OCTOBER 2015 ™
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 Texas Homes as Investments Title Insurance Rental Markets Modular Housing Mortgage Interest Rates Property Tax Legislation Perils of Poor Tax Records
Helping Texans make better real estate decisions since 1971
OCTOBER 2015 ™
JOURNAL OF THE REAL ESTATE CENTER AT TEXAS A&M UNIVERSITY
Meet Our New Chief Economist Dr. Jim Gaines has been the Center’s housing and demographics specialist for the past decade. The Dallas Morning News called him the “most quoted real estate expert in Texas.” In this new role, his laser-sharp insights into the real estate industry will be more valuable than ever. “The Center is always growing and evolving, incorporating new technology and analytical techniques,” says Gaines. “We are on the forefront of real estate research. It’s challenging, and I’m excited about moving things forward.”
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TIERRA GRANDE
OCTOBER 2015
www.recenter.tamu.edu
Director, GARY W. MALER Chief Economist, JAMES P. GAINES Senior Editor, DAVID S. JONES Managing Editor, NANCY MCQUISTION Associate Editor, BRYAN POPE
VOLUME 22, NUMBER 4 ™
TIERRA GRANDE
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JOURNAL OF THE REAL ESTATE CENTER AT TEXAS A&M UNIVERSITY
14 Mod Squad
From modest to mega, modular homes are an emerging market. They’re built in sections to the same code as site-built homes and then assembled at the buyer’s site. BY HAROLD D. HUNT
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: C. Clark Welder, San Antonio, chairman; Russell Cain, Port Lavaca, vice chairman; Mario A. Arriaga, Conroe; Jacquelyn K. Hawkins, Austin; Doug Jennings, Fort Worth; Walter F. “Ted” Nelson, Houston; Doug Roberts, Austin; Kimberly Shambley, Dallas; Ronald C. Wakefield, San Antonio; and Bill Jones, Temple, ex-officio repre senting 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 licen sees. Other subscribers, $20 per year. Subscribe online at www.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: Real Estate Center files, pp. 1, 2–3, 14–15, 28; Robert Beals II, p. 6; JP Beato III, pp. 4, 10–11, 16–17; courtesy Texas Manufactured Housing Association, pp. 18, 19. © 2015, Real Estate Center. All rights reserved.
2 Sound Investment
Profitability of Texas Homes Looking for a great investment? You may be living in one. Texas homes as a whole yield higher profits than McDonald’s, Home Depot and Lowe’s. BY ALI ANARI
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Home Security
Understanding and Negotiating Title Insurance Comprehending title insurance is as easy as pie — if that pie resembles the federal tax code. By contrast, this article covers what homebuyers need to know to protect their purchase (without making them dizzy). BY JUDON FAMBROUGH
10 Rent ON THE COVER West 7th Street Bridge, Fort Worth
PHOTOGRAPHER JP Beato III
OCTOBER 2015
Natural Vacancy Rates in Major Texas Markets Nobody can see into the future, but the relationship between vacancy rates and rents provides a good idea of which direction rents will go in the short run. BY ALI ANARI AND HAROLD D. HUNT
20 Going Up?
What Mortgage Rate Changes Mean for Homebuyers It has to happen eventually. The Fed will raise its interest rate. Probably not by much, but even small changes can make big differences for homebuyers. BY JAMES P. GAINES
26 Property Tax Legislation 2015
The Texas Legislature looked at a heap of property tax related bills this spring and adopted more than 30. Don’t be the last one on your block to find out what it’s all about. BY CHARLES E. GILLILAND
28 Burden of Proof
Poor Records May Increase Taxes Keeping all the documentation you need for taxes can be tedious, but if the IRS comes knocking, you’ll be glad you did. BY JERROLD J. STERN
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Housing Market
Profitability H of Texas Homes
ow profitable are Texas houses as an investment? An ongoing research project at the Real Estate Center at Texas A&M University found that Texas homes are more profitable than the national average, and significant variations in profitability exist across the state’s metropolitan housing markets.
Home as Investment
By Ali Anari 2
Owner-occupied homes are both consumer goods and investment goods. Once a house is built, it generates streams of current and future benefits in the form of rental incomes and streams of costs in the form of maintenance, insurance and taxes. From an investment perspective, homes have to compete with alternative investments such as bonds and stocks for profitability measured in terms of yield or rate of return on investment. Investors in asset markets compare yield returns TIERRA GRANDE
Table 1. Texas Metro Areas Ranked by Median Annual Rents, 2009–13 Rank
Region
Gross Rent (Dollars)
1 2 3
Austin-Round Rock Midland Dallas-Fort Worth-Arlington United States Houston-Sugar Land Killeen-Temple Texas San Antonio-New Braunfels College Station-Bryan Corpus Christi Tyler Odessa Lubbock Sherman-Denison Waco Abilene Laredo Victoria Beaumont-Port Arthur Longview Amarillo Wichita Falls San Angelo El Paso Texarkana McAllen-Edinburg-Mission Brownsville-Harlingen
11,856 11,316 10,848 10,848 10,728 10,320 10,212 10,092 10,068 9,996 9,936 9,468 9,360 9,216 9,048 8,964 8,904 8,820 8,736 8,700 8,700 8,688 8,664 8,640 8,364 7,692 7,668
4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 18 20 21 22 23 24 25
Source: U.S. Census Bureau
gross rental yield is 12 percent. This is the return on investment before the homeowner’s costs. Net rental yield on homes is computed by dividing net profit from renting a house by the house price. Net profit is equal to annual gross rent minus annual housing costs including property tax, insurance, maintenance costs and management fees. If annual operating costs for our example total $18,000, annual net rent is $6,000, resulting in a net rental yield of 3 percent. Net rental yields are also called capitalization rates or cap rates.
Computing Net Rental Yields on different assets and channel their investing funds to assets generating the best returns. Over time, yields or rates of return on various investment goods in asset markets tend to converge to their long-term equilibrium values.
Measuring Profitability Several methods exist for measuring the profitability of housing investments. This research project used net rental yield because financial data for Texas homes was readily available. For stocks, dividend or earnings yield is computed by dividing total dividends or earnings paid during a period by the stock price. In real estate economics, gross rental yield and net rental yield are used to measure the profitability of rental properties as investments. Gross rental yield is simply annual rent as a percentage of the property price. For instance, if annual rent for a house is $24,000 and the house price is $200,000, the OCTOBER 2015
D
ata for computing net rental yields on Texas homes were collected from the 2009–13 datasets of the U.S. Census Bureau’s American Housing Survey. The data are five-year averages of median gross rents, median homeowner costs and median home values for 2009–13. Both the rent and housing cost data in the survey include costs of utilities. When housing costs are deducted from rents, the resultant net profit or net rent figures are net of the costs of utilities. Table 1 shows Texas metropolitan areas ranked by median annual gross rent. Austin-Round Rock had the highest gross rent from 2009 to 2013 followed by Midland, Dallas-Fort Worth-Arlington, Houston-Sugar Land and Killeen-Temple. The median gross rents for these five Texas metro areas were higher than the statewide average. The first three metro areas had gross rents even higher than the national average. At the bottom of the table, Brownsville-Harlingen had the lowest gross median rent followed by McAllen-Edinburg-Mission, Texarkana and El Paso.
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Table 2. Texas Metro Areas Ranked by Median Annual Homeowner Costs, 2009–13 Rank
Region
Homeowner Costs (Dollars)
1 2 3 4 5 6
Austin-Round Rock Dallas-Fort Worth-Arlington Houston-Sugar Land Midland College Station-Bryan Victoria Texas United States Corpus Christi Sherman-Denison Killeen-Temple Laredo Wichita Falls Waco Lubbock San Antonio-New Braunfels Tyler Amarillo Abilene San Angelo Odessa Beaumont-Port Arthur Texarkana Longview Brownsville-Harlingen El Paso McAllen-Edinburg-Mission
7,200 6,552 6,372 5,844 5,484 5,448 5,424 5,424 5,400 5,364 5,328 5,328 5,292 5,256 5,196 5,196 5,124 4,932 4,716 4,716 4,596 4,560 4,488 4,320 4,260 4,164 4,152
7 8 9 9 11 12 13 13 15 16 17 17 19 20 21 22 23 24 25
Source: U.S. Census Bureau
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Table 3. Texas Metro Areas Ranked by Median Annual Net Rent, 2009–13 Rank
Region
Net Rent (Dollars)
1
Midland United States Killeen-Temple San Antonio-New Braunfels Odessa Tyler Texas Austin-Round Rock Corpus Christi College Station-Bryan El Paso Longview Houston-Sugar Land Dallas-Fort Worth-Arlington Abilene Beaumont-Port Arthur Lubbock San Angelo Texarkana Sherman-Denison Waco Amarillo Laredo McAllen-Edinburg-Mission Brownsville-Harlingen Wichita Falls Victoria
5,472 5,424 4,992 4,896 4,872 4,812 4,788 4,656 4,596 4,584 4,476 4,380 4,356 4,296 4,248 4,176 4,164 3,948 3,876 3,852 3,792 3,768 3,576 3,540 3,408 3,396 3,372
2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25
Source: U.S. Census Bureau TIERRA GRANDE
Table 4. Texas Metro Areas Ranked by Median Value of Homes, 2009–13 Rank
Region
Median Value (Dollars)
1
Austin-Round Rock United States Dallas-Fort Worth-Arlington Midland Houston-Sugar Land College Station-Bryan San Antonio-New Braunfels Texas Tyler Killeen-Temple Amarillo El Paso Victoria Laredo Longview Corpus Christi Lubbock Sherman-Denison Waco San Angelo Beaumont-Port Arthur Texarkana Odessa Wichita Falls Abilene Brownsville-Harlingen McAllen-Edinburg-Mission
192,000 176,700 150,000 145,700 141,400 140,200 131,100 128,900 120,800 119,200 116,800 111,400 110,300 108,800 108,000 107,700 106,800 104,500 104,200 98,800 95,200 95,100 91,200 89,400 89,000 78,300 78,100
2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25
Source: U.S. Census Bureau
Homeowner costs are the second component for computing net rental yields. Table 2 presents Texas metropolitan areas ranked by homeowner costs (taxes, insurance and maintenance costs). Austin-Round Rock had the highest owner costs followed by Dallas-Fort Worth-Arlington, Houston-Sugar Land, Midland, College Station-Bryan and Victoria, all higher than the national and statewide averages. McAllen-Edinburg-Mission had the lowest owner costs followed by El Paso, Brownsville-Harlingen and Longview. educting homeowner costs from gross rents for each Texas metropolitan area results in net rental income (Table 3). Midland had the highest net rent, even higher than the national average, followed by Killeen-Temple, San Antonio-New Braunfels, Odessa and Tyler. Victoria had the lowest net rental income followed by Wichita Falls, Brownsville-Harlingen and McAllen-Edinburg-Mission. For computing net rental yields, net rental income for each metro area is compared with the median home value for the area. Texas metropolitan areas are ranked by the median value of owner-occupied homes in Table 4. Austin-Round Rock had the highest home prices, even higher than the national average, followed by Dallas-Fort Worth-Arlington, Midland, Houston-Sugar Land, College Station-Bryan and San Antonio-New Braunfels. Dividing net rent for each region from Table 3 by the median home value for the region in Table 4 and multiplying the resultant number by 100 gives net rental yields (Table 5). The average net rental yield for Texas from 2009–13 was 3.71 percent, well above the 3.07 percent for the United States. Odessa had the highest net rental yield followed by Abilene, McAllenEdinburg-Mission, Beaumont-Port Arthur and BrownsvilleHarlingen. At the bottom of the rankings are Austin-Round
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OCTOBER 2015
Table 5. Texas Metro Areas Ranked by Net Rental Yield, 2009–13 Rank
Region
Yield (Percent)
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16
Odessa Abilene McAllen-Edinburg-Mission Beaumont-Port Arthur Brownsville-Harlingen Corpus Christi Killeen-Temple Texarkana Longview El Paso San Angelo Tyler Lubbock Wichita Falls Midland San Antonio-New Braunfels Texas Sherman-Denison Waco Laredo College Station-Bryan Amarillo Houston-Sugar Land United States Victoria Dallas-Fort Worth-Arlington Austin-Round Rock
5.34 4.77 4.53 4.39 4.35 4.27 4.19 4.08 4.06 4.02 4.00 3.98 3.90 3.80 3.76 3.73 3.71 3.69 3.64 3.29 3.27 3.23 3.08 3.07 3.06 2.86 2.43
17 18 19 20 21 22 23 24 25
Sources: U.S. Census Bureau and Real Estate Center at Texas A&M University
Rock, Dallas-Fort Worth-Arlington, Victoria and HoustonSugar Land. Comparing median home values in Table 4 and net rents in Table 3 shows that the main reason for lower net rental yields in the metropolitan areas of Austin-Round Rock, Dallas-Fort Worth and Houston-Sugar Land is their higher home prices. For comparison, five-year average dividend yields for McDonald’s Corporation, Home Depot and Lowe’s were 3.30 percent, 2.2 percent and 1.7 percent, respectively. The net rental yields in Table 5 are before-tax net rental yields because the net rental incomes are before taxes. When considering a home as an investment, keep in mind that real estate properties are the least liquid investments and rental incomes and owner costs are volatile. Compare price appreciation to general inflation, tax considerations and capital gains. Given that an owner-occupied home provides shelter for a long time, gains from housing as an investment are valuable additional advantages for homeowners. Dr. Anari (m-anari@tamu.edu) is a research economist with the Real Estate Center at Texas A&M University.
THE TAKEAWAY Texas homes are profitable investments, with yields exceeding the national average for homes in most metro areas when profitability is measured in terms of average yield. Average yields on Texas homes exceeded yields for McDonald’s Corporation, Home Depot and Lowe’s in the 2009–13 period.
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Homebuying
For
first-time buyers, purchasing a home is no small matter. Negotiating the sales contract, securing a loan from a mortgage company and acquiring casualty insurance for the property present challenges. Perhaps the most ominous and least understood is negotiating and acquiring title insurance, one policy for themselves and one for the lender. For those unfamiliar with title insurance, the title policy appears to be an array of confusing and often contradictory terms and provisions. Grasping the difference between an exception and an exclusion baffles even attorneys. So, where does the coverage lie? First and foremost, the policy identifies and insures who owns the property according to the public records. This should be the same individuals who appear on the sales contract as the sellers. Second, the policy reveals any impediments that keep the current owner(s) from conveying clear title, such as recorded mortgages, mechanic liens on the property or unsatisfied judgments against the sellers. If the policy fails to disclose an impediment of record that affects the value of the property, the title company may be liable.
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TIERRA GRANDE
Third, while the policy should reveal any restrictions on the use of the property, it does not guarantee that the restrictions have been or are being violated. The same goes for possible encroachments on to or off of the property. To gain coverage for these matters, specific endorsements or amendments must be purchased. A residential title policy covers only residential property which is defined as a tract of land five acres or less with improvements designed primarily for occupancy of one to four families situated in a platted subdivision. It also includes property consisting of more than five, but not more than 200 acres, with improvements designed primarily for occupancy of one to four families used by the buyers for agricultural production. To understand a residential owner’s title policy and to gain perspective on how to make changes, prospective buyers must understand and coordinate three documents: the initial sales contract, the title commitment and the title policy.
The Sales Contract To gain strategic and economic advantages from a title company, buyers should request three items from the sellers in the sales contract. The possibility of getting each depends on whether it is a buyers’ or sellers’ market. First, ask the sellers to provide a residential owner’s title policy from a title company selected by the buyers. Here’s why. Lenders require buyers to purchase a lender’s title policy for the mortgagee as a condition for granting the loan. The cost depends on the amount of the loan. Texas Department of Insurance (TDI) sets the nonnegotiable rates. Assume the purchase price for a home is $200,000. The buyers put 20 percent down leaving a loan balance of $160,000. The premium for the lender’s policy based on the loan value would be $1,207.40. The buyers receive no protection under this policy. uyers have the option, but not a requirement, to purchase an owner’s title policy for their personal benefit. Here, the cost of the policy depends on the purchase price. The premium for a $200,000 owner’s policy is $1,429. Combined, the two policies cost $2,635.40. However, under what is known as a simultaneous issue, the buyers could get both for an out-of-pocket cost of just $100 if the sellers comply with the request. Here’s how it works. If the owner’s title policy is purchased first, the title company will simultaneously issue a lender’s title policy for $100 as long as the amount of the loan does not exceed the sales price. So, if the sellers provide an owner’s policy for the buyers, the buyers can then simultaneously purchase the lender’s
policy for $100. This cost, however, does not include any endorsements added to the policy by the lender. The endorsements could run as high as $150. ven if the sellers do not provide the owner’s policy, the buyers may purchase the owner’s policy first for $1,429 and then get the lender’s policy issued simultaneously for $100. This represents a savings of over $1,100 as opposed to purchasing the two policies separately. Next, ask the sellers to provide a survey that satisfies the requirements for amending the title policy to read “shortage in area” only (This is found in paragraph 6.C. of the sales contract and is sometimes call the “survey exception”). By doing so, the title policy insures against discrepancies, conflicts, encroachments or overlapping improvements other than those shown on the survey. It will not insure against any shortage in area, though. Without the amendment, the policy provides no coverage for these items unless a specific endorsement is purchased. To get this amendment, the title company may require a survey showing the (1) size and location of all improvements, including any protrusions on to and intrusions from adjoining properties and (2) location of all easements, roadways, fences and utility lines affecting the property that can be platted. This survey need not be current as long as the seller signs an affidavit stating that no improvements have been added since the last qualifying survey. If improvements have been added, a new survey must be ordered. Finally, ask the seller to fund the expense for obtaining the survey exception as specified in paragraph 6.A.(8) of the sales contract. The amendment can be purchased only after providing the qualifying survey. Currently, the cost of the amendment when purchased by a person and not a business entity is 5 percent of the base premium for the owner’s policy or about $72 for a $200,000 owner’s policy. Hopefully, the sellers will comply with these requests. Otherwise, these items can and possibly should be purchased by the buyers.
E
The policy identifies and insures who owns the property according to the public records and reveals anything that would keep the current owner from conveying clear title.
B
OCTOBER 2015
The Title Commitment After both parties sign the sales contract, it will be delivered to the selected title company. In about 20 days, the title company issues what is known as the title commitment. The commitment is an agreement from the title company to issue a title policy based on the terms and conditions expressed in the document. The only way to change the title policy is to change the commitment. The changes or amendments are possible only between the time the commitment is issued and closing. Buyers must act quickly or miss this limited opportunity.
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Experienced buyers know the key provisions and how to make changes. Sometimes the changes are free for the asking, but most of the time they come in the form of an amendment or an endorsement for an extra charge. The endorsements are standardized and promulgated by the TDI for a set fee discussed later. he title commitment is divided into four sections or schedules: A, B, C and D. Practitioners nicknamed them appropriately: About the Deal, Buyer Beware, Clear (or Cure) for Closing and Disclosures from Company. Changes possibly can be made to schedules B and C. The two deserve buyers’ scrutiny. Schedule A (About the Deal) describes the key elements of the transaction. These include the effective date of the commitment, the amount of the policy (for the owner’s policy, this would be the sales price), type of policy being issued (owner’s or lender’s), name(s) of current owner(s) of record, type of estate being conveyed (generally fee title), and the legal description of the property. Buyers should make sure the name(s) of current owners and the legal description on the commitment corresponds with those on the sales contract and loan documents. Schedule B (Buyers Beware) lists the things not insured, better known as exceptions. Two types of exceptions appear: standard and special. The first nine listed items in the schedule are standard exceptions and appear on every commitment. All items listed thereafter are special exceptions and directly affect the property being conveyed. Some of the exceptions can be removed. Otherwise they reappear in Schedule B of the title policy. One of the standard exceptions (item 2) states that the policy does not insure against any discrepancies, conflicts, or shortages in area or boundary lines, or any encroachments or protrusions, or any overlapping of improvements. All the items except shortage in area may be eliminated (or deleted) by getting the survey exception discussed earlier. Schedule C (Cure for Closing) lists the requirements that must be satisfied as a condition for closing. These include such things as showing proof that property taxes, standby fees and assessments have been paid; the property is not being adversely possessed (no third party in possession); and existing liens that need to be paid and released. The title company generally satisfies these requirements. However, if they are not cured, the title company places them in Schedule B of the title policy and the buyers are not protected against the noted uncured title defect(s). Buyers should lodge a written objection with the title company according to paragraph 6.D of the sales contract if this occurs. If buyers file an objection to title, the burden rests on the sellers to cure. However, according to the sales contract, the sellers have no obligation to incur any expense in doing so.
T
Some title companies inform buyers of uncured provisions they placed in Schedule B of the policy. There is no mandate to do so. Consequently, buyers should inquire about any uncured provisions when they receive notice of the scheduled closing. If the uncured provisions are not removed, the buyers may wish to withdraw from the transaction. Schedule D (Disclosures) contains information regarding the estimated premium costs and the names of the shareholders, directors and officers of the underwriter and the title company issuing the policy and the names of any party receiving a portion of the premium for furnishing title evidence, examination and/or closing the transaction. Schedules B and C of the commitment do not list all of the uninsured items. The policy contains a section entitled exclusions from coverage that contains even more. Most notable are defects and adverse claims that are not of record, yet known to the buyers and not disclosed to the title company. No changes can be made to these items. The title policy, however, contains a section entitled covered risks that is extremely beneficial to buyers. Basically, it insures title is vested in the person(s) or entities disclosed in Schedule A on the day the policy is issued. If buyers suffer a subsequent economic loss or damage from an insured risk, the title company will pay up to the face value of the policy. However, the defect or loss must occur before (not after) the policy is issued. Some of the noteworthy items in this section include protections from forgeries, fraud, undue influence, duress, incompetency, incapacity or impersonation in a past conveyance; improper filing, recording or indexing of any recorded documents; and invalid powers of attorney. The benefits from this coverage cannot be overemphasized.
Buyers should inquire about any uncured provisions when they receive notice of the scheduled closing.
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Endorsements
A
dditional benefits may be gleaned from the policy via endorsements purchased during the commitment period. The TDI promulgates a myriad of endorsements, but few apply to an owner’s residential title policy. Here are the ones that do. • Although not an endorsement, the policy may be amended to limit the exceptions listed in schedule B, item 2 discussed earlier to shortage in area only. • Endorsement T-19.1 insures, with qualifications, against damages (1) for the violation of enforceable covenants including deed restrictions, (2) for the removal of an improvement in violation of a building setback line, (3) for encroachments on to and off of the property or on to an easement and (4) to improvements (excluding crops, landscaping, lawn, shrubbery or trees) resulting from the development of minerals. However, the coverage for TIERRA GRANDE
mineral development does not apply if caused negligently or by fracturing, explosions, vibrations or resulting from subsidence (sinking or settling of the soil). The title company may remove the mineral coverage from the endorsement and leave the other three and still charge 10 percent of the base premium. However, with the proper survey, the cost is 5 percent of the base premium. • In lieu of endorsement T-19.1, buyers may purchase coverage for surface damages stemming from mineral extraction at a cheaper rate with either endorsement T-19.2 or T-19.3. The first applies to residential property encompassing one acre or less and the second to residential property encompassing more than an acre. The coverage differs slightly. T-19.2 covers damage to improvements (except lawns, shrubbery or trees) located on the property on or after the policy is issued. T-19.3 covers damages to permanent buildings located on the property on or after the policy is issued. Neither covers damages from subsidence. Either endorsement costs $50. etween 2009 and 2011, title companies were required to issue either of the two endorsements when (1) requested by the buyers, and (2) the title company inserted a general exception to the minerals in Schedule A or B of the commitment and policy. The wording in Schedule A states, in essence, that the company does not insure title to the minerals in and under the property and that may be produced from the property. The language in Schedule B removes coverage from “all leases, grants or reservations of minerals whether or not they appear in the public records.” Even though the language differs, the effect is the same: the policy does not cover the ownership of the minerals. After 2011, title companies may, if it meets with their underwriting standards, issue either endorsement when the two conditions mentioned above are met. It is no longer mandatory.
B
• Endorsement T-34 may be issued after closing for increased coverage when the property appreciates in value. Otherwise, the maximum coverage for the owner’s policy remains the original purchase price.
The Policy
T
he policy will not be delivered to the buyers at closing but sent approximately 30 days later depending on the title company. To make sure the policy conforms to any changes in the commitment, buyers should review the “final commitment” prior to closing. This document should be available once the buyers receive notice of the scheduled closing. The policy contains five parts: (1) covered risks mentioned earlier; (2) exclusions from coverage which cannot be changed; (3) Schedule A which contains, among other things, the possible exception to mineral coverage; (4) Schedule B, subtitled exceptions from coverage, contains all the items from Schedules B and C of the commitment that were not deleted or cured; and (5) conditions that define the key words used in the policy, describes how an insured seeks recovery, and how the title company must respond to a claim. Direct all inquiries regarding title insurance to your local title company or attorney. 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 Acquiring a title insurance policy is a challenging task in the homebuying process. Most buyers are not aware of what the policy covers or the changes that can be made. Properly negotiating the sales contract and the title commitment can mean significant benefits and savings to the buyers.
Points to Remember • The title policy insures legal access to the property. However, legal access does not mean vehicular access. A mere pathway to the property satisfies the legal requirement. There is no endorsement for residential property that insures vehicular access. The problem becomes more apparent in unplatted subdivisions. • When negotiating the sales contract, include an option to change title companies if the initial one will not, or cannot, extend the coverage desired by the buyers. While all title policies are the same, title companies are not.
OCTOBER 2015
• Ask for copies of all the restrictions affecting the use of the property as shown in Schedule B of the title commitment. Make sure no prohibitions appear that may restrict the buyers’ desired use of the property. • Finally, make sure the legal description shown on the contract and in the policy corresponds with the property actually viewed. The title policy does not guarantee that the property viewed matches the property described and insured.
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Rental Market
Like labor markets, which include employed and unemployed persons, real estate markets include rented and vacant properties available for rent. Owners and managers of rental properties generally keep an inventory of vacant properties that can be rented on short notice. Because this practice is costly, finding optimal levels of vacant inventories is essential. Rental Housing Units in United States, Texas, and Major Texas Cities, 2010 Region Dallas-Fort Worth Houston San Antonio Austin Total Texas Cities Texas United States
Rental Units
Occupied
Vacant
Vacancy Rate (Percent)
1,103,975 872,777 302,943 294,696 2,574,390
978,363 752,334 274,466 275,835 2,280,766
125,612 120,443 28,477 18,861 293,624
11.4 13.8 9.4 6.4 11.4
3,558,025 43,181,184
3,180,874 39,640,327
377,151 3,540,857
10.6 8.2
Source: U.S. Census Bureau
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TIERRA GRANDE
Figure 1. Dallas Rental Housing Sector: Vacancy Rates
14
Percent
12 10 8 6 2002
2004
2006
2008 2010 Year:Quarter
2012
2014
Source: Real Estate Center at Texas A&M University
Figure 2. Houston Rental Housing Sector: Vacancy Rates
16
Percent
14 12 10 8 6 2002
2004
2006
2008 2010 Year:Quarter
2012
2014
Source: Real Estate Center at Texas A&M University
14
OCTOBER 2015
Percent
12 10 8 6 2002
2004
2006
2008 2010 Year:Quarter
2012
2014
Source: Real Estate Center at Texas A&M University
Figure 4. Austin Rental Housing Sector: Vacancy Rates
14 12 Percent
An ongoing research project at the Real Estate Center at Texas A&M University has developed a number of economic models of the relationships between supply and demand for rental properties and their rents in Texas real estate markets. The concept of natural vacancy rate is a useful framework for estimating the relationships between changes in vacancy rates and rents. Texas has a large rental housing market. With more than 3.5 million units, Texas accounted for about 8.2 percent of the U.S. rental housing market of more than 43 million in 2010 (see table). More than 2.5 million of the state’s multifamily residential units are in Dallas-Fort Worth, Houston, San Antonio and Austin. Dallas-Fort Worth had more than 1.1 million multifamily residential units in 2010 followed by Houston (872,777 units), San Antonio (302,943 units) and Austin (294,696 units). The state’s total rental housing inventory comprises rented and vacant units available for rent (see table). The vacancy rate is the number of vacant rental housing units divided by the total number of rental housing units, which varies from a high of 13.8 percent in Houston to as low as 6.4 percent in Austin. The vacancy rate tends to increase when the supply of rental units grows faster than demand. It is an indicator of the flexibility of the supply side of the rental housing market. In 2010, the vacancy rate in Texas’ rental housing
Figure 3. San Antonio Rental Housing Sector: Vacancy Rates
10 8 6
4 2002
2004
2006
2008 2010 Year:Quarter
2012
2014
Source: Real Estate Center at Texas A&M University
11
Dollars Per Square Foot
Figure 5. Texas Major Metro Areas: Rental Housing Sector Rents
1.2
Austin Dallas Houston San Antonio
1.1 1.0 0.9 0.8 0.7 2002
2004
2006
2008 2010 Year:Quarter
2012
2014
Source: Real Estate Center at Texas A&M University
4
Figure 6. Dallas Rental Housing Sector: Rent Growth Rates
Percent
3 2 1 0
–1 –2 2004
2006
2008 2010 Year:Quarter
2012
2014
Source: Real Estate Center at Texas A&M University
5
Figure 7. Houston Rental Housing Sector: Rent Growth Rates
Percent
4 3 2 1 0 –1 2004
2006
2008 2010 Year:Quarter
Source: Real Estate Center at Texas A&M University
12
2012
2014
market was 10.6 percent compared with 8.2 percent for the United States, which shows that the supply side of Texas’ rental housing market was more flexible and robust than the nation’s.
Natural Vacancy Rate The concept of natural vacancy rate is closely related to the concept of nonaccelerating inflation rate of unemployment (NAIRU). According to renowned economist Milton Friedman’s NAIRU, there is a level of unemployment rate that tends neither to raise nor lower the wage rate or inflation rate. According to NAIRU, wage and inflation rates are determined by the difference between the actual level of unemployment rate and NAIRU rather than the unemployment rate. Applying the concept to real estate markets, there are natural vacancy rates in rental real estate markets, such as apartments and offices, at which the growth rates of rents are zero. Rents tend to increase (decrease) when actual vacancy rates fall below (rise above) the natural vacancy rates. The concept and the measure of natural vacancy rate is important for owners and managers as well as renters. When the vacancy rate in a local housing market is getting close to the natural vacancy rate in that market, it is a signal to developers to build more units or to increase rents. For renters, vacancy rates lower than natural vacancy rates signal higher rents in the foreseeable future. Monitoring vacancy rates and comparing them to natural vacancy rates can help city planners optimize the effectiveness of a local community’s land-use patterns and infrastructure. ata needed for estimating the natural vacancy rate in a local rental housing market consist of the time series of vacancy rates and rents in the local market. For estimating natural vacancy rates in Texas’ major rental housing markets, the Real Estate Center compiled available time series of rents and vacancy rates for the state’s major cities. This research project used the quarterly time series of rents and vacancy rates for apartment markets in Dallas-Fort Worth, Houston, San Antonio and Austin from third quarter 2002 to fourth quarter 2014. All four Texas rental housing markets recorded upward trends in vacancy rates in the Great Recession (GR) of 2007–09 (Figures 1–4). Dallas-Fort Worth’s vacancy rates that were moving at around 10 percent before the GR increased to 12.9 percent in fourth quarter 2009, trended downward as the local economy recovered from the GR, and fell to less than 8 percent in 2014 (Figure 1). Houston’s vacancy rates trended upward from late 2005 and reached 14.7 percent in fourth quarter 2009, then trended downward, falling to less than 10 percent in 2014. San Antonio’s rental housing market had its highest vacancy rate of 12.4 percent in fourth quarter 2009. Austin’s vacancy rate climbed to 13.3 percent in second quarter 2009 and since then has been trending downward, falling to less than 8 percent in 2014.
D
TIERRA GRANDE
Figure 8. San Antonio Rental Housing Sector: Rent Growth Rates
4
Percent
3 2 1 0 –1 2004
2006
2008 2010 Year:Quarter
2012
2014
Source: Real Estate Center at Texas A&M University
These changes in vacancy rates are reflected in corresponding rents and growth rates of rents (Figures 5–9). Rental housing markets with lower vacancy rates like Austin experienced higher growth rates of rents. Rent levels in Austin were well above corresponding rents in other Texas cities (Figure 5). The average rent per square foot per month for Austin during the data period was $1 compared with 90 cents for Dallas-Fort Worth, 87 cents for Houston and 86 cents for San Antonio. Annual growth rates of rents show Dallas with four quarters of declining rents in the GR (Figure 6). Rent growth rates in Houston’s rental housing sector were trending downward in the GR, and since 2010 have been trending upward (Figure 7). San Antonio’s rental housing market has not had a rate decline since 2003 (Figure 8). Austin’s rental housing market had five quarters of negative growth rates in the GR, and since 2011 has posted annual growth rates as high as 5.4 percent in third quarter 2012 (Figure 9).
Estimating Natural Vacancy Rates
T
Figure 9. Austin Rental Housing Sector: Rent Growth Rates
6
Percent
4 2 0
–2 –4 2004
2006
2008 2010 Year:Quarter
2012
2014
Source: Real Estate Center at Texas A&M University
Figure 10. Dallas Rental Housing Sector: Rent Growth Rates and Vacancy Rates
Rent Growth Rate (Percent)
3.0 2.5 2.0 1.5
he simplest way to estimate natural vacancy rates is to bring together time series of vacancy rates and growth rates of rents, then plot a scatter diagram and fit a line of the relationship between the two variables. The point of the intersection of the fitted line and the zero line is the estimated natural vacancy rate. Figure 10 shows moving averages of annual growth rates of Dallas rents on the vertical axis and their corresponding vacancy rates on the horizontal axis. A fitted line of the relationship between the two variables was estimated using regression analysis. As the figure shows, the lower the vacancy rate, the higher the growth rate of rents. The fitted line crosses the zero line between vacancy rates of 11 and 12 percent. The growth rate of rent in this market is zero at the point of the intersection of the zero line and the fitted line. A more exact estimated relationship from the regression analysis shows that the natural vacancy rate for Dallas during the period was 11.5 percent. Rent growth rates in Dallas were positive (negative) when actual vacancy rates were smaller (larger) than the natural vacancy rate of 11.5 percent (Figure 10). Similar analyses for Houston, San Antonio and Austin show natural vacancy rates of 14, 11.2 and 10 percent, respectively. Dr. Anari (m-anari@tamu.edu) and Dr. Hunt (hhunt@tamu.edu) are research economists with the Real Estate Center at Texas A&M University.
1.0 0.5
THE TAKEAWAY
0.0
The relationship between vacancy rates and rents in real estate rental markets can help managers and renters better understand the current state of rental markets and the direction of rents in the foreseeable future. The concept of natural vacancy rate can help builders plan the timing of new rental construction.
–0.5 –1.0
7
8
9 10 11 12 Vacancy Rate (Percent)
13
Source: Real Estate Center at Texas A&M University OCTOBER 2015
14
13
Housing Market
14
TIERRA GRANDE
What exactly is a modular home? “It’s just a house,” says Larry Wilkinson, a consultant working with Oak Creek Homes, one of several modular home manufacturers in Texas. “They are largely self-contained units built in a factory and assembled at the home site.” Modular homes use the same framing systems and material applications as site-built homes. OCTOBER 2015
15
M
IN URBAN INFILL SETTINGS, modular homes minimize the disruption neighborhoods experience during regular on-site construction. This modular home in Austin’s Bouldin Creek neighborhood was built elsewhere and installed on the site.
Modular homes are not the same as “manufactured housing,” which is constructed according to the 1976 Federal HUD (Department of Housing and Urban Development) code. In Texas, residential modular homes are built to the same building codes as site-built homes. This means they may be seen in a city’s traditional residential neighborhoods as well as rural areas. According to the Texas Department of Licensing and Regulation, a municipality must accept modular housing constructed under the Texas Industrialized Housing and Buildings (IHB) program. “If an area is zoned single-family residential, then the municipality must accept an IHBqualified single-family residential building into that area. However, any deed restrictions filed of record affecting modular housing must be abided by,” says Wilkinson. Under Chapter 1202 of the State Occupations Code, a municipality may not require or enforce any amendments to the mandatory state codes for “industrialized housing” (the state’s terminology for modular housing) as a prerequisite for granting construction permits or certificates of occupancy. In coastal counties, modular homes must also meet the Texas windstorm construction requirements if buyers want to qualify for Texas Department of Insurance windstorm coverage. Depending on location, a qualified home’s wind rating will fall between 90 and 140 miles per hour.
Comparable in Value Modular homes are always classified as real property. This means comparables for appraisal purposes must be other similar site-built or modular homes. The law does grant municipalities authority to adopt state-permitted ordinances affecting modular homes. For example, a city may adopt an ordinance requiring single-family modular housing to have a value equal to or greater than the median taxable value for each single-family dwelling located within 500 feet of the proposed modular home installation site. This is known as the “500-foot rule.” “Under the rule, an audit of homes within 500 feet of the proposed site is conducted,” says Wilkinson. “The modular home should complement existing homes with similar construction elements, such as size, roof pitch, exterior siding and window style.” A check of six modular single-family homes located within the City of Austin and built
16
between 2003 and 2008 revealed that their values are similar to nearby site-built homes. According to Travis County central appraisal district data, the modular homes ranged from $146,000 to $732,000 in appraised value ($108 to $375 per square foot) and 1,330 to 2,430 square feet in size.
Inspection Process Modular homes are subject to a stringent inspection process, both in the manufacturing facility and in the field. “In the facilities where the modules are constructed, manufacturers will have both their own quality control inspectors and outside third-party inspectors,” says Martin Montgomery, principal engineer/owner of RCS Enterprises LP. Before a modular home is built, a third-party engineering company performs a design review and must approve modular home plans sent by the manufacturer to state IHB officials in Austin for final approval. Any steps, decks, porches or attached garages must be designed and approved by a professional engineer. “Foundations for modular homes have to be designed and approved by a professional engineer,” says Montgomery. “The amount of engineering and inspection that goes into modular housing is extensive, and that’s a good thing for homebuyers.” The party inspecting the homes in the field will vary. “Out in the county, department-approved, codeknowledgeable, third-party code inspectors will carry out at least three inspections at the home site,” says Wilkinson. “Within municipalities and their extraterritorial jurisdictions, they will be conducted by city inspectors.” “There will first be a pre-pour inspection of the foundation,” says Montgomery. “Next comes an inspection after the modules have TIERRA GRANDE
been field installed and set on the foundation. Last will be a final inspection where everything is looked at.” Another layer of protection comes from the licensing of various parties involved in the process. Modular builders must be licensed by the state as “industrialized builders” while manufacturers must be licensed as “industrialized housing manufacturers.” A full list of industrialized builders and manufacturers can be found at https://www.tdlr.texas. gov/ihb/ihblists.htm. Plumbing, electrical, HVAC and other specialty subcontractors must be licensed by their various state regulatory entities.
Labor Shortages Favor Modular Modular home sales in Texas have historically been quite limited, averaging about 700 units annually since 2011 according to DJ Pendleton, executive director of the Texas Manufactured Housing Association. However, with the recent OCTOBER 2015
shortage in skilled labor available to Texas residential builders, modular housing may become a more viable alternative to site-built housing than it has been. Montgomery has seen an ebb and flow of interest in modular from site-built homebuilders over the years. “Modular housing works well in areas where labor is tight,” says Montgomery. “Areas that have experienced heavy oilfield activity such as Midland would be a good example in Texas. The tighter the labor, the better modular works.” “Just finding a homebuilder in some rural areas of Texas can be a challenge as well,” says Keith Alexander, division president and general manager of Palm Harbor’s Austin manufacturing plant. “Many homebuilders have no interest in building in rural areas.” A recent builder survey by the National Association of Home Builders (NAHB) noted “shortages of labor and subcontractors have become substantially more widespread since 2013.”
17
In the NAHB survey, 65 percent of builders revealed they paid higher wages/subcontractor bids, 62 percent admitted labor shortages had raised their home prices, and 60 percent said labor shortages had created difficulty in completing projects on time.
Other Advantages “The ability to construct housing without delays in a climate-controlled environment, especially during winter months, is a huge plus for modular,” says Cal Davis, Homebuilding PR and communications specialist for Clayton Homes, another Texas modular housing manufacturer. Materials are less exposed to the elements in factory construction applications. “Ask any homebuilder who is frustrated with subcontractors or whose timetable is severely thrown off by weather if they would prefer less delay and less headaches to achieve their same quality result,” says Pendleton. “Financing entities also like the fact that the time to design, build and assemble a home is significantly reduced,” says Davis. “With modular construction, site preparation and foundation work can carry on at the same time the structure is being built.” “Another advantage is the ability to ramp up capacity if demand should increase,” says Montgomery. Manufacturing operations use integrated computer systems to efficiently manage and monitor the construction process in real time. This also results in minimal material waste. he ability to purchase material and appliances in bulk offers volume purchasing power. This keeps the costs competitive with site-built homes, even after module transportation is factored in. “Direct cost comparisons are difficult, because the level of material options and design customization can vary a lot with both modular and site-built homes,” says Wilkinson. Finally, the level of neighborhood disruption can be minimized in urban infill applications when modular housing is used. As the structure is not being constructed on-site, the amount of time and personnel on location should be shorter than with site-built homes.
T
Creative Construction Challenges One limitation of modular housing is the size of a module that can be transported at a reasonable cost. “We are pretty much limited to modules
18
that are less than 16 feet wide and 76 feet long,” says Wilkinson. “Any larger and transportation costs begin to increase exponentially.” eight is another consideration. The maximum cost-effective height for highway delivery in most of Texas is 15½ feet. With consumer preferences favoring steeper roof pitches and taller interior walls, creative construction designs have become necessary. “Manufacturers developed a hinged roof system to handle the problem,” says
H
Wilkinson. “It’s flat while being transported but swings up to the designed pitch when the home is assembled at the site.” Lower delivery height can also improve site access in some cases. The typically long, narrow geometry of modules creates another challenge: comparisons to manufactured housing. “Stigma is probably one of the biggest hurdles modular housing has to overcome,” says Jayar Daily, vice president of operations for American Homestar Corporation (Oak Creek Homes). “The perception has been that modular is somehow inferior to site-built housing,” says Davis. “I know that’s not true. But it’s our job to properly educate the public about the benefits of modern modular housing.” “Many builders and financial institutions are often unfamiliar with the state’s industrialized housing program as well,” adds Alexander. One factor that can affect this perception is the choice of “off-frame” or “on-frame” modular construction. As a rule, the homeowner chooses one of the two systems. However, some private TIERRA GRANDE
puter-aided design software. The hope is that potential modular homebuyers will find greater aesthetic appeal in designs that are increasingly moving toward more open floor plans and away from a basic box configuration. One interesting new modular product on the horizon is a hybrid prototype called Home Core under development by Oak Creek homes. The kitchen, bathrooms and utility room are constructed as a single modular “core unit,” leaving the remainder of the home to be stick-built around it. The result is a home where 90 percent of the electrical, plumbing and HVAC work and 100 percent of finished cabinetry work is completed MODULAR HOME INSPECTIONS are as rigorous as those at the factory. The stick-built porfor site-built homes. Because modulars are classified as real tion can be completed at the site with property, comparables for appraisal purposes are similar to siteonly a framing and finish installation built homes or other modulars. contractor. The factory unit will include the HVAC duct lenders mandate the use of off-frame construction. work, furnace and closet-mounted air handler/ Government financing entities such as FHA and VA blower. The outside condenser unit will be to date have no preference. installed by an HVAC contractor at the site. In on-frame construction, the module is built “Home Core modules we’ve designed are typion two steel beams used to transport it to the site cal examples for a potential builder to consider, just like manufactured housing. The steel beams but we realize that each builder will have their are then integrated into the foundation system. own ideas for what they might want in their core ff-frame modules are designed around a units,” says Charley Boyer, chief operating officer/ traditional concrete or wooden pier and vice president of the manufacturing division for beam foundation system. The modules Oak Creek Homes. are transported to the site on factory-built chassis “We see Home Core units working well with transports and then lifted into place with cranes. affordably-priced home developments,” says “On-frame would be my preferred system,” Boyer. “Module sizes of 15' × 36' or less allow two says Montgomery. “The steel beams offer extra Home Core units to be delivered on one carrier structural support, and it’s probably at least system, reducing freight costs from the factory to $5,000 less expensive than off-frame construction. the building site.” The finished homes can be made to look the same “This new hybrid approach to team up with using either system.” traditional custom site-built homebuilders shows Problems generally arise when city inspectors that technology and innovation are not only see a modular unit coming in on wheels and the occurring inside factory walls but beyond to tap frame not leaving. “They think you are deliverinto other markets where we can sell our proding a manufactured home, not modular,” says ucts and produce quality housing options,” says Montgomery. Pendleton. City officials have been known to block installation until legal wrangling clears up the fact that Dr. Hunt (hhunt@tamu.edu) is a research economist with the it’s modular construction. All modular homes will Real Estate Center at Texas A&M University. have a dataplate identifying it as modular construction and noting the specific building codes THE TAKEAWAY it was constructed to. Montgomery concedes that modular homes headed for suburban or urban infill Modular housing is not the same as manuapplications are probably better off using off-frame factured housing. These homes are built to construction to avoid conflicts with local officials. the same code as site-built homes in the area. Modular homes are an emerging market Future of Modular segment that may help mitigate weather and The design flexibility in modern modular floor plans labor issues during new home construction. continues to improve with the increased use of com-
O
OCTOBER 2015
19
Going Up?
Homebuying
By James P. Gaines
Manipulating the mortgage interest rate to encourage homebuying is nothing new. The Fed started lowering interest rates, especially the home mortgage rate, in the early 1980s. Between November 1978 and November 1990, except for a few months, the 30-year fixed mortgage rate was above 10 percent, peaking at 18.45 percent in October 1981. Although the Fed’s main concern at that time was overall inflation, the mortgage interest rate was one of the costs it was trying to get under control to boost the residential market and stimulate general economic growth. 20
What Mortgage Rate Changes Mean for Homebuyers
S
ince early 1991, the 30-year fixed mortgage rate has been almost steadily declining. Although volatile throughout the period, until spring 2013 each subsequent peak was lower than the previous peak and each subsequent low point was lower than the previous one (Figure 1). The mortgage interest rate since November 1990 fell from 10 percent to an historical low of 3.35 in December 2012, a 22-year period during which the homeownership rate went from 64 percent to a peak of 69 percent and then slid to less than 64 percent again by first quarter 2015. During the housing boom, the mortgage interest rate generally hovered in the 6 percent range, but as the housing bust and recession began in 2007, the Fed became far more directly active in the mortgage market. In December 2007, the 30-year fixed-rate was 5.96 percent. It rose to 6.35 percent when Fannie Mae and Freddie Mac were placed in conservatorship in September 2008 (Figure 2). The 30-year mortgage rate has not exceeded 8 percent since September 2000, 7 percent since April 2002, 6 percent since November 2008, and 5 percent since February 2011. During this time the Fed aggressively bought mortgagebacked securities from the government-sponsored entities TIERRA GRANDE
Figure 1. 30-Year Fixed Mortgage Rate History 20
Nov. 1990 to Oct. 1993. First free fall, from 10% to 6.8%
18
Interest Rate (Percent)
16
Growing inflation, inverted 14 yield curve and inconsistent 12 monetary policy
10
Oct. 1993 to May 2000. Roller coaster. Rates between 7% and 9%
Nov. 1978 to Nov. 1990. Double-digit mortgage rates
8 6
May 2000 to Aug. 2008 June to Dec. 2003. 2012. Second Quantitative free June 2003 easing Dec. 2012. fall, to Aug. 2008. (QE) with Tapering from and end Housing third 8.6% boom, from free fall, of QE. to 5.2% 5.2% to 6.5% to Waiting 6.5% for rise 3.35% in Fed funds rate
4 2 1972
1976
1980
1984
1988
1992
1996
2000
2004
2008
2012
2016
Sources: Haver Analytics; Federal Home Loan Mortgage Corporation (Freddie Mac) and Real Estate Center at Texas A&M University
to keep interest rates low and to provide liquidity to the housing market to foster housing activity. Throughout 2012 and the first half of 2013, the mortgage interest rate dropped below 4 percent. In May 2013, then Fed Chair Ben Bernanke gave a speech suggesting that the Fed might curtail its securities purchasing program in the future. The market jumped 1.23 percentage points from 3.35 percent on May 3 to 4.58 percent by August 23. By the time the Fed did start “tapering” its purchases of treasuries and mortgagebacked securities in January 2014, the mortgage rate stood at 4.53 percent and started a slow, steady decline. In effect, the market capitalized the expected action and subsequent rate hike almost six months before the actual event. For the past year or more, most observers have been guessing when, not if, the Fed would start raising its target Fed funds rate to raise general interest rates. The Fed’s principal weapon to influence economic activity is the cost of money, and for the past six years they have kept the Fed funds rate at
zero. The Federal Open Market Committee announced after its January 2015 meeting that a rate increase could occur “sooner than currently anticipated.” Since then, the mortgage rate has increased nearly one-half percentage point, from 3.59 percent to 4.04 percent. Again, the market may have already capitalized an expected future increase, causing current rates to rise.
Mortgage Interest Rates and the Texas Housing Market Historically, monthly home sales in Texas have followed the expected inverse pattern relative to changes in the overall mortgage interest rate. As the rate declined, sales increased, and when the rate increased sales tended to fall (Figure 3). Prior to the 2004–07 housing boom, monthly home sales in Texas grew at an average of 0.7 percent per month. During the boom, Texas monthly home sales increased at a full 1 percent per month before falling off at virtually the same
Figure 2. 30-Year Fixed Mortgage Rate: 2007 to Current 9
GSEs placed in conservatorship 9/6/08
8
7/20/07 6.73
Interest Rate (Percent)
7 6 5 4
9/5/08 6.35
12/7/07 5.96 Great Recession begins
3 2
11/28/08 5.97
Great Recession ends
7/3/09 5.32
2/11/11 5.05
Fed announces MBS purchase program 11/25/08. Last time rate > 6%
1/3/14 4.53
5/31/13 3.81
11/23/12 3.31 Historically lowest FHLMC 30-year FMR
1 2007
QE tapering begins; Dodd-Frank rules become effective
Last time rate > 5%
2008
2009
2010
2011
2012
Bernanke hints at tapering MBS purchases
2013
Sources: Federal Home Loan Mortgage Corporation (Freddie Mac) and Real Estate Center at Texas A&M University OCTOBER 2015
2014
Price of WTI peaks at $107.95
6/20/14 4.17
2/6/15 3.59 Fed says rate increase could occur “sooner than currently anticipated.” 1/28/15
2015
JULY
2015
21
Figure 3. Texas Monthly Home Sales and 30-Year Mortgage Interest Rate Dec. 2003 – Feb. 2007 Average 1.0%/month
May 2000 8.52
9
Interest Rate (Percent)
8 7
27,000
June 2011 – Dec. 2013 Average 1.4%/month
25,000 23,000
Jan. 2014 Average 21,000 0.3%/month
Interest Rate
6
19,000
June 2003 5.23
5
17,000 April 2009 4.81 Oct. 2010 4.23
4 Jan. 1995 – Dec. 2003 Average 0.7%/month
3 2
Home Sales
15,000 13,000
Nov. 2012 3.35
11,000
1
12-Month Moving Average Number of Sales Texas Home Sales
10
9,000
1995
1997
1999
2001
2003
2005
2007
2009
2011
2013
2015
Sources: Federal Home Loan Mortgage Corporation (Freddie Mac) and Real Estate Center at Texas A&M University
pace during the 2007 recession until mid-year 2011. As Texas emerged from the effects of the recession and the state’s economy expanded from both energy and nonenergy sectors, Texas home sales escalated at an even faster pace, growing an average 1.4 percent per month between June 2011 and year-end 2013. During this time, the U.S. housing market remained in the doldrums and the Fed specifically kept mortgage interest rates down to stimulate housing activity. In November and December 2012, the 30-year fixed mortgage rate hit its lowest recorded level at 3.35 percent. ince the beginning of 2014, the pace of growth in home sales has reverted closer to the preboom level. The initial slowdown in home sales growth in the first half of 2014 was probably at least partially a result of the increase in the mortgage rate experienced after the bump in the spring of 2013. The continued slowdown in the home sales growth rate probably reflects growing uncertainty about the Texas economy as the price of oil and the rig count plummeted during the second half of 2014 and early 2015.
S
Though not as pronounced, home prices, like the volume of housing sale activity, broadly move inversely with the mortgage interest rate. In Texas, the median home price increased on average about 4.3 percent per year between January 1995 and December 2008. This includes the boom period when monthly home sales inflated roughly 12 percent per year, but prices did not increase at a correspondingly high rate. During the recessionary period of 2008–11, the median home price was essentially flat, increasing on average about 0.5 percent per year, including two years when the median price declined slightly (Figure 4). Since early 2012, the Texas median home price has increased around 7.7 percent per year, nearly double the annual rate of increase in the preboom years. The rapid rise in the median price occurred primarily because of the boom in the Texas economy and despite the precipitous jump in the mortgage interest rate in 2013. Over the long term, such a rapid increase in home prices is neither sustainable nor desirable. Affordability, especially to median-income and
Figure 4. Texas Median Home Price and 30-Year Mortgage Interest Rate 10
240,000 Dec. 2008 – Feb. 2012 $145,792 – $148,150 0.04%/month, ~.5%/year
Interest Rate (Percent)
8 7
Interest Rate
6
Feb. 2012 – $148,150 0.64%/month, ~7.7%/year
220,000 200,000 180,000 160,000
5
140,000
4
120,000
Jan. 1995 – Dec. 2008 $79,775 – $145,792 0.36%/month, ~4.3%/year
3 2
100,000 80,000
Home Sales
1
Median Home Price 12-Month Moving Average Median Price
9
60,000
1995
1997
1999
2001
2003
2005
2007
2009
2011
2013
2015
Source: Real Estate Center at Texas A&M University
22
TIERRA GRANDE
Table 1. Total Monthly Payments at Alternative Interest Rates for a Home Priced at:* Rate (%)
$75,000
$100,000
$125,000
$150,000
$184,400
$200,000
$250,000
$300,000
$400,000
$500,000
3.00 3.25 3.50 3.75 4.00 4.25 4.50 4.75 5.00 5.25 5.50 5.75 6.00 6.25 6.50 6.75 7.00 7.25 7.50 7.75 8.00 8.25 8.50 8.75 9.00
618.77 627.44 636.27 645.24 654.35 663.61 673.01 682.55 692.22 702.03 711.97 722.03 732.21 742.52 752.94 763.48 774.13 784.89 795.75 806.71 817.77 828.93 840.18 851.52 862.95
825.03 836.59 848.35 860.31 872.47 884.82 897.35 910.07 922.97 936.04 949.29 962.70 976.28 990.03 1,003.92 1,017.98 1,032.17 1,046.52 1,061.00 1,075.62 1,090.37 1,105.24 1,120.24 1,135.36 1,150.60
1,031.29 1,045.74 1,060.44 1,075.39 1,090.59 1,106.02 1,121.69 1,137.58 1,153.71 1,170.05 1,186.61 1,203.38 1,220.36 1,237.53 1,254.91 1,272.47 1,290.22 1,308.15 1,326.25 1,344.52 1,362.96 1,381.55 1,400.30 1,419.20 1,438.24
1,237.55 1,254.89 1,272.53 1,290.47 1,308.70 1,327.22 1,346.02 1,365.10 1,384.45 1,404.06 1,423.93 1,444.06 1,464.43 1,485.04 1,505.89 1,526.96 1,548.26 1,569.77 1,591.50 1,613.43 1,635.55 1,657.86 1,680.36 1,703.04 1,725.89
$1,521.36 $1,542.68 $1,564.37 $1,586.42 $1,608.83 $1,631.60 $1,654.71 $1,678.16 $1,701.95 $1,726.06 $1,750.49 $1,775.23 $1,800.27 $1,825.61 $1,851.24 $1,877.15 $1,903.33 $1,929.78 $1,956.48 $1,983.44 $2,010.64 $2,038.07 $2,065.73 $2,093.61 $2,121.70
1,650.06 1,673.18 1,696.71 1,720.63 1,744.94 1,769.63 1,794.70 1,820.13 1,845.93 1,872.08 1,898.57 1,925.41 1,952.57 1,980.05 2,007.85 2,035.95 2,064.35 2,093.03 2,122.00 2,151.23 2,180.73 2,210.49 2,240.49 2,270.72 2,301.19
2,062.58 2,091.48 2,120.89 2,150.79 2,181.17 2,212.04 2,243.37 2,275.17 2,307.41 2,340.10 2,373.22 2,406.76 2,440.71 2,475.07 2,509.81 2,544.94 2,580.43 2,616.29 2,652.50 2,689.04 2,725.92 2,763.11 2,800.61 2,838.41 2,876.49
2,475.09 2,509.78 2,545.06 2,580.94 2,617.41 2,654.45 2,692.05 2,730.20 2,768.90 2,808.12 2,847.86 2,888.11 2,928.85 2,970.08 3,011.77 3,053.93 3,096.52 3,139.55 3,183.00 3,226.85 3,271.10 3,315.73 3,360.73 3,406.09 3,451.79
3,300.12 3,346.37 3,393.42 3,441.26 3,489.88 3,539.26 3,589.40 3,640.27 3,691.86 3,744.16 3,797.15 3,850.81 3,905.14 3,960.11 4,015.70 4,071.90 4,128.70 4,186.07 4,244.00 4,302.47 4,361.47 4,420.97 4,480.97 4,541.45 4,602.38
4,125.15 4,182.96 4,241.77 4,301.57 4,362.35 4,424.08 4,486.75 4,550.33 4,614.83 4,680.20 4,746.44 4,813.52 4,881.42 4,950.13 5,019.62 5,089.88 5,160.87 5,232.58 5,304.99 5,378.09 5,451.83 5,526.22 5,601.22 5,676.81 5,752.98
*Assumes 15 percent down, 30-year fixed-rate mortgage, 38 percent maximum debt-to-income ratio, 5.6 percent taxes, insurance and utilities Source: Real Estate Center at Texas A&M University
somewhat below median-income households, becomes a serious issue that might get worse if prices do not revert to their “normal” pace of increase. The current shortage in the supply of existing homes offered for sale and relatively subdued levels of new construction unbalance the housing supplydemand relationship toward higher prices.
Outlook for Higher Mortgage Interest Rates and Effect on Texas Housing
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he outlook for a mortgage rate change varies greatly. The Fed has made no secret that it expects to increase rates at some point, most likely sometime in third or fourth quarter 2015. In Fannie Mae’s recent “Monthly National Housing Survey,” 50 percent of the respondents expected rates to go up in the next year; only 4 percent thought rates would go down. There was no indication in the survey of how much rates would change. The uncertainty about rate changes also emerged in the recent New York Federal Reserve Bank “Housing Survey — 2015.” The New York Fed reported an expected increase in the mortgage rate of one-half percentage point in 2015 and 1.5 percentage points within three years. But the findings were highly volatile. Respondents to the survey felt rates were almost equally likely to go down. The responses indicated that they believed there is about a 10 percent chance rates could go down by at least 1 percentage point and an equal 10 percent chance rates could increase by 2 percentage points or more. Most of the uncertainty incorporates recent international financial actions, the uncertainty about oil prices and the continued modest pace of domestic economic growth.
OCTOBER 2015
A change in the 30-year fixed mortgage interest rate results in a directly proportional change in the monthly payment homebuyers must pay. The computed payments in Table 1 and 2 assume a 15 percent down payment acquiring a 30-year fixed-rate mortgage that requires total monthly housing costs be no more than 38 percent of the buyer’s monthly gross income (debt-to-income [DTI] qualifying ratio). The total monthly housing costs depicted in Table 1 include the mortgage payment of principal and interest (PI) plus allowances for property taxes (at an effective rate of 2.8 percent of the price of the home), utilities (electricity, gas, water and sewer estimated at an effective rate of 2 percent of the price) and insurance (at an effective rate of 0.8 percent of the price of the home), collectively referred to as TUI. In 2014, the median-priced Texas home was $184,400, the highlighted column in Table 1. The total monthly payment (PITUI) for the median-priced home, therefore, could range from $1,521.36 per month at a 3 percent interest rate to as much as $2,121.70 if the rate equaled 9 percent, a difference of $600.34 per month. The difference in the total payment from a 3 percent to a 9 percent rate is 39.5 percent at all prices. The PI portion of the total payment would actually nearly double, increasing by 91 percent if the rate changed from 3 to 9 percent. Because the TUI portion of the total payment is assumed to be a fixed 5.6 percent of the price and does not vary by the interest rate, the total payment increases at a lesser rate. Under the given assumptions, the property tax for the median-priced home is $5,163.20 per year or $403.27 per month; utilities cost $307.33 per month or $3,688.00 per year;
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and property insurance costs $122.93 per month or $1,475.00 priced home would be $67,000, an income 23 percent more per year. The total monthly cost of TUI equals $860.53. At than the current median. very 1 percentage point increase in the interest rate an interest rate of 4 percent, the monthly mortgage payment between 3 and 6 percent necessitates 5.8 percent more (PI) for the median-priced home equals $748.30, $112.23 less income to buy the same-priced home. For an increase than the total TUI. For the median-priced home, the PI does in the rate from 6 to 7 percent, 5.7 percent more income is not exceed the amount of TUI until the interest rate equals necessary; for an increase from 7 to 8 percent, 5.6 percent or exceeds 5.25 percent, resulting in a monthly PI of $865.52. more; and from 8 to 9 percent, 5.5 percent more income is The prevailing mortgage interest rate has not been as high as required. If rates were to suddenly jump from 3 to 5 percent, 5.25 percent since August 2008 (Table 2). Applying the assumed qualifying ratio of 38 percent the required income to buy the same-priced home would have to the PITUI across the range of interest rates provides the to increase by 12 percent. Similarly, if rates jumped from 3 required annual income a to 6 percent, the required Table 2. Monthly Payments for Median-Priced Home: $184,400 household must have to income would have to qualify for an 85 percent increase by slightly more Mortgage Housing (PI) Percent Required mortgage (Table 3). than 18 percent. Rate (%) Payment (PI) Payment (PITUI) of (PITUI) Annual Income The median Texas On average, every one3.00 660.82 1,521.36 43.4% $48,043 household income in quarter percentage point 3.25 682.14 1,542.68 44.2% $48,716 3.50 703.83 1,564.37 45.0% $49,401 2014 was estimated to be increase in the mortgage 3.75 725.89 1,586.42 45.8% $50,097 approximately $54,524. interest rate requires an 4.00 748.30 1,608.83 46.5% $50,805 Thus, the median-income additional 1.4 percent 4.25 771.07 1,631.60 47.3% $51,524 household in Texas last income to qualify to buy 4.50 794.18 1,654.71 48.0% $52,254 year would qualify to buy the same-priced home. 4.75 817.63 1,678.16 48.7% $52,995 the median-priced home Since 1984, the average 5.00 841.41 1,701.95 49.4% $53,746 5.25 865.52 1,726.06 50.1% $54,507 as long as interest rates annual rate of growth 5.50 889.95 1,750.49 50.8% $55,278 were no greater than 5.25 in the nominal Texas 5.75 914.69 1,775.23 51.5% $56,060 percent. With the current median household income 6.00 939.74 1,800.27 52.2% $56,851 mortgage interest rate has been 2.8 percent. If 6.25 965.08 1,825.61 52.9% $57,651 around 4 percent, Texas the state achieves the 6.50 990.70 1,851.24 53.5% $58,460 housing remains affordaverage annual increase in 6.75 1,016.61 1,877.15 54.2% $59,278 7.00 1,042.80 1,903.33 54.8% $60,105 able even if household median household income 7.25 1,069.24 1,929.78 55.4% $60,940 income is a fraction of in the coming year, gen7.50 1,095.95 1,956.48 56.0% $61,784 the median. Even at 50 eral housing affordability 7.75 1,122.90 1,983.44 56.6% $62,635 percent of median income should not be greatly 8.00 1,150.10 2,010.64 57.2% $63,494 ($27,250), households affected so long as rates do 8.25 1,177.54 2,038.07 57.8% $64,360 can essentially afford a not increase by more than 8.50 1,205.19 2,065.73 58.3% $65,234 8.75 1,233.07 2,093.61 58.9% $66,114 $100,000 home if the one-half percentage point. 9.00 1,261.17 2,121.70 59.4% $67,001 interest rate is no greater If the general mortgage *Assumes 15 percent down, 30-year fixed-rate mortgage, 38 percent maximum debt-tothan 4 percent, and can interest rate increases by income ratio, 5.6 percent taxes, insurance and utilities cost afford a $75,000 home at a Source: Real Estate Center at Texas A&M University more than one-half point, rate as high as 9 percent. either incomes will have Holding the down payment, qualifying ratio and estimated to grow at an above-average rate or households will be forced costs of TUI constant, a lower mortgage interest rate allows to buy lower-priced homes. a given amount of income to buy a higher-priced property. What Can We Expect? The price of home relative to the amount of income required It seems likely that interest rates will move upward some(the price-to-income multiplier) increases as the rate lowtime in late 2015 or early 2016. Recent economic and ers. Comparing the required income to the price of a house employment data indicate inflation and unemployment in Table 3 indicates that at a 3 percent rate, a given amount are approaching levels that could signal a rate increase by of income can qualify buyers to purchase a home priced at the Fed. The Fed has held its baseline rate at near zero for 3.84 times the income. As the rate increases, the multiplier more than six years and appears nervous about continuing effect declines to 3.24 at 6 percent and 2.75 at 9 percent. A at that level too much longer for fear of overstimulating the household earning the $54,524 median income, for example, economy. On the other hand, international events, such can effectively afford to buy a $209,000 home at a 3 percent as Greece’s default and ongoing bailout, uncertainty in the interest rate but only a $150,000 home at a 9 percent rate. At energy sector with oil and gas prices dropping and the still 9 percent, the required income to buy the $184,400 median-
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TIERRA GRANDE
Table 3. Annual Income Required for a Home Priced at: Rate (%)
$75,000
$100,000
$125,000
$150,000
$184,400
$200,000
$250,000
$300,000
$400,000
Price Multiplier
3.00 3.25 3.50 3.75 4.00 4.25 4.50 4.75 5.00 5.25 5.50 5.75 6.00 6.25 6.50 6.75 7.00 7.25 7.50 7.75 8.00 8.25 8.50 8.75 9.00
$19,540 $19,814 $20,093 $20,376 $20,664 $20,956 $21,253 $21,554 $21,860 $22,169 $22,483 $22,801 $23,123 $23,448 $23,777 $24,110 $24,446 $24,786 $25,129 $25,475 $25,824 $26,177 $26,532 $26,890 $27,251
$26,054 $26,419 $26,790 $27,168 $27,552 $27,942 $28,337 $28,739 $29,146 $29,559 $29,977 $30,401 $30,830 $31,264 $31,703 $32,147 $32,595 $33,048 $33,505 $33,967 $34,433 $34,902 $35,376 $35,854 $36,335
$32,567 $33,023 $33,488 $33,960 $34,440 $34,927 $35,422 $35,924 $36,433 $36,949 $37,472 $38,001 $38,538 $39,080 $39,629 $40,183 $40,744 $41,310 $41,882 $42,459 $43,041 $43,628 $44,220 $44,817 $45,418
$39,080 $39,628 $40,185 $40,752 $41,328 $41,912 $42,506 $43,108 $43,719 $44,339 $44,966 $45,602 $46,245 $46,896 $47,554 $48,220 $48,892 $49,572 $50,258 $50,950 $51,649 $52,354 $53,064 $53,780 $54,502
$48,043 $48,716 $49,401 $50,097 $50,805 $51,524 $52,254 $52,995 $53,746 $54,507 $55,278 $56,060 $56,851 $57,651 $58,460 $59,278 $60,105 $60,940 $61,784 $62,635 $63,494 $64,360 $65,234 $66,114 $67,001
$52,107 $52,837 $53,580 $54,336 $55,103 $55,883 $56,675 $57,478 $58,293 $59,118 $59,955 $60,802 $61,660 $62,528 $63,406 $64,293 $65,190 $66,096 $67,010 $67,934 $68,865 $69,805 $70,752 $71,707 $72,669
$65,134 $66,047 $66,975 $67,920 $68,879 $69,854 $70,843 $71,847 $72,866 $73,898 $74,944 $76,003 $77,075 $78,160 $79,257 $80,366 $81,487 $82,620 $83,763 $84,917 $86,082 $87,256 $88,440 $89,634 $90,837
$78,161 $79,256 $80,370 $81,504 $82,655 $83,825 $85,012 $86,217 $87,439 $88,677 $89,932 $91,203 $92,490 $93,792 $95,109 $96,440 $97,785 $99,144 $100,516 $101,901 $103,298 $104,707 $106,128 $107,561 $109,004
$104,214 $105,675 $107,161 $108,671 $110,207 $111,766 $113,349 $114,956 $116,585 $118,237 $119,910 $121,605 $123,320 $125,056 $126,812 $128,586 $130,380 $132,192 $134,021 $135,867 $137,731 $139,610 $141,504 $143,414 $145,338
3.84 3.79 3.73 3.68 3.63 3.58 3.53 3.48 3.43 3.38 3.34 3.29 3.24 3.20 3.15 3.11 3.07 3.03 2.98 2.94 2.90 2.87 2.83 2.79 2.75
*Assumes 15 percent down, 30-year fixed-rate mortgage, 38 percent maximum debt-to-income ratio, 5.6 percent taxes, insurance and utilities cost Source: Real Estate Center at Texas A&M University
relatively lackluster expansion in the overall economy, may constrain Fed actions for awhile. As of now, it’s unclear when rates will change. If rates are not increased in 2015, the probability of a rate hike, or perhaps more than one rate hike, increases significantly in 2016. It also appears likely that when the Fed does increase the rate, it will do so in small, incremental amounts over time rather than raising rates substantively in the short term. ost research about changes in mortgage terms on the housing market concludes that a change in down payment requirements generally affects the housing market more than an interest rate change. However, as down payment requirements are normally more flexible and not as fixed, the shorter-term impact of a rate change can be more pronounced. The major impact, as with many changes, is most felt by households on the edge of qualifying or not qualifying to buy a home. Even a small change in the interest rate can mean a nearly 1.5 percent increase in the income required to qualify for a home. As a consequence, the household is forced to buy a somewhat less expensive home to qualify for a loan and afford the non-mortgage monthly costs. A mortgage interest rate increase dampens effective housing demand to some degree. Quite often, though, the psychological impact may be more pronounced than the actual economic impact. Prospective buyers become nervous about making a housing commitment, and consequently do nothing. One countereffect, of course, that comes from the
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OCTOBER 2015
psychological influence is a short-term increase in homebuying activity in anticipation of future rate increases. When mortgage interest rates do increase, it is highly unlikely they will change more than one-quarter to one-half percentage point. While this may sway buyers on the margin for loan qualifying, the overall market should not be greatly affected. In fact, any shift in demand that occurs may actually bring better balance between supply and demand. Whatever level of impact results, it will more likely be felt by lowerincome and first-time buyers, as these groups tend to be more on the margin for loan qualifying than higher-income and repeat buyers. In the longer run, the mortgage rate may wind up reverting to the 5 to 6 percent range. Such a significant move would have a much more pronounced impact on the market, but this magnitude of change will probably be some time in coming. Dr. Gaines (jpgaines@tamu.edu) is chief economist with the Real Estate Center at Texas A&M University.
THE TAKEAWAY A small increase in the mortgage interest rate is likely in the next quarter or two. It should have little impact on the overall housing market but will affect buyers caught on the edge of qualifying for a loan. These buyers will have to make a larger down payment or buy a slightly less expensive home.
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Property Taxes
By Charles E. Gilliland
T
exas legislators assembled in Austin having campaigned on promises of meaningful property tax relief. A strident drumbeat of criticism singled out the unequal appraisal protest and appeal as a “corporate loophole” resulting in assessments falling short of the market value standard. As the curtain went up on the session, legislators faced an avalanche of bills addressing property taxes. They adopted more than 30 of the proposals. Much of the legislation addressed arcane situations. For example, one measure, HB 275, explicitly added “eggs” to the list of exempt farm products recited in section 11.16 of the property tax code. Others dealt with administrative issues such as changing requirements for annual applications for certain exemptions to a one-time application, or protecting the confidentiality of photos of property interiors taken by appraisal districts. However, several measures will likely have more wide-reaching effects.
Homestead Exemption Perhaps the most noteworthy adopted act increased the school homestead exemption by $10,000. SB 1 amends the Texas Property Tax Code while SJR 1 proposes the constitutional amendment needed to ratify the $10,000 increase. Section 11.13(b) of the Property Tax Code governs the basic homestead exemption for school taxes and had remained at $15,000 since the early 1990s. State leaders saw an increase in this amount as the best way to provide property tax relief to disgruntled Texas homeowners. Obviously, school districts would likely face budget shortfalls because of the expanded exemption. Consequently, HB 1, which sets the state budget, included $3.8 billion to mitigate the impact of possible revenue losses to local school districts. Despite this so-called “hold harmless” provision, concern that taxing units might undermine tax relief by eliminating their separate additional optional percentage homestead exemptions prompted the exemption provisions to also stipulate that, “The governing body of a school district, municipality, or county that adopted an exemption under Subsection (n) for the 2014 tax year may not reduce the amount of or repeal the exemption. This subsection expires December 31, 2019.” This passage seems to preclude dropping that exemption for at least four years. However, reports indicate that some school districts have moved to eliminate the optional exemptions before the law takes effect. Those actions suggest that
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promised relief may be far less than expected in some districts. Responding to political pressures, legislators insisted that the measure should apply to the 2015 tax year even though voters must approve the relief in an election on November 3rd. Officials at local taxing units sending tax bills before the election must base the total on the $25,000 total exemption and note that the result is a provisional tax bill. In the unlikely event that voters scuttle the intended relief, the tax liability would revert to the $15,000 exemption amount, raising homeowners’ tax liabilities. For most of the disabled or over-65 homeowners with a frozen property tax liability, an added $10,000 exemption would provide no relief. To extend a benefit to those homestead owners, the legislation provides for a reduction in the 2014 tax ceiling equal to the amount of reduction resulting from the $10,000 exemption and the 2015 tax rate adjusted for any new improvements made during 2014. ccording to a study published by the District of Columbia, Houston’s 2013 tax rate was $2.56 per $100 of assessed value. If school taxes composed 60 percent of that total, the increased exemption would reduce homeowner taxes by $154. However, the provision did not alter the 10 percent increase in taxable value allowed for homesteads by the Property Tax Code. Thus, a home formerly valued at $100,000 after the existing school tax exemption could increase to $110,000 with a new appraisal. The exemption would return the taxable value to $100,000, likely resulting in no change in tax liability assuming the tax rate remained the same. Therefore, appraisal increases may offset some of the anticipated tax relief.
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Unequal Appraisal Appeal The Texas Constitution requires that taxation be “equal and uniform,” meaning that properties with identical market values must incur identical tax liabilities. This provision bars appraisal districts from choosing favored taxpayers for preferential treatment. For example, an appraisal district cannot appraise homes of most owners at market value while setting a public official’s home value at a fraction of its market value. TIERRA GRANDE
This specification creates two possible avenues to seek relief in district court. First, a taxpayer can dispute the appraised taxable value when it exceeds the market value of his or her property. Alternatively, the property owner might concede that the tax appraisal does not exceed market value, but that the appraisal represents a higher percentage of market value than the appraisals of other properties on the tax roll. When the argument centers on the issue of unequal appraisal for protest at the appraisal review board (ARB), Section 41.43(b) (3) of the Property Tax Code, or 42.26 (a)(3), establishes the
form of HB 2083. In the heated arguments leading up to the session, opponents of unequal appraisal protests accused taxpayer experts of picking only those comparable properties that proved their case while ignoring others. Further, many insisted that unjustified adjustments were made to reach a foregone conclusion. Consequently, HB 2083 insists that: The selection of comparable properties and the application of appropriate adjustments for the determination of an appraised value of property by any person under Section 41.43(b)(3) or 42.26(a)(3) must be based on the application of generally accepted appraisal methods and techniques. Adjustments must be based on recognized methods and techniques that are necessary to produce a credible opinion. Critics of unequal appraisal appeals deemed this compromise to be inadequate. However, it does give appraisal district staff grounds for addressing perceived abuses both at the ARB and at the appeal stage.
Requirements for Binding Arbitration
grounds for granting relief. These sections instruct the ARB or court to grant relief when the subject’s appraised value exceeds the median appraised value of a reasonable number of comparable properties appropriately adjusted. At the ARB, the appraisal district must prove that the value does not exceed the median. The burden of proof moves to the taxpayer in district court. The language appears to suggest an analytical approach roughly similar to the standard appraisal process. There, the opinion of market value derives from an analysis of a limited number of sold properties that are similar to the subject. This level of evidence of unequal treatment falls far short of the onerous standards specified in subsections (1) and (2) of the two code sections, making it easier to prove the case. In fact, prior to the addition of the language in subsection 42.26(a)(3), few if any taxpayers could afford the substantial sums required to meet the prescribed evidence in (1) and (2). After the (3) entered the code, unequal appraisal appeals became more prevalent, with numerous commercial and industrial taxpayers employing them to achieve sizable property tax savings. In some cases, buyers successfully argued for taxable value far less than the price they had just paid for the property because they provided evidence that competing, comparable properties enjoyed values well short of the value suggested by the market price. Critics decried these results, arguing that this “loophole” allowed well-heeled taxpayers to avoid paying a fair amount based on the property’s market value. Articles appeared narrating this practice as twisting tax laws to favor corporations and commercial taxpayers at the expense of others. Legislative provisions poured in, attempting to eliminate or vastly curtail use of this unequal appraisal option. However, none of those proposals survived as opponents pointed out the inherent injustice of allowing blatant discrimination among taxpayers. Finally a compromise emerged in the OCTOBER 2015
Chapter 41A of the Property Tax Code allows certain property owners to appeal an ARB decision using an assigned qualified arbitrator instead of filing a lawsuit in district court. Previously, only owners of residence homesteads as defined in Section 11.13 of the code or properties with appraised or market values of $1 million or less could avoid the expense of a district court appeal by opting for binding arbitration. SB 849 expands the previous qualifications to include properties with market value of $3 million or less, making arbitration accessible to more property owners. The act also changes the amount of the fee required to obtain binding arbitration. Instead of a $500 flat fee, the new schedule depends on aspects of the property under appeal. For owners of qualified homesteads, fees start at $450 but increase to $500 for homes with values in excess of $500,000. Non-homestead appeals start at $500 for properties with values of $1 million or less. The fee rises to $800 for properties between $1 million and $2 million and to $1,050 for the $2 million to $3 million properties. The comptroller’s administrative fee remains at $50.
Surviving Spouse of Totally Disabled Veterans
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enerally, surviving spouses of totally disabled veterans qualify for a 100 percent exemption on their residence homestead. The veteran’s exemption became operational in 2009 with the spouses’ right entering the code in 2011. However, surviving spouses of veterans who had died prior to those dates were not covered by the exemption. HB 992 and HJR 75 will expand this right to those spouses if voters approve the required constitutional amendment on November 3, 2015. These measures represent the most significant legislation likely to affect property taxes for most Texas property owners. For more information, see Center publication “Property Tax Protest & Appeal.” Dr. Gilliland (c-gilliland@tamu.edu) is a research economist with the Real Estate Center at Texas A&M University.
THE TAKEAWAY A $10,000 increase in the homestead exemption, appealing unequal appraisals and using an arbitrator to appeal an appraisal review board decision are among the property tax topics the Texas Legislature addressed this session.
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Income Taxes
Burden of Proof
By Jerrold J. Stern
Poor Records May Increase Taxes
R
egardless of whether a taxpayer correctly includes income and deductions on a tax return, an IRS audit could lead to additional taxes, interest and penalties if the taxpayer does not have adequate supporting documentation. In general, the IRS is deemed correct by the courts. Taxpayers have the burden of proof. They must furnish records showing that income and deductions on the return are accurate. Taxpayers frequently lose court cases because of inadequate documentation. Some of these losses are in the real estate area and highlight avoidable recordkeeping mistakes. Several recent tax court cases provide examples. In 2014, additional taxes, interest and an “accuracy-related substantial understatement penalty” were imposed on a property owner because of inadequate documentation of hours spent managing the property. Documenting the number of hours was necessary for the owner to show he was a real estate professional, and, therefore, eligible to deduct losses. Ideal documentation would have included “contemporaneous daily time reports, logs or similar documents.” If these were not available, acceptable documentation could have included “identification of services performed over the period and the approximate number of hours spent performing such services, based on appointment books, calendars or narrative summaries (see “Part-Time Pitfalls” at https://assets.recenter.tamu. edu/Documents/Articles/2070.pdf.) Roughly a year after the tax year in question, the taxpayer created a calendar based on “very cryptic notes” contained in a notebook. The notes were incomplete with regard to the hours spent in connection with the property and lacked any supporting documents. After the IRS audit, a second logbook was created that listed more items such as additional hours, including the time spent on Craigslist ads, emails and travel time to and from the property.
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The taxpayer was required to pay taxes and interest based on the disallowance of the rental losses he claimed. In addition, he was required to pay an accuracyrelated penalty of 20 percent of the tax because he was found to be negligent. “Negligence includes any failure to make a reasonable attempt to comply” with the tax law, such as “failure to keep adequate books and records or to substantiate items.” In a 2014 tax court case, various deductions claimed by a real estate salesperson were denied because of a lack of documentation. The disallowed deductions pertained to depreciation, insurance, mortgage interest and homeowner association dues for three properties. One requirement for depreciation is that the property has been “placed in service” during the year — that is, advertised for rental or actually rented. The IRS claimed that two of the properties were apparently under construction during the tax year and, thus, were not yet eligible for depreciation. The salesperson had no proof that the properties were placed in service during the tax year. Deductions associated with the third property were disallowed because the salesperson could not demonstrate that he owned or had any legal interest in the property.
In 2013, a real estate salesperson lost deductions for rental expenses associated with a duplex. The property was co-owned with his cousin. No rental income was reported for the year in question, and it could not be proved that the property was advertised or available for rent. The salesperson was unable to provide supporting evidence showing how expenses were allocated between the duplex units. Also, there was insufficient evidence with regard to the actual cost of the building (separate from the land). The salesperson’s “educated guess” was disregarded by the IRS and the court. Furthermore, the salesperson allocated all of the depreciation deduction to himself, rather than splitting it 50/50 with his cousin. A 2015 tax court case provides additional examples of poor documentation. While the case pertains to a real estate appraiser, similar documentation issues arose. The items questioned by the IRS included depreciation, interest, repairs, supplies, taxes, legal and professional fees, travel, utilities expenses and operating losses. o avoid the problems illustrated here, obtain advice from a tax accountant or attorney knowledgeable in real estate matters before real estate activities begin. Salespersons should consider recommending such advice to their clients.
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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 Regardless of whether a taxpayer correctly includes income and deductions on a tax return, an IRS audit could lead to additional taxes, interest and penalties if the taxpayer does not have adequate supporting documentation. TIERRA GRANDE
OCTOBER 2015
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