The Mortgage Market Continues to Heal

Home sales are increasing and home prices rising. The health of the mortgage market is continuing to improve.

Every quarter the Office of the Comptroller of the Currency does an EKG on the health of existing mortgages in America. It’s called the OCC Mortgage Metrics Report. The patient was very sick a few years ago, but the recovery process is continuing. The prognosis is continued improvement.

Here are some key facts from the report released in March, 2014:

1) At the end of 2013, 91.8 percent of mortgages were current and performing, up smartly from 89.4 percent a year earlier.

2) The number of foreclosures in process continues to decline.


3) The number of short sales continues to decline.


4) The number of delinquent mortgages continues to decline as well.


It’s taking a long time to recover, but the mortgage market is on the mend. It’s hard to believe that 2008 is now six years ago! Back then the fear was that when the large overhang of foreclosures hit the market, it would put downward pressure on prices. This uncertainty caused some potential buyers to sit on the sidelines until the outlook became clearer. Each year that the number of troubled loans in the system declines, this fear diminishes. As I read through the OCC report, a Beatles tune was running through my mind — “I’ve got to admit it’s getting better, a little better all the time.”

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Good News From the Medical Field

Our country is beset with a lot of unsettling changes in the 21st century. The pervasive uncertainty regarding health care is a prime example. What will it cost? How will employers deal with it? How will hospitals deal with it? How will doctors deal with it? Will anyone want to get into the medical profession if it becomes a government-regulated utility?

I was curious to see how young people were viewing the massive changes going on in the medical field. A report dated Oct. 24, 2013, from the Association of American Medical Colleges (AAMC) provides some insight to this issue, and the news is positive.

The report notes that a record number of students have applied to and enrolled in medical schools in America in 2013. The number of applicants increased by 6.1 percent to 48,014, surpassing the previous record high experienced in 1996.

For the first time in history, the number of students enrolled for their first year of medical school exceeded 20,000.

Here is a table from the AAMC website that shows the continued and growing interest in students wanting to become a doctor.


What I see in this trend is some room for optimism regarding the future of America. The older generations (including me) are unsettled by the massive change in many areas of our lives. But the younger generations don’t have the history and experience of “what used to be.” Clearly, some young people still want to become doctors and serve people.

In a similar way, I find young people to be very realistic about the future of Social Security. Ask anyone under the age of 30 if they think they will receive Social Security payments. Most have told me they don’t expect to receive “anything.” They realize that the current Social Security framework is not sustainable and headed toward insolvency. If this makes them more self-reliant and less dependent on government, then the likelihood of America going bankrupt is lessened.

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Foreign Investments in U.S. Commercial Real Estate

Why is the U.S. dollar strong? Why is the ten-year Treasury rate at 2.7 percent, even when the tapering operation is underway? Why are cap rates for commercial real estate still compressing? The answer to these three questions could be that while the United States has its problems, it’s still the prettiest pig at the trough. Where else are you going to invest your money?

Remember the BRIC countries? For several years, that was the ubiquitous investment theme. Brazil, Russia, India and China. Money rolled into these countries. Exchange-traded funds and mutual funds were launched. America was viewed as the slow-growth option. The future was brighter in the BRICs.

What a difference a few years can make. Money is now pouring out of these countries as their economies stagnate and their currencies weaken. As money flows out of BRICs and other distressed countries like Venezuela and Argentina, guess where it is going?

If you guessed American real estate and U.S. Treasury bonds, you would be right. Foreign investment in American property continues to expand. Money from China, South America and Israel is making its way into the Texas property markets and is driving prices higher and cap rates lower in several locations in the United States.

Standard and Poor’s recently cut Brazil’s credit rating to one level above “junk bond” status. The Central Bank of Brazil raised its forecast for inflation in 2014 from 5.6 percent to 6.1 percent in recent days. According to Reuters, the Bank expects GDP growth to be 2 percent this year due to a slowdown in investment.

In February, Russia’s GDP grew at an anemic rate of .3 percent, up from just .1 percent in January. Reuters reports that Russia’s GDP grew at just 1.3 percent for 2013. Around $70 billion of investor capital moved out of Russia in the first three months of the year. Who wants to invest in a country run by Vladimir Putin?

Inflation in India is currently running around 8 percent. Economic growth has been below 5 percent for the last seven quarters and grew at 4.5 percent in 2013, which was the lowest growth rate in a decade. With high inflation, the ten-year government bond rate is almost 9 percent. The value of the rupee hit a record low last August.

The rate of growth in the Chinese economy is slower than it has been in recent years, and the news has been full of articles about Chinese investors purchasing commercial real estate in the United States and making mortgage loans here as well.

In addition to the challenges in the BRIC countries, Europe is not doing all that well either. In recent days the European Central Bank has suggested that it would consider dropping interest rates to below zero! This would in effect force banks and investors to pay the government to keep their money. Central banks don’t do this unless there are severe threats of recession and/or deflation on the horizon.

Expect money to continue to pour into American commercial real estate and even houses until the cycle changes and other parts of the world start to outperform. It could be a few years.

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Texas House Price Increases

Home prices are increasing again, and the media just can’t resist reporting the possibility of a new crisis forming. This time it has to do with reports that home prices are overvalued in some Texas cities. To add drama to the story, the worry about home price bubbles forming is pondered as well. Here’s the good news. Home price increases are normal. Take a look at the chart below that has annual price appreciation rates for Texas for the past 38 years. The data comes from the Federal Housing Finance Agency. Here is what we can glean from the data:

  • Home prices in Texas increased in 31 of the past 38 years.
  • The highest rate of appreciation was 17.8 percent in 1981.
  • House prices increased by more than 10 percent in five of those years
  • Texas home prices declined in six of the past 38 years.
  • Four years of decline occurred in the 1980s when the oil market collapsed.
  • Two years of decline were during the Great Recession in 2009 and 2010.
  • The largest decline was in 1987, when prices fell 9.6 percent.

The average rate of house price appreciation over the past 38 years is 4 percent.

For those who are on vigilant alert for a “price bubble” in the Texas housing market, here is another fact for consideration. Texas home prices went up by 12 to 15 percent for four years in a row from 1976 to 1979. Then they went up an additional 17.8 percent in 1981. This supercharged price appreciation didn’t create a bubble in Texas. Home prices fell in 1986, 1987 and 1988 but not because a price bubble burst. Prices fell because the price of oil dropped below $15 per barrel and crushed the state economy. When the 2013 FHFA numbers come out soon, it looks like Texas home prices will have increased about 5.5 percent for the year. This is not the making of a bubble, but it is slightly above average. We’ll take it! Tex home appreciation The data for the chart is the All-Transactions House Price Index for Texas (not seasonally adjusted).Here is the URL: If you have an interest in the FHFA House Price Index, here is their description of their index:

The HPI is a broad measure of the movement of single-family house prices. The HPI is a weighted, repeat-sales index, meaning that it measures average price changes in repeat sales or refinancings on the same properties. This information is obtained by reviewing repeat mortgage transactions on single-family properties whose mortgages have been purchased or securitized by Fannie Mae or Freddie Mac since January 1975.   The HPI serves as a timely, accurate indicator of house price trends at various geographic levels. Because of the breadth of the sample, it provides more information than is available in other house price indexes. It also provides housing economists with an improved analytical tool that is useful for estimating changes in the rates of mortgage defaults, prepayments and housing affordability in specific geographic areas.

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Insights, Future Research

Every year the Real Estate Center hosts its annual Real Estate Industry Leadership Conference in Austin. Leaders from statewide real estate related trade associations are invited to attend.

The purpose of the program is to share current Center research, gain insights from attendees and solicit ideas for future Center research as well as provide a private forum to discuss public policy issues.

Associations attending this year included the Texas Association of Realtors, Texas Association of Builders, Texas Mortgage Bankers Association, Texas Apartment Association, Independent Bankers Association and Texas Manufactured Housing Association.


Here are some insights from those attending.

  • There are shortages of lots in many metro areas even though lots are in the development pipeline.
  • Shortages of skilled labor in construction trades are holding housing inventories at low levels.
  • Layoffs in the government sector have led to shortages of staff to approve plats and plans, thus lengthening the approval process for new development.
  • Developers and builders are reluctant to take on much risk given the uncertainties emanating from shifting federal policies and regulations.
  • Some lenders are still reluctant to (or under regulatory scrutiny not to) lend. All of these factors have kept inventories tight and driven up production costs, especially in the metro areas of Texas. The participants also cited concerns about not having adequate infrastructure to meet Texas’ future growth needs.

Future Research Suggestions

About ten areas for study were suggested, including:

  • publishing an easy-to-understand housing affordability monitor for all metro areas on the Center’s website;
  • exploring the effects of new flood, windstorm and hailstorm insurance rates in Texas and how they affect affordability and the resultant economic impacts on communities (not just coastal areas);
  • determining at what point traffic congestion becomes a deterrent to economic expansion and growth;
  • analyzing the sales performance disparity between new and existing homes;
  • exploring the impacts of even more rapid urbanization of Texas on both metro and nonmetro areas; and
  • determining how Texas will provide the infrastructure to accommodate the growth that appears to be coming to the state.

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2014 Real Estate Outlook

So far this year, the housing market has been hampered by negative factors such as weather, higher mortgage rates and prices, shortage of properties for sale and tight lending practices. Even so, the housing market continues to grow. The outlook for 2014 is good — not only for residential but for the real estate industry as a whole.

Regarding residential properties, experts predict smaller price increases this year. Their best guess is that prices will be up but not as much as last year. Some surveys show consumers expect to pay 3 percent more each year for the next ten years. In other words, home prices will likely increase less than mortgage rates, indicating that the consumption motive to purchase a house is stronger than the investment one. Also, the futures markets have home price increases at 5 percent annually. Experts see a continued buyer preference for rentals because household formation has been slowed by unemployment.

The effect institutional investors have on home price increases is comparable to the homebuyer tax credit. Any long-run, permanent effects they have are unclear. Institutional investors are perceived as having a temporary effect on home prices. Purchasing decisions are made based on profit and return; single-family homes do not represent the same cost structure as apartment buildings to maintain and service. As home prices and interest rates increase, profitability decreases for institutional investors. Given this, the long-run market potential for 1.7 to 1.8 million housing starts per year is still years away.

For the commercial sector, private nonresidential construction has picked up since the recession ended. While commercial builders saw a strong decline during the recession, construction has begun to pick up again. Experts see growth throughout the private, nonresidential construction sectors.

Retail construction remains muted because of a lack of growth in consumer spending and an increase in consumer preference for online purchases.

In contrast, hotel construction has picked up largely because of a boost in corporate profits, which has fueled business travel. Hotel construction is particularly cyclical, and it closely follows the pattern of real gross domestic growth and corporate profits.

The outlook for industrial construction growth remains uncertain. Institutional construction has seen a volatile recovery after a 2013 decline precipitated by a lack of funding at the federal, state and local government levels.

After a muted 2013, office construction has picked up, driven by employment growth in the energy and technology sectors. More jobs means more demand for office space in regions with a strong energy-technology presence.

Workplace density is increasing and will have an impact in future building construction. In 2010, the average space per office worker globally was approximately 225 square feet. By 2013, 64 percent of global corporations were at 150 square feet or less space. By 2018, it is expected that 52.3 percent of global corporations will be at 100 square feet or less. That’s because the most effective way for companies to lower costs is to increase density.

Real estate sector analysts have expressed concerns about the shortages in the supply of skilled labor to build houses, and commercial and office buildings. The shortage is said to have been caused by an older construction labor force, a movement to other industries, less immigration labor and a generational problem in training and recruiting young workers.

As long as the economy continues generating slow job growth, the real estate sector will continue to grow at a slow pace. Job growth is needed to increase household formation as the hiring of new workers leads to greater demand for housing and commercial and office space. This has been the case for Texas where metropolitan areas, such as Houston and Austin, continue to show the strongest performance in real estate markets versus other regions that lack energy and technology industries.

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Where Will Residential Mortgage Rates be a Year from Now?

The Federal Reserve has been manipulating long- and short-term interest rates for several years now. They have purchased large amounts of long-term Treasury bonds and mortgage-backed bonds in an effort to drive mortgage rates low. Clearly they have succeeded in their mission. At one point in 2013, the 30-year fixed-rate mortgage fell to 3.5 percent.

After several years of this “quantitative easing,” the Fed has begun the process of ending their direct intervention in the bond and mortgage market. This effort has been referred to as “tapering.” They are gradually reducing the amount of bonds and mortgages they purchase, until ultimately they will no longer be buying them at all.

The conventional wisdom is that mortgage rates will increase when the tapering process ends. If that occurs, what will 30-year mortgage rates be after the Fed exits the bond market at the end of the year?

The 30-year fixed-rate mortgage is determined by two things: the rate of interest on the ten-year Treasury bond plus the risk premium that investors demand to invest in mortgages. In the following chart, you can see how these two rates track together.

Since January 2004, the average 30-year mortgage rate has been 1.72 percent higher than the ten-year Treasury bond rate.

Note that the spread is pretty volatile. During this period, it was as low as 1.19 percent and as high as 2.96 percent.

30-year interest rates

The next step is to estimate what the ten-year Treasury rate might be when the Fed ends their bond purchases. As you can see from the previous chart, the ten-year Treasury has ranged from a high of 5.25 percent in 2006 to a low of about 1.5 percent in 2012.

In the four years before the financial crisis, from 2004 to 2008, the ten-year ranged from 4 percent to 5 percent. So it’s reasonable to expect that the interest rate on the ten-year Treasury will increase from its current level of 2.7 percent to a more “normal” level of 4.5 percent by the first of next year.

If this turns out to be true, the 30-year mortgage rate should be about 6.25 percent by 2015.

Of course, if the economy turns soft again, Treasury rates and mortgage rates will not likely rise to these levels. We will have to wait and see. But clearly, now is a great time to buy a house while rates are this low. If our economy has any strength at all, we are unlikely to see 4.5 percent mortgages for a long time.

I’ve heard noted economists say that “only fools try to forecast interest rates.” However, I enjoy economics. It’s a social science, subject to huge forecasting errors. But what’s the fun of being an economist if you don’t step into the batter’s box and swing for the fence? Everyone knows that economists were put on earth just to make the weatherman look good.

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Taking a Look at the Labor Force Participation Rate

As usual, there is always some new “crisis” in the country. In recent months, the concern is the labor force participation rate. This is the percentage of Americans who have jobs. Keep in mind that this measures only people who earn an income from a job that gets reported to or collected by government agencies.

Listening to the news channels, the decline in the participation rate is viewed as an indication that our economy is so weak that people can’t find jobs and are just dropping out of the market altogether. The reporting makes me feel that there must be something terribly wrong to make people leave the workplace.

One explanation offered for the decline in the participation rate is that people without sufficient education can’t get a job in the 21st century high-tech marketplace. Look at the first chart below, which is the participation rate of Americans with less than a high school education. If you look at just the past ten years, you could feel that we must surely be in a crisis as the participation rate has fallen from 47 to 44 percent.

If you take a look at the rest of the historical data, it offers a different perspective. This shows that the participation rate of our least educated population is higher than it was all through the 1990s.


Another conjecture is that the decline is due to baby boomers getting older and retiring. Here is another popular speculation that doesn’t appear to be supported by the data. The percentage of all Americans over the age of 65 who are working has been increasing since 2008. The increase has been huge, from 21.5 percent to nearly 24 percent in just the past five years.

The 40 percent drop in stock prices in 2008 caused a lot of older Americans to postpone retirement. Then the Federal Reserve’s zero interest policy has crushed retiree incomes from CDs and bonds. No wonder 70-year-olds are going back to work.


Take a look at the participation rate for men 20 years and older in the next chart. The historical trend is stunning. The labor force participation rate has been declining almost continuously since 1950. Shortly after the end of World War II, nearly 90 percent of American men were in the workforce. By 1975, that number had fallen to 80 percent. The decline has continued in recent years and has now fallen to nearly 72 percent.


What about the women? The chart below shows that labor force participation increased almost every year since 1950. Women worked very hard in the 1940s and the 1950s, too. It’s just that much of their work wasn’t measured by government statistics. The female participation rate peaked at slightly over 60 percent in the late 1990s and remained there for more than a decade. In recent years the rate has declined as well.


The lens of the news media has been sharply focused on the declining labor force participation rate. This is not a new phenomenon. Men have been leaving the workforce for the past 60 years. Women are now starting to follow suit. Unfortunately, if you are over 65 you are bucking the trend by going back to work. Low interest rates on your CDs and bonds don’t go very far these days.

What does this mean for the economy going forward? It could mean that American households are getting more comfortable with the idea of lower household income. As more and more Americans leave the workforce, their ability to pay high prices for houses, cars and clothes is reduced. They could decide they don’t need to upgrade their phone every year. Their incomes may not support continuous price increases like we have become used to in the past 50 years.

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Economic Challenges for Many American Cities

Some cities and states in America have been doing very well in the four years since the end of the Great Recession. But for many other cities and states, it seems the recovery is still waiting to happen.

If you live in a region that has a big presence in the oil and gas industry, the recovery has been robust; job growth is happening; houses are selling, and commercial real estate is filling up. Construction cranes are again dotting the horizon.

If you live in other regions of the country that do not have an oil and gas presence, things may be a lot different. Here are the “headwinds” that are facing those areas of America (including parts of Texas).

Challenge 1. Federal government spending and hiring is not growing. In some cases, it’s declining. For cities that have a large federal government employment base, job growth is just not happening.

Challenge 2. In the past five years, state and local government spending has not grown either. This means that government hiring has been constrained. In some cases, layoffs in state and local government have mitigated job growth in the private sector. Tight government budgets also have negative impacts on local businesses that provide goods and services to government entities.

Challenge 3: Since 2007, there has been a dramatic decline in the construction of new homes. While building permit activity is rebounding, it is still much less than 2006 and 2007 levels. Home building activity has a strong multiplier effect in the job market.

Challenge 4. Every city in America is impacted by the uncertainty of the cost of health care under the new health care law. Business owners have been reticent to hire workers because they don’t know how the new law will impact their costs of doing business.

Challenge 5. Federal Reserve monetary policy has handsomely rewarded people who own stocks and houses. Setting interest rates at zero has caused stocks to surge to record highs. House prices are rising again. If many people in your community own stocks and houses, then your local economy is doing well. If a lot of people in your community don’t own stocks and houses, then you aren’t doing so well.

Challenge 6. Some communities in America are retirement destinations. When Americans get older, they seem to have a preference for sunshine, warm weather and a low cost of living. But the flow of retirees moving to these areas dropped substantially after the stock market crash in 2008. Many people have postponed retirement because of this event. Another reason that some may have postponed moving to sunnier climes is that the value of their homes may have dropped substantially in the past five years and is just now starting to recover.

Here is the good news for the many cities in America still waiting for the recovery.

In many parts of the country, state and local government revenue is increasing. Property taxes are up; sales tax revenue and income tax revenues are increasing as well. This means that states and cities are under less pressure to lay off workers and may actually start adding workers in 2014.

For cities that are retirement destinations, the good news is that the stock market has fully recovered from the 2008 crash. Many people who want to play golf rather than shovel snow may feel like making the move. As house prices move higher, retirees will have more equity to use to purchase their new retirement dream.

New home construction is finally starting to rebound. Building permits and new home sales are increasing, and home builder optimism is strong. More home building will mean more employment.

Unfortunately, there are continuing headwinds to employment growth in 2014. Congress and the president still cannot come up with any meaningful plans to encourage the private sector to expand. The hopes that were created by Simpson/Bowles’ proposed reforms are long gone. Tax reform is not on the table. The uncertainty of the cost of health care has been extended for another two years. Small employers are still going to be wary of hiring additional workers this year and next.

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Good News from the Business Sector

There are many reasons to be bullish about the U.S. economy in 2014. Small businesses have a very large impact on the employment market. They employ about 65 percent of all workers in America and create about 80 percent of new jobs.

This first chart shows the monthly results of a survey of small businesses done by the National Federation of Independent Business. It shows the “net percent” of those who say they are going to hire and those who are going to fire workers. As you can see, there has been a steady increase in the percentage of small businesses that say they are going to hire workers soon.

small biz outlookThe following chart shows that proprietor’s income is at an all-time high. After flat income growth from 2007 to 2010, income has skyrocketed by 40 percent in the past four years. We live in a capitalistic system in America. When income and profits increase, businesses are much more likely to hire workers.

proprietors income

The final chart shows that the net worth of companies that are not banks or farms has rebounded to a record high. The net worth of our nation’s companies is nearing $20 trillion.  Clearly, American business is healthy and vibrant. In spite of poor leadership in Washington, underlying fundamentals in the business world are looking good.

nonfram nonfin

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