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Fretting over Mortgage Backed Securities, Fitch Warns about Home Prices in Texas


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Fretting over Mortgage Backed Securities, Fitch Warns about Home Prices in Texas
by Wolf Richter • April 6, 2016

Real estate pros are preparing for a downturn.

Texas is, let’s say, in transition – from a phenomenally booming economy to something other than a booming economy. The oil bust is hitting in some places, and contagion is spreading.

In Houston, commercial real estate, particularly the office market, is melting down. Some smaller oil towns have been hit hard. Consumers, hit by “negative ripple effects,” as the Dallas Fed put it so elegantly, are having second thoughts about spending, for the first time since the Financial Crisis.

But some cities are still hopping. And in terms of home prices, Dallas is still exuberant, as “David in Texas” wrote in an email:

The real estate frenzy in the Park Cities area of Dallas and the surrounding neighborhoods continues unabated and west Plano (where Toyota is moving its North American HQ) is going completely nuts.

And the pros, the astute ones who’ve been through this before, are already smelling a rat. In mid-February, “C in Dallas” wrote this in an email:

I am one of 16 investors in a small, experienced-only, investor group that meets every two weeks here in Dallas with a combined 1400+ house rentals and 1600+ apartment unit rentals, mostly B-class and C-class properties rented to blue-collar, working-class folks for $800-$1200 a month for houses and $600-$1000 a month for apartments.

He owns over 100 houses and duplexes in Dallas and a fourplex in Houston.

To prepare for the downturn, I am selling some, paying off some, and fire-walling them away from banks, pulling out cash, and leveraging up some of my long-term keepers at today’s ridiculous rates and valuations to generate cash and pay-off the others.

So the housing boom is still raging in Dallas and other places and valuations are “ridiculous,” but the pros see a dust cloud on the horizon and are circling the wagons in preparation.

Now comes Fitch Ratings. It’s interested in the topic of housing and home prices because it rates Mortgage Backed Securities — both residential (RMBS) and commercial (CMBS). They’re once again in vogue, impossible as this might seem, after what the country and the world have been through during the Financial Crisis because of them.

And Fitch isn’t inclined toward undue pessimism.

For example, in February, Fitch surmised that the San Francisco housing market was “16% overvalued.” This is a housing market where the median home — 50% cost more, 50% cost less — sells for over $1.1 million, where a classic 20% down payment for that median home would set you back $220,000, in a city where the median household income, depending who does the counting, is between $78,400 and $84,160.

These income limitations push even a 5% cash down payment ($55,000) out of reach because the median household in perhaps the most expensive city in the US can save absolutely nothing for a down payment. And for this median household to make mortgage payments, after a 5% down payment (charged to eight credit cards), on a median home is completely illusory. San Francisco is not “16% overvalued.” It’s ludicrously overvalued.

So we know Fitch is not given to hysterics about a housing market being overvalued. Nevertheless it now warned about Texas.

“Texas homes are now overvalued by 10% to 15% on average,” it said. So similarly overvalued as San Francisco? That would be a scary thought.

For the last two years, home prices in the state’s two largest cities, Houston and Dallas, grew faster than incomes. Smaller cities, such as Midland, also face risk from their economic dependence on natural resources and the decline in the price of oil.

Dallas became overvalued in 2014, while Houston began in 2013. Dallas and Houston have seen 42 and 54 months of consecutive price growth, respectively. And, over just the past two years, Dallas home prices grew 10%, outpacing income growth by 3.3%.

“In some Texas cities, the risk of the overvaluation is amplified by the decline in energy prices,” it added. The oil bust has started to bite in numerous ways, including the destruction of highly-paid jobs in the sector – job cuts that have been going on since late 2014 and have built into a crescendo. Just in the first quarter this year, Texas-based companies announced an additional 60,350 job cuts, by far the highest in the nation.

And so Fitch warns that “any decline in income or increase in unemployment would diminish sustainable prices.” That is, even if home prices remained flat, their overvaluation would rise as a function of additional oil bust contagion hitting incomes and jobs.

We see the potential for the biggest impact of the oil price decline in cities, such as Midland, where 40% of wages come directly from the natural resources industry. The risk is more muted in Houston where oil and gas make up only 10% of income. Dallas is well diversified around the private sector, outside of natural resources.

So no problem in Dallas.

During the last oil bust, Dallas too was supposed to have been spared due to its diversified economy. But oil-bust contagion, including a housing crash, took down nine of the ten largest banks in Texas, and these banks were big in Dallas, including the institution where I was banking: MCorp and its brand “MBank.” It collapsed in 1989, at the time the second most costly resolution in FDIC history.

The shrapnel ricocheted through the local economy. It wasn’t as bad as Houston. And it wasn’t nearly as bad as Tulsa, Oklahoma, which billed itself as the “Oil Capital of the World,” a title it relinquished to Houston after all the oil companies had moved to Houston. No major city got hit as hard as Tulsa. And it never really recovered. But it wasn’t pretty in Dallas either. Surely, this time around, it won’t be as bad, but we doubt Fitch’s scenario that the Dallas housing market will be left unscathed.



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