What Does Real Estate Have To Do With Oil?

by: University of Maryland REC Investments

Summary

With oil hitting new lows, the next decline in US production is only just beginning.

States like Texas and North Dakota are seeing tremendous declines in real estate prices.

In oil-focused cities, commercial and residential real estate alike is correlating drastically with price declines.

By Sadiq Asad

When U.S. crude oil producers flooded the market in late 2014 by rapidly increasing production in the hopes to finally turn a profit, they entered the beginnings of what will certainly go down as a historic battle of market share. What happened next was based on two simple concepts: businesses need to make a profit and as supply increases, prices decrease. So, in response to U.S. producers, OPEC (Organization of the Petroleum Exporting Countries) ramped up oil production to drive down oil prices in what many believe as the hope that U.S. producers couldn't return profit and would be forced to exit the market. But as we've seen, it didn't work. A year later, U.S. producers have developed better technology and more efficient methods and now oil sits at a multi-decade low, including the Great Recession, at just below $30 per barrel.

While the U.S. and OPEC continue production and oil remains around $30 per barrel, OPEC countries, whose main export is petroleum, are facing very difficult consequences. Since oil is the predominant stream of revenue in OPEC countries and it is now providing less than a third of the revenue to governmental budgets, these countries are, for the first time in years, operating at a deficit and facing rising unemployment. Saudi Arabia, for example, emptied $62 billion from its reserves and is having to issue bonds for the first time in nearly a decade. Similarly, Venezuela, whose exports are almost entirely made up of oil is now facing a multi-year decline in GDP, now at -4%. As worried investors flood out of Venezuelan markets, Venezuela is facing a textbook example of hyperinflation with the Venezuelan Bolivars fast approaching 900 per U.S. dollar. Click to enlarge

And what's happening on the other side with the U.S. economy? Currently, the top producing states are Texas, Oklahoma, North Dakota, and Alaska and each of these states has a significant dependence on the oil industry. To understand how these macroeconomic forces are affecting states, it is necessary to study the more local economies of each of these states. A useful indicator of the wellbeing of these states is through analyzing real estate trends in high oil producing cities. Looking at trends in residential real estate sales and future real estate contracts, we have a clearer understanding of how these global events affect the U.S. economy.

With regards to Texas, the volatility in the real estate market is significantly less when compared to the real estate market in a state like North Dakota. The driving force behind this is the diversification of each states GDP. Since the GDP of Texas is less reliant on the wellbeing of oil, there has still been growth in the housing market throughout Texas as a whole. Specifically, the percent change in residential sales has increased by 3.4% since November 2014. This does not mean, however, that oil is not affecting cities in a more localized way. Looking at Houston, for example, revenues from energy service firms have declined by an average of 27% since the price of oil began to fall dramatically. As a result, energy firms are having to lay off thousands of employees which ultimately drives down the real estate markets. In fact, the percent change of home sales during the last year declined by over 10% and Class A office buildings are showing declines in occupancy by over 8%. These are all multi-year lows.

So, what's next for real estate in a city like Houston? OPEC isn't letting up, prices continue to plunge, and many oil drillers are going bankrupt. For 2016, Houston will continue to see real estate markets shrink, employment will continue to fall, and the price at the pump will continue to stay near $2 per gallon.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.