January 2022 Newsletter

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As we move forward in the new year, many of you will begin to turn your thoughts to tax preparation. While we are not tax professionals, our staff at Frontline knows how stressful tax time can be. We strive to reduce your stress by providing the needed documents such as year-end reports and 1099s, all of which have been issued to our investors.   Though the long-term goal for purchasing an investment property is to build equity and value over the initial investment of the property there are many benefits to be taken advantage of in the meantime. One of the biggest benefits is the tax deductions allotted to real estate investors! However, it can be easy to overlook many of the deductions available to you. Below are some things you may want to consider while preparing for tax season:

The following are deductions that you should track each year: Mortgage interest Homeowners association dues Property taxes and insurance Professional fees such as attorneys, accountants, etc. All property management costs such as management fees, leasing fees, etc. Utility payments Miscellaneous repairs Added or replaced appliances Repairs to units such as HVACs, water heaters, etc. Travel expenses incurred because of your investments Tenant concessions Some deductions should be amortized over a period of years. (It is especially important to seek the advice of a tax professional regarding these items): New paint, carpet, fencing, gutters, roof, and other major improvements Replacement of units such as HVACs, water heaters, etc. A major loss to the property Most of the items listed above can be found on your year-end statement provided by Frontline Property Management, Inc. Year-End statements were issued to each of our investors within the first two weeks of January. It is important to ensure you use the year-end statements versus the monthly statement sent out for December. Some other items to consider while preparing for your tax filing: Did you sell or buy a property in the current year, or are you anticipating transactions in the upcoming year? Be sure to make a copy of your final closing papers for your tax person to review for significant deductions including:  Amortization of points and other loan cost on investment loans Fees paid for new mortgages or refinances Exchange fees for 1031 exchanges of your properties Insurance, taxes, interest, and utilities paid during escrow. Review your expenditures carefully for any missed deductions and be sure to consult your tax professional to ensure that you are providing the IRS with reasonable and valid deductions. Make your investment portfolio work for you!

Jay Hartley MPM®, RMP®  Owner - Managing Partner Office | 817.377.3190 Direct | 817.288.5546 Frontline Property Management, Inc. 3000 Race Street, Suite 132 Fort Worth, TX 76111 Visit our Website

Fed Signals a Dramatic Shift in Policy—With Big Changes Coming for Interest Rates

On November 15, the Federal Reserve announced that they could raise interest rates as many as three times in 2022, signaling a dramatic shift in policy.  This is big news because at the start of the COVID-19 pandemic the Fed made two big moves to stimulate the economy. It lowered interest rates to near–zero and began a program of asset purchases—both of which worked as intended. And now it appears we’ll be taking a step back from those two stimuli in 2022, which could have a significant impact on the housing market. Why are these 2022 interest rate hikes important? Ideally, the Fed would back off these economic stimuli slowly—first by tapering asset purchases gradually until they hit zero, and then by gradually raising interest rates by 0.25% at a time. This is what they did after the Great Recession to much success.  This is also a surprising move because, until recently, the Fed has signaled that it would end asset purchases completely in mid-2022 while raising rates only once toward the end of the year. But, the nation has been dealing with persistently high inflation, which hit 6.8% in November, per the Consumer Price Index—and this issue is what appears to have forced the central bank’s hand.  And, now the Fed intends to complete asset purchases by March 2022, with interest rates poised to climb shortly thereafter.  What does this mean for the economy? For the economy as a whole, this is welcome news. The nation’s GDP is growing and unemployment is returning to pre-pandemic levels. Thus, there is little need for further economic stimulus. The biggest issue in the economy now is inflation, and raising the interest rates is the Fed’s best tool to fight inflation, as it reduces monetary supply.  Hopefully, this action by the Fed will reel in inflation as supply chain disruptions are sorted out. In turn, this will hopefully return the inflation rate to a level that’s closer to the Fed’s 2% target. That will likely take at least a year, though.  What does this mean for the housing market? But even if this action is good for the economy as a whole, it will likely have significant implications for the housing market. When interest rates increase, it puts downward pressure on housing prices, because it makes the cost of a mortgage—or any other type of loan—more expensive.  This is illustrated in the chart below. As depicted, there is a negative correlation between interest rates and housing prices. When one goes up, the other tends to go down—and vice versa.

But, the good news is that this is not always the case. There have been many times in U.S. history in which interest rates have increased and housing prices also increased in tandem. This occurred most recently from 2013 to 2018, when there was a decent amount of volatility in interest rates. Still, the housing prices went up consistently before flattening in 2018, when interest rates hit post great recession highs.  That’s why it’s difficult to predict what will happen to the housing market as interest rates rise next year. When it comes to complex markets such as the housing market, there is no single indicator or factor that determines which way prices will move—and by how much they will shift. Rather, there are many forces at play—some of which are well understood and I will detail below – and others of which are unknown.  What will the housing market look like in 2022? In my opinion, the biggest drivers of housing prices in 2022 will be interest rates, affordability, demand, supply, inventory, and inflation.  And, as stated earlier, the biggest forces in 2022 to exert downward pressure on the housing market will likely be interest rates and affordability. As interest rates rise, mortgages will get more expensive, which in turn hurts affordability. Since we now know that the Fed will be raising interest rates in 2022, mortgage rates are extremely likely to rise as well—unless bond yields remain as low as they are, which seems unlikely. As mortgage rates increase, borrowers will not be able to afford to take loans as they are currently, and housing prices will feel the downward pressure as a result.  Home affordability has also been declining for months, as interest rates creep up slowly and home prices continue to hit new highs. However, with wage growth as high as it is in the U.S, some of the declining home affordability could be offset by these new interest rate hikes.  On the other side of the equation, there are forces that will likely exert upward pressure on housing prices. In my opinion, those are supply, demand, inventory, and inflation.  The housing supply in the United States is severely strained—and has been throughout the pandemic. It is estimated that the U.S. is short about 5 million-plus when it comes to the necessary housing stock. This is not the type of issue that can change overnight. It will likely take a decade or more for this dynamic to shift, and the constrained supply heavily contributes to the higher prices we’re seeing.  Demand is also strong by almost every measure. First and foremost, the total number of home sales is very healthy, according to Redfin. And, despite the very high home prices, people are still buying.

Information from the Mortgage Bankers Association, which maintains a survey of lenders that tracks purchase application data, backs up this buying trend. “Housing demand remains strong as the year comes to an end amidst tight inventory and steep home-price growth,” Joel Kan, MBA’s Associate Vice President of Economic and Industry Forecasting, said. Still, that demand could decline as affordability declines, and is one of the variables I am most interested in monitoring over the next year.  Inventory, meanwhile, remains near all-time lows.  When inventory is this low, it indicates that the market is very competitive, which tends to lead to higher prices.  I don’t personally see a glut of inventory coming online anytime soon. And for those who think a foreclosure boom is going to happen—it’s not. The data shows that forbearance is low, and it’s extremely unlikely that we’ll see a foreclosure crisis in any shape or form.  Lastly, there’s inflation. As prices of goods and services increase across the economy, just as they are now, asset prices tend to increase as well. Housing is likely to be included in that equation.

Texas Housing Insight

Texas housing sales slowed in October but trended upward amid continued supply constraints. Along with higher mortgage interest rates, double-digit home-price appreciation chipped away at housing affordability. Elevated demand persisted as homes averaged roughly one month on the market. On the supply side, single-family housing permits increased for the second consecutive month, but housing starts declined as lumber and other input material prices rose. The relatively low level of inventory available for sale is the greatest challenge to Texas' housing market. The state's diverse and expanding economy, favorable business policies, and steady population growth, however, support a favorable outlook. Supply The Texas Residential Construction Cycle (Coincident) Index, which measures current construction activity, flattened nationally and within Texas due to decreased construction values despite employment and wage gains during October. The Texas Residential Construction Leading Index ticked down as weighted building permits decreased, signaling a potential slowdown in future activity. Among the major metros, weighted building permits and residential starts increased, except in Dallas-Fort Worth (DFW), where there was a decrease in both metrics. Inflationary pressures, however, tempered economic expectations and may slow construction activity in coming months. Single-family construction permits accelerated 4.5 percent in October, increasing for a second straight month. Houston topped the national list for seven consecutive months with 3,887 nonseasonally adjusted permits after registering a healthy seasonally adjusted increase. DFW ranked second on the national list and posted a double-digit monthly expansion to 3,523 permits. Meanwhile, Austin and San Antonio issued 1,480 and 872 permits, respectively. On the other hand, Texas' multifamily sector registered incremental growth as issuance shifted from two-to-four units to five-or-more units. The metric ticked up just 0.7 percent on a monthly basis but elevated 12.3 percent year to date (YTD) relative to the same period last year. Despite strengthening economic conditions and ample housing demand, total Texas housing starts declined as lumber prices increased 17.9 percent in October. Single-family private construction values, however, increased slightly in real terms, but the metric continued to trend downward in Texas' major metros. The majority of the statewide growth was attributed to the elevation in Austin and DFW values. Texas' months of inventory (MOI) normalized at 1.6 months as sales activity and new listings slowed. A total MOI around six months is considered a balanced housing market. Supply remained relatively constant across all price cohorts except in the upper and lower extremes. For example, inventory tightened for homes priced less than $300,000 and for luxury homes (those priced more than $500,000), diminishing to 1.2 and 2.5 months, respectively. Inventory in the major metros decreased slightly in October, except in Houston, where MOI flattened at 1.7 months. Supply remained the most constrained in Austin at 0.9 months, while San Antonio's MOI lowered to 1.7 months. North Texas' metric declined at the largest rate, falling to 1.1 and 1.2 months in Dallas and Fort Worth, respectively. Depleted inventory remains a major headwind to the health of Texas' housing market. Demand Total housing sales flattened in October, dipping 0.3 percent amid rising mortgage interest rates and dwindling inventory. The slowdown was attributed to historically low activity for homes priced less than $200,000. On the other hand, the number of homes sold priced between $400,000 and $499,999 reached an all-time high. Reduced transactions at the lower end of the price spectrum slightly outweighed the uptick in the higher price ranges. Housing sales decreased in all metro areas except for in Dallas. San Antonio reflected statewide fluctuations across the price spectrum as total sales declined 1.5 percent. In Houston, the metric dropped 0.9 percent, while activity in Austin contracted 3.2 percent. Sales in North Texas slowed overall, decreasing 3.4 percent in Fort Worth. However, transactions in Dallas increased 1.9 percent due to strong gains for homes priced between $200,000 and $299,999. Texas' average days on market (DOM) rose marginally to 32 days, confirming robust demand and attributing sales decrease to limited inventory. Austin's DOM improved by one day, averaging 19 days, while North Texas' metric also increased, selling after an average of 23 days in Fort Worth and 27 days in Dallas. San Antonio's and Houston's metrics registered narrow gains, matching the statewide average of 32 days in both metros. With monetary policy possibly normalizing, starting with the Federal Reserve Bank's tapering of bond purchases, economic growth forecasts for the coming years point to a slow return to the long-run structural trend as the initial and strongest stage of recovery likely reached its peak. It's becoming clearer that inflation pressures will be permanent. The ten-year U.S. Treasury bond yield ticked up for the second consecutive month to 1.6 percent2, while the Federal Home Loan Mortgage Corporation's 30-year fixed-rate elevated to 3.1 percent. The median mortgage rate for the typical Texas homebuyer remained constant at 3.1 percent for GSE loans in September3 and ticked down ten basis points to 2.9 percent for non-GSE loans. Although mortgage interest rates rose over the past two months, Texas home-purchase applications increased in October but fell 6.5 percent YTD. Meanwhile, refinance applications declined on a monthly basis and were down 24.6 percent since December 2020. Year-over-year (YOY) purchase and refinance applications diminished 9.8 and 10 percent, respectively, largely due to baseline effects after a surge of remodeling and refinancing in 2020. Increasing rates, lenders adding more requisites, and the shrinking pool of households able to refinance are likely impacting refinance activity as well. (For more information, see “Finding a Representative Interest Rate for the Typical Texas Mortgagee". In September, the median loan-to-value ratio (LTV) constituting the “typical“ Texas conventional-loan mortgage dropped from 87.8 a year earlier to 84.5. The debt-to-income ratio (DTI) elevated from 35.4 to 36.4, while the median credit score increased ten points to 749 over the same period. The LTV GSE borrowers decreased from 85.4 last September to 85.9; however, DTI grew from 35.4 to 36.4. Overall improved credit profiles reflected the fact that only the most qualified housing applicants were able to outbid their competition for their desired homes amid exceptionally tight inventories and robust demand. Prices Average home prices were boosted by the ongoing shift in the composition of sales toward higher-priced homes due to constrained inventories at the lower end of the market. The Texas median home price rose for the tenth consecutive month, appreciating 1.4 percent on a monthly basis and 15.5 percent YOY to a record-breaking $312,700 in October. The share of luxury homes sold in Austin continued to expand, contributing to the 24.4 percent YOY surge in the median price ($453,600). The Dallas metric ($383,100) increased 17.6 percent, while annual price growth in Fort Worth ($319,600) shot up to 18.2 percent. Houston's ($309,100) and San Antonio's ($303,000) metrics elevated 15.1 and 18.4 percent, respectively. The Texas Repeat Sales Home Price Index accounts for compositional price effects and provides a better measure of changes in single-family home values. Texas' index corroborated significant home-price appreciation, accelerating 18.6 percent YOY. The repeat sales index also accelerated in the major metros, except in Austin and Houston, as annual price growth reached recent peaks. The metric dipped to 35.1 percent in Austin, followed by Dallas and Fort Worth with 24.1 and 22 percent home-price appreciation, respectively. San Antonio posted an 18.4 percent annual hike, while Houston's index decelerated to 14.6 percent. Increasing home prices pressured housing affordability, particularly in an environment of low real wage growth. Single-Family Forecast The Texas Real Estate Research Center projected single-family housing sales using monthly pending listings from the preceding period (Table 1). Only one month in advance was projected due to uncertainty surrounding the COVID-19 pandemic and the availability of reliable and timely data. Texas sales are expected to recover 2.7 percent in November after October's decline. The metric is estimated to rebound 2.5 and 2.4 percent in Austin and Houston, respectively, with additional increases of 4.9 percent in DFW. Transactions in San Antonio, however, are forecasted to slow further to -3.6 percent. Sales through November 2021 should accelerate relative to the same period in 2020. On the supply side, inventories reached a trough in May 2021 and should improve in the coming months. Listings seemed to reach a trough in May and are rising, easing some of the price pressures amid a rise in new and pending listings. (For more information, see 2021 Mid-Year Texas Housing & Economic Outlook).

Household Pulse Survey According to the U.S. Census Bureau's Household Pulse Survey, the share of homeowners behind on their mortgage payments increased to 6 percent nationally and 9 percent in Texas (Table 2). Houston and DFW hovered above the national average at 13 and 8 percent, respectively. The share of Texas respondents who were not current and expected foreclosure to be either very likely or somewhat likely in the next two months declined from 27 percent in September to 14 percent in October (Table 3). The proportion of delinquent individuals at risk of foreclosure fell in North Texas, decreasing from 20 to 18 percent, and declining 28 percentage points to 16 percent in Houston. The Federal Housing Finance Agency's foreclosure and REO eviction moratoria for properties owned by Fannie Mae and Freddie Mac (the Enterprises) expired Sept. 30, 2021. Continued stability in the housing market is essential to Texas' economic recovery.

Disclaimer: This is designed to provide general information regarding the subject matter covered. It is not intended to serve as legal, tax, or other financial advice related to individual situations. Consult with your own attorney, CPA, and/or other advisor regarding your specific situation.