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FEDERAL RESERVE BANK OF DALLAS

•

EL PASO BRANCH

ISSUE 2 • 2006

Crossroads

E C O N O M I C T R E N D S I N T H E D E S E RT S O U T H W E S T

Housing Market
Trends in El Paso

ousing prices have received considerable
attention in recent years as concerns over potential excess appreciation have emerged for both
national and regional markets. In general, moderate increases in house prices often reflect and
contribute to a region’s economic and financial
health. In fact, the strong U.S. housing market has
been a key factor in sustaining consumer spending in recent years. Home prices can be too high
or too low, but if a market becomes misaligned
with excessively high prices, the resulting correction can reduce perceived wealth and leave homeowners saddled with high payments.
As in many other areas, price increases in the
El Paso housing market have raised questions
about whether local real estate prices are still in
line with regional economic conditions. Since
2003, home prices in El Paso have risen 39.8 percent, exceeding the 24.8 percent increase for the
U.S. but falling short of the hottest markets, such
as Honolulu (67.1 percent), Miami (64 percent)
and Los Angeles suburbs such as Riverside (84.6
percent). Some argue the El Paso increases are a
correction in a historically underpriced market;
others say restrictions on local development are
artificially inflating prices.1
This article is a brief look at recent conditions
in El Paso’s housing market. We will not resolve
the question of whether home prices are too high
or too low, but we can look closely at the forces
driving El Paso’s recent price increases. A surge in
demand driven by recent employment gains and
the expansion of Fort Bliss is probably the major
factor pushing prices up — and El Paso’s ability to
develop new lots and to meet this surge in
demand may be the key to whether a growing
bubble lies ahead.

Home Prices in the Local Economy
Households tend to benefit from strengthening housing markets. It has been argued that gains
in housing wealth were largely responsible for the
strength in consumer expenditures observed in
the United States during the 2001 recession.2

Much of that strength is attributable to mortgage refinancing
and subsequent household equity
withdrawals. Not all cash-out refinancing is used for personal
consumption, but survey evidence confirms that a substantial percentage of it does support
retail purchases.3 Robust consumer expenditures have helped
improve overall business conditions in the U.S., as well as in the
El Paso region.
Recent mortgage innovations
and other developments have
contributed to higher household
liquidity. Moreover, those innovations include loan options that
make it easier for first-time buyers to qualify for mortgages,
with smaller down payments
than those historically required
by lenders. These changes probably increase effective demand
and can lift overall house prices.
Consequently, if a bubble existed
and burst, home prices would
fall and an important support for
consumption would be gone.
Such a development would reduce retail activity around the
country, including in El Paso.
A “bubble” generally describes
a substantially overvalued asset
price (often 20 percent or more
above historical norms) that is
in danger of collapsing.4 A house
price bubble can also be defined
as an upward deviation of the
market price from the true value
of the house. The term also refers
to situations in which excessive
public expectations of future
price increases cause prices to
become temporarily elevated.
During housing market bubbles, homebuyer behavior changes.
Structures that prospective buyers would normally consider too
expensive are frequently regarded as acceptable purchases.
That occurs because investors
believe they will be compensated by significant future price
appreciation. In addition, firsttime homebuyers may worry that

if they don’t buy now, they won’t
be able to afford a house later.

Housing Bubbles
There are two basic categories of housing bubbles: price
bubbles and supply bubbles. Price
bubbles generally occur in expensive, supply-constrained markets. These are regions with a
tight supply of new homes resulting from tough and often
artificial restrictions on development, such as zoning or a limited
supply of vacant land. On the
other hand, supply bubbles generally occur in the inexpensive,
supply-abundant markets when
builders expand too rapidly,
eventually leading to housing surpluses. Both conditions have been
argued to exist in El Paso. Real
estate agents have complained
that El Paso is underpriced,
while builders have argued that
the supply of available lots is too
small for a fast-growing market
of more than 725,000 people.
In general, key characteristics of a price bubble include
price levels that have been bid
up beyond what is consistent
with underlying fundamentals
plus sustainable buyer expectations of future price increases.
As we have seen, housing prices
have risen substantially in El
Paso since 2003, but price increases alone don’t provide conclusive evidence of a housing
bubble. Two measures have been
widely used to examine the purported existence of housing bubbles: (1) home prices relative to
rents, and (2) affordability.
One widely used indicator of
housing market health is the
ratio of single-family home prices
to implicit rents.5 Implicit rent,
or owner’s equivalent rent, is
defined as the amount a homeowner would have to pay to rent
a housing unit. Accordingly, the
ratio of home prices to rents
should reflect the future benefits of ownership, through either

rental income earned by a landlord or implicit rent saved by an
owner–occupier. Because it uses
data from owner occupancy and
rental markets, the price-to-rent
ratio helps signal whether supply-and-demand market imbalances are temporarily inflating
single-family prices beyond reasonable levels. Large and long
deviations in the price-to-rent
ratio from its historical average
may be seen as the onset of a
bubble.6
Unfortunately, we do not
have a long series on implicit
rents for El Paso. Chart 1 illustrates the relationship between
housing prices and rents in the
U.S. and El Paso from 2001 to
the present. Comparisons are
also included for Houston and
Dallas, two rapidly growing markets for single-family homes that
both have the capacity for rapid
development. The El Paso ratio
turns around later and grows
more slowly than the U.S. ratio,
but it also grows much faster
than the other Texas cities’
ratios over the past two years.
While we don’t know to what
extent this is a deviation from
historical norms, it is clear that
during the past two years single-

Chart 1

Ratio of Single-Family Home Prices
to Rents in U.S. and Texas Cities
Index, 2001 = 1
1.4
U.S.
1.3
1.2

El Paso

1.1

Dallas

Houston

.9
.8
2001

2002

2003

2004

2005

2006

NOTE: 2006 is through September.
SOURCES: Office of Federal Housing Enterprise
Oversight; Bureau of Labor Statistics;
Texas A&M Real Estate Center.

family housing in El Paso was
subject to a shock not shared by
the local cost of lodging.
Another frequently used measure of overpriced housing is its
long-term affordability in the local
market, comparing the median
family income in El Paso to the
income required to qualify for a
conventional mortgage on the
median-priced El Paso home. If
this ratio is relatively low, down
payments and monthly mortgage payments are more difficult to meet. From a financial
institution’s perspective, this reduces the pool of qualified borrowers in the credit market.
Such conditions would naturally
lessen demand and place downward pressure on home prices.
Higher mortgage interest rates
would exert similar effects on
housing markets.
Chart 2 shows this affordability index for a conventional mortgage in El Paso annually from
1990 to 2006. The largest values
indicate the most affordable markets, and low values indicate diminished affordability.7 The least
affordable year is 1990, when
interest rates stood at 9.9 percent. The most affordable year is
2004, the end of a period of low
and declining interest rates and
stagnant growth in El Paso.
The sharp recent decline in
affordability was due to a combination of rising interest rates
(from 5.9 percent to 6.5 percent) and substantial increases
in local home prices. Chart 3, for
example, shows how affordability
declined quarterly from 2004Q3
to 2006Q2 and how it would
have declined if interest rates had
remained constant at 2004Q3
levels. Clearly, home price increases dominated interest rates
in this movement.
The current affordability index is low but within ranges visited in the not-distant past. Part
of the steep slide in affordability
was attributable to a desirable

Chart 2

Affordability Index for El Paso Declines in Recent Years
Index
1.9
1.7
1.5
1.3
1.1
.9
.7
.5
’90

’91

’92

’93

’94

’95

’96

’97

’98

’99

’00

’01

’02

’03

’04

’05

’06

NOTE: 2006 is through September.
SOURCES: Texas A&M Real Estate Center; Department of Housing and Urban Development;
authors’ calculations.

correction after a period of low
mortgage rates and poor economic performance. Comparing
El Paso’s affordability with other
Texas cities, El Paso ranks very
near the bottom of the list.
However, the fact that it is
accompanied at the bottom by
Brownsville and McAllen suggests that very low median family income on the border plays a
significant role in determining
the level of these indexes relative to other areas.

Why Higher Home Prices?
The sharp appreciation in
home prices since 2004 is partly

due to local job growth, as U.S.
industrial production rebounded
and as Mexico’s economy and
the maquiladora industry began
to grow strongly. However, more
relevant is the resetting of
expectations about the current
and future demand for these
houses due to the 2005 decision
to double the size of El Paso’s
largest employer — Fort Bliss.
The Base Realignment and
Closure Commission made this
event a high probability in 2004,
and Congress and the president
approved it in 2005. It will bring
as many as 21,000 new troops
and their families to the city,

Chart 3

Interest Rates Versus Affordability
Index
1.9
1.8
1.7
1.6
Rates hold

1.5
1.4

Actual rates

1.3
1.2
1.1
1
Q3

Q4
2004

Q3
2005

Q2
2006

SOURCES: Texas A&M Real Estate Center; Department of Housing and Urban Development;
authors’ calculations.

with about half seeking housing
off base. About 4,000 troops
have already arrived, and the
remainder will be in El Paso by
2012. The demand curve for El
Paso’s housing shifted quickly
and sharply to the right, with
the local stock of single-family
homes unable to catch up to
demand in a short period. Prices
responded accordingly.
If the recent price increases
have a solid basis in underlying
demand growth, the question of
a housing bubble emerging depends on the city’s ability to
deliver new homes to market in
a timely way. Barriers or delays
will simply push prices higher as
demand grows and could create
(or add to) a speculative atmosphere in local housing.
During the first nine months
of this year, El Paso issued the
lowest number of permits for
single-family houses since 2002
(Chart 4 ). The slow pace seems
to be the result of a shortage of
developed lots in the city.
Although several large masterplanned developments are under
way in El Paso, including a
3,500-acre development near
Fort Bliss in northeast El Paso,
these projects have yet to impact the market. Meanwhile, lot
prices have soared.

There is a clear need to prudently expedite the development of new land and lots, and
especially not to allow it to be
delayed by the kind of artificial
land-use controls —often coming under various smart-growth
and new urbanism labels — that
have created the bubbles we
now see imploding on both
coasts.
— Jesus Cañas
Thomas M. Fullerton, Jr.
Roberto Tinajero
Cañas is an assistant economist at the El Paso Branch of
the Federal Reserve Bank of
Dallas. Fullerton is a professor
of economics at the University
of Texas at El Paso. Tinajero is
a transportation economist at
the El Paso Metropolitan Planning Organization.

Notes
1

Home-price appreciation figures are
from the National Association of
Realtors, annual 2003 through
2006Q3.
“House Price Bubbles,” by John
Krainer, Federal Reserve Bank of San
Francisco Economic Letter, March 7,
2003.
“Mortgage Refinancing in 2001 and
Early 2002,” by Glenn Canner, Karen
Dynan and Wayne Passmore, Federal
Reserve Bulletin, December 2002,
pp. 469 – 81.

“Making Sense of Elevated Housing
Prices,” by John V. Duca, Federal
Reserve Bank of Dallas Southwest
Economy, September/October 2005.
The implicit rent measure used here
for the United States, Houston and
Dallas is from the consumer price
index for the respective area. The
consumer price index is not collected
in El Paso, and an index of rental
values for zero- to five-bedroom
apartments is used in its place.
“House Prices and Fundamental
Value,” by John Krainer and Chishen
Wei, Federal Reserve Bank of San
Francisco Economic Letter, Oct. 1,
2004.
These calculations follow the methodology of the Texas Affordability Index
of the Real Estate Center at Texas
A&M University, available at
http://recenter.tamu.edu/data/
dataaffd.html.

Crossroads

ECONOMIC TRENDS IN
T H E D E S E RT S O U T H W E S T

ISSUE 2 • 2006

Crossroads is published by the El Paso
Branch of the Federal Reserve Bank of
Dallas. The views expressed are those
of the authors and do not necessarily reflect the positions of the Federal Reserve
Bank of Dallas or the Federal Reserve
System.
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Please direct requests for subscriptions,
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Branch, Federal Reserve Bank of Dallas,
301 E. Main St., El Paso, TX 799011326; call 915-521-5233; fax 915521-5228; or subscribe via the Internet
at www.dallasfed.org.

Chart 4

Pace Slows for Single-Family Permits Issued in El Paso
Permits
4,500
4,000
3,500

Articles may be reprinted on the condition
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reprinted material is provided to the
Research Department, El Paso Branch,
Federal Reserve Bank of Dallas.

3,000
2,500
2,000
1,500
1,000

Crossroads is available on the Bank’s
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500
0
1999

2000

2001

NOTE: 2006 is through September.
SOURCE: Texas A&M Real Estate Center.