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5/14/2013 @ 2:36PM
Trulia Bubble Watch: Today's Rising Home Prices Are A Rebound, NOT A Bubble
Although
home price gains rival those of the last decade’s bubble, home prices
today look undervalued by 7%. Prices are overvalued only in a few
California and Texas metros.
Home prices today are rising nearly
as fast as they did during the peak bubble years of 2005-2006. Since
that bubble helped push us into the Great Recession, we should all be on
high alert for the next housing bubble. To track whether home prices
are in or nearing bubble territory, today we introduce Trulia’s Bubble
Watch, which is based on the most recent price data from the Trulia
Price Monitor and other data sources.
So are we in bubble
territory? No. Bubble-phobes can rest easy. Even with recent sharp home
price increases, prices are still low relative to fundamentals and are
far below bubble levels.
Back to Basics: How to Spot a Bubble
To
see a bubble, you first need to know what you’re looking for. A bubble
in home prices (or in the price of any asset – like stocks or even
tulips) is when prices soar above their fundamental value. Fundamental
value is based on supply, demand, and realistic expectations about the
future. We all learned in Economics 101 that prices move back toward an
equilibrium determined by fundamentals of supply and demand. In a
bubble, however, rising prices encourage speculation and fuel further
demand – up until when the bubble suddenly bursts and people rush to
sell, which causes prices to accelerate downward, sometimes well below
their fundamental value. Bubbles are notoriously difficult to predict
and hard to confirm until after they’ve burst: it’s impossible to be
sure whether price gains are justified by fundamentals until, if and
when, a bubble bursts. San Francisco home prices, for instance, are the
highest in the country; is that “irrational exuberance” by speculative
homebuyers, or are those prices justified by strong job growth, high
incomes, great weather, and constraints on the local housing supply?
To
answer that question, we assess whether home prices are overvalued or
undervalued relative to their fundamental value by comparing prices
today with historical prices, incomes, and rents. Incomes determine how
much people can pay for housing, and price increases aren’t sustainable
if they push prices too high relative to incomes. Rents reflect how much
people value housing even if they won’t benefit from price appreciation
(as renters don’t, but owners do); the price-to-rent ratio is like the
price-earnings (P/E) ratio for stocks. Using data from multiple sources
(see footnote), we create several measures of fundamental value and
combine them in order to calculate how overvalued or undervalued home
prices are relative to fundamentals.
Home Prices are Undervalued 7% Nationally and Regionally in 91 of the 100 Largest Metros
We
estimate that national home prices are 7% undervalued in the second
quarter of 2013 (2013 Q2). During last decade’s bubble, prices were as
high as 39% overvalued in 2006 Q1, then during the bust, fell to 15%
undervalued in 2011 Q4. Therefore, even with the recent price increases,
home prices nationally remain undervalued relative to fundamentals and
much lower than in the last bubble. That’s why today’s price gains are
actually still a rebound, not a bubble. This chart shows how far prices
are from bubble territory:
At the metro level, prices are below their fundamental value in 91 of the 100 largest metros. Prices are overvalued in the California metros of Orange County (+9%), Los Angeles (+5%), San Jose (+3%), and San Francisco (+2%), and the Texas metros of Austin (7%), San Antonio (5%), and Houston (2%), as well as in Portland (plus Honolulu, which at 0.01% is ever so slightly overvalued). The California metros are far less overvalued than at the height of the bubble – Orange County prices were 71% overvalued in 2006 Q1! Even the Texas metros, which largely avoided last decade’s housing bubble, are less overvalued today than at their peaks during the last bubble.
| Market Where Home Prices are Overvalued | |||||||||
| # | U.S. Metro | Home prices relative to fundamentals, 2013 Q2 | Home prices relative to fundamentals at local peak | When home prices peaked locally | |||||
| 1 | Orange County, CA | +9% | +71% | 2006 Q1 | |||||
| 2 | Austin, TX | +7% | +12% | 2007 Q2 | |||||
| 3 | San Antonio, TX | +5% | +12% | 2007 Q1 | |||||
| 4 | Los Angeles, CA | +5% | +78% | 2006 Q1 | |||||
| 5 | San Jose, CA | +3% | +59% | 2005 Q4 | |||||
| 6 | San Francisco, CA | +2% | +52% | 2005 Q4 | |||||
| 7 | Houston, TX | +2% | +8% | 2005 Q1 | |||||
| 8 | Portland, OR-WA | +1% | +44% | 2007 Q1 | |||||
| Note: positive numbers indicate overvalued prices; negative numbers indicate undervalued. Among the 100 largest metros. To see if prices are over or under valued in the 100 largest metros, see here. | |||||||||
| Markets Where Home Prices Most Undervalued | ||||
| # | U.S. Metro | Home prices relative to fundamentals, 2013 Q2 | Home prices relative to fundamentals at local peak | When home prices peaked locally |
| 1 | Las Vegas, NV | -24% | +70% | 2006 Q1 |
| 2 | Detroit, MI | -23% | +42% | 2005 Q1 |
| 3 | Palm Bay-Melbourne-Titusville, FL | -22% | +75% | 2006 Q1 |
| 4 | Akron, OH | -21% | +19% | 2005 Q1 |
| 5 | Cleveland, OH | -21% | +21% | 2005 Q1 |
| 6 | Warren-Troy-Farmington Hills, MI | -20% | +34% | 2005 Q1 |
| 7 | Jacksonville, FL | -18% | +45% | 2006 Q4 |
| 8 | Toledo, OH | -18% | +25% | 2005 Q2 |
| 9 | Dayton, OH | -17% | +16% | 2005 Q1 |
| 10 | Lake County-Kenosha County, IL-WI | -17% | +29% | 2006 Q1 |
| Note: positive numbers indicate overvalued prices; negative numbers indicate undervalued. Among the 100 largest metros. To see if prices are over or under valued in the 100 largest metros, see here. | ||||
Other indicators aside from home prices, like mortgage lending and construction activity, confirm that the housing market isn’t forming a new bubble. Mortgage credit remains very tight, especially for people with lower credit scores, and the new “qualified mortgage” rules under Dodd-Frank intend to prevent the recurrence of toxic mortgages that artificially inflated housing demand in the last bubble. Also, construction activity, though rebounding, is still well below normal levels, and the vacancy rate is falling, so there’s no evidence of overbuilding today like we had during the last decade.
Is the Next Bubble Coming Soon?
If prices keep rising as fast as they are today, we’d be back in bubble territory in several years. However, prices are unlikely to keep rising as fast as they are today, for three reasons:
1. Inventory
should expand. Tight inventory is boosting prices today as buyers bid
up prices on scarce homes; however, as prices continue to rise, more
people will sell as they get back above water or decide to cash out, and
more new construction will add to inventory.
2. Mortgage
rates should rise. Low mortgage rates today increase buying power
because borrowers can afford a more expensive house for the same monthly
payment. Rates are likely to rise as a result of the strengthening
economy, either through market forces or Fed actions, which – along with
more inventory – should slow down price gains.
3. Investor
interest should fade. Undervalued prices have attracted investors, who
have helped push up home prices as they have bought and rented out
homes. But as prices rise, investor interest will fade.
Is Another Bubble Coming Ever?
Even though we’re not in bubble territory today, another one is coming – someday. The history of American real estate is full of speculation, bubbles, and busts. Trulia’s own survey of consumers shows that most people expect prices to get back to the peak of the previous bubble again in the next 10 years – including people in housing markets where prices had been overvalued most. Furthermore, our rent-versus-buy analysis, which indirectly reveals where people expect prices to rise the most long-term, shows that people expect future prices to rise more if they live in metros where booms and busts were more common in the past. This is another sign that people seem to think prices go up but not down. Will government help to prevent another bubble? Perhaps the new mortgage rules will help – but the more cynical answer is “no.” The most recent bubble was more severe than earlier housing bubbles, and if we didn’t previously learn from the past, then why should we learn from it now? In short: housing bubbles look almost inevitable. Whether you’re buying a home, selling a home, or setting housing policy, remember that the next housing bubble is probably just a matter of time. But, as Trulia’s Bubble Watch shows, that time is not now.
Source: http://www.forbes.com/sites/trulia/2013/05/14/trulia-bubble-watch-todays-rising-home-prices-are-a-rebound-not-a-bubble/
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