Although some high-cost metros across the country have been experiencing double-digit home price gains lately, homes are still 3% undervalued nationally, calming fears of another approaching housing bubble, according to a recent analysis from Trulia.
Trulia’s Bubble Watch indicates whether home prices are overvalued or undervalued compared to their fundamental value by companied prices today with historical prices, incomes and rents. The more prices are overvalued when compared to their fundamentals, the closer the market is to a housing bubble and possibly a subsequent crash.
However, sharp price increases are not necessarily a sign of impending bubble trouble, rather a bubble develops when prices look high relative to fundamentals.
For the third quarter of 2014, Trulia estimates home prices are nationally 3% undervalued compared to their historic norms, down from when they were 6% undervalued a year ago.
To gain a better understanding of what undervalued vs. overvalued prices look like relative to the potential of a bubble, by comparison home prices were 34% overvalued in the first quarter of 2006—when the last bubble was inflating. When the bubble finally burst and the market crash ensued, by the first quarter of 2012 home prices had dropped to 13% undervalued, according to the Trulia data.
While some markets have been experiencing sizable price growth compared to others, a test of whether another bubble may be approaching depends largely upon whether or not prices in those high-cost areas are rising at a faster pace than others.
“Price gains in overvalued markets are a sign that we’re headed for danger, while price gains in undervalued markets are probably just a sign of getting back toward normal,” writes Trulia Chief Economist Jed Kolko in the Bubble Watch analysis.
Areas like Austin, TX and Los Angeles have experienced the highest price growth relative to their fundamental levels and are 19% and 15% overvalued. Year-over-year, these metros reported 11.9% and 8.9% increases in asking prices, respectively. When compared to their fundamental elves from the first quarter of 2006, prices in these areas were 2% and 73% overvalued.
On the other end of the spectrum, metros such as Dayton, OH (21%); Cleveland, OH (19%) and Detroit (18%) lead the nation as metros where home prices are most undervalued. Relative to their fundamentals from the first quarter of 2006, prices in Dayton were 8% overvalued, while in Cleveland they were 13% overvalued and in Detroit they were 33%.
Another measure of bubble risk, Trulia notes, is the number of markets that are more than 10% overvalued. As of the third quarter of 2013, only seven of the top 100 metros surpassed this level—the highest number since the first quarter of 2009, when prices were plummeting and the bubble had mostly deflated.
“All this means is that bubbles should not be our top housing worry today,” Kolko writes. “Our latest Housing Barometer shows that weak construction and subpar young-adult employment are the recovery’s big red flags. By contrast, prices are slowing to a sustainable pace and staying within striking distance of normal.”
Written by Jason Oliva