The Galveston Housing Bubble

1. The Galveston Housing Bubble Prepared for the Galveston Planning Commision 08 January 2008 By David Stanowski TheFinancialHelpCenter.com

2. The basic questions: • Why are there such divergent opinions about the Galveston real estate market? • How can developers have such grand plans for new projects, when others see problems with new developments?

3. The differences of opinion: • Developers are forecasting that current conditions are going to continue into the future with little change. • Market historians are forecasting that current conditions are going to change dramatically. • The no-change scenario is always more acceptable, and easier to envision.

4. Idealized graph of several market cycles

5. Many developers see this future

6. Developer’s general economic and demographic arguments • The U.S. economy is doing well. • There are a lot of affluent people in nearby cities that have the money and desire to own a second home on The Island. • Millions of Baby Boomers are retiring; they have a lot of money; and many want to live on the beach. • Building vacation homes is good for the Galveston economy.

7. Market historians see this future

8. They recall the 1980’s in Galveston • Large-scale development planned on East Beach. • Including a Golf course surrounding the Lagoon. • J.R. McConnell over reached.

9. Market historian’s general economic and demographic arguments • Source: MeasuringWorth.com

10. Median HH Income adjusted with CPI • Source: CensusBureau.govSource: MeasuringWorth.com

11. Median HH Income adjusted with gold • Source: CensusBureau.govSource: Barchart.com

12. Job growth during the four major post WWII business cycles has declined • Source: Economic Policy Institute

13. Many people have responded to these conditions by becoming speculators • Americans are spending every dollar they make. • Borrowing more to supplement their lifestyle. • Speculating to try to “get ahead”. • Now borrowing money (leverage) for speculation. • A great deal of this leveraged speculation, since 2002, has ended up in the real estate market.

14. Exotic mortgages and resets

15. Leverage has ramped up everywhere • Residential & commercial real estate, hedge funds, private equity, M&A. • $400 Trillion of off-exchange derivatives that must be unwound. • $600 Trillion of on-exchange derivatives. • In comparison, the U.S. GDP is about $13 Trillion. • Source: The Bank for International Settlements

16. Savings rate has turned negative

17. Households: liabilities exceed cash

18. Homebuilders are very pessimistic • Source: National Association of Home Builders

19. Philadelphia Housing Sector Index:Investors are bearish on homebuilders

20. Has home building been good for the Galveston economy? • 2005 Median Household Income: • Galveston $30,500 • Texas $42,139 • U.S. $46,242

21. Galveston economy • The population peaked about 1980 • The number of jobs peaked in 1995 • Per Capita Retail Sales are 36% below those for the State of Texas

22. Summary of the two positions: • The real estate cycle has been repealed; it’s onward and upward from here. • Many people WANT TO own a beach house or condo. • The cycle is at or near a top; prices and sales should be heading lower. • Few people can afford a second home; or get the financing.

23. What is a bubble? • When prices move far beyond established levels of value, a market is in a bubble or mania. • Bubbles are rare. • Few people are aware of past bubbles. • Even fewer can see a bubble while they are in one.

24. This is a forecast; not a report on current conditions • If post-bubble conditions in Galveston were more developed, it would already be pretty obvious to many people. • Since many types of data are not available, just for the City, much of this forecast is forced to use national data.

25. The housing bubble is world wide

26. Price versus value studies: U.S. market

27. Shiller’s Inflation-adjusted housing prices: 1890-2006 • A return to typical post-WWII levels of 100-120 would require a price drop of 40-50%!

28. Total housing value - GDP • It would take a general price decline of around 36% to erase the current $7.4 Trillion in over valuation! • Source: Federal Reserve Flow of Funds B.100Source: Federal Reserve Flow of Funds F.6

29. Price/Rent Ratio • If rents remain relatively constant, prices need to fall 37% to bring the P/R ratio back to the average level. • Source: Census Bureau

30. Home Price/Income • Prices need to fall 42% to bring this ratio back to its established level. • Source: Census BureauSource: Census Bureau

31. Cost to buy versus rent • Difficult to get reliable data for Galveston. • A recent study for Los Angeles County showed that a person buying a house today will not break even with a renter for 17 years! • Click here for details.

32. Price versus value studies; conclusions • The average residential property needs to undergo a price correction of 35-50%, to be fairly valued again. • Properties in the hottest areas (CA, AZ, NV, FL, and the Northeast) are at risk of even larger corrections. • Price corrections after the peak in real estate bubbles are always slow in coming, because many sellers react by holding out for unrealistic prices, for long periods of time, or simply withdraw properties for sale, hoping for a better market in the future.

33. San Diego: December 18, 2007

34. National post-bubble fallout • What are the indicators that show the bubble has topped in many areas?

35. Foreclosures • Foreclosures have more than doubled over the past 12 months. There were 1.2 million foreclosure fillings in 2006, up 42% from 2005. August 2007 saw 243,947 foreclosures, up 115% from August 2006; on a pace to see more than 2 million foreclosures in 2007. • Source: RealtyTrac

36. Vacant Housing Units • In 3Q 2007, there were 17,900,000 vacant housing units, but only 2,070,000 were for sale. 15,830,000 are not YET on the market! • Source: Census Bureau

37. Leverage - mortgages • Source: Federal Reserve Flow of Funds L.217Source: Federal Reserve Flow of Funds B.100

38. Leverage – equity extraction

39. Median existing-home prices • Source: NAR Press Releases

40. Existing homes for sale • Source: NAR Press Releases

41. Existing homes – months supply • Data going back to 1999 shows that inventory usually held between 4 and 5 months of supply, until the recent surge. • Source: NAR Press Releases

42. Median new-home prices • Source: Census Bureau

43. New homes for sale • Source: Census Bureau

44. New homes – months supply • Data going back to 1999 shows that inventory usually held between 4 and 5 months of supply, until the recent surge. • Source: Census Bureau

45. Housing units completed • Building did not drop into last cycle bottom! • Source: Census Bureau

46. Texas real estate • Does lower price growth remove Texas from the national bubble? • Housing prices have not fully recovered from the 1980's oil boom and bust. • Houston prices are similar but slightly weaker than for the whole state.

47. Texas housing prices – page 1

48. Texas housing prices - page 2 • Sources: Texas A&M Data for GalvestonOFHEO Data for MSA'sOFHEO Data for StatesOFHEO Data for U.S. • Galveston housing prices are trading on completely different fundamentals, than the rest of the state; namely the market for vacation homes.

49. The Galveston real estate market • 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?

50. Skyscraper indicator hypothesis • This was developed by Edward Dewey in the 1940’s. • It correlates human optimism to the number and height of high-rise buildings under construction. • Extreme optimism is reached at major economic peaks, so severe economic downturns usually follow; not just declines in real estate prices.