America's Unbalanced Housing Recovery

Headlines would have us believe that the United States housing market is becoming increasingly healthy, particularly given that prices are heading back up when one looks at national data.  An analysis by Trulia shows that on a national basis, things look relatively good, however, on a local basis, prices in some areas certainly have the appearance of "bubbling up".

Trulia calculates whether housing prices are overvalued or undervalued based on a comparison of current prices to historical prices, incomes and rent.  One simply cannot compare today's prices for homes with prices in the past to determine whether or not a price bubble is developing.  That is why measures, including price-to-income and price-to-rent, are key to determining housing valuations.  As we all found out during the Great Recession and just prior, as prices rise and homes become overvalued when compared to fundamentals, the risk of a price crash rises as well.

Here's what Trulia found:

You can clearly see that, while housing prices on a national level are not overvalued like they were in the mid-2000s, the upward trend in valuation is quite clear since early 2012 and is relatively steep.

Things look completely different when we look at local markets.  Of the 100 largest metropolitan markets in the United States, 19 or nearly one-fifth are overvalued.  Even more critically, three of the nation's five most overvalued housing markets are in southern California and eight out of eleven of California's large metropolitan markets are overvalued.  

Here is a listing showing where the nation's most overvalued housing markets are located and by how much:

How does the current level of housing market overvaluation compare to the past?  As I noted above, 19 out of 100 housing markets were overvalued in Q1 2014, the highest number since Q4 2009 and, of those, 4 large metro areas had overvaluations in excess of 10 percent, the highest level since Q4 2008.  Looking back to the height of the housing bubble in the mid-2000s, all 100 of the nation's largest housing markets were overvalued and 91 percent had overvaluations in excess of 10 percent.  As the housing bubble burst, all 100 markets were undervalued.

Trulia concludes that national housing prices are roughly in line with fundamentals, however, it is important to note that the same cannot be said for most of California's major housing markets where prices are outstripping people's ability to pay for a home.  The median price paid for a house in California in February 2014 was $355,000, up 22.8 percent on a year-over-year basis and up 60.6 percent from the post-peak trough of $221,000 in April 2009 but still below the peak of $484,000 in the spring of 2007.  The problem with local overvaluation in California is exemplified in the case of Los Angeles where a median house is now valued at 7.7 times the median household income in that market as shown on this graph:

With houses considered affordable when a median house is valued at 3 times the median household income in that market or less, it certainly is starting to look like a key part of America's real estate market is heading towards the next bubble as housing in California becomes increasingly unaffordable.  At this point, we can only guess how much of a negative impact a real estate market correction on the west coast could have on the nation's economy.  With nearly 10 percent of America's detached homes located in California, the impact could be substantial.