APRIL 2008 PUBLICATION 1854
http://recenter.tamu.edu/pdf/1854.pdf
Housing Markets
A July 2005
Tierra Grandearticle concluded that the risk
of a price bubble in the Texas
residential market was low. This
assertion has held true, as the
average price of homes sold in
Texas rose 6.1 percent in 2005
and 5.6 percent in 2006. The
latest 2007 estimates of average
home price appreciation show a
4.5 percent increase.
The median price of homes sold
in Texas rose 5.1 percent in 2005
and 4.6 percent in 2006. Estimated
median home price appreciation
for 2007 shows a 3 percent
increase.
fter a five-year boom fueled by
low mortgage rates and a growing
national economy, what
went up in the U.S. real estate
markets from 2001 to 2005 reversed
directions in 2006. Once
again the Real Estate Center is being
asked, “will there be a house price bubble in Texas?”
The initial response is that real estate markets are local and
regional markets, while national economic trends are averages
of local and regional economic indicators. Consequently,
what is said about national averages may not hold for local and
regional economies.
The risk of a housing price bubble in Texas is still low. Here
is why.
Asset Prices and Fundamentals
Prices of real estate properties, like other asset prices, are
equal to the sum of the present values of future streams of
earnings to be derived from the assets. House prices are equal
to the sum of the discounted values of future net rents. Net
rents are rents after deductions of housing costs (taxes and
maintenance costs). This fundamental relationship between
house prices and net rents may be disturbed in the short run by
supply and demand imbalances, but values of houses over their
useful lives are determined by net rents.
The relationship between house prices and rents resembles
the relationship between stock prices and dividends (or earnings),
but there is an important difference. While stock prices
and earnings are not influenced by the family incomes of
stockholders, house prices and rents are influenced by the family
incomes of owners and renters of dwelling units. Competition
among buyers and renters of residential units to buy or
rent “better” residential units makes regional family income
an important determinant of regional home prices and rents.
Table 1. Home Price/Rent Ratios
United States, Texas and Texas Metros
2006 2005
Region
House
Price
Annual
Rent
Price/Rent
Ratio
House
Price
Annual
Rent
Price/Rent
Ratio
United States $185,200 $7,632 24.3 $167,500 $7,368 22.7
Texas 114,000 6,768 16.8 106,000 6,540 16.2
Abilene 70,100 5,532 12.7 64,500 5,244 12.3
Amarillo 95,800 6,108 15.7 92,700 5,544 16.7
Austin–Round Rock 164,100 8,100 20.3 161,000 7,608 21.2
Beaumont–Port Arthur 77,700 5,256 14.8 73,900 4,980 14.8
Brownsville-Harlingen 65,200 4,584 14.2 62,100 4,488 13.8
College Station–Bryan 112,000 6,276 17.8 105,200 6,372 16.5
Corpus Christi 92,200 6,288 14.7 83,500 6,324 13.2
Dallas–Fort Worth–Arlington 141,100 7,536 18.7 133,900 7,368 18.2
El Paso 88,000 5,472 16.1 78,600 5,220 15.1
Houston–Baytown–Sugar Land 129,800 7,236 17.9 123,400 6,960 17.7
Killeen–Temple–Fort Hood 97,900 6,588 14.9 93,800 6,480 14.5
Laredo 94,100 5,364 17.5 87,200 5,268 16.6
Longview 89,500 5,460 16.4 87,400 5,304 16.5
Lubbock 93,800 6,228 15.1 84,600 6,396 13.2
McAllen-Edinburg-Mission 66,500 4,644 14.3 61,200 4,704 13.0
Midland 87,800 5,400 16.3 85,200 4,980 17.1
Odessa 54,000 4,908 11.0 53,100 4,656 11.4
San Angelo 80,000 5,736 13.9 80,300 5,376 14.9
San Antonio 105,600 6,852 15.4 97,200 6,528 14.9
Sherman-Denison 86,400 5,880 14.7 90,600 5,736 15.8
Tyler 106,100 6,252 17.0 99,000 6,072 16.3
Victoria 85,700 5,364 16.0 72,800 5,424 13.4
Waco 92,200 5,748 16.0 89,200 5,628 15.8
Wichita Falls 79,800 5,496 14.5 74,000 5,520 13.4
Sources: U.S. Census Bureau and Real Estate Center at Texas A&M University
The stock market analogy suggests that price/earnings (P/E)
ratios for stock in stock markets contain the same information
as the ratio of home prices to rents in residential markets. P/E
ratio in stock markets is the ratio of expected future earnings
to current earnings. Higher P/E ratios imply higher expected
future earnings compared with current earnings.
If these expectations prove to be wrong, the market will
“correct” stock prices, and the prices will fall, resulting in
more appropriate P/E ratios. The severity of the correction
depends on how high the P/E ratios have been.
To know whether house prices in an area have risen to levels
not likely to be sustained by fundamentals, look at house
price/rent (P/R) ratios for houses in the area and compare them
with a “normal” P/R ratio for residential markets. But what is
a normal P/R ratio in the U.S. residential markets?
Table 2. Median Sales Price of Existing Apartments-Condos-Co-ops
Third Quarter 2007
Region Price Ratio to U.S. Price
United States $226,900 1.00
Austin–Round Rock 171,700 0.76
Dallas–Fort Worth–Arlington 134,900 0.60
Houston–Baytown–Sugar Land 124,100 0.55
Sources: National Association of Realtors and Real Estate Center at Texas A&M University
THE TAKEAWAY
House values are determined by net rents. Stock priceto-
earnings ratios can be helpful when studying home
price-to-rents ratios. Monitoring these ratios can yield a
“normal” price-to-rent ratio for an area, which in turn can
suggest whether a price bubble may occur.
Here again, the stock market analogy may help. The normal
P/E ratio in the stock market is the market P/E ratio — that
is, the average of P/E ratios for all stocks traded in the market
over a long period. The normal P/R ratio for the U.S. housing
markets is the average (or median) house price for the United
States divided by average (or median) annual rent for the
United States.
The argument for this method of computation of P/R ratio
is that local and regional house prices and rents in the United
States are mean-reverting variables because of the free flow of
resources and people. Regional and local rents and home prices
may deviate from the
national averages in the
short run, but they revert
to national averages in
the long run.
When P/R ratios for
residential markets are
computed, it is assumed
that the impact of family
incomes on house prices
is of the same magnitude
as the impact of family
incomes on rents.
This assumption is reasonable because in the long run, higher
incomes drive both house prices and rents.
What Do P/R Ratios Tell Us?
ouse price/rent ratios are computed by
dividing the regional house prices
by regional rents in 2005 and 2006
(Table 1). The normal P/R ratio in
2005 — the P/R ratio for the United
States in 2005 — was 22.7. The P/R
ratio for Texas was 16.2, only 71
percent of the national average.
Among the state’s metropolitan areas,
Austin–Round Rock had the highest
P/R ratio (21.2) in 2005, followed by Dallas–Fort Worth–
Arlington (18.2), Houston–Baytown–Sugar Land (17.7) and
Midland (17.1). Odessa experienced the lowest P/R ratio (11.4)
in 2005, followed by Abilene (12.3), McAllen-Edinburg-Mission
(13.0), and Corpus Christi and Lubbock (13.2).
The P/R ratio for the United States rose from 22.7 in 2005
to 24.3 in 2006. Over the same period, the Texas P/R ratio rose
from 16.2 to 16.8. But despite this rise, the 2006 Texas P/R
ratio was still only 69.1 percent of the national average.
The P/R ratio for Austin–Round Rock in 2006 was 20.3,
smaller than in 2005. After Austin–Round Rock, Dallas–Fort
Worth–Arlington with 18.7 and Houston–Baytown–Sugar Land
with 17.9 had the largest P/R ratios, both larger than their 2005
ratios. The P/R ratio for San Antonio rose from 14.9 in 2005
to 15.4 in 2006 but was still significantly below the national
average.
The lower-than-national-average P/R ratios for Texas and
its metro areas suggest that the risk of a home price bubble is
minimal. In fact, the mean-reverting nature of home prices and
rents indicates that even higher home prices and rents may be
expected in the foreseeable future.
Movement of investment funds from and to different asset
classes as well as movement of people and resources from and
to different regions of the country result in the convergence of
the long-run P/R ratios for homes and the long-run P/E ratios
for stock prices. Analyzing long-run price and earning data for
stocks (from Shiller) suggests a long-run P/E ratio of about 20
for the U.S. stock market,
or a 5 percent yield
including inflation rate.
Assuming the same
long-term P/R ratio
for the U.S. residential
markets, the P/R ratios
for the United States in
2005 and 2006 exceeded
the long-term P/R ratio
(Table 1). There is much
news these days about
slower home price
growth and even home price decreases in a number of U.S. regions.
But all Texas metro areas except Austin have P/R ratios
of less than 20.
As in any economic study, some data and statistical problems
must be acknowledged. The home price data used in this
research are for owner-occupied units. Rent data are contract
rents defined by the U.S. Census Bureau as “rent agreed to or
contracted for, regardless of any furnishings, utilities, fees,
meals, or services that may be included.”
Regarding the home prices, prices for rental units and owneroccupied
units in any area normally follow each other although
with some time lags. The prices of apartments, condos and
co-ops — residential units mostly used for renting — in major
Texas metro areas were well below the national average in
third quarter 2007 (Table 2). The ratios of prices in metro areas
to the average price for the United States again indicate that
the risk of a home price bubble for Texas in current economic
conditions is low.
Dr. Anari (m-anari@tamu.edu) is a research economist with the Real Estate
Center at Texas A&M University.
MAYS BUSINESS SCHOOL
Texas A&M University
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Director,
Gary W. Maler; Chief Economist, Dr. Mark G. Dotzour; Communications Director, David S. Jones; Associate Editor, Nancy McQuistion; Associate Editor,Bryan Pope;
Assistant Editor, Kammy Baumann; Art Director, Robert P. Beals II; Graphic Designer, JP Beato III; Circulation Manager, Mark Baumann; Typography,Real Estate Center.
Advisory Committee
D. Marc McDougal, Lubbock, chairman; Ronald C. Wakefield, San Antonio, vice chairman; James Michael Boyd, Houston; Catarina Gonzales Cron, Houston;
David E. Dalzell, Abilene; Tom H. Gann, Lufkin; Jacquelyn K. Hawkins, Austin; Barbara A. Russell, Denton; Douglas A. Schwartz, El Paso;
and John D. Eckstrum, Conroe, ex-officio representing the Texas Real Estate Commission.
Tierra Grande
(ISSN 1070-0234) is published quarterly by the Real Estate Center at Texas A&M University, College Station, Texas 77843-2115. Subscriptionsare free to Texas real estate licensees. Other subscribers, $20 per year. Views expressed are those of the authors and do not imply endorsement by the
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