As we are officially entrenched in the fourth quarter of 2014, it is important to determine the current state of the housing market. Taking into consideration key, fundamental values (price-to-income ratio, the price-to-rent ratio, and prices relative to their long-term trends), Trulia has recently forecasted the direction of home prices. The results may be surprising to some.
Real estate is particularly local, as each region has demonstrated its own propensity for recovery. In other words, markets will continue to fluctuate independently from one other. Southern California, in particular, experienced larger than average appreciation rates over the last year. In fact, according to a recent report issued by Trulia, Southern California has some of the most overvalued markets in the nation. Prices in Los Angeles and Orange County were each 15% above what economic fundamentals projected, according to Trulia chief economist Jed Kolko. In the Inland Empire, they’re 11% overvalued.
Surprisingly, these numbers are lower than they were three months ago, probably because price appreciation has eased while incomes have climbed. But it’s a contrast from the nation’s market as a whole, which remains 3% “undervalued.”
Despite current home values, L.A. is not at risk of experiencing another bubble. In fact, the closest thing this country has to a housing bubble is actually in Texas – the same state that has somehow avoided the worst part of the recession. Austin, Texas has seen prices surge to the point that they now sit 19% above what the local economy and past trends would support. The bubble and crash of the mid-2000s largely passed Austin and its Texas neighbors by, but this time, they are right in the mix of things. Houston, too, is experiencing similar appreciation rates, as it is, according to Trulia, the eighth most overvalued market.
It is important to note, however, that what we are experiencing now is nowhere near the bubble we experienced in the mid-2000s. To better understand our current situation, it is important to familiarize yourself with what a “bubble” really is. The term bubble is used loosely and refers to circumstances in which prices increase beyond their fundamental value. Drastic increases in price, which are currently the result of low inventory levels, are the root of speculation and further demand. However, exponential growth is typically unsustainable, causing the bubble burst. As the market begins to trend downward, homeowners proceed to sell to avoid significant losses. A massive exodus of homeownership then facilitates the creation of a market with houses well below their fundamental value.
While the threat of a new housing bubble remains possible, it is important to familiarize yourself with the differences between this year and the previous financial crisis. According to Gary Thomas, the Realtors’ president, “the boom period was marked by easy credit and overbuilding, but today we have tight mortgage credit and widespread shortages of homes for sale.”
However, several factors will likely prevent prices from growing the way they are now:
- Expanding Inventory: Tight inventory has boosted prices, 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.
- Rising Mortgage Rates: 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.
- Fading Investor Interest: Investor interest will fade as prices increase, allowing more homeowners to enter the market.
With that in mind, it does not hurt to familiarize yourself with the current situation. The most overvalued market in the U.S. was Austin, Texas (overvalued by 19%), followed by Los Angeles (15%), Orange County (15%), San Francisco (12%) and Riverside-San Bernardino (11%). In fact, the median price for single-family homes in Austin jumped 11% year-over-year in August to $247,500 and the average price rose 9% to $311,414, according to data released last week by the Austin Board of Realtors.
Austin is actually more overvalued in 2014 than it was in 2006 (when it was only 2% overvalued); the same is true for Houston, which was overvalued by 8% in the third quarter of 2014 versus just 1% in 2006. Other overvalued markets have at least cooled in the intervening years: Los Angeles was 73% overvalued, Orange County was 66% overvalued and San Francisco was 46% overvalued in 2006.
Almost all of the most undervalued metro areas are in the Midwest and New England, Trulia found. Dayton, Ohio, was undervalued by 21% (versus 8% in the first quarter of 2006), Cleveland was undervalued by 19% (versus 13% in 2006) and Detroit was undervalued by 18% (compared with 33% in 2006). Price gains in the Midwest have generally outpaced those in New England.
Seven of the top 100 metro areas are overvalued by more than 10%, the highest number since the first quarter of 2009. The last time that many metro areas were overvalued was the second quarter of 2000, early in the housing market bubble. Still, Kolko says a housing bubble should not be a top housing worry in 2014, as the market is still held back by weak construction and young adult employment.