Oil Prices and the Houston Housing Market

Skyline of Houston, TexasWe’ve been getting asked, A LOT, about what the real estate market in Houston is going to do in 2015 with oil prices dropping so far so fast.  The short answer is we don’t know for sure, and neither does anyone else.  However, we do have some ideas based on a combination of expert opinions, research, and gut feelings.  We are using this same information to make buying and selling decisions in our business so this is not a, “Do as I say.  Not as I do” opinion, but a plan we’ve put in place in our own real estate businesses (Custom Home Building, Real Estate Brokerage, Flips, and Rentals) that are all centered around the real estate market.

Houston’s 2015 Economic Forecast
On January 6th the Greater Houston Builder’s Association (GHBA) hosted Dr. Mark Dotzour of the Texas A&M Real Estate Center who, in our opinion, is the foremost expert on the industry.   We were fortunate enough to attend the presentation and will attempt to summarize his presentation below with a sprinkling of our own research:

Demand For Housing Is High
People are moving to Houston (and Texas) in record numbers.  In 2014 Houston was the #2 city in the country for population growth.  It is also the #1 destination for U-Haul trailers for five years in a row, with an average of 137,000 people moving to the city per year.

Supply of Housing is Low
Anytime available home inventory is below 6 moths it’s considered a seller’s market.  According to the Houston Association of Realtors (HAR), inventory in December 2014 was at 2.5 months.

Houston is still considered a bargain compared to most of the country.  Ask anyone from the East or West coast and they are shocked to find how far their home buying dollar goes here.  The relative affordability of Houston housing should help insulate a drop in pricing.   You can find more information on affordability here:  Culture Map:  Houston Housing Underpriced  

Builders Cannot Keep Up With Demand

Banks learned from their mistakes in the 2008 real estate bust.  They are not willing to loan to builders at a rate that can keep up with demand.

Labor Shortage
In addition, there is not enough labor to build the houses.  When oil was booming the construction industry lost a good deal of their labor force to the oil fields.  This causes longer build times delaying delivery of finished homes.  Builders are fighting over labor.

Increased Time to Build
It now takes, in the Houston area, two to four months longer to build than it did several years ago.  One reason we already discussed, which is a labor shortage.  In addition, with apartments and other commercial property being constructed all throughout Houston, architects and engineers are flooded with work, which means it takes longer to push out a set of plans for city approval.

In addition, the city is taking longer and longer to approve plans because they do not have the staff to review.  What used to take a week or two can now take up to two-months for city approval.

Homebuyer Lending
Bank have also changed their underwriting criteria for homebuyers.  Once again, learning their lessons from 2008, they are requiring higher credit scores to qualify.  In addition, they are requiring 20% down payments.  This equates to buyers not getting into trouble with their loan (for the most part anyway… there are always a few).

What this means for the banks is that they are in a better position financially because they do not have as much risk in the market.

Interest Rates
Interest rates are at historical lows and are anticipated to stay low for the foreseeable future.

City Diversification
Houston is no longer just an “Oil and Gas” city.  It is much more dynamic than in the 80’s when the whole city went bust because of oil prices.

Dr. Dotzour believes oil prices will remain low through the summer and possibly into the fall.  They will then begin to rise again.  How high?  No one is certain.  However, he had sound reasoning in his presentation, and this is the one that stood out the most to me.  Oil derived from fracking will drop significantly as most of the oil from these wells (70%) are extracted within the first year.  With oil dropping below $50 a barrel drilling will significantly decrease.  This will lead to less supply, which will lead to increased prices.

There are other factors to consider as well.  Dr. Dotzour also pointed out that the economy continues to expand despite the U.S. fighting 5 wars concurrently:

  1. A “HOT” war with Iraq, Syria, Afghanistan
  2. Cyber war with Russia and North Korea
  3. Currency war with China, Japan, and Europe
  4. Carbon war with OPEC
  5. Mortgage war with Dodd-Frank regulators

He believes part of the precipitous drop in oil prices is the U.S. trying to suffocate Putin in Russia, and are doing a pretty good job of it.

More than likely oil prices will rebound in late summer or early fall.  How much no one is sure.  What does all this mean for the Houston Real Estate market?  The indicators point to real estate prices stabilizing and possibly going flat, but sales will continue to happen as supply for housing is low and demand is high. Homes may sit on the market longer but will hold their values.

Ways to Reduce Your Risk
If you are like us you like to hope for the best and plan for the worst.  Here are some strategies you can implement to reduce your risk while the market shakes out:

We all know that location is king in real estate.  Buy in the nicer parts of town.  Avoid “War Zones.”  For example, the Inner loop and Galleria remained attractive and still experienced price appreciation even in the worst real estate market in history from 2008 – 2012.  You will pay more for these types of properties, but you reduce your risk.

Do Not Factor in Appreciation
This is key.  When analyzing projects look back not forward.  If prices have been going up in the area you want to buy, it can be tempting to anticipate the price continuing to rise.  We strongly recommend you never project price appreciation into a buying decision.

Do Not Over-Leverage
One of the major advantages real estate offers is the ability to leverage an asset to increase returns.  This can also work against you; especially in a declining market.  We recommend taking a page out of the banker’s handbook… keep at least a 20% margin (or better).  Simply, don’t finance more than 80% of the value of the asset and, with the market potentially in flux in Houston, you probably want to keep that at 70% loan-to-value.  What this means to the investor is you could potentially absorb a 30% drop in prices.

Even in one of the worst (if not the worst) real estate market ever to hit Houston in 2008 through 2012, prices only dropped 5% – 6% (on average).

Price Point
Even when an economy stagnates or contracts there are two segments of the real estate market that tends to still do well.  It is the lower-end (below $120,000) and the luxury market ($750,000+).

In the lower-end of the housing scale I would caution against flipping (reasons why are for a different article).  However, if you are looking to pick up some rental property this is when you buy.  Rentals in this price point are in high demand.

On the luxury price point there also tends to be a steady market.  Why?  Because the wealthy tend to have cash reserves and can afford large down payments (if not purchase with all-cash) and have high credit scores that allow them to qualify for bank financing.

Cash Flow
If you are going after rental properties do not purchase them if they do not have positive cash flow.  Negative cash flow can get you into trouble if the market goes South and you cannot sell when you originally timed.

Also, assume you will hold your rentals for the long-term.  A mistake we see rental investors make is they think they will hold the asset for a year or two and then sell to pull out their equity.  The problem is timing.  If the market dips you could be at break-even or worse because you have to also keep in mind there are costs to sell the property (Realtor commissions and closing costs, which can run 7% to 10% of your sale price).

If you go in with the mentality the rental will be a long-term hold, but you will sell if the market is right, you will be not only be financially positioned, but also mentally positioned to ride out any valleys in the market.

Renovation Cost Estimates
Because of the construction going on all around Houston prices for materials has increased significantly.  In addition, labor prices have gone up due to the lack of manpower lost to the oil and gas industry.  We could see a decrease in labor and materials in 2015, but I wouldn’t count on it.  When you are budgeting for your project plan on your renovation costing you more in 2015.

Great Product
Competition for buyers will increase in 2015.  This means you need to have the best product on the market in whatever neighborhood you are buying in.

Competitively Priced
You also need to be competitively priced.  We’re not saying if you have the best product you can’t command a higher price, but be careful not to get greedy.  Your house will sit on the market costing you money.

One of our mentors beat this into our head continually.  Best product.  Best Price. It’s a winning combination.

Like we mentioned throughout the article we are not clairvoyant and neither is Dr. Dotzour or anyone else we have referenced.  However, based on the experts, research, and a feeling for the market (being deep into it every day), we believe the Houston real estate market will forge ahead.  Perhaps not at the pace it’s been on, but we don’t see a collapse happening in 2015.