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Are we in another real estate bubble that is about to POP?

Posted on October 15, 2014 by Anthony Vulin in Market Update, Real Estate, Uncategorized

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Home prices have risen pretty fast in the last few years, in fact, price gains last year were similar to the peak bubble years of 2005-2006. Bubble-phobes are wringing their hands and looking skyward to see if it’s falling.
So . . . are we in bubble territory? The answer is no and there’s some very solid research to back this up. Even with recent sharp home price increases, prices are still low relative to fundamentals; annual price increases are slowing way down and are far, far below the bubble levels of 2006.
The Basics: A bubble in home prices (or in the price of any asset – like stocks or even tulips) occurs when prices soar above their fundamental value. Fundamental value is based on supply, demand, and realistic expectations about the future. We all learned in Economics 101 that prices move back toward an equilibrium determined by fundamentals of supply and demand. In a bubble, however, rising prices encourage speculation and fuel further demand – up until the bubble suddenly bursts and people rush to sell. Bubbles are notoriously difficult to predict. On the surface, a bubble and strong economic growth look exactly the same. 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 limited local housing supply?
To answer the question, Trulia’s Bubble Watch assesses whether home prices are overvalued or undervalued relative to their fundamental value by comparing prices today with historical prices, incomes, and rents. Incomes determine how much people can pay for housing, and price increases aren’t sustainable if they push prices too high relative to incomes. Rents reflect how much people value housing even if they won’t benefit from price. Using data from multiple sources, Trulia creates several measures of fundamental value and combine them in order to calculate how overvalued or undervalued home prices are relative to fundamentals.
Nationally, Trulia estimates that home prices are 3% undervalued in the third quarter of 2014. In 2006 Q1, during the past decade’s housing bubble, home prices soared to 34% overvalued before dropping to 13% undervalued in 2012 Q1.

The most overvalued market is now Austin Texas, at 19%, followed by the California metros of Los Angeles and Orange County at 15%. San Francisco is about 12% overvalued. (To put this in perspective, Los Angeles was 73% overvalued in 2006!) It should also be noted that these numbers are receding slightly as price increases slow down and incomes rise.
Here’s the point. There is very slight over-valuing going on in Southern California right now, but nothing anywhere near a “bubble”, and, yes, you can find markets where homes are actually undervalued. But, do you really want to live in Detroit?

Marc Grayson

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