Analysis: Why there’s no housing bubble … yet

By Ruth Mantell

MarketWatch (MCT)

Published: Monday, July 22 2013 12:00 a.m. MDT

Because rates have increased more than 1 percentage point since early May, some buyers will have to scale back their purchase plans. Also, the record low interest rates created an urgency to buy that will lose some power even though mortgages remain relatively inexpensive, said Robert Shiller, an economist at Yale University.

Amy Sancetta, AP

Enlarge photo»

WASHINGTON — As home prices rise, so are concerns that a new housing-market bubble may be appearing, particularly in cities with double-digit annual growth rates.

Are there red flags in recent data?

“I wouldn’t say that we have bubbles today. But if prices keep rising at these rates, pretty soon you will be in bubble territory,” said Dean Baker, co-director of the Center for Economic and Policy Research, a Washington think tank. “Generally, you don’t see situations with rapidly rising prices and they just stop.”

Before the bubble burst, year-over-year price growth reached above 17 percent. The current rebound has yet to reach such a frenzied pace, though home prices recently posted year-over-year growth of 12 percent, the fastest rate since 2006, according to the Case-Shiller index that tracks 20 cities.

Many of the cities with the largest price gains are where housing crashed hardest when the bubble burst. For example, Las Vegas home prices recently posted year-over-year growth of 22 percent, but remain more than 50 percent below a 2006 peak, according to the most recent S&P/Case-Shiller report. Prices in both Phoenix and Miami are also more than 40 percent below local peak levels in those cities, despite recent jumps higher.

“What’s important to keep in context is that those double-digit gains are off of very low prices. Even with those gains prices are still relatively low,” said Frank Nothaft, chief economist at federally controlled mortgage buyer Freddie Mac.

Tight inventory, pent-up demand and investors have supported price gains. Despite those gains, prices are 26 percent below peak levels, according to Case-Shiller’s 20-city composite index. Take San Francisco, for example, where inventory is lean and competition is fierce between would-be buyers. Among the 20 cities tracked by the Case-Shiller index, San Francisco recently posted the fastest year-over-year growth, hitting just under 24 percent. Yet even there, prices are 26 percent below peak.

Looking forward, such large price gains are unsustainable, especially as rising mortgage rates cut affordability and income growth plods along. At a certain point, rapidly rising prices mean investors looking for high rates of return will be less interested. With fewer investors, first-time buyers and others may have a better shot at participating in some of the hottest markets. Rising prices also encourage greater home construction, which expands inventory levels and eases some pressure off of prices, though builders have complained about a deteriorated infrastructure making it tough to ramp up work.

Jed Kolko, chief economist at real estate site Trulia, compared current prices with historical prices, incomes and rents, and found that home prices were 7 percent undervalued in the second quarter, compared with being overvalued by a peak of 39 percent, which was hit in the first quarter of 2006.

“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,” Kolko said in a blog post.

But is housing affordable?

In a healthy market, owning a home should be within reach for a typical family, economists say.

A gauge from the National Association of Realtors, a trade group, indicates that affordability has declined 18 percent since January, hitting 172.7 in May, but is 17 percent above its average in the past decade. A reading of 100 means that a household with median income would have exactly enough income to qualify for buying a median-priced existing single-family home.

Separate analysis from CoreLogic recently found that Hawaii and the District of Columbia were unaffordable, while other pricey areas were near peak affordability.

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