APRIL 2014 ™
JOURNAL OF THE REAL ESTATE CENTER AT TEXAS A&M UNIVERSITY
NON-PROFIT ORG. U.S. POSTAGE PAID HOUSTON, TEXAS PERMIT No. 4126 COLLEGE STATION, TEXAS 77843-2115
In This Issue Months of Inventory and Sale Prices Border and Metro Economies Penalty-Free IRA Withdrawals Flood Insurance Reform Yellen and the Fed Buying Electricity Property Tax Protest
APRIL 2014 ™
JOURNAL OF THE REAL ESTATE CENTER AT TEXAS A&M UNIVERSITY
VOLUME 21, NUMBER 2 ™
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JOURNAL OF THE REAL ESTATE CENTER AT TEXAS A&M UNIVERSITY
Director, GARY W. MALER Chief Economist, MARK G. DOTZOUR Senior Editor, DAVID S. JONES 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, RR DONNELLEY, HOUSTON
ADVISORY COMMITTEE: Kimberly Shambley, Dallas, chairman; C. Clark Welder, Beeville, vice chairman; Mario A. Arriaga, Spring; James Michael Boyd, Houston; Russell Cain, Port Lavaca; Jacquelyn K. Hawkins, Austin; Walter F. Nelson, Houston; Doug Roberts, Austin; Ronald C. Wakefield, San Antonio; and Avis Wukasch, Georgetown, ex-officio repre senting the Texas Real Estate Commission.
14 On the Water Front
Flood Insurance Reform Means Higher Premiums Legislation aimed at tackling the National Flood Insurance Program’s $24 billion debt will end subsidies for nearly 440,000 program participants and base premiums strictly on a property’s risk levels. BY CHARLES E. GILLILAND AND HARRISON HUNT
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 licen sees. 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: Robert Beals II, pp. 1, 2; Real Estate Center files, pp. 6–7, 10, 22; courtesy of Shaine Mata, p. 8; JP Beato III, pp. 9, 11, 26–27; AP Photo/Matt Rourke, pp. 14–15; AP Photo/David J. Phillip, pp. 16–17; AP Photo/ Star-Telegram/Joyce Marshall, p. 18; courtesy of United States Federal Reserve, p. 19; Kari Rives, pp. 24, 26–27. © 2014, Real Estate Center. All rights reserved.
2 Closing the Gap
19 Yellen at the Helm
A study of sales data reveals how an area’s housing inventory affects prices. When months of inventory is high, buyers have an advantage and usually pay less for homes. BY ALI ANARI
Janet Yellen appears committed to the Fed’s mandate to maximize employment and keep prices stable. Don’t look for her to raise interest rates until unemployment gets closer to 5 percent. BY MARK G. DOTZOUR, COLT KOKEL AND JOSHUA PARULIAN
22 Purchasing Power
How Housing Market Conditions Affect Negotiations
Major Metros, Border Cities
Llano County bluebonnets
PHOTOGRAPHER Laurence Parent
The Business of Buying Electricity
Texas’ economy is massive and strong. But there are big differences between the economies of its major metropolitan statistical areas (MSAs) and Border MSAs. These differences center on economic diversity. BY LUIS B. TORRES AND JAMES P. GAINES
Businesses buying electricity in Texas need to do some serious homework to get the best deal. With different types of electric providers and pricing methods varying widely as well, there are no easy comparisons to be made. BY HAROLD D. HUNT
13 Penalty-Free IRA With-
26 Property Tax Protest
Generally speaking, the IRS won’t let you pull money out of an IRA penalty free unless you’re 59½. But first-time homebuyers and those who haven’t owned a home in the past two years can withdraw money to use toward purchasing a home. BY JERROLD J. STERN
If your property tax bill makes you scream, take heart. Texas’ Property Tax Code allows you to appeal to your local appraisal board if a property is not assessed at fair market value or if other properties in your area are assessed differently. BY CHARLES E. GILLILAND
drawals for Home Purchase ON THE COVER
Where to From Here?
Closing the Gap How Housing Market Conditions Affect Negotiations By Ali Anari
here’s always room to negotiate,” real estate agents are fond of saying. Research shows that’s true because the final sales price is usually less than the original asking price. A research project at the Real Estate Center studied the relationship between changing housing market conditions and both list and sale prices. The research finds that the larger the “for-sale” inventory, the larger the “spread” or difference between sale price and list price. That is, market conditions, as measured by months of inventory of homes for sale, affect the gap between list and sale prices. The dataset used for this project consisted of 15 years of housing sales data (1998–2012) compiled from the Multiple Listing Service (MLS) for the Austin metropolitan area.
List Price/Sale Price Gap When a house is listed for sale, the list price/asking price is set by homeowners and their agents. The actual sale price is determined by local housing market conditions and willing buyers and sellers. When housing demand exceeds supply in a local market, sale prices can be close to or even exceed list prices. By contrast, when the number of home sellers exceeds that of homebuyers, sellers may have to reduce their asking prices to increase the likelihood of a sale. These market conditions are commonly known as a seller’s market or a buyer’s market. Because sellers seek to maximize their asking prices while buyers want to minimize the costs of buying homes, a gap often exists between asking prices and sale prices due to (1) market conditions, (2) buyers’, sellers’ and agents’ knowledge about home sales transactions and housing market conditions and (3) how buyers, sellers and their agents use market information to attain their objectives. Knowledgeable and reliable real estate agents can help homebuyers and sellers narrow the list price/sale price gap. APRIL 2014
Figure 1. Austin Residential Market Average List Price and Average Sale Price 1998–2012 300,000
List Price Sale Price
The difference between the initial list price of a house and the final sale price is the spread, just like the difference between a bid price and an ask price in the stock market. Because of changing market conditions, the 150,000 spread between average list prices and average sale prices in local housing markets widens or narrows over time. Although the sale price for an individual home can be 100,000 more or less than its list price, national averages show 1998 2000 2002 2004 2006 2008 2010 2012 average sale prices have been less than average list prices. Year:Month In Austin’s housing market, the average list prices were Source: Real Estate Center at Texas A&M University higher than average sale price in all months from 1998 through 2012 (Figure 1). Both exhibit monthly Figure 2. Austin Residential Market seasonal variations Moving Averages of List Price and Sale Price with peaks in summers 1998–2012 and troughs in winters. 280,000 Adjusted for seasonality, List Price the 12-month moving Sale Price averages of list and sale 240,000 prices show changing spreads between list and sale prices (Figure 2). The 200,000 spread narrowed in 2006 and 2007 and widened after 2008. During the 160,000 period studied, the average list price of homes sold in Austin was $225,892 120,000 compared with an aver1998 2000 2002 2004 2006 2008 2010 2012 age sale price of $218,522. Year:Month Over the past 15 years, Source: Real Estate Center at Texas A&M University the average sales price was 96.7 percent of the average Figure 3. List Price/Sale Price Spread as Percentages list price, and the average spread was 3.26 percent. 1998–2012 verage percentages of the list price/sale price spread as 6 a percentage of list price are shown in Figure 3. Because Spread of seasonality in list and sale prices, the average Moving Average Spread 5 spreads also exhibit seasonal variations. The moving average of the spreads fell from 2.2 percent in 4 December 1998 to an all-time low of 1.1 percent in January 2001. The moving average of the spread increased to more than 3 3.8 percent in February 2004, in the aftermath of the dot-com bubble bursting. In the nationwide housing market rebound 2 of 2005–07, the spread trended downward until November 2006, when it fell to 2.6 percent. The downward trend was 1 reversed in 2007, and the Great Recession of 2009 forced sellers to reduce the prices of their homes for sale by more than 4.6 0 percent in October 2009. 1998 2000 2002 2004 2006 2008 2010 2012 Implementation of a number of Federal Reserve policy initiaYear:Month tives, as well as the Housing and Economic Recovery Act of Source: Real Estate Center at Texas A&M University 2008 and the American Recovery and Reinvestment Act of 2009, Dollars
decreased the average list price/sales price spread from November 2009. The spread fell to 4 percent in June 2010, but the impact of the policy measures did not last long; the spread climbed to 4.4 percent in June 2011. Since then, the spread has been trending downward.
Home Price Discounts and Months of Inventory of Homes Months of inventory Price reduction, percent
Source: Real Estate Center at Texas A&M University
Spread, Months of Inventory
Figure 4. Austin Residential Market Home
Months of Inventory
hanges in average list price/sale price Sale Price Reduction and Months of Inventory spread reflect changing local market 1998–2012 conditions. The number of months of 12 inventory is an appropriate measure of local Spread housing market conditions, as it illustrates Months of Inventory the relative supply and demand for homes. 8 Months of inventory is calculated by dividing 6 the number of homes for sale at the end of a 4 month by the number of homes sold in that month. This metric summarizes the supply 4 and demand of the local housing market. 0 Figure 4 shows average percentages of the 2 list price/sale price spread (blue line, left axis), and averages of months of inventory (right axis, red line) of homes for sale in the 0 Austin area. The months of inventory aver1998 2000 2002 2004 2006 2008 2010 2012 ages are computed by dividing the number Year:Month of homes for sale at the end of each month Source: Real Estate Center at Texas A&M University by moving averages of monthly home sales. The average spread and the average month of inventory move in the same direction. Figure 5. Austin Residential Market A scatter diagram of the spread and months of inventory Home Sale Price Reduction and Inventory quantifies the relationship between list price/sale price spread 5 and months of inventory (Figure 5). The computed trend line shows that as the inventory of homes for sale gets larger, the spread gets larger too. That is, as the inventory of homes 4 increased in Austin, home sellers had to offer a larger discount to list price. The table shows the average spread associated with months of inventory of homes for sale. This discount 3 from list price to sale price increased 0.62 percent for each onemonth increase in inventory of homes for sale. Dr. Anari (firstname.lastname@example.org) is a research economist with the Real Estate Center at Texas A&M University.
THE TAKEAWAY Finding the “right price” for a home for sale is not an easy task, but homebuyers and their agents can make more informed decisions by paying attention to the relationships between list prices, sale prices and inventory of homes for sale. APRIL 2014
Months of Inventory
Source: Real Estate Center at Texas A&M University
McAllen improves, allowing new homes to be built at a lower cost and The variations in regional industry mix, among other facat a faster rate. However, if the price of lumber or drywall or tors, lead to economic, demographic and housing market labor increases, the cost of new homes goes up. Most of these differences, especially between the state’s major metropolitan fundamentals are determined locally because housing is a nonstatistical areas (MSAs): • Austin-Round Rock (Austin), tradable good, which means local factors play a dominant role • Dallas-Fort Worth-Arlington (Dallas), in determining price. • Houston-The Woodlands-Sugar Land (Houston) and Demographic Changes, Comparisons • San Antonio-New Braunfels (San Antonio), and Border MSAs: heer size plays a major role in any market comparison. • Brownsville-Harlingen (Brownsville), In 2012, 65 percent of the state’s total population resided • El Paso, in the four major MSAs while 9 percent lived in the four • Laredo and largest Border MSAs. None of the Border MSAs possess a popu• McAllen-Edinburg-Mission (McAllen). lation greater than one million; all the major MSAs exceed that This is the first of a two-part analysis comparing the econoamount. McAllen and El Paso top 800,000; Dallas and Houston mies and housing markets of the four principal Border commueach are home to more than six million. nities with the state and the four major MSAs. From 2001 to 2012, the total population of each of the major Growth in a local economy creates jobs, providing greater MSAs grew faster than the state’s 1.9 percent growth rate. employment, higher wages and prosperity, especially for a Houston, Dallas and San Antonio expanded between 2.1 and more highly educated and skilled workforce. Higher-paying 2.3 percent, while Austin exploded by more than 3.2 percent. jobs tend to attract migration from other parts of the state Laredo’s and McAllen’s population grew at 2.5 and 2.9 percent, and country, creating population growth. Jobs and population respectively, while Brownsville and El Paso increased by 1.7 growth, in turn, increase the demand for housing, putting and 1.6 percent, respectively. upward pressure on home prices. Energy and technology industries Figure 1. Accumulated Net Domestic and are generally not as prevalent in the International Migration, Major and Border MSAs 2001–12 Border regions as in the major MSAs. McAllen-Edinburg-Mission The Border MSAs depend essentially on the performance of the Mexican Net Domestic Laredo economy and U.S. government and, to International a lesser extent, state and local governEl Paso ment employment. These areas rely Brownsville-Harlingen heavily on international trade, making transportation and retail trade with San Antonio-New Braunfels Mexican consumers more influential. The government sector comprises Bor- Houston-The Woodlands-Sugar Land der enforcement officials, Homeland Dallas-Fort Worth-Arlington Security and federal public programs Austin-Round Rock that address the high poverty levels prevalent in the region. –50 0 50 100 150 200 250 300 350 400 450 Thousands of People ocal housing markets derive Note: Estimated by Real Estate Center at Texas A&M University. from local demand and supply Source: U.S. Census Bureau conditions. Demand factors include demographic characteristics, employment growth, A major difference in total population growth involves total income growth, changes in financing mechanisms and interest net migration, domestic and foreign. People have been leaving rates as well as local attitudes, tastes and preferences, and loca- the Border MSAs faster than they have been moving to them. tional characteristics such as accessibility, quality of schools While the major MSAs had high levels of positive net domestic and crime. migration, three of the Border MSAs underwent negative net Supply-side factors include the age and quality of the existdomestic migration during the same period. Only McAllen ing housing stock, new construction, building technology, posted positive domestic immigration. Dallas attracted more land availability and the industrial efficiency of the housthan 400,000 net new residents from other states and counties ing market. New home construction technology continually while Houston added more than 300,000 (Figure 1).
Dallas Some of the domestic outflow in the Border MSAs has been offset by positive international immigration. El Paso and McAllen Anglo Hispanic Other attracted the greatest number of international migrants among the 2008–12 McAllen-Edinburg-Mission 2050 Border MSAs (Figure 1). Foreign migration has also been an imporLaredo 2008–12 2050 tant contributor to population El Paso 2008–12 growth in the major MSAs, espe2050 cially in Houston and Dallas, with 2008–12 Brownsville-Harlingen 2050 each adding more than 350,000 San Antonio-New Braunfels 2008–12 people. 2050 The accumulated number of forHouston-The Woodlands-Sugar Land 2008–12 eign migrants moving to Houston 2050 exceeded net domestic migration Dallas-Fort Worth-Arlington 2008–12 2050 from 2001 to 2012. San Antonio Austin-Round Rock 2008–12 received the fewest number of 2050 foreign immigrants among the 0 20 40 60 80 100 major MSAs. International migraPercent Total of Population tion continues to play a determinNote: Estimated by Real Estate Center at Texas A&M University. ing role in the state’s population Sources: Texas State Data Center and Office of the State Demographer growth, consequently shaping the state’s overall demographic pattern. The biggest demographic differences Figure 3. Population Projections between the major and Border MSAs center around education, age and ethnicMajor and Border MSAs 2050 ity. According to the Census Bureau, McAllen-Edinburg-Mission from 2008–12 the major MSAs’ populations included a smaller percentage of Laredo 2050 the population under 25 years old. The 2012 El Paso major MSAs’ populations contain about 36 percent under 25, whereas the Border Brownsville-Harlingen MSAs’ populations run more than 40 percent. San Antonio-New Braunfels The major MSAs’ residents also Houston-The Woodlands-Sugar Land exhibit a higher general level of educational attainment than the Border areas. Dallas-Fort Worth-Arlington Approximately 22 to 24 percent of the Austin-Round Rock Border communities’ and the major MSAs’ populations possess a high school 0 4,000 8,000 12,000 18,000 Thousands of People diploma. Within the Border MSAs, the Notes: Estimated by Real Estate Center at Texas A&M University. percent of the population with a bacheSources: Texas State Data Center and Office of the State Demographer lor’s degree or higher ranges from around 13 percent in Brownsville to about 18 percent in El Paso. Within the major MSAs, the percent of the population with a college degree or better runs between about 24 percent in San Antonio to as high as 36 percent in Austin. Not surprisingly, the Hispanic population is much greater in the Border MSAs than in the major MSAs (Figure 2). The Houston MSA contains the most diverse population composition
Figure 2. Population by Race 2008–12 and Population Projections by Race 2050 Major and Border MSAs
Houston of both groups. McAllen’s and Laredo’s Hispanic populations 79 percent (El Paso) of both the U.S. and Texas median family exceed 92 percent while Brownsville’s and El Paso’s are more income levels. In contrast, the major MSAs all equal or exceed than 80 percent. San Antonio’s population includes approxithe U.S. and Texas median level, ranging from 100 percent in mately half Hispanic, and the other major MSAs are more San Antonio to 117 percent in Austin. equally distributed. According to the Bureau of Economic Analysis, the four ased on population projections by the Texas State major MSAs generated about 73 percent and the Border areas Demographer’s Office, seven of the eight MSAs being comFigure 4. Median Household Income pared will at least double in populaMajor and Border MSAs 2012 tion by 2050. Houston, Dallas and Austin nearly triple. Only El Paso is McAllen-Edinburg-Mission projected to not quite double in total Laredo population. Hispanics will represent El Paso Texas $50,740 a substantial majority of the populaBrownsville-Harlingen United States tion by 2050 in each of the MSAs San Antonio-New Braunfels $51,371 (Figure 3). Houston-The Woodlands-Sugar Land The four major MSAs encompass Dallas-Fort Worth-Arlington 65.4 percent of the households in Austin-Round Rock the state, while the Border MSAs 0 10,000 20,000 30,000 40,000 50,000 60,000 contain 7.5 percent of the state’s Dollars total number of households. HouseNotes: Estimated by Real Estate Center at Texas A&M University. American Community One Year Estimates. Source: U.S. Census Bureau hold formation, a major factor in housing demand, increased in both the major MSAs and the Border areas. The rate of increase in the number of houseFigure 5. Median Household Income Growth holds between 2006 and Major and Border MSAs 2012 2012 in the major MSAs McAllen-Edinburg-Mission and two of the Border MSAs Laredo greatly exceeded both the El Paso national and state rates of Brownsville-Harlingen expansion. The number Texas San Antonio-New Braunfels 0.4% of households in Austin, Houston-The Woodlands-Sugar Land United States McAllen and Brownsville –0.8% Dallas-Fort Worth-Arlington ballooned by 3 percent, 4 Austin-Round Rock percent and 5.3 percent,
respectively. The El Paso and Laredo household formation rate exceeded the national rate of 0.6 percent but fell short of Texas’ 1.7 percent rate of increase.
Notes: Estimated by Real Estate Center at Texas A&M University. American Community One Year Estimates. Converted to real terms with the Consumer Price Index U.S. city average 1982–84=100. Sources: U.S. Census Bureau and Bureau of Labor Statistics
Income, Employment, Industry Diversification A significant disparity between Border and major MSAs is reflected in the differences in median household incomes among the areas. The major MSAs enjoy a median household income substantially greater than the Border MSAs as well as the United States and Texas median (Figure 4) and that grew more than the national median household income in 2012 (Figure 5). The Border MSAs range from 60 percent (Brownsville) to
about 4 percent of Texas’ gross state product (GSP) in 2012. A substantial economic difference between the major MSAs and the Border communities is evident by comparing the 2012 gross metropolitan product (GMP) per capita in each area. The benchmark U.S. GDP per capita was $49,587 and Texas’ was $53,623, or 8 percent greater. The major MSAs produced GMP per capita values ranging from $72,442 (135 percent of Texas’ value) in Houston to $41,179 (77 percent of Texas’ value) in San Antonio. The Border MSAs’ GMP per capita ranged from TIERRA GRANDE
Figure 6. GMP per Capita Major and Border MSAs 2012 McAllen-Edinburg-Mission Laredo El Paso Brownsville-Harlingen San Antonio-New Braunfels Houston-The Woodlands-Sugar Land Dallas-Fort Worth-Arlington Austin-Round Rock
Texas $53,623 United States $49,587
10,000 20,000 30,000 40,000 50,000 60,000 70,000 Dollars
Note: Estimated by Real Estate Center at Texas A&M University. Source: Bureau of Economic Analysis
Figure 7. Private Nonfarm Employment Growth Major and Border MSAs 2002–13 McAllen-Edinburg-Mission Laredo El Paso Brownsville-Harlingen San Antonio-New Braunfels Houston-The Woodlands-Sugar Land Dallas-Fort Worth-Arlington Austin-Round Rock
Texas 1.4% United States 0.3%
0.5 1.0 1.5 2.0 2.5 3.0 Percent of Texas Total Employment
Notes: Estimated by Real Estate Center at Texas A&M University Data up to November 2013. Source: Bureau of Labor Statistics
Figure 8. Unemployment Rates Major and Border MSAs 2012 McAllen-Edinburg-Mission Laredo El Paso Brownsville-Harlingen San Antonio-New Braunfels
Texas 6.4% United States 7.5%
Houston-The Woodlands-Sugar Land Dallas-Fort Worth-Arlington Austin-Round Rock 0
Note: Estimated by Real Estate Center at Texas A&M University. Source: Bureau of Labor Statistics APRIL 2014
$35,916 (67 percent of Texas’ value) in El Paso to a low of $19,869 (37 percent of Texas’ value) in McAllen (Figure 6). With the exception of San Antonio, GMP per capita for Texas major MSAs is higher than for the state and the nation. The major MSAs accounted for 68.1 percent of Texas’ nonfarm employment in 2012, and the Border MSAs accounted for 6.8 percent of the state total. Laredo and McAllen posted the highest employment growth rates from 2002 to November 2013 among all of the MSAs (Figure 7). Although employment in all eight of the MSAs studied grew faster than the nation, only El Paso and Dallas failed to expand as fast as the state overall. The unemployment rate is higher in the Border MSAs than the major MSAs (Figure 8). Laredo’s unemployment is most similar to the major MSAs. McAllen and Brownsville’s unemployment rates exceed 11 percent. Only Austin’s unemployment rate is less than the statewide average of 6.4 percent. ocal industry mix represents an important economic characteristic of each area and helps explain the major differences between the Border communities and the major MSAs. Areas with substantial energy and technology industries performed well after the Great Recession. Austin’s and Houston’s employment growth between 2011 and 2013, for example, greatly exceeded the state and national growth. An area with a more diversified economy has a lower risk of being affected negatively by declines in any single industry. A highly concentrated economy in which the vast majority of output, earnings and employment derive from a single or a few key industries can be greatly affected by shocks to those industries. Location quotients (LQ) reflect the level of industrial diversification for each of the eight MSAs. An LQ compares an MSA’s share of employment with the corresponding national share. The United States represents the benchmark of diversity because it contains a mix of all industries
in all regions. An individual LQ for a specific industry in a community greater than one represents relative specialization or concentration in that industry within the area. The greater the LQ, the greater dependence the area has on the specific industry and, therefore, the more specialized (less diversified) the area is. enerally, the major MSAs show more specialization in construction; professional scientific and management services; wholesale and retail trade; and finance, insurance, and real estate. As expected, Houston exhibited lower values in these categories and measured greater reliance in oil and gas extraction, construction and wholesale trade. By contrast, the Border MSAs’ economies concentrate in retail trade; transportation, warehousing and utilities; educational and health services; and public administration (government). All MSAs share a specialization in the construction industry, with the major MSAs registering the highest values. Laredo had the highest individual levels of concentration in specific industries: transportation and warehousing as well as mining extraction (see table). A Hachman Index summarizes the LQs for geographical areas to measure how closely an MSA’s industry distribution compares with that of the United States. This measure is bounded between zero and one, where one means the MSA has the same industrial structure as the United States and is, therefore, considered diversified, and zero represents an industrial structure that is concentrated in a few industries and not diversified.
Overall, the local economies of the major MSAs were more diversified than the Border MSAs. The least diversified MSAs include Laredo and McAllen. Laredo’s economy focuses on energy and transportation, and McAllen’s economy relies on energy, education and construction. Interestingly, Dallas and San Antonio were found to be the most diversified, possessing an industrial structure most similar to that of the United States. The second part of this comparative analysis between the Border MSAs and the major MSAs will examine how the economic characteristics of the areas affect housing supply, demand and home prices. Dr. Torres (email@example.com) and Dr. Gaines (jpgaines@tamu. edu) are research economists with the Real Estate Center at Texas A&M University.
THE TAKEAWAY Fundamental structural differences exist between the economies of Texas’ four main Border communities and the four major MSAs. Strong energy and technology sectors account for the prosperity in the major MSAs. The Border communities are somewhat less affluent and not as economically diversified as the major metros, instead depending primarily on the performance of the Mexican economy and U.S. government employment.
Industry Mix for Employment with U.S. Employment as Benchmark 2012 AustinRound Rock
HoustonThe WoodlandsSugar Land
San AntonioNew Braunfels
0.6 1.0 0.7 1.2 1.0 1.2 0.8
2.3 1.0 0.2 1.1 1.1 2.9 0.4
1.5 1.3 0.4 1.1 1.2 1.2 0.5
1.0 0.9 1.6
0.7 1.0 1.4
0.8 1.2 0.9
Location Quotient (LQ) > 1 = Specialization in a given industry
Industry Civilian employed population 16 years and older Agriculture, forestry, fishing and hunting, and mining 1.7 0.4 0.6 1.8 0.8 1.4 Construction 1.3 1.3 1.2 1.5 1.2 1.1 Manufacturing 0.9 0.8 1.0 1.0 0.6 0.6 Wholesale trade 1.1 0.8 1.1 1.3 1.0 0.9 Retail trade 1.0 1.0 1.0 0.9 1.0 1.1 Transportation and warehousing, and utilities 1.1 0.6 1.3 1.2 0.9 1.0 Information 0.8 1.3 1.1 0.7 0.9 0.8 Finance and insurance, and real estate and rental and leasing 1.0 1.1 1.4 0.9 1.3 0.8 Professional, scientific, and management, and administrative and waste management services 1.0 1.3 1.2 1.1 1.0 0.7 Educational services, and health care and social assistance 0.9 0.9 0.8 0.9 1.0 1.3 Arts, entertainment, and recreation, and accommodation and food services 0.9 1.1 0.9 0.8 1.1 1.0 Other services, except public administration 1.1 0.9 1.0 1.2 1.0 0.9 Public administration 0.9 1.4 0.6 0.7 1.1 1.1 Hachman Index between 0 and 1, where 1 = diversified and 0 = specialized/concentrated
Industry Civilian employed population 16 years and older
Note: Estimated by Real Estate Center at Texas A&M University. Source: Bureau of Economic Analysis
By Jerrold J. Stern
IRA WITHDRAWALS FOR
axpayers who withdraw funds from IRAs before age 59½ must pay a 10 percent penalty unless they satisfy one of the exceptions. An exception exists for certain homebuyers who qualify as “first-time homebuyers.” They are allowed to withdraw a (lifetime) maximum of $10,000 penalty-free for the purchase of a home. To use the exception successfully, homeowners must avoid certain pitfalls, as demonstrated by a recent tax court case. Assume married couple Mary and Jeff began their careers seven years ago and saved a total of $15,000 for a down payment for their first home. They find a $175,000 home they want to buy. Because mortgage interest rates are typically higher for mortgages larger than 80 percent of a home’s purchase price, they decide to make a down payment of $35,000 (20 percent of $175,000). This leaves them $20,000 short. Mary and Jeff can make up the difference if each withdraws $10,000 from an IRA. Under the first-time homebuyer exception, the 10 percent early withdrawal penalty tax would not apply. A “first-time homebuyer” is defined as anyone who has not owned a home during the prior two years. Thus, a better term might be “not-recent homebuyer.” Now assume Mary and Jeff are 50-yearold empty nesters. They sold their home and moved into a rental condo two years ago. This year, they decide to buy the condo, but they will need an additional $20,000 for the down payment. They can withdraw funds from their IRAs ($10,000 each) without penalty as long as they never before made use of the firsttime homebuyer exception, which has a $10,000-per-taxpayer lifetime maximum. The 10 percent early withdrawal penalty is avoided even if the $10,000 is used
HOME PURCHASE to help purchase a home for a “qualified relative,” defined as children, grandchildren, and ancestors of the taxpayer or the taxpayer’s spouse. As a result, a 2013 tax court decision required that the 10 percent penalty be applied to a $10,000 IRA withdrawal by Laura Ung. Ung used the $10,000 to pay part of the cost of a home that she and her brother purchased. However, only the brother was listed as the owner on the property deed and residential purchase agreement. Ung lost the case because siblings are not considered
Mary and Jeff is from traditional IRAs. The $20,000 is taxable at their marginal tax rate. If their marginal tax rate is 25 percent, their tax liability increases by $5,000. The benefit of the first-time homebuyer rule is that the 10 percent penalty for early withdrawal does not have to be paid in addition to the $5,000. Thus, the couple avoids paying an additional $2,000 (10 percent of $20,000) to Uncle Sam. The rules for Roth IRAs differ from those of traditional IRAs. If the IRA is a Roth, withdrawals of up to $10,000 used to purchase a “first home” are completely free of tax and penalty (as long as the funds have been in the IRA for five years or more). Again, the $10,000 amount is a lifetime limit. Roth distributions are tax-free because contributions to Roths are made with “aftertax” dollars. The contributions are after-tax because they are not deductible and do not affect tax liability. Homebuyers who want to use IRA funds for their purchase should pay careful attention to the tax law’s IRA withdrawal rules. For specific advice, consult a tax accountant or tax attorney.
A “first-time homebuyer” is defined as anyone who has not owned a home during the prior two years.
“qualified relatives,” and she was not a legal owner or co-owner of the property. “Qualified” uses of the withdrawn IRA funds include costs for acquisition, construction or reconstruction. Closing costs also qualify. IRAs consist of two types — traditional and Roth. Funds contributed to traditional IRAs are “before-tax” contributions because they are deductible in the year they are made and, thus, lower taxable income and tax liability. However, when traditional IRA funds are withdrawn (and not rolled over to another pension-type account), the funds are fully taxable regardless of the age or other circumstances of the taxpayer. Returning to the earlier examples, assume the $20,000 withdrawn by
Dr. Stern (firstname.lastname@example.org) 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 First-time homebuyers and others who qualify may make penalty-free IRA withdrawals to fund the down payment. A recent court case highlights the importance of satisfying all tax law criteria.
he Biggert-Waters Reform Act, also known as the Flood Insurance Reform Act of 2012, attempts to end subsidies for flood insurance premiums offered through the National Flood Insurance Program (NFIP). NFIP has been hemorrhaging money for the past 45 years, and there has been serious concern about the long-term viability of the program. After catastrophic losses from hurricanes Katrina and Sandy, nearly all hope for a seamless recovery has been lost. As of July 2013, NFIP was $24 billion in debt and borrowing money from the Treasury to pay claims. The act seeks to address this shortfall by increasing premiums to compensate for the risk associated with each property, ending the long-standing subsidies. Ending subsidies could affect substantial numbers of property owners by saddling them with much higher premiums. The act does authorize extension of the massively indebted program, but subsidies for 438,000 policies would end. The act further specifies a schedule for eliminating the remaining 715,000 subsidized policies altogether.
DAMAGE FROM Hurricane Ike on Galveston Island, 2008.
FLOODWATERS POUR into a beachfront area of Galveston Island as Hurricane Ike approaches.
A July 2013 U.S. Government Accountability Office (GAO) Report to Congressional committees on flood insurance concluded that the Federal Emergency Management Agency (FEMA) needed more information on subsidized properties to accurately assess the impact of the act. GAO estimated that about 1.1 million of the 5.5 million NFIP policies involved discounted rates that failed to reflect the full actual risk of flooding. Furthermore, a large portion of the discounted properties were located in high-risk areas. These owners could suffer a significant financial hardship as FEMA implements the act. The problem is magnified for many of these owners because NFIP is essentially the sole flood insurance provider for much of the nation. eginning in 1968, NFIP subsidies were intended to encourage municipalities and cities to opt in to the program. After communities joined the program, property owners faced a federally mandated obligation to purchase an NFIP policy. The implementation of NFIP made up for the lack of private flood insurance, which occurred because of the difficulty of quantifying flood risks. Participation in NFIP required communities to create new floodplain management regulations designed to mitigate flood risks and better understand the floodplain for the soon-to-be insured properties.
was the grandfathering of subsidized premiums. Simply put, so long as there have been no substantial improvements or damage to the property, subsidized policies can stay in force indefinitely, even transferring to new owners when the property is sold. Some of the original policies, with premiums set before adequate floodplain data was available, have persisted for decades as subsequent policies are grandfathered in and maintained. For policies based on accurate maps, where a policy owner can prove the property was built to code at the time of construction, subsidized low rates can be locked in indefinitely. This applies even if the floodplain map has changed and identifies the property as riskier than before. Because FEMA did not periodically re-evaluate floodplain maps, many are outdated and no longer accurately assess flood risk for many properties. According to a 2005 study by the Department of Homeland Security, more than 70 percent of FEMA’s maps are more than ten years old. In addition, many of the maps were drawn by hand. Updating these maps also requires obtaining new elevation information. A 2010 senate study revealed that the information contained in the National Elevation Dataset is 40 years old on average. These circumstances led GAO to conclude that elevation/baseflood information currently remains unknown for 97 percent of NFIP’s subsidized properties.
GAO estimated that about 1.1 million of the 5.5 million NFIP policies involved discounted rates that failed to reflect the full actual risk of flooding. The subsidies dispelled fears that the new mandatory flood insurance policies would place undue hardships on owners of the properties most at risk, instead allowing them to adjust to the new costs over time. Intended as a temporary arrangement, subsidies have survived unchanged for decades with later policies being grandfathered at the subsidized rates. As FEMA’s Multi-Hazard Flood Map Modernization Program brings new floodmaps online, and as NFIP approaches bankruptcy, it has become necessary to align premiums for these highly subsidized policies with the actual risk of flood damage. The structural obstacles that pushed NFIP into a $24 billion deficit are glaring. One of the issues that magnified NFIP losses
Biggert-Waters Reform The Biggert-Waters Reform Act has several proposed avenues for restoring NFIP solvency. The thrust of the proposal is to eliminate endless grandfathering, update floodplain maps to TIERRA GRANDE
more accurately assess risk, and gradually align current subsidized rates with actuarially defined rates attuned to true flood risk. The act specifies the following list of properties slated to have subsidies eliminated: • any residential property that is not a primary residence; • any severe repetitive-loss property; • any property that has incurred floodrelated damage in which the cumulative amounts of payments under this title equaled or exceeded the fair market value of such property; • any business property; and • any property that has experienced or sustained substantial damage exceeding 50 percent of the fair market value or substantial improvement exceeding 30 percent of the fair market value. ate increases for these properties would be phased in over several years, rising by 25 percent each year. Other properties for which the owner has voluntarily allowed an NFIP policy to lapse or refused to accept mitigation assistance after a major disaster would also face elimination of subsidies. Clearly, a substantial number of property owners face escalated premiums as the act goes into effect. NFIP involves two types of policies, subsidized and full-risk. Full-risk properties have appropriately priced premiums that reflect the risk associated with the insured property. Premiums for subsidized policies are lower, sometimes substantially
lower, than their risk profile would justify. The reform envisions repricing some subsidized premiums but, because of the long history of subsidies and grandfathering, insuring agencies don’t have the information needed to adjust premiums without re-evaluating each individual property. For example, the owner of one property with a history of flooding paid a subsidized premium of $1,500 per year. Under the act, that premium is scheduled to increase $24,000 annually. The subsidized premium ensured that the property owner remained unaware of the actual flood risk associated with the property. The GAO insists that FEMA generally lacks the data needed to ascertain the proper full-risk premium at the elevated risk levels and also lacks a plan for obtaining the needed information. This dearth of information and vague wording of the act led GAO to state that the NFIP plan is essentially just waiting for property owners to volunteer to pay for a new Elevation Certificate. The certificate is designed to help evaluate the likelihood that a property may flood by providing detailed data on property elevations relative to flood plains. An application for
The reform envisions repricing some subsidized premiums but, because of the long history of subsidies and grandfathering, insuring agencies don’t have the information needed to adjust premiums without re-evaluating each individual property. an Elevation Certificate requires owners to submit a property description and its situation in relation to adjacent grade elevations. The information would have to be signed and sealed by a qualified surveyor, engineer or architect. Obtaining an Elevation Certificate would likely represent a significant expense for property owners. Because the NFIP plan assumes that property owners will bear the expense of obtaining a new certificate, it runs a risk of adverse selection. Specifically, owners most willing to pay for
TEXAS FLOODS arenâ€™t limited to the Gulf Coast. Tropical Storm Hermine flooded this Arlington neighborhood in 2010.
the evaluation are more likely to be confident that their property faces little flooding risk, qualifying them for lower rates. Owners of properties located in high flood-risk areas will be less likely to volunteer to pay for a certificate that would likely raise their NFIP premiums. he lack of specific property data and up-to-date flood maps makes it impossible to assess the actual impact of changes imposed by the act. However, older properties might face substantial increases. Specifically, FEMA uses flood insurance rate maps (FIRM) to assess flood risk associated with a particular property, but structures built before the FIRM guidelines went into effect generally involve an elevated level of risk. These structures were built before a community opted in to NFIP (early to mid-â€™60s), and are, therefore, probably not compliant with the localized floodplain building codes. The effects of repealing subsidies might hit these properties particularly hard. In addition, repetitive-loss properties, which represent 1.3 percent of all NFIP policies, will account for 15 to 20 percent of future losses, according to recent estimates. NFIP has not increased rates on properties that have had repeated claims. Private insurers routinely raise rates on such properties, which will likely face increased premiums under the act. Finally, language in the act specifies use of losses from catastrophic years in calculating averages for setting premiums. That provision virtually ensures that average rates will rise. Responding to concerns about increased premiums inspired by the act, a push has emerged to delay the effects of the
legislated premium increases. Known as the Homeowner Flood Insurance Affordability Act, Senate Bill 1846 would delay premium increases for four years, or six months after FEMA proposes policy changes and regulations to address affordability issues. The Congressional Budget Office estimates that the latter would occur during calendar year 2018. It would also delay increases for properties sold after July 6, 2012, the effective date of the act. The bill would not block rate increases for most business properties, second homes or repeat flood properties. Rates on those properties are currently scheduled to increase by 25 percent per year until they reach full cost. Reaction to this legislation has been strong. Keep an eye on Congress for revisions, delays or other changes to this law. Dr. Gilliland (email@example.com) is a research economist and Hunt is a research assistant with the Real Estate Center at Texas A&M University.
THE TAKEAWAY The National Flood Insurance Program is more than $24 billion in debt in large part because of government subsidies paid to property owners to help pay premiums. The Biggert-Waters Reform Act seeks to end the subsidies and base premiums on risk assessments that reflect the actual risk of flooding. Premiums would rise significantly for substantial numbers of program participants. TIERRA GRANDE
Where to From Here?
at the Helm By Mark G. Dotzour, Colt Kokel and Joshua Parulian
anet Yellen, the new chair of the Federal Reserve, holds one of the most powerful positions in the world. Fed decisions to cut interest
rates (add accommodation) can create trillions of dollars in new wealth in a matter of days. Conversely, decisions to raise interest rates can create recessions and massive layoffs. The Fed is considered to be politically independent, but the Fed chair is appointed by the president. In his last press conference in December, outgoing Fed Chair Ben Bernanke was compelled to remind Yellen that “Congress is our boss.” The chair reports to Congress twice a year on the Fed’s activities. The Federal Reserve can earn profits from interest on bonds that it owns. Since the Fed began operations in 1914, it has remitted about 95 percent of its net earnings to the Treasury. In 2003, it paid approximately $22 billion and in 2012 a record $88.4 billion in profit. When interest rates start to increase, these profits can turn into losses. Yellen will work hard to maintain the perception that the Fed is indeed independent from Congress and the White House because this will reassure the public that the huge federal deficits will not be allowed to create runaway inflation in the future.
The Fed’s Mission Created by Congress in 1913, the Fed was a response to the financial panic of 1907, also known as the “1907 Bankers Panic.” The stock market fell nearly 50 percent, and there were numerous runs on banks. One very wealthy man at the time, J. P. Morgan, pledged large sums of his own money to calm the financial panic. Congress felt vulnerable knowing that the entire American financial system could have collapsed without the intervention of one man, so it created the Fed. Its mission is to provide the nation with “a safer, more flexible, and more stable monetary and financial system.” APRIL 2014
One hundred years after its creation, the Fed has two mandates from Congress: maximize employment and maintain stable prices. When unemployment is too high, it keeps interest rates low for a long time, which usually causes stock prices and home prices to increase. Hence, those who own stocks and houses
“ “ “ get wealthier and are more likely to buy things. In a 2005 speech, Yellen discussed this issue, saying:
Monetary policy affects the economy not primarily through short rates but instead through its effects on asset prices, including bond rates and equity prices. If financial markets have a good understanding of the central bank’s objectives and strategy, they will react appropriately to policy moves.
ow interest rates also encourage people to take out loans to buy cars and boats and take vacations. These activities create jobs. The Fed will want to keep interest rates low until it feels that America has reached “full employment.” The second mandate, to maintain stable prices, can be described as keeping inflation from increasing above 2 percent per year. When the economy has reached full employment, prices can start to increase faster. When the inflation rate rises above 2 percent for a sustained period, the Fed may begin to increase interest rates to reduce economic activity. This has been referred to as “removing the punch bowl from the party.” Yellen became Fed Chair after the worst recession since the 1930s. Unemployment is high and inflation is very low. This scenario suggests that the Fed will keep interest rates low for a long time. The low interest rates have pushed stock markets to record highs and have contributed to significant home price increases. The U.S. economy is recovering, and unemployment has now fallen to 6.7 percent. As the economy continues to improve, the Fed will begin to allow interest rates to rise to a more “normal” level. Many real estate professionals and investors are studying this issue intently, knowing that rising interest rates can have an impact on residential and commercial real estate sales volume and price trends. Nobody could have guessed that Americans would be able to buy a home with a 3.5 percent mortgage rate. That was an historic gift from the Fed in an earnest attempt to repair the damage done to the housing market. To offer some perspective, the average 30-year mortgage rate was 8.9 percent in the 1970s, 12.7 percent in the 1980s, 8.12 percent in the 1990s and 6.29 percent in the 2000s. Higher interest rates will not only cause home mortgage rates to increase but will also increase borrowing costs for
commercial real estate (CRE) investors. As their borrowing costs increase, the net income from CRE buildings will decline. Additionally, as the interest rates on bonds increase, the expected investment return on real estate will move up as well. This could create downward price pressure on CRE property values. The biggest unknown is when the Fed will start to increase interest rates. In other words, how low will the unemployment rate have to get before rates are increased? In a 2008 speech, Yellen remarked that:
Slower economic growth has pushed up the national unemployment rate to 6.1 percent — over a full percentage point above the level that, in my view, is consistent with “full employment.”
This indicates that she views a 5 percent unemployment rate as full employment. Unless she’s changed her mind, expect her to keep the Fed Funds rate low until we get to that point. Recent remarks have indicated that she would keep interest rates “lower for longer” than people may expect. Don’t look for interest rates to increase until we get closer to a 5 percent unemployment rate unless consumer price inflation moves above 2.5 percent for a sustained period. The Fed’s second mandate, price stability, will keep interest rates low to help the economy grow as long as inflation stays “well behaved.” In a 2008 speech, Yellen enunciated her views on acceptable inflation rates:
The core PCE Price Index rose by 2.5 percent over the past 12 months, which is somewhat above the range that I consider consistent with price stability . . . .
Another issue that Yellen considers of keen importance is credibility. She notes that Americans and investors all over the globe must have confidence that the Fed will not tolerate or allow sustained high rates of inflation. Fed pronouncements on occasion assert that inflation expectations are “well anchored.” What this means is that global investors still have confidence TIERRA GRANDE
“ “ “ that the Fed will not allow inflation to get out of control. In her words:
Credibility is all about what the public expects the Fed will do in the future.
It is only when the Fed’s commitment to low inflation is credible that people will expect low inflation in the future and set prices accordingly.
In a 2009 speech, she clearly staked her position as a defender against runaway inflation with these words:
Let me be unequivocal. The Fed is committed to doing everything in its power to foster recovery while maintaining price stability. When it’s necessary to withdraw the extraordinary stimulus we have put in place, we won’t hesitate.
This is why it will be important for Yellen to establish a reputation of maintaining independence from Congress and being diligent not to let things get out of hand. Credibility comes from communication and transparency. The Fed is going to do its best to let people know what it is doing and give some benchmarks as to when it will make its moves. The Fed is like a large boat that throws out a large wake. When that big boat makes an unexpected move, a lot of small boats can get swamped. Communication is important to Yellen. Expect her to do her best to communicate the goals and policies of the Fed clearly so the market can correctly anticipate Fed actions.
Asset Price Bubbles
ne byproduct of low interest rates over a long period can be asset price bubbles. In the past three years we have seen record high prices in gold, farmland, stocks and bonds. House prices have increased rapidly in the past two years. Higher interest rates in 2013 burst the price bubble in gold and the bond market. Some market analysts wonder if the Fed will increase interest rates solely for the reason of stopping a bubble in the housing market or the stock market. APRIL 2014
The Fed suspected there was a price bubble in the stock market as early as 1996 but chose not to burst the bubble with higher interest rates. Instead, Greenspan tried to warn the public about “irrational exuberance” in the stock market. The market increased substantially for another three years before it experienced a major correction in 2000. In a 2005 speech, Yellen addressed the issue of using monetary policies to stop the forming bubble in the housing market. She noted that the share of residential construction in GDP was at its highest level in decades, and that the price-to-rent ratio was about 38 percent above its long-run average. She remarked:
It’s obvious that the housing market sector represents a serious issue for monetary policy makers to consider.
Her conclusion was revealing:
. . . it seems that the arguments against trying to deflate a bubble outweigh those in favor of it. So, my bottom line is that monetary policy should react to rising prices for houses or other assets only insofar as they affect the central bank’s goal variables — output, employment and inflation.
Dr. Dotzour (firstname.lastname@example.org) is chief economist and Kokel and Parulian are research assistants with the Real Estate Center at Texas A&M University.
THE TAKEAWAY Fed Chair Janet Yellen will likely keep interest rates low until unemployment is closer to 5 percent, unless inflation moves above 2.5 percent for a sustained period and/ or global investors lose confidence in her commitment to price stability. It is unlikely that the Fed will raise interest rates solely because of concern about a stock market or real estate market bubble.
etail electricity markets were deregulated across most of Texas in 2002. Whether a particular commercial or industrial customer now benefits from lower electricity rates than they would have under the state’s old regulated system is difficult to say. However, there is little doubt that procuring that electricity has become a more complex task since deregulation. Electricity procurement is only one of many factors businesses consider when choosing a location for their facilities. But the steeper learning curve for companies considering power options in deregulated regions of Texas can be intimidating when measured against states with fully regulated power markets. This brief overview identifies the major factors commercial and industrial firms should consider when obtaining power in the state’s deregulated areas.
Electric Utility Types The Texas Legislature’s deregulation of retail electricity applies only to investor-owned utilities within the Electricity Reliability Council of Texas (ERCOT) region (see map). ERCOT covers about 75 percent of the land area of Texas and 85 percent of the state’s electricity load. Four basic types of electric utilities operate in Texas: investor-owned utilities (IOUs), municipally-owned utilities (MOUs), cooperatives (co-ops) and, to a small extent, river authorities. Both inside and outside the ERCOT region, service areas are usually “single certified” to one of these types of electric utilities. However, occasions do arise when a service territory will be “dual-certified.” These are areas where customers can obtain power from more than one of these electric utilities. APRIL 2014
Co-ops are private, nonprofit utilities owned and controlled by the members to whom they provide power. Created in the 1930s to bring electricity to sparsely populated communities, 74 co-ops continue to primarily serve the state’s rural areas. Texas MOUs and co-ops set their own electricity rates and are not regulated by the state’s public utility commission (PUC). When located within the ERCOT region, they are allowed to join the deregulated market but are not required to do so. Once an MOU or electric co-op decides to opt-in to the deregulated electric market, they forfeit the ability to opt out later. Thus far, only one Texas co-op and no MOUs have opened their markets to competition.
Regulated Market The Texas PUC has typically granted only one investor-owned utility in any given area outside ERCOT a license to provide electrical service. The PUC also sets the rates that can be charged to customers in those areas. Procuring electricity in regulated markets is a fairly straightforward process. Businesses go directly to the utility serving the area to negotiate power contracts. Although rates or “tariffs” are based on peak demand and the amount of energy used per month, regulated utilities can also include a variable fuel cost factor that can be passed through to clients. In the dual-service areas outside ERCOT’s region where service territories overlap, an IOU and co-op or an IOU and MOU may both have the right to provide electric service. In these regulated dual-certified areas, clients may need an opinion from a third-party consultant to determine whether a co-op, IOU or MOU offers the best price.
Power bills contain three general components: regulated wires charges, contracted energy charges, and variable “passthrough” service charges or fixed service charge “adders.” Clients should make sure they understand how passthroughs work. They should also make sure all pass-throughs are listed individually and flagged as to whether or not they are in their power contract. This is critical for an apples-to-apples comparison of rates between REPs. “Pass-throughs often get clients in trouble,” says Bill Thomas of Thomas Engineering, an energy management and consulting firm. “I have seen clients get quotes for their power of 4.9, 5.0, and 5.1 cents per kilowatt-hour (kWh) for example, and then see a fourth REP offer a price of 4.0 cents. This should raise a red flag. Margins are extremely thin in the electricity market. They may be signing up for variable pass-throughs that could increase dramatically for things like nodal congestion or line loss charges to get the price down to that 4.0 cent number.”
In the areas that are deregulated within ERCOT, electric power providers have been unbundled and separated into three segments: power generation, transmission and distribution utilities (TDU) and retail electric providers (REP). Generators own power plants and sell their electricity to REPs on the ERCOT wholesale electricity market. REPs compete by marketing electricity to commercial and industrial (as well as residential) clients in any deregulated area under various rate plans. They can also provide customer service functions such as billing. All REPs must be certified by the PUC to do business in Texas, and REPs set their retail power rates based on what the market will pay. TDUs own the power lines the electricity flows through. The transmission and distribution of electricity, the “wires” component, remains regulated throughout Texas. Wires charges are based on a client’s peak demand and power usage. Parties involved in helping clients obtain Amarillo Area covered by ERCOT power in deregulated markets include: • Brokers – have third-party agreements Regulated areas with REPs and their fee for services is built into the cost of the REPs’ price of power; • Consultants – work directly for the client Lubbock looking for power and are paid by the client they represent, either up front or over time; Dallas • Aggregators – brokers or consultants who Abilene pool small and large users together to negotiate a more favorable power price; and • Direct Salespersons – REP El Paso employees who negotiate power Alpine contracts with Austin clients. ompanies should Houston know their electrical San Antonio load profile and tolerance for price risk before choosing the Beaumont type of power contract they want to execute. They should also make sure the parties they choose to work with are knowledgeable and can structure pricing to fit their firm’s Corpus Christi needs. It is important to know how long the parties and REPs have Laredo been in the business. Direct salespersons are often assigned a specific geographic area whether they are experienced or not. Larger power users may have the leverage to bypass REP salespeople and negotiate directly with the pricing desks. Brownsville A broker’s or consultant’s level of experience and expertise must also be assessed. Finding a competent broker or consultant can be difficult. Although references from other companies are probably the most effective method, firms can ask Thomas regularly sees clients taking on variable risks they REPs for their opinion or conduct a Google search using “Texas aren’t even aware of. “Companies should read their power electricity procurement” as the search criterion. contracts carefully. If they don’t understand it, hire someone who does. I am constantly surprised by how many companies Pricing Methods for Deregulated Power obtaining power don’t even read their contract.” Three general methods of pricing are used for electricity conCompanies wanting price certainty for the service charge tracts in deregulated Texas markets. They are flat fixed pricing, component can mitigate the variable pass-through risk by opting block and index pricing, and real-time pricing. for a fixed charge or “adder” instead that can be included in the
power charge. Although the fixed adder may look more expensive than paying variable pass-throughs, pass-through charges can become quite high if some unexpected power event should occur for even a short period. “If REPs quote an adder of more than 1.0 cent per kWh, shop other REPs,” advises Thomas.
Pricing Method 1: Fully Fixed Power Pricing
ully fixed pricing is based on a set charge per kWh. Electricity rates are the highest under fixed pricing contracts but also offer the most price certainty. Flat fixed pricing is most commonly used for retail businesses and small and medium-sized commercial customers. Clients should watch out for “volume bandwidth” clauses in their fixed contracts. If a 10 percent bandwidth clause is in their contract and their power usage stays within the band, they pay the fixed contract price. If clients exceed their maximum allowed usage by more than 10 percent, REPs can charge an overage based on the real-time price or contract pricing, whichever is higher. Alternatively, if clients use less than their bandwidth, REPs may credit them using the lower price of power. Again, this should be laid out in the contract. “Most REPs will offer unlimited bandwidth contracts where they pay the same price for power regardless of usage,” says Thomas. “Just remember that this will cost you a premium for the privilege of price certainty.” REPs may also tell clients they have never settled volume swings, meaning they have never charged clients for any usage above the bandwidth. “However, if it’s not in the contract, the client has no guarantees,” says Thomas.
“I have seen prices swing from 5.0 cents to $5 per kWh during unexpectedly heavy demand periods or extreme weather,” says Thomas. “The longest duration of extremely high realtime prices I recall was probably the two days when prices hovered around $3 per kWh back in early February 2011. If power users, and even REPs, haven’t hedged their cost of power correctly, they could be out of business.” This method works best for clients that can change their load quickly to avoid price hikes. Some examples might be foundries or other manufacturers. Other possibilities might be companies that can pass through most of the increased electricity costs to others. “Any small or medium-sized commercial company has no business executing real-time price contracts,” says Thomas. They can’t weather the price volatility, and it also requires someone on staff monitoring prices at all times.
Contract Length Most REPs won’t go further than five years out on a contract. They are buying that power from the generator and are unlikely to take the risk of locking into a price for any longer. REPs will want to make sure the client has good credit and will actually be in business for the length of the contract. Clients may not want to step into a long-term power contract at first. In multitenant properties, tenants may have no choice. If possible, companies should give themselves time to see if their REP is competent and offers good customer service. REPs may also want to size up a new customer. “It is not uncommon to see REPs go month-to-month with a threemonth deposit for clients they are not sure about to allow them to build credibility over time,” says Thomas.
If clients exceed their maximum allowed usage by more than 10 percent, REPs can charge an overage based on the realtime price or contract pricing, whichever is higher.
Pricing Method 2: Block and Index Pricing A client’s price risk is increased under this method. A set price is paid for a specific block of power, and any amount used over or under the block is settled at a price based on the real-time cost of power. ERCOT sets real-time power prices every 15 minutes. The ideal customer for this option uses a consistent amount of power over specific time periods. Very unpredictable power users are not candidates. “Only large power users such as manufacturing operations should consider this option. We are talking one megawatt or more,” says Thomas. This method allows the customer the flexibility to use more power when market prices dip while layering in blocks of power at a fixed price. So it offers some budget predictability. “There are downside risks,” says Thomas. “For example, if the client doesn’t use its whole block of power and the realtime price should be less than the contracted price, the client would have to pay the difference between the fixed block price and the real-time price for the unused energy portion for that 15-minute period.”
Pricing Method 3: Real-Time Pricing Firms take on the most risk under real-time pricing. Their energy cost will be re-established every 15 minutes by ERCOT. Under this method, large swings in rates are possible. APRIL 2014
Buyer Should Beware
ompanies looking for power should be aware that dozens of REPs and many more brokers do business in Texas. Also, no certification or licensing is required to become a broker or consultant. Although REPs must be certified, their salespeople are not required to do so. “Every year there is increased competition and confusion on who to pick to offer you power,” says Thomas. “For companies, it often comes down to price and not relationships. My most successful clients have taken the time to build relationships with all the parties involved.” Dr. Hunt (email@example.com) is a research economist with the Real Estate Center at Texas A&M University.
THE TAKEAWAY Obtaining power in the deregulated areas of Texas is challenging. As a result, commercial power users must do considerable research to identify the best deal for their type of operation.
The integrity of the property tax relies on accurate market value estimates of properties making up the tax base. Presumably, those values reflect the public goods and services property owners enjoy from the entities that use property taxes to fund their operations. However, the market value of any particular property is unknown unless the property changes hands in a free-market exchange. To implement an annual property tax, officials must estimate market values for all properties each year. APRIL 2014
n Texas, county appraisal districts determine the value of each taxable property. The annual cycle begins with the district devising an appraised value designed to serve as the basis for calculating the owner’s tax liability. As the spring unfolds, the property tax cycle moves from the appraisal phase to the equalization phase. During the equalization phase, property owners can review the appraised value to evaluate its accuracy. When owners disagree with the estimates presented by the appraisal district, they can take advantage of remedies provided by the Property Tax Code to adjust appraisals that do not represent a fair assessment of their properties. Those remedies focus on two issues: market value and equal and uniform appraisals. The former addresses the accuracy of the value estimate; the latter seeks to ensure that all property owners are treated fairly in the assessment process.
Excessive Appraisal The market value remedy may require a district court to determine if the appraised value on the appraisal district’s roll exceeds the value required by law. The court must decide if the appraisal district missed the mark in estimating property value. Typically, this determination involves teams of dueling experts with each team producing and defending an appraisal of the subject property while criticizing the judgments and conclusions of other experts. This kind of confrontation occurs owing to the subjective aspects of deciding “market value.” Definitions of market value ultimately require an estimated value that complies with legal requirements. Official formulations contain specifications of characteristics a transaction must meet to be considered evidence of market value. Those requirements roughly distill to an amount reflecting the probable price a property would command in an open and competitive market transaction. Appraisal at all levels calls for circumstances often at variance with actual conditions observed in contemporary economies. Client’s intended use, principals’ motivations, number of competitors and a myriad of other circumstances can impact observed market transactions. All of these factors drive modern appraisal applications. These complicating factors guarantee that no single hard-and-fast formula can reliably produce a credible estimate of market value.
Rather than an immutable mathematical algorithm, appraisal is an interpretive art. An appraiser is called upon to skillfully transform market information into an estimate of value for a subject property. That estimate must reflect the realities of the economic and legal environment of that subject property. The results rely on a set of assumptions and interpretations designed to capture those realities. Clearly, differences in assumptions and interpretations can produce different bottom line estimates. The court must decide which competing analysis most closely approximates the value required by the Property Tax Code. The court might also decide that neither appraisal is correct and, therefore, settle on a different value. The amount specified by the court becomes the value used to determine the property tax liability.
he Texas Constitution calls for equal and uniform treatment of property owners. That provision prohibits discriminatory practices in assessing taxes. For example, suppose an assessor appraises sold properties at or near their sales price while leaving other properties’ taxable values unchanged. Over time, disparities created by this practice would result in significantly different tax liabilities for similar properties. The equal and uniform provision allows property owners to protest or appeal when their properties have been appraised by a different standard than other properties. That means that even if the appraisal district value does not exceed market value, an owner can seek relief if the property was treated differently from other properties in the tax base. The district court must grant relief when presented with evidence proving that a subject property was appraised unequally. The Property Tax Code specifies the following as evidence of such appraisals: • the appraisal ratio of the property exceeds by at least 10 percent the median level of appraisal of a reasonable and representative sample of other properties in the appraisal district; • the appraisal ratio of the property exceeds by at least 10 percent the median level of appraisal of a sample of properties in the appraisal district consisting of a reasonable number of other properties similarly situated to, or of the same general kind or character as, the property subject to the appeal; or • the appraised value of the property exceeds the median appraised value of a reasonable number of comparable properties appropriately adjusted. The first two provisions require substantial resources to establish the appraisal ratios of a sample large enough to meet standards of statistical testing. Because of the expense implied by those tests, many unequal appraisal protests and appeals rely on the third option. Some controversy has arisen concerning this specification of the code, which does not define “reasonable number” and “appropriately adjusted.” Instead, the code leaves that determination to analysts preparing studies of sampled properties. Such studies typically examine the appraisals of a set of similar
properties after adjustments are made for differences from the subject. The studies are designed to identify valuation differences between the subject and the sample. In addition to quarrels over the sample contents and adjustments made, this provision calls for a departure from the market value standard of taxation. Specifically, critics argue that granting relief by reducing the subject’s appraised value to the median value of the sample results in an unconstitutional departure from taxation based on market value, which the Texas Constitution requires. In essence, they reason that this provision allows taxpayers to use an artificially low value as the basis for their property tax liability. In Harris County Appraisal District (HCAD) v. United Investors Realty Trust, the Court of Appeals of Texas, Houston (14th District) addressed these issues. An expert witness for the taxpayer, owner of a neighborhood shopping center, found the median appraisal of a sample of seven comparable properties to be $62.71 per square foot while the subject property appraisal amounted to $85.13 per square foot. The HCAD appraisal of the subject property followed from a recent purchase by United Investors Realty Trust. The sale price exceeded the HCAD appraisal by more than 9 percent. Despite these facts, the court found the taxpayer expert’s analysis to be compelling evidence of unequal appraisal and reduced the subject taxable value. Responding to HCAD’s argument that the result did not reflect the “market value” of the subject as required by the Texas Constitution, the court noted, “If a conflict exists between taxation at market value and equal and uniform taxation, equal and uniform taxation must prevail.” t first, it might appear that the court condoned an egregious violation of property tax policy by abandoning the market value standard. However, further reflection suggests that the properties making up the sample in the study had been valued at far less than a valuation based on the United Property sale would justify. The ruling seems to suggest that HCAD may have erred by not raising appraisals on all properties based on the new data point. However, one sale does not provide conclusive proof that a market has risen. Additional sales at higher values might confirm the increased appraised value and justify a revaluation. Meanwhile, raising one property without raising others would unjustly penalize the owner of that property. The unequal appraisal provision appears to be aimed at avoiding this, even if the property is taxed at a level below market value.
Rather than an immutable mathematical algorithm, appraisal is an interpretive art.
Dr. Gilliland (firstname.lastname@example.org) is a research economist with the Real Estate Center at Texas A&M University.
THE TAKEAWAY High effective tax rates in Texas give rise to confrontations between taxpayers and appraisal districts as property owners seek to minimize their tax liabilities. Many of those disagreements will likely continue to focus on unequal appraisal. TIERRA GRANDE
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