Wshington Update: April 4, 2008
Find the latest legislative news updates from Washington, D.C., that impact Resort and RLI.
In This Issue
Farm Bill Talks Continue as April 18th Deadline Looms
Congress Debates Housing Incentive
HUD's Proposed RESPA Regulation Published in Federal Register
How Major Hurricanes Impact Housing Prices and Transaction Volume
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Farm Bill Talks Continue as April 18th Deadline Looms
Staffers from the House Agriculture and Ways and Means Committees, and the Senate Agriculture and Finance panels are working virtually around the clock trying to sort out the details to a farm bill that, as of press time, still hovered around $10 billion above baseline. Much of the back and forth between farm bill conferees and staff revolve around how the funding will be broken out (the latest reports indicate energy title spending at around $900 million above the baseline). Dozens of lobbyists and USDA staff are on call to offer input to negotiators as conferees push against a deadline of April 18, when the latest extension of current farm law will expire. Many lawmakers, along with the White House, have called for a one-year extension of the 2002 Farm Bill if no agreement on a new farm measure can be reached by the 18th. A "framework" document devised by the leaders of both the Senate and House Agriculture Committees last month laid out a plan suggesting how the money might be allocated among various titles. But the "framework" has reportedly undergone various changes as divisions crop up between the House and Senate, and between Democrats and Republicans.
The Senate version of this Farm Bill included a curious limitation on some like-kind exchanges. The proposed modification would disqualify exchanges of "improved real property" with "unimproved agriculture real property." Thus, the owner of a building could not use the 1031 exchange technique to acquire "unimproved agriculture real property." The provision would have had the effect of imposing a "toll charge" on any person selling the affected property. The toll charge would have taken the form of either a reduction in the price that the seller could obtain on sale or the transaction would require a selling farmer/rancher to pay tax on the transaction.
NAR vigorously opposed this provision in the Farm bill. Other organizations followed NAR's lead. NAR is cautiously optimistic that this provision will not be included in any final version of the Farm Bill.
Housing Incentive Debate in House and Senate
The Senate is presently debating a major housing bill that includes both tax and FHA changes designed to shore up the troubled market. The Senate bill (H.R. 3221) has four tax provisions. It includes a one-time special property tax deduction of $500 for individuals who do not itemize their deductions. A second provision directed to homebuilders provides them with additional tax benefits associated with net operating losses generated during 2007 and 2008. The bill allows state housing agencies to issue mortgage revenue bonds (MRBs) up to $10 billion to refinance subprime mortgages. Finally, the bill creates a tax credit that would be available for one year from date of enactment to individuals who purchase foreclosed properties. The credit would be a $7000 credit to be taken in increments of $3500 for two years from the year of purchase.
The House Ways and Means Committee will mark up a package on Wednesday, April 9. Like the Senate package, the Committee's bill will include additional authority for state housing agencies to issue MRBs for refinancing subprime mortgages. The package will also include important modifications of the low-income housing tax credit. The credit was enacted in 1986; these changes are intended to modernize several of its provisions. Of primary interest to Realtors is a proposal for a tax credit for the purchase of a home. Unlike the Senate bill, the Committee version will not restrict the types of property that would qualify for the credit. The credit would be available for first-time homebuyers. The amount of the credit will likely be somewhere in the range of $7500 - $9000. It will likely include income limits on prospective purchasers in a range between $70,000 to $75,000 on a single return or $110,000 to $150,000 on a joint return. No matter what the income limit, it will have a phase out so that individuals who earn a dollar (or more) than the designated amount will receive some portion of the credit, but not the full amount.
The Senate bill is being considered as an "emergency" and so is being debated under procedures that do not require that the tax benefits be "paid for." The Ways and Means bill will be "paid for," but the contemplated revenue raisers do not relate in any way to real estate.
Proposed RESPA Regulation Published in Federal Register
On Friday March 14, 2008 the Federal Register published HUD's long-awaited proposed regulation on the Real Estate Settlement Procedure Act. The 94-page proposed regulation includes, among other things, a mandatory four-page Good Faith Estimate (GFE) and a modified HUD-1/1A, a required "closing script" that must be read orally at settlement, enhanced disclosures and new rules concerning volume discounts, average cost pricing and "required use." There will be a 60-day public comment period which expires on May 13, 2008. NAR will study the proposal and file formal comments with the Department of Housing and Urban Development.
Links:
Federal Register:
http://a257.g.akamaitech.net/7/257/2422/01jan20081800/edocket.access.gpo.gov/2008/pdf/08-1015.pdf
Major Hurricanes Impact Housing Prices and Transaction Volume
Eli Beracha, Journal of Real Estate Analysis
We seek to investigate the extent to which coastal impacts of major hurricanes may affect short- and medium-term housing prices. Our investigation is largely motivated by the increased strength and frequency of storms threatening the eastern and southeastern United States. Namely, several major hurricanes have recently impacted the Gulf of Mexico region and the Eastern Seaboard causing billions of dollars in damages. Escalating worldwide focus on global warming and other potential causes of this increased meteorological activity has not altered the contention by meteorologists that this is not an aberration. On the contrary, widespread expectation of future storm seasons characterized by above-average frequency, strength and duration of hurricane-level storms remains the consensus. It follows then that a better understanding of the economic impact of these storms is a beneficial contribution to real estate literature.
CONVENTIONAL WISDOM AND THE POPULAR PRESS
Conventional wisdom and the popular press suggest that a noticeable shock to the housing industry is to be expected after a major hurricane. How that shock plays out, however, is not so clear. Following the recent sequence of highly active storm seasons, the popular press published mixed opinions regarding the repercussions these storms might have on real estate markets sustaining substantial damage. Generally speaking, press articles imply the reaction in residential real estate to major storms takes the form of a bubble. That is, markets surge from a housing shortage immediately following a storm, and then correct in the medium term as supply gradually returns to prior levels. For example, Katrina, the most notorious of these recent storms hit New Orleans in August 2005. Rich (2005) suggests that storms like Katrina are a stimulus to local real estate. Pointing to frenzied buying activity as people left homeless scramble to secure a residence, the shortage of building supplies driving up housing costs, and out-of-state investors buying in droves, Rich paints a rosy picture of real estate markets impacted by a major storm.
Roney (2007) also points to an initial surge in residential real estate, quoting the National Association of REALTORS® (NAR) as her source for median home sale prices jumping more than 8.7 percent in the New Orleans area immediately following Katrina. Roney then backtracks, however, suggesting that home prices rose only as a direct result of federal and state aid for the multibillion dollar damage left in the wake of the storm. She cites a subsequent price correction of 6.7 percent as evidence of the unpredictability of home values. Bajaj (2007) explains this drop by quoting Jan Hatzius, a Goldman Sachs economist, as saying that prices have fallen in the past year to correct for a surge immediately after Katrina, again suggestive of a bubble pattern.
Not all press articles project a bubble reaction, however. Keegan (2005) points to his personal experience with Hugo in 1989 and its impact on the Charleston, S.C. region, observing a massive and lengthy recovery effort after substantial devastation in the region. He also points to panhandle and central communities in Florida "still reeling" a year after storms ravaged these areas. Nonetheless, even if it belies conventional wisdom, practitioners and academics alike might be interested to know what the data collected surrounding these events do suggest.
PRIOR ACADEMIC RESEARCH
Conventional wisdom and popular press articles aside, existing academic research on this subject is sparse. In fact, very little in academic or practitioner real estate journals has addressed natural disasters and their impact on residential prices.
Hallstrom and Smith (2005) hypothesize that housing values respond to information about new hurricanes. Using a difference-in-differences framework based on the 1992 storm, Andrew (one of the strongest storms to ever hit the U.S.), they find a proximity effect where homeowners respond to information conveyed by storms passing nearby and subsequently observe prices dip as much as 19 percent, in spite of missing that residential area. Bin and Polasky (2004) conduct a highly regionalized study examining the home price differential for Pitt County, N.C. homes located in flood zones ex-ante and ex-post hurricane Floyd. They find the discount of residential property values for homes located in flood-plains significantly increased after the 1999 major storm and its associated flood damage to those homes.
Counter to Bin and Polasky, however, Speyrer and Ragas (1991) find repeated flooding does not continue to reduce prices, suggesting the market is relatively efficient in discounting the risk of repeat floods. Consistent with prior studies, Speyrer and Ragas find homes located in floodplains do experience lower property values than comparable homes not located in floodplains. New to their study, however, they determine that a large part of the price reduction is a direct result of mandated flood insurance as required by The Flood Disaster Protection Act of 1973. This Act requires Federal Standard Flood Insurance coverage for homes in certain zones. Accordingly, real estate pricing in our study should not be sensitive to zones, as this information should already be incorporated in price data.
A DIFFERENT APPROACH
Our contribution to this area of research is unique, first, because of our ability to look at Zip Code-level data. Most prior studies employ MSA-level (Metropolitan Statistical Area) or state-level data, neither of which allows for the precision obtained by a Zip Code-level analysis. Second, by examining the impact from several major hurricanes in a relatively constrained time period, we eliminate some of the variability of macroeconomic factors over time that could potentially affect results. Conversely, where some studies have considered only data from one or two storms during a brief interval (or even two unrelated intervals) taking our data from several hurricanes over a continual, but longer period generates less bias in the data. Finally, by considering several measures (price per square foot and transaction volume, in addition to raw price change differences), we aim to generate more comprehensive and definitive results.
In sum, we explore the sensitivity of median U.S. home prices and volume to the impact of major hurricanes, at the Zip Code level. Specifically, we examine quarterly changes in residential real estate price and volume following a major hurricane impact, and we test whether these particular Zip Code quarterly changes differ significantly from changes occurring in the rest of the state over the same time periods. In this way, we account for the rapid growth in population and associated increasing price trend occurring over this timeframe in the coastal states we examine.
We find some evidence from our three measures suggesting that during the first two quarters following a major hurricane, changes in home prices and transaction volume in the affected Zip Codes experience a temporary relative decline, followed by a positive correction. This temporary dip and bounce-back pattern exhibits characteristics resembling a short-term reversal consistent with the overreaction hypothesis, as often applied to financial market events. When looking at one full year following a hurricane, however, we see some evidence that areas hit by hurricanes outperform comparable areas not affected by the storm, a counterintuitive result.
HYPOTHESES
While the colloquial concept of market overreaction as a manifestation of normal psychological behavior has been observed for generations, its formal documentation and analysis is a relatively modern development. DeBondt and Thaler (1985) define the overreaction hypothesis simply as a hyper-response to new information. The hypothesis suggests both that extreme movements in stock prices are followed by movements in the opposite direction to "correct" the initial overreaction and that greater magnitudes of the initial price change are generally offset by increasingly extreme reactions.
Evidence of overreaction has primarily been found in analysis of stock returns following large one-day stock price declines. Brown, Harlow and Tinic (1988) as well as Atkins and Dyl (1990) find significant reversals for stocks experiencing one-day price declines. Many differences between investments in marketable securities versus homes exist, however. Exposure to housing price risk is largely non-diversifiable for individual homeowners. Home prices and changes in home prices vary by location. Arbitrage is costly and largely infeasible. Further, real estate markets do not have the liquidity of financial markets. As a result, the residential real estate market is often characterized as relatively inefficient relative to markets for financial securities. Still, similarities remain.
Bremer and Sweeney (1991) examine common stock returns following one-day price declines of 10 percent or more over nearly a quarter century, finding significant positive abnormal returns extend three days immediately following the declines. They further note that this prolonged recovery period is inconsistent with prices fully and quickly reflecting relevant information and suggest that market illiquidity may partially explain their findings, as also supported by Capozza, Hendershott, and Mack, (2004). The real estate market, as one of the more illiquid asset markets, consequently provides a vehicle to help maintain the idea that prolonged recovery periods may indeed be associated with illiquid markets. The reaction in real estate may remain analogous, but the timeframe may also be extended as a result of a relatively slower and more illiquid marketplace.
Accordingly, as we are interested in how major hurricanes affect observed changes in median home prices, median price per residential square foot, and residential transaction volume across our sample of 52 affected Zip Codes, we expect to see reactions resembling some form of overreaction, as a hurricane clearly is viewed as a natural (unforeseen) event with negative implications. Consequently, we test hypotheses gauging any reaction to six natural events in these three variables. Specifically, we look first at quarterly movements, and then reaction over a one-year period.
We expect quarterly changes in our price and volume variables across the state will differ significantly from changes occurring in those Zip Codes impacted by a major hurricane. Our method tests consecutive null hypotheses that the state-adjusted difference for each volume and price variable at times t-1, t-0, t+1, t+2 and t+3 is not significantly different than the adjusted difference for each variable at time t-0, t+1, t+2, t+3 and t+4, respectively.
Further, when looking specifically at how these differ, we expect to see some evidence of a decline in the quarter or quarters immediately following the hurricane event, and then we anticipate some form of rebound as a correction to the initial negative impact. Should there be these results, this should also break out as evident in basic regressions, showing as negative correlation between periods. That is, if the initial reaction is lower, then subsequent results should be higher. Conversely, if higher initially, then lower subsequently.
While Rich (2005) suggests post-storm growth "could come at the expense of building in other regions" in the state, we expect our findings to suggest otherwise. Substantial and rapidly occurring negative shocks to the market are likely to be associated with a substantial drop in demand, leading selling pressures to temporarily lower prices. As the public perception is that hurricanes spur growth and investment, any market drop should indeed be a temporary effect.
CONCLUSION
We investigate subsequent changes in quarterly housing prices and volume for 52 U.S. Zip Codes impacted by six major hurricanes from 2004-2005, for one year following the natural event. We obtain results that are consistent with home price changes following an overreaction pattern, similar to that found in financial markets after an unforeseen negative shock to the market. During the first two quarters following a major hurricane, our data suggest that changes in home prices and transaction volume in the affected Zip Codes experience a temporary dip, followed by a positive correction. Thus, some evidence emerges that a transitory price decline presents a buying opportunity, providing some support for a short-term reversal. A time-extended form of a short-term reversal (a few months as opposed to a few days) as we find, is consistent with Bremer and Sweeney (1991) who suggest that illiquid markets may partially explain the inefficiency of a prolonged recovery period.
When examining changes in our measures one full year following a hurricane, little evidence emerges suggesting a lingering effect on residential real estate prices, as prices have generally corrected back to their prior trend-line. Still, a nominal positive difference is found. Although statistically insignificant, this presents some evidence that areas hit by hurricanes outperform comparable areas not affected by the storm, a counterintuitive result. This leaves the door open to further research in this area, something presently in development.
Our study is unique compared to prior work in this area. First, we look at Zip Code-level data where most prior studies employ MSA-level (Metropolitan Statistical Area) or state-level data, neither of which allows for the precision obtained by a Zip Code-level analysis. Second, by examining the impact from several major hurricanes in a relatively constrained time period, we have less bias in our data than data from only one or two hurricanes and we eliminate some of the variability of macroeconomic factors that could potentially affect results. Finally, we use several measures to generate more definitive results.
Contrary to popular opinion, our results do not present evidence of an immediate surge in prices from a housing supply reduction and capital infusions to drive demand as prior popular press articles have implied. Thus, the housing market reaction to a major hurricane impact does not seem to exhibit behavior indicative of a bubble. That is, while it may be possible that a housing shortage immediately follows major storms and later corrects as supply returns to prior levels, overshadowing this possible outcome seems to be a short-term precipitous drop in demand. This might be due to large quantities of people relocating after a major storm, but all such reasoning would be entirely speculative. We do not seek to explain our results, only to present them.
