Real Estate Bubble
by David Stanowski
25 October 2007
The most fundamental evidence to "prove" that there is a residential real estate bubble, in Galveston, is the existence of a world-wide housing bubble! If there is a housing bubble from London to Madrid to Dublin to Peking to Los Angeles to Phoenix to Las Vegas to Miami; how can there NOT be a housing bubble in Galveston? The credit bubble that fueled this phenomena exists throughout the international banking and financial system; the same system that financed the recent building in Galveston.
Even if Galveston had not built any new housing, during the last few years, the existing housing stock would still be subject to these financial forces. However, the local newspaper is often filled with stories touting how much building is going on, and plans for even more construction, so local builders have not been idle!
The "Skyscraper Indicator", developed by Edward Dewey, in the 1940s, correlates human optimism to the number of high-rise buildings under construction. Simply stated, when people are very optimistic, they tend to express their feelings in massive construction projects, especially tall buildings, like skyscrapers, because they have a need to build toward the sky! Since this extreme optimism is reached at major peaks, in the economy, severe economic downturns usually follow; not just declines in real estate prices.
The Empire State Building was conceived in 1929, and by the time it was finished, in 1931, there was almost no demand for its office space. That is why it wasn't profitable until 1950!
Locally, the 11-story United States National Bank Building was built in 1925, the 10-story Jean Lafitte Hotel was completed in 1927, and the 12-story Buccaneer Hotel was built in 1929. These were major projects, and three of the tallest buildings in the City, that celebrated the fact that Galveston had rebuilt itself, after the 1900 Storm, even as it tried to ignore what the Houston Ship Channel was doing to business at the Port. Like The Empire State Building, these local projects were completed during the Roaring 20's, in the years before the Depression, of the 1930's, hit the country.
The 23-story American National Life Building was completed in 1972, right at the beginning of a 10-year-long deep recession. Some how, the new start, for the local economy, that this project represented, never took hold!
Today, not one, but two 27-story towers are nearing completion on East Beach. The two buildings that make up the Palisade Palms complex, are now the tallest buildings on The Island! In addition, last year, "one of the largest land deals in Galveston history" transferred ownership of the 1,050-acre Chapoton Ranch to Marquette Land Investments. They plan to build a massive master-planned community on the property.
Both of these projects stand as a testament to the unbridled enthusiasm and optimism that influenced thinking, on The Island, during the last days of the international-residential-real-estate bubble! Based on historical precedence, and the significance of these projects, as symbols; it could be many years before Palisade Palms is fully occupied, and the Chapoton Ranch project may never be built!
Everything mentioned above points toward a real estate bubble, in Galveston, but is there data on the local market that actually "proves" its existence, as there is on the national level?
All discussions of real estate markets must begin with the caveat that data is hard to come by. Real estate is not traded in a central open-outcry market, like stocks and commodities, so the data is not as available, nor as accurate, as in these other markets. Most of it is collected by local NAR offices, and compiled and distributed in a haphazard manner. In addition, there is mounting evidence that, as the national bubble cools, some NAR offices are manipulating, or withholding data that they feel puts their local market in a negative light. During my initial research, I found that data for Galveston was more difficult to obtain than for most larger cities.
Unlike the previous article, on the national real estate bubble, Professor Robert Schiller has not developed an inflation-adjusted price history of the Galveston real estate market, there is no data on the total value of the local housing stock as a percentage of the total local economic activity, there is no solid data on Price/Rent ratios for Galveston, and there is no reliable data available to compute a buy versus rent comparison. So, what can we do?
Data is available to compute the ratio of the Median Housing Price to the Median Household Income, for the City of Galveston! In 2005, this ratio stood at a lofty 5.20, on a national basis, but it was at an even frothier 5.32, in the City of Galveston! If the fact that Median Housing prices are now 5.20 times Median Household Incomes "proves" that there is a national- residential-real-estate bubble, then when this same ratio stands at 5.32, in Galveston, it "proves" that the bubble exists in Galveston, too!
It should be even more informative to compute the growth in this ratio, over a selected period of time. 1990 was used for the beginning of this period, because Median Income data is available, from the 1990 census, and that year was also near the last low in the national real estate market. 2005 was used as the end point, due to the fact that Median Income data were estimated for that year, by the Census Bureau, and it was also the top of the national housing bubble.
Rather than just comparing the growth in this ratio, in the U.S., versus in the City of Galveston, four other cities were selected that are widely accepted as some of the worst extremes within the national housing bubble.
OFHEO price data was used for all the locations studied, except Galveston, since it is not available for towns of this size. Other price data does exist for many of these locations, that may vary from the OFHEO price series, to some extent, but this data is computed using the same methodology for all locations!
Source: OFHEO for Major Metropolitan Areas
Source: OFHEO for Texas
Source: OFHEO for U.S.
Source: Census Bureau for 1990 Median Incomes
Source: Census Bureau for 2000 Median Incomes
This data says that Galveston is far more overpriced than: the State of Texas, Houston, the U.S., Las Vegas, and Los Angeles! Only Phoenix and Miami are more over priced than Galveston! Galveston fits very nicely right in the middle of all four extreme bubble areas.
The fact that the State of Texas, in general, and the City of Houston, in particular, are far less over priced than the country, as a whole, explains why it is widely believed that Texas is not part of the international housing bubble. However, since Texas is subject to the same international credit and financial forces, as the rest of the world, it will also suffer some of the negative effects, of this bubble, even though it did not experience massive price gains!
Looking at just the simple price changes, for all the major cities in Texas, over this same period of time, confirms the fact that most areas of the state have not seen price increases nearly as high as the country, as a whole, let alone the most extreme bubble areas; except for Galveston! Austin is the only other city in Texas that exceeds the national average.
Source: OFHEO for Major Metropolitan Areas
Source: OFHEO for Texas
Source: OFHEO for U.S.
What happened in Texas? The following long-term chart of U.S. housing prices versus Texas housing prices shows that housing prices in Texas peaked above U.S. prices, in 1984, at the time of the peak in the 1980's oil boom. Then Texas prices declined below U.S. prices, until they bottomed in 1988, as the oil boom turned to bust; and they didn't move back above their 1984 high until 1993! Houston housing prices (not shown) followed the same pattern as Texas housing prices, during this period, but were even weaker than the state, as a whole.
Apparently, housing prices, in the state of Texas, have never fully recovered from the 1980's oil boom and bust, which means that Galveston housing prices are trading on completely different fundamentals, than the rest of the state; namely the market for vacation homes. The second-home market has always been the most vulnerable during previous real estate declines, because second homes are not a necessity, like primary residences.
The pattern of home sales, in Galveston, is very different than in most of the extreme bubble areas,
because they have not yet declined dramatically! Sales did peak in April of 2005, at the time of the top in the national bubble, but sales since the peak are remaining at or above the typical level of about 75 sales per month! Sales were even able to rebound in 2006 and 2007, but could not quite equal the level reached in 2005.
Another way to analyze a data series is to plot its rate of change, or momentum. Since momentum nearly always peaks before the data series itself, it provides an early warning of an impending reversal. Sales momentum peaked in June 2002, as the economic weakness in 2001-2002 ended. The next, somewhat lower peak was made in March 2004, thirteen months before sales peaked, in April 2005. Ever since then, momentum has trended lower, forecasting lower sales ahead, without a new surge.
Some of the data on the number of homes for sale, in Galveston, is missing, but the following graph still paints a pretty clear picture. Until 2006, there were usually about 750 homes on the market during any given month, but that almost tripled by June 2007!
This surge in inventory has pushed the months supply of inventory up to 20.8, in June 2007! The typical level, right before the surge was about 7.5 months, but inventory did run between 20 and 32 months during 1990, 1991 and 1992. The biggest concern with this level of inventory is that it is double the recent national level of about 10 months! It is also higher than one of the worst bubble areas, Phoenix, which is sitting at 18 months.
Since sales have not dropped below the typical 2002-2004 levels, this surge in months of inventory comes almost exclusively from the rise in inventory itself, not from a drop in sales! Apparently, throughout 2006 and 2007, a large number of property owners decided it was time to sell! The question is are they selling to buy another property in Galveston, or selling to leave?
At the time of publication, the bubble, in the Galveston real estate market, had not yet burst, because there has not been a sustained price decline. The market made a top in October 2005, but after a price decline of 21%, it pushed to a new high in March 2006. This top produced a drop of 23%, but also yielded to a new high in March 2007. So far, prices have declined for five months, and 16%, but this high needs to hold to confirm that Galveston is following the national trend lower.
Price momentum made a peak in January 2005 to kick off the price surge in 2005-2007. Then it made a somewhat higher peak in March 2006, twelve months before prices peaked, in March 2007. Ever since then, momentum has trended lower, forecasting lower prices ahead, without a new surge.
Foreclosures are rising dramatically across the country, and in many areas, in the State of Texas, but there is little or no data on foreclosures in Galveston.
The Median Price to Median Household Income ratio, as well as long-term price growth, for the City of Galveston, confirms the fact that the same inflated housing prices that created an international housing bubble, have effected the local market. However, for some reason, the negative fallout from the bubble has not been seen in Galveston, yet!
Many sellers have refused to lower their asking price, to the level that will facilitate a deal, so inventories, of houses for sale, have continued to build. Eventually, this rising inventory should begin to cause a rather steep decline, in local prices. The history of previous bubbles is for prices to return all the way to their starting point!
The unique factors effecting the Galveston Real Estate Market must also be considered when trying to predict how the fall out from the bubble will effect the City of Galveston.
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