The U.S. housing market’s steady climb out of the cellar has some wondering whether a bubble is on the horizon, but one expert says those fears are unfounded. Trulia economist Jed Kolka noted recently that houses are still largely undervalued despite steadily increasing prices in the overall market. Even so, he admits bubbles are hard to define because of the mix of elements that create them. It’s often difficult to determine whether rising prices are the product of overeager buyers and sellers, or if it’s driven by strong economic growth, or a blend of both. Regardless, Trulia reports that prices remain below their fundamentals in more than 90% of the country’s largest metro areas. For more on this continue reading the following article from TheStreet.
National home prices are still undervalued relative to their fundamental value, Trulia economist Jed Kolko noted in a blog post Tuesday, soothing concerns the market is heading into bubble territory.
While price gains in some markets are starting to rival those bubble years, this is still more reflective of a "rebound" from the bottom, according to Kolko.
"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," Kolko wrote. "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?"
Trulia looked at various underlying fundamentals in the housing market such as income, rents and historical prices to answer that question. If home prices rise beyond what people can afford, then the gains are unsustainable. Similarly, rent reflects "how much people value housing" even if they don’t benefit from price appreciation.
The study found that national home prices in the second quarter of 2013 were 7% undervalued relative to fundamentals. During the bubble, prices were 39% overvalued in the first quarter of 2006. In the bust that followed, prices became once again cheap relative to fundamentals and were 15% undervalued in the fourth quarter of 2011.
Prices are below their fundamentals in 91 of the 100 largest metros. Overvalued markets include Orange County, California, Los Angeles, San Jose, San Francisco and the Texas metros of Austin, San Antonio and Houston. But even these markets are not as overvalued today as they were in the bubble years. Orange County was 71% overvalued in the first quarter of 2006.
Meanwhile, despite the strong gains in Las Vegas, the market remains among the most undervalued. Several Florida cities also remain undervalued relative to fundamentals.
Housing analysts have become increasingly bullish on the housing recovery. Affordability is the best it has been in years, they say, thanks to rock bottom interest rates. Meanwhile, investor demand is helping clear distressed inventory from the market at a rapid pace, removing the overhang from the market. The lack of new construction in recent years and the dwindling supply of existing homes has led to a shortage of inventory nationwide, causing prices to surge even higher.
Still, the gains in some market such as Phoenix has been so rapid, that people fear it is another bubble. Skeptics point to the fact that investors are driving demand, while first-time home buyers remain locked out of the market since mortgage credit conditions remain tight.
The impact of investors in the overall housing market is somewhat overstated. Analysts have pointed out that while investors — big and small — play an outsized role in some deeply distressed markets such as Phoenix and Las Vegas, first-time home buyers are returning in other markets.
Still, the fact that incomes have largely remained flat and mortgage credit remains tight means home ownership is within reach only to a privileged few. There isn’t enough real demand for homes to support the rise in home prices, argue housing bears.
But prices are still not out of whack with fundamentals. What’s more, home prices are likely to slow in the next year or two anyway, according to Trulia’s Kolko.
For one, as home prices rise, inventory will expand as new construction picks up and sellers are lured back into the market.
Secondly, the current low interest rates will not last forever. Either a strengthening economy or Fed action could cause interest rates to rise, slowing price gains.
And finally, investor demand will slow as prices continue to rise and interest rates move higher.
But the recovery will likely remain intact. "Just as these factors should cause home prices to slow down, job growth and increased household formation should support a continued recovery in housing demand," wrote Kolko.
This article was republished with permission from TheStreet.