How to Avoid a Housing Bubble

Interesting research by Ali Anari, a Research Economist from the Real Estate Center at Texas A&M University titled "Land, Lots of Land - How Texas Dodged the Housing Bubble", reveals how Texas managed to dodge the housing bubble of the mid- to late-2000s.  

As we know, house prices are composed of two components; the cost of the land and the cost of construction which itself consists of two components, the cost of labor and the cost of building materials.  It was the ample supply of land and an efficient land development process that gave Texans a residential real estate advantage that most of the rest of the United States missed.

Here is a graph showing what happened to the average value of an average single-family detached home in the four main centres in Texas from 1984 to 2012:

Notice the complete absence of a collapsing bubble?

From 1985 to 2012, the average annual growth rate in home values for the four cities was:

Dallas: 1.8 percent

Houston: 3.8 percent

Fort Worth: 2.2 percent

San Antonio: 3 percent

When you look at the growth rate, it quickly becomes apparent that prices in these four markets were below the rate of inflation.

Now, let's look at a graph showing what happened to the average value of an average single-family detached home in four main centres in California from 1984 to 2012:

And there's the collapsing real estate bubble for you.

From 1985 to 2012, the average annual growth rate in home values for the four cities was:

San Francisco: 7.2 percent

San Jose: 8.2 percent

Santa Ana: 6.8 percent

Los Angeles: 7.0 percent

While these growth rates are two to three times the rates seen in Texas, the situation was far worse over the six year period from the first quarter of 2000 to the first quarter of 2006.  Here are the total growth rate in home values for the four cities over the six year period:

San Francisco: 109.4 percent

San Jose: 77.6 percent

Santa Ana: 164.2 percent

Los Angeles: 164.9 percent

By 2012, housing prices had fallen from their 2006 peak prices by the following amounts in the four California markets:

San Francisco: 38.2 percent

San Jose: 28.9 percent 

Santa Ana: 36.9 percent

Los Angeles: 37.5 percent

Statistics show that construction costs in all four markets in both Texas and California rose steadily over the period from 1984 to 2012 with no "bubble" in any of the eight communities.  The construction costs for an average single-family detached home in Texas ranged from $50,000 to $70,000 in 1984 and rose to between $120,000 and $160,000 in 2012.  The construction costs for a similar style home in California rose from between $45,000 and $55,000 in 1984 to between $165,000 and $225,000 in 2012.

What really changed was the cost of the land component in both states.  Here is a graph showing the land component costs in Texas between 1984 and 2012:

Here is a graph showing the land component costs in California between 1984 and 2012:

As you can quickly see, the rise in house prices in California (as shown above) closely mirror the rise in the cost of the land component.

Interestingly, between 2000 and 2010, the number of housing units in Texas grew by 22.3 percent compared to only 12 percent in California.  Despite the greater demand for housing in Texas, the state's housing market successfully met the growing demand for homes by supplying and developing additional low-cost land for housing developments.

While many economists blame the ready availability of easy credit for America's housing market implosion, as this analysis shows, perhaps states that saw their residential real estate markets collapse could learn from the example of Texas.