 1.8), Houston-Sugar Land-Baytown (Figure 1.10), and San Antonio (Figure 1.19) are experiencing more solid recoveries because their economies are more diversified. These metro areas account for more than two-thirds of the state’s economy. Their recovery and economic growth are expected to help smaller metro areas. TIERRA GRANDE


Contributing Factors

T

he Center’s research program on Texas business cycles found metro areas with a larger share of employment in the service-providing sector fared better than those with a higher share of goods-producing employment (mining, construction and manufacturing). In particular, metro areas with a larger share of employment in the education, health services, leisure and hospitality industry and the government sector fared better in the recession. Specifically, the research found four main factors explaining the severity of the Great Recession across the state’s metro areas. These factors are (1) relative share of employment in the education and health services industry, (2) relative share of government sector employment, (3) relative share of mining and construction employment, and (4) level of educational attainment (the area’s workforce measured by the proportion of adults with a college degree or higher). These four factors alone explained more than 75 percent of the variation in recession intensity across the state’s metro areas.

Education and Health Services Industry The education and health services industry was the only U.S. industry not affected by the Great Recession. It continued to

generate jobs and helped the recovery (Figure 2). Texas’ education and health services industry was more robust than the nation’s, posting annual employment growth rates topping 4 percent. Texas metro areas with smaller shares of employment in the education and health services industry suffered more than those with larger shares in the recession. The share of employment in that industry in 2009 varied from as low as 8.7 percent for Odessa to as high as 23.7 percent for McAllen-EdinburgMission (see table). The Odessa and Midland metro areas, which had less than 10 percent of their jobs in the industry, suffered most in the recession (see table). Center research found that an increase in the share of employment in the metro area’s health and education services industry by 10 percent reduced the recession intensity by 1.7 percent.

Government Sector While the U.S. government sector experienced job losses beginning in July 2009, Texas’ government sector continued to create jobs during the recession (Figure 3). Consequently, Texas metro areas with larger shares of employment in the local government sectors weathered the recession better at the trough. The share of government employment in the state’s metro areas in 2009 varied from as high as 37.5 percent for College

Figure 1. Nonfarm Employment Growth Rates (Percent) for Texas Metropolitan Statistical Areas, 2008–11 Figure 1.2

Figure 1.1

Abilene

10

0

0

–10

2008

2009

2010

2011 –10

College Station-Bryan

10

2008

2009

2010

10

–10

2008

Corpus Christi

2009

2010

2011 –10

2008

Figure 1.11

2010

2009

2010

2011 –10

2008

2008

2009

2010

2011

–10

2010

2010

2011 –10

2010

2008

2009

Longview

2011 –10

2010

2011

–10

2008

2009

2010

2008

2009

2011 –10

2010

2008

2009

2010

2011 –10

Lubbock

2008

2009

2010

2011

2010

2011

Midland

10

0

2008

2009

2010

2011 –10

0

0

2008

2009

2010

2009

2011 –10

Sherman-Denison

2008

2009

2010

2011

Figure 1.25

Waco

10

2008

Figure 1.20

10

2011 –10

2011

Figure 1.15

Figure 1.24

2010

2010

Houston-Sugar Land-Baytown

10

2011 –10

2009

10

10

0

2009

2008

Figure 1.10

San Antonio-New Braunfels

Victoria

2008

2011 –10

Figure 1.19

San Angelo

10

2011 –10

2010

0

Figure 1.23

2010

2009

El Paso

10

0

2009

2008

0

10

Tyler

2008

2011 –10

Brownsville-Harlingen

Figure 1.14

Figure 1.18

0

2009

2009

0

10

0

2008

2008

Figure 1.22

Texarkana

10

0

10

0

Figure 1.9

0

10

0

Figure 1.21

–10

2009

2011 –10

Beaumont-Port Arthur

Figure 1.13

Odessa

10

0

2010

10

Figure 1.17

McAllen-Edinburg-Mission

2009

0

Figure 1.16

–10

2008

10

2011 –10

0

2008

0

Dallas-Fort Worth-Arlington

Laredo

10

0

–10

0

Figure 1.12

Killeen-Temple-Fort Hood

10

2009

10

Figure 1.8

0

0

10

2011 –10

Figure 1.7

Figure 1.6

10

Austin-Round Rock-San Marcos

Figure 1.5

Figure 1.4

Figure 1.3

Amarillo

10

Wichita Falls

0

2008

2009

2010

2011 –10

2008

2009

2010

2011

Sources: U.S. Texas Workforce Commission and Real Estate Center at Texas A&M University JANUARY 2012

23


Recession Intensity and Duration and Explanatory Factors for Texas Metropolitan Areas During Great Recession

Metropolitan Area

Recession Intensity

Recession Duration

Education and Health Share

Odessa Midland Longview Victoria Beaumont-Port Arthur Wichita Falls Laredo Tyler Dallas-Fort Worth-Arlington Abilene Texarkana Houston-Sugar Land-Baytown Sherman-Denison Corpus Christi San Angelo Amarillo Austin-Round Rock-San Marcos San Antonio-New Braunfels Brownsville-Harlingen Waco El Paso Lubbock Killeen-Temple-Fort Hood McAllen-Edinburg-Mission College Station-Bryan

–10.3 –9.0 –6.8 –6.5 –6.3 –6.2 –5.4 –4.9 –4.7 –4.5 –4.2 –4.2 –3.9 –3.8 –3.5 –3.2 –3.1 –2.7 –2.4 –2.2 –2.1 –2.1 –1.7 –1.1 –0.8

14 13 15 17 16 28 15 16 19 22 15 16 15 14 20 20 14 14 11 15 14 15 9 13 4

8.7 9.0 14.6 13.2 13.3 15.0 14.3 20.8 11.3 19.7 15.7 11.1 19.3 15.4 16.3 14.1 10.6 14.3 23.5 18.3 12.0 15.1 14.1 23.7 10.6

Mining and Construction Government Share Share 21.2 23.5 13.9 14.9 12.9 6.9 4.8 6.7 5.8 9.1 4.2 11.1 5.9 12.4 7.8 6.2 5.7 6.5 3.3 5.9 5.6 4.9 4.8 4.7 7.5

14.9 12.2 12.3 17.4 15.7 21.3 24.6 13.8 13.0 19.4 24.0 14.1 14.6 18.9 19.6 18.2 21.1 18.5 23.5 16.4 23.8 22.4 28.3 24.7 37.5

Education (Bachelor’s or Higher) 12.8 23.0 17.5 16..7 16.4 17.9 19.2 23.4 30.0 20.7 16.7 27.9 19.3 19.8 20.2 22.0 38.7 24.8 14.6 21.1 20.4 26.5 18.3 16.1 33.3

Sources: U.S. Bureau of Labor Statistics, U.S. Census Bureau and Real Estate Center at Texas A&M University

Figure 2. Education and Health Services Industry Employment Growth Rates Texas and United States, 2007–11 5

PERCENT

4 3 2 NOV. 7 1 2007

2009

2011

Sources: U.S. Bureau of Labor Statistics and Real Estate Center at Texas A&M University

Figure 3. Government Sector Employment Growth Rates Texas and United States, 2007–11

Mining and Construction Industry

4

PERCENT

2 0

–2 –4 2007

2009

2011

NOV. 7

Sources: U.S. Bureau of Labor Statistics and Real Estate Center at Texas A&M University

24

Station-Bryan to as low as 12.2 percent for Midland. College Station-Bryan had the largest share of government employment in the local economy followed by Killeen-Temple-Fort Hood and McAllen-Edinburg-Mission. These three metro areas suffered least in the recession (see table). Center research revealed that a 10 percent increase in the government share of employment reduced recession intensity by 1.4 percent. Interestingly, the government sector, which played a key role in alleviating the negative impact of the recession, did not remain immune to its adverse impacts. Eventually, local and state government revenues were reduced, leading to government spending cuts and job cuts. Texas government jobs fell from 1,884,100 in October 2010 to 1,828,700 in October 2011, a decline rate of 2.9 percent. But the state’s robust private sector offset the negative impact of government job losses (see Monthly Review of the Texas Economy, http://recenter.tamu.edu/pdf/1862.pdf). The Texas economy, like the U.S. economy, expanded during the boom fueled by a nationwide credit expansion from 2003 to 2008. The state’s economic expansion was further strengthened by higher crude oil prices prior to the onset of the Great Recession. While the U.S. mining and construction industry experienced job losses beginning in July 2007, the state’s mining and construction industry continued to generate jobs until January 2009 (Figure 4). The monthly average spot price for West Texas intermediate crude oil reached an all-time high of $133.44 per barrel in July 2008. The average annual employment growth rate of Texas’ mining and construction industry climbed to 8.7 percent in November 2007, and remained above 5 percent until August 2008 (Figure 4). TIERRA GRANDE


Figure 4. Mining and Construction Industry Employment Growth Rates Texas and United States, 2007–11 10

PERCENT

In the aftermath of the oil price collapse from $133.44 in July 2008 to $39.16 in February 2009, Texas metro areas with larger shares of employment in mining and construction industries were hit hard. In 2009, that industry’s employment share varied from as high as 23.5 percent for Midland to 3.3 percent for Brownsville-Harlingen. The petroplexes of Odessa and Midland not only suffered from lower oil prices, but also from the general impact of the nationwide recession. They suffered most among the state’s metro areas in terms of job losses (table, Figures 1.15 and 1.17). Longview, Victoria and Beaumont-Port Arthur had more than 12.9 percent mining and construction employment and also bore the brunt of the recession (see table). Center research shows that an increase of 10 percent in the mining and construction employment share increased recession intensity by 1.9 percent.

0 NOV. 7

–10

–20 2007

2009

2011

Sources: U.S. Bureau of Labor Statistics and Real Estate Center at Texas A&M University

Educational Attainment Despite all its adverse effects, the Great Recession did something positive. It highlighted the importance of educational attainment. While the national unemployment rate among persons 25 years and older with less than a high school diploma peaked as high as 15.7 percent in November 2010, the rate for that group with a bachelor’s degree or higher was only 5.1 percent that month and has not exceeded this rate since then. Texas metro areas with more employees holding bachelor’s degrees or higher suffered less during the recession in terms of job losses. The share of higher-educated employees in metro populations in 2009 varied from 38.7 percent for Austin-Round Rock-San Marcos to 12.8 percent for Odessa. College StationBryan suffered least in the recession not only because the metro area had the largest share of government employment but also because it had the second largest share of persons 25 years or older with a bachelor’s degree or higher (see table).

Center business cycle research found that a 10 percent increase in the share of population with bachelor’s degree and higher reduced recession intensity by 1.2 percent. Dr. Anari (m-anari@tamu.edu) is a research economist with the Real Estate Center at Texas A&M University.

THE TAKEAWAY The Real Estate Center’s business cycle research program found that shares of employment in the government sector, education and health services industry, mining and construction industry, and the level of educational attainment were the most important factors explaining the differences in relative severity of the Great Recession in the state’s metro areas.

THE OIL PRICE COLLAPSE during the Great Recession dealt a significant blow to areas dependent on petroleum industry employment.

JANUARY 2012

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Legal Issues

Historically, local governments could change land use regulations, then apply the new rules to planned projects that did not yet have a permit, and sometimes, even to projects with permits. They also could limit certain changes to existing but newly nonconforming projects, which were considered grandfathered under prior regulations. 26

TIERRA GRANDE


G

randfathered rights were based on legal principals of equity and fairness resulting in a judicial balancing of private property owners’ rights to use real estate and local governments’ rights to regulate land use for the benefit of the public. The result was limited protection of private property rights. The Texas Legislature expanded this protection in Chapter 245 of the Texas Local Government Code, which protects owners from changes in certain regulations once they have filed a development permit application (http://www.statutes.legis. state.tx.us/Docs/LG/htm/ LG.245.htm). These vested rights apply to some, but not all, land use regulations, and only to the project described in the application. If the project becomes dormant, the vested rights may be lost. Although these protections have been in place since 1987, many owners are not aware of them. According to the Texas attorney general, statutory vested rights run with the real property, much like a restrictive covenant (deed restriction). They do not belong to the party filing the application.

When does vesting occur? A project is vested on submission of an application for a required permit. The permit may be the first in a series of permits for a project. A “mailbox rule” applies, which allows the application to be mailed by certified mail, return receipt requested. In that case, vesting occurs when the application is deposited in the mail, as documented on a certified mail receipt. This provision enables owners to submit last-minute applications before regulations change. The application must describe the proposed project in enough detail that the local government receives “fair notice” of the nature and scope of the project, with a particular focus on the features to be vested.

How is ‘project’ defined? The definition of project is broad and includes “an endeavor over which a regulatory agency exerts its jurisdiction and for which one or more permits are required to initiate, continue or complete the endeavor.” It leaves much room for litigation, and there are already several reported decisions. In one case, the court held that a residential subdivision development was a single project including the design, platting and construction of the lots, as well as the subsequent construction of houses on the lots. The courts look to the specific facts of each matter to determine if the current project is sufficiently similar to the project covered by an earlier application.

How long does vesting continue? Vested rights continue as long as the project is not dormant, and the permit does not lapse. An owner may prevent a project JANUARY 2012

from becoming dormant by making “progress toward completion,” which is evidenced by: • filing an application for a final plat or plan; • a good-faith attempt to file a permit application necessary to begin or continue toward completion of the project; • costs being incurred for developing the project, such as roadway, utility and other infrastructure facilities (but not land costs) exceeding 5 percent of the appraised market value of the land for the project; • posting of fiscal security; or • payment of utility connection or impact fees. A local government may pass regulations that cause an individual permit to expire no less than two years from application, and an entire project to expire no less than five years from application, if no progress is made toward completion. Vesting will also expire.

What land use regulations may be vested? • • • • • • • •

Landscaping Tree preservation Open space Park dedication Property classification Lot size/dimensions/coverage Building size Regulations that do not change development permitted by a restrictive covenant required by a municipality

What regulations may not be vested? • • • •

Zoning regulations not listed previously. Nonzoning land use regulations not listed previously. Certain construction regulations. Regulations relating to sexually oriented business, colonias, permit fees, annexation, utility connections, flooding, public works, imminent destruction of property or injury of persons.

Why did Texas Legislature adopt vested rights?

V

ested rights protect the reasonable expectation of owners and developers to be able to develop under the regulations applicable at the inception of a project. Substantial risk, costs and time are saved if the regulatory scheme is “frozen” when the development process is commenced. A recent court decision describes the justification for vested rights: . . . to prohibit land-use regulators from changing the rules governing development projects “in the middle of the game,” thereby insulating alreadyunderway development and related investment from the vicissitudes and uncertainties of regulatory decision making and all that may influence it. That intent is further confirmed by the Legislature’s

27


that may be vested as preventing application of use limitations explicit findings regarding chapter 245’s purpose: in new zoning regulations to a vested project. For example, if a to combat “administrative and legislative practices multifamily project is vested, the rezoning of the project area that often result in unnecessary governmental to single family after the date of vesting will not prevent the regulatory uncertainty that inhibits the economic development of that project. development of the state[, ] increases the costs of This is a dramatic change from prior law, which would housing and other forms of land development[, ] grandfather only a similar multifamily project if it had received and often resulted in the repeal of previously issued a permit and construction had commenced. The extent of permits causing decreased property and related property classification vesting is an ongoing debate between values, bankruptcies, and failed projects.” . . . [the] lawyers representing owners who assert broad application and purpose of chapter 245’s statutory predecessor, those representing citformer chapter 481 of ies who assert a narrower the government code, scope. Guidance from the was to “establish courts will be needed to requirements relating settle the issue. to the processing and issuance of permits Building Size and approvals by govThe allowable size of ernmental regulatory a building may not be agencies in order to reduced by subsequent regalleviate bureaucratic ulation after vesting. This obstacles to ecobroad protection should nomic development.” apply to limits on setback, . . . Moreover, as an buildable area or footprint, incidental matter of height, floor area ratios, historical fact, the square footage and any legislative record other land use regulation reflects that bill that has a direct impact on proponents advocated building size. chapter 245 as an appropriate response Lot Size/Dimensions/ to instances when STATUTORY VESTED RIGHTS were created to ensure that changes Coverage the City of Austin in land use regulations could not be applied to development projects Residential lot developers had purportedly already in progress. This protection ends if a project becomes dormant have significant protecor if the project permit lapses. imposed new regulation from post-application tory restrictions regulatory changes attempting to reduce density by increasretroactively on development projects that were ing minimum lot sizes or dimensions, or reducing maximum already underway, causing project failures, bankbuilding or impervious coverage. ruptcies, and regulatory uncertainty for developers and landowners. Although statutory vested rights have been around for almost 15 years, some real estate practitioners are not aware of them. Local governments, which have an interest in applying current regulations, are unlikely to notify owners or developers of their vested rights. It is up to owners or developers to understand and assert their vested rights. Even then, some local governments interpret vested rights narrowly.

Significant Areas of Protection Property Classification The Texas Association of Realtors interprets the 2005 addition of “Property Classification” to the list of land use regulations

28

Wilson (rwilson@wcglaw.net) is a board-certified commercial real estate attorney with Wilson, Cribbs & Goren P.C. of Houston, a fellow of the American College of Real Estate Lawyers and a Counselor of Real Estate. He has a long-standing relationship with the Center through the commercial seminar offered jointly by the Center and the South Texas College of Law.

THE TAKEAWAY Vested rights freeze land use regulations affecting property classification, building size, lot size/dimension/coverage and certain other matters once the owner or developer files a permit application for that project. TIERRA GRANDE


JANUARY 2012

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Tierra Grande - January 2012  

The Real Estate Center is the nation's largest publicly funded organization devoted to real estate research. The Center's flagship periodica...

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