One economic indicator that I consult from time to time is the Global Insight quarterly study on housing prices in America. Here’s an interesting conclusion from the report: of the 330 regional markets surveyed, Houston is the most undervalued.

The Global Insight uses a number of factors in determining the theoretical price equilibrium level for each market, to include tax rates, population density, income levels, plus a somewhat nebulous “desirability factor”. So, as with all economic studies there is some art mixed in with the science, but nonetheless I find this study to be an useful data point when thinking about the relative valuation of markets.

The fact that Houston is ranked as the most undervalued market is interesting in light of the underlying economic factors and the disparity between the market’s current reactions with how it behaved in the past. Nowadays when we think about real estate bubbles we immediately think of California, Las Vegas, Florida, and other regional markets that have grabbed headlines with their flying property values over the past several years. But we forget that the poster child for real estate market collapses was Houston in the mid-to-late eighties.

Texans were knee deep in irrational exuberance long before Alan Greenspan coined the term. When the Gulf States kicked off the Arab oil embargo in response to Western support for Israel in the Yom Kippur War, the resulting spike in oil prices fueled investments in the oil industry. This, in turn, pushed property values to unsustainable heights.  Everyone wanted their own Southfork Ranch. 

Fast forward to the early years of the 21st century. Two rounds of armed conflict in the Gulf, rising demand and tightening supply have again sent oil prices into the stratosphere; and I’d argue that this time around the increases have more fundamental sustainability than in years past. Money is flowing into operational oil centers like Texas and Louisiana. But, the real estate market hasn’t responded. Yet.

The graph below shows the Department of Energy refiner acquisition cost of imported oil. 

Will property values in Houston and other economic centers for energy go up? In the short term, perhaps not. Economic malaise and a jittery credit market will help to continue to keep a lid on the prices, but I love the fact that the downside risk in undervalued markets is relatively low. Currently, investors in some markets need to plop down a 40% down payment in order to get into an property that generates breakeven month-to-month cashflow. Getting into an undervalued one where 5% does the trick feels pretty prudent.