The Three Percent Solution

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42 | Th e M Rep o RT o r i g i nat i o n s e r v i c i n g a na ly t i c s s e c o n da r y M a r k e t ANALYTICS the latest W ith home price appreciation leveling off nationally, housing analysts who have been watching the market in fear of another bubble can "continue to rest easy," said one economist. Based on fundamentals, including prices-to-income, prices-to-rents, and historical data, Trulia Chief Economist Jed Kolko estimates that home prices at the national level were still 2 percent undervalued in the fourth quarter of 2014. While slowing price growth in the last year has helped smooth out housing's recovery, "[s]harply rising prices aren't necessarily a sign of a bubble," Kolko noted. "By definition, a bubble develops when prices look high relative to fundamentals." Breaking down local market data, Trulia reports that home prices in 70 of the country's largest markets are now within 10 percent (both higher and lower) of where the company says they should be based on long-term fundamentals, the highest number of markets since prices bottomed out in early 2012. Out of the remaining 30, nine were classified as "overvalued" by more than 10 percent, while the rest were all undervalued. As of Q 4, the most overvalued market is Austin, Texas, where home prices are now 16 percent higher than the level that local conditions should support, Trulia says. The city (along with several of Texas' other top metros) came through the housing crisis relatively unscathed and has recovered at a faster pace than many others. Taking the second and third top spots for overvaluation are Orange County (+15 percent) and Los Angeles (+13 percent). Several other California locales also appeared on the list of the top 10 overvalued markets: San Francisco (+12 percent), Riverside-San Bernardino (+12 percent), San Jose (+12 percent), and Oakland (+10 percent), attesting to the effects of low inventory levels and the state's tech boom. Meanwhile, all of the most undervalued metros today are in the Midwest and New England, led by three Ohio metros: Cleveland (-20 percent), Akron (-17 percent), and Dayton (-17 percent). While it's no surprise that the most overvalued markets also tend to be less affordable than others, Kolko explained that "overvaluation and undervaluation aren't necessar- ily the same as affordability." "Our valuation measure looks at local prices relative to what's normal historically in each local market," he said. "Right now, New York and Boston both look several percentage points undervalued relative to long-term fundamentals, even though they're far more expensive than Houston or Austin on a price-per- square-foot basis." Despite drawing lines between price increases, affordability, and over- and undervalua- tion, Kolko says all three are looking encouraging at the moment: "Price increases are slowing nationally, well before a bubble has formed. ... And we expect price increases to keep slowing in 2015. Bubble-watchers can continue to rest easy." Still, as the housing sector continues to recover, it's mostly the top tier of the market that's seeing all the benefits. Taking data from its monthly home price tracker, Black Knight Financial Services found that while high-value properties in the country's hardest-hit states have made solid strides in recovering to their pre-crisis peaks, low-value homes are still struggling to make progress. "We looked at [Home Price Index] appreciation from pre-crisis peaks to today in the 10 states currently trailing further behind their pre-crisis housing maxi- mums," said Trey Barnes, SVP of loan data products at Black Home Prices still 2% Undervalued nationally The Midwest and New england have the most undervalued homes, while Texas and California have plenty of overvalued ones. As the housing sector continues to recover, it's mostly the top tier of the market that's seeing all the benefits.

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