Climate Change, Flood Risk Could Pierce The Houston Housing Market Bubble

As sea levels and risk of flooding continue to rise in and around Houston, so do property values, insurance prices and the chances of popping a real estate bubble that hasn't adequately factored in the threat of climate change.

According to a new study, property in Houston and other Texas cities is already overvalued based on flood risk. That's left experts worrying a major storm or climate change-related disaster could spur a mass exodus from hurricane-prone areas, triggering a wave of defaults that would leave many borrowers underwater on their mortgages as well as their properties.

Texas has about $9.8B of overvalued property, a Nature Climate Change study found, using property transaction and flood risk data to calculate the overvaluation of residential property — the difference between fair market value and what the study considers an "economically efficient" price for properties at risk.

The economically efficient price is one that accounts for the cost of future damage to properties inside and outside of the Federal Emergency Management Agency's 100-year flood zone.

An Axios analysis found that Texas’ biggest cities, including Houston and Dallas, have a significant amount of such overvaluation.

“If we have another one of those 500-year floods that happen every 10 years, for the areas that get flooded, it will most definitely have an impact [on market values],” said Jim Gaines, the chief economist for the Texas Real Estate Research Center at Texas A&M University.

Flood risk is worsening in Harris County due to climate change and urban sprawl, the Houston Chronicle reported. FEMA maps place more than a third of the county’s land into a flood plain, and that designation is expected to increase substantially when FEMA releases its updated maps some time this year. 

A 2021 study found that 28.7% of residential properties and 34.1% of commercial properties in Harris County are at risk of being inoperable due to flooding. What's more, the number of Harris County homes at risk of storm surge flooding will double by 2050, CoreLogic predicted in its Hurricane Risk Report 2023. 

More than 14.6 million properties in the United States face at least a 1% annual probability of flooding, with expected annual damages to residential properties exceeding $32B, according to the Nature Climate Change study. Of all the natural hazards exacerbated by climate change, flooding is the deadliest, costliest and most widely experienced in the United States, the study states.

Greater frequency and severity of flooding under climate change is predicted to increase the number of properties exposed to flooding by 11% and hike average annual losses by at least 26% by 2050, presenting substantial costs to property owners, insurers, mortgage lenders and the federal government, according to the study.

Yet this year, Harris County homeowners saw an average 16% increase in their appraised property values, Houston Public Media reported, and about 95% of homes increased in value.

The median price of a home in Harris County was $322K in May 2023, up from $225K in May 2018, the year following Hurricane Harvey, per Texas Real Estate Research Center data.

For “acts of God,” like flooding, tornadoes and winter storms, market memory typically lasts about two years, Gaines said. 

Harris County overall didn't see much of a dip in market home prices following Hurricane Harvey. The median price sat at about $220K in August 2017, the month it hit, before dropping to $215K in September 2017, according to TREC. The median price was back up to $220K by March 2018. 

But property values plummeted in flood-prone areas, like parts of Meyerland, Braes Heights and Bellaire, and homes near the Addicks and Barker reservoirs, the Chronicle reported.

Harvey also limited supply, considering the 9% to 12% of all buildings in Harris County that flooded. Mortgage loan delinquency rates rose and foreclosures spiked, partly because some homeowners had to pay mortgages on flood-damaged houses while also paying for a short-term housing, the Texas Law Review reported.

Almost three-quarters of the homes that flooded were outside of the 100-year flood plain, meaning flood insurance was typically not required, the Houston Chronicle reported.

Following Hurricane Harvey, thousands of flooded homes were converted to rentals, though those numbers are hard to track, per the Chronicle. Of the single-family Harris County properties that had a homestead exemption in January 2017, more than 28,600 of them no longer had that exemption in January 2018, according to Harris County Appraisal District data. 

Flooding has been a mere aside to supply and demand, which largely dictates housing prices, Gaines said.

“People have been forced, because of the limited inventory and supply, to pay higher prices,” he said. 

But flooding should have a large impact on marketability of a home, Gaines said. As of September 2019, Texas law requires homeowners to disclose information about flood risks and history before they sell their property. 

In the case of flood risk, what you don’t know can hurt you, Michael Craig, an economist with HUD policy development and research, said in a statement to Bisnow. Research shows that flood disclosure laws like the ones recently passed in Texas help markets price in risk, he said.

But most people go to buy a home on a nice sunny day, making flood risk invisible, said Tom Larsen, senior director of insurance solutions for CoreLogic.

“The challenge with trying to ascribe the risk of that home to the home price is it’s not visible to people,” Larsen said. “To have home prices better aligned with flood risk does seem rational … But that takes a lot more information.” 

Home prices are not properly discounted to account for the potential costs of flood damage, according to the study. There is an average discount of 4.6% for properties located in the 100-year flood zone, but a study has shown an average overvalue of 8.5% in flood-prone areas due to not accounting for increased damage risk from climate change, according to Nature Climate Change.

Insurers are already using information like that CoreLogic provides to increase prices, Larsen said. 

“From the insurance perspective, flooding remains a generally underinsured peril,” he said.

Hurricane Harvey was an inflection point for insurers, said Danielle Lombardo, the chair of insurance brokerage Lockton Global's real estate practice. Texas’ weather volatility is increasingly making the state difficult to insure, she said.

“Every time insurance underwriters think they’re getting enough premium for the risk, there’s another catastrophic event,” Lombardo said.

Texas is the third-hardest state in which to insure a home, behind California and Florida. After major home insurers pulled out of California and Florida, some say Texas could be next. Some smaller insurers in the Texas Gulf Coast region have become insolvent in the past year or stopped covering hurricane-prone property. 

A trend in that direction, fueled by increased costs to replace a building, could lead to coverage becoming more expensive and property owners getting less for their money.

“For hurricane insurance, a deductible may have been 3% of your total insurable value. Now, it’s 5%,” Lombardo said. “That’s a massive number that most people don’t set aside reserves for.” 

The Texas Windstorm Insurance Association found that this year, rates are 20% below what they should be for residences and 22% below what they should be for commercial properties. 

Lenders will often require buying flood insurance, which adds to overall housing cost, Gaines said. 

“That’s gotten expensive,” he said.

Prices for flood insurance in Harris County could increase 75% or more under a restructure of the National Flood Insurance Program. In ZIP code 77204, in southeast-central Houston, about 47% of policies are expected to increase by $20 or more per month, a FEMA database shows.

A perfect storm of circumstances leading people to flee areas most impacted by climate change-driven weather could create another financial crisis.

Though experts say it isn’t likely, a sudden sell-off in high-risk markets due to climate change could lead to a substantial drop in home values. That would leave low equity borrowers underwater on their mortgages and trigger defaults — all without direct damage from a flood event, Craig said.

We have not yet seen a large sudden shift in prices like that, he said.

“On the other hand, if capitalization of climate risk into home values is more gradual through slower growth in prices relative to non-flood areas, there would be no trigger for defaults,” he said. “This type of price behavior has been observed in some markets following flood events.”

Following Hurricane Harvey, most people stayed in their homes and repaired them, Larsen said.

“There was not a massive dislocation,” he said. “Your home may have gone down in value in the short term. But if you don't sell it, you won't see that loss … that’s really key for a lot of homeowners.” 

In Harris County, those most impacted by severe weather would be the homeowners who bought houses within the past few years in areas that flood, since they have less equity and bought when prices were high, Gaines said.

If they have resources and are not pressured to sell, it is more manageable, he said.

“It’s all on paper until you actually have to do something,” Gaines said.

Realistically, people have other things to worry about than the riskiness of their homes, Larsen said. When buying a house, the appearance and layout tend to outweigh the fear of an extreme event that may or may not happen, he said.

CoreLogic is issuing reports and supporting initiatives to try to elevate the visibility of flood risk, Larsen said. If awareness of the risk goes mainstream, home prices should fall into alignment.  

“It's tough to elevate the riskiness of your home to a really important level,” Larsen said. 

“It's certainly been an impediment to date of trying to achieve that perfection, where the price of it really is aligned with the risk.”