In an article that appeared recently
in CoreLogic's blog, Popping the Housing
Bubbly Theory, CoreLogic's Chief Economist Dr. Mark Fleming presents a different
take on current home prices and whether recent gains are sustainable. Current thinking maintains that a housing
bubble may already exist because home price appreciation has substantially
outpaced the rate that rents have grown.
Renting and owning are generally considered to be "economic
substitutes," so Fleming says, "A significant difference in pricing should draw
more demand to the less expensive option, therefore driving up pricing and
removing the significant difference. This constant reversion to equilibrium
between the two substitutes means any significant difference must be due to
irrational exuberance on the part of the homeowner or renter."
But he argues for an alternative
view. Because most homeowners use their
income to pay their mortgage it follows that an established relationship exists
between income and home prices. This
relationship means that home price growth cannot be sustained at higher levels
than income growth because housing would become unaffordable, demand would
decline, bringing price growth back into alignment with income growth.
It is also important to note that the
significant variation in income levels across markets directly influences
housing differences. "A million-dollar
home in San Francisco is very different from a million-dollar home in Columbus,
Ohio," he points out.
Fleming says CoreLogic uses this fundamental relationship
between house prices and income to forecast home prices. In each market there is a gap between the
home price implied by the income level, i.e. the fundamental home price, and
the actual or forecasted house price.
This gap is measured as a percentage of the fundamental price. By
constructing a composite measure of house prices relative to fundamental prices
it is possible to construct a population-weighted average of the largest 50
market gaps over time. This allows us to
see that house prices clearly got well ahead of what was fundamentally
supported by income levels in the early 2000s and then there was a significant
over correction. The figure below has
been updated and provides a home price forecast through the end of 2015.
Fleming concludes that home prices,
despite the double digit increases in the last two years, are actually
undervalued relative to income and says that judging the bubbliness of prices
cannot be done simply by comparing those prices to rents. "Doing so misses the point made earlier that
much of the recent house price appreciation is a result of market correction
for the significant undervaluation caused by the price declines in the late
aughts. Instead, analyzing home price levels relative to fundamental prices
leads us to conclude that there is no need to fear a bubble for at least a few
years to come, if at all."
In a second blog piece titled Disproportionate Recovery in Housing's
Freshman Year of Healing, Thomas Vitlo a Sr. Business Analyst in CoreLogic's
Office of the Chief Economist looks at the distribution of new home sales in
the market and geographically. New home
sales in the current market, he says, are well below what we would expect in a
more stable market, making up an 8.9 percent share of home sales in December
compared to an average of 12.1 percent in 2000-2002. While new home sales are well below historic
levels they have been increasing their share over the last year, but the growth
is not evenly distributed.
Looking at the nation's census regions he finds that the southern states
have some of the highest shares of new home sales while the
northeastern state are not faring as well. Kentucky, Georgia, and
Oklahoma have seen their new home share increase by 2.4, 2.0, and 1.6
percentage points respectively Connecticut fell 0.5 percentage points
and New Jersey was down 0.5 points. Vitlo attributes this to the
relatively inexpensive housing markets in the south while the three
northern states have not had a significant new home rebound due to their
being high cost housing areas.
But he offers another explanation for
the discrepancy. Connecticut and New Jersey, as well as Massachusetts
where the percentage of new home sales was unchanged, are judicial
foreclosure states. This means they have longer foreclosure timelines
which have prevented inventories of bank-owned real estate (REO) from
clearing quickly. There are similar problems with distressed properties
in the Midwest with the exception of the booming energy state of North
The second figure compares the monthly
average new home sales share in 2013 compared to more stable times from
2000-2002. States that are above the
line had higher new home sales shares in 2013 compared to 2000-2002 and can be
deemed as improving. As an example,
Nevada averaged a 31.2 percent new home sales share during the early 2000s,
which was the highest share in the country, but in 2013 that share was only 5.1
percent, as limited supplies and distressed properties competed with the new
home sales market.