In an article that emerged fairly recently in CoreLogic’s blog, Popping the Housing Bubble Theory, CoreLogic’s Chief Economist Dr. Mark Fleming presents a different take on current home prices and whether or not recent gains are sustainable. Current thinking maintains that a housing bubble may currently exist since home price appreciation has significantly exceeded the rate that rents have grown. Renting and owning are typically considered to be “economic substitutes,” so Fleming says, “A significant difference in pricing should draw more need to the less expensive choice, therefore driving up pricing and removing the considerable difference. This constant reversion to equilibrium between the two substitutes means any significant difference must be due to irrational exuberance for the homeowner or tenant.”.
But he argues for an alternative picture. Because most homeowners use their income to cover their mortgage, it’s logical that an established relationship should prevail between income and home prices. This relationship means that home price growth can not be maintained at higher levels than income growth because housing would become unaffordable, demand would drop, bringing price growth back into position with income growth.
It is also important to note that the considerable variation in income levels across markets directly affects 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 basic 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 creating a composite measure of house prices relative to fundamental prices it is possible to build a population-weighted average of the largest 50 market gaps gradually. This enables us to see that house prices clearly got well ahead of what was fundamentally sustained by income levels in the early 2000s and then there was a considerable over correction. The figure below has been revised and provides a home price projection through the end of 2015.
Fleming concludes that home prices, despite the double digit increases in the last two years, are really undervalued relative to income and says that evaluating the bubbliness of prices can not be done simply by comparing those prices to rents. “Doing this 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. Evaluating home price levels relative to fundamental prices leads us to conclude that there is no need to suspect a bubble for at least a few years to come, if at all.”.
Straight off blog piece labelled “Disproportionate Recovery in Housing’s Freshman Year of Healing”, Thomas Vitlo a Sr. Business Analyst in CoreLogic’s Office of the Chief Economist checks out the circulation of new home sales in the marketplace and geographically. New home sales in the current market, he states, are well below what we would expect in a more stable market, comprising an 8.9 percent share of home sales in December compared to approximately 12.1 percent in 2000-2002. While new home sales are well below historic levels they have been growing their share over the last year, but the growth is not equally distributed.
Considering the nation’s census regions, he discovers that the southern states have some of the highest shares of new home sales, compared to the northeastern states that are not participating on the same level. 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 associates this to the relatively affordable housing markets in the south while the three northern states have not had a considerable new home rebound because of there being high cost housing locations.
He offers another illustration for the discrepancy. Connecticut and New Jersey, along with Massachusetts where the percentage of new home sales were the same, are judicial foreclosure states. This implies they have longer foreclosure timetables which have slowed the inventories of bank-owned real estate (REO) from being liquidated. There are similar problems with distressed properties in the Midwest with the exception of the booming energy state of North Dakota.
The second figure matches up the monthly average new home sales share in 2013 compared with 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 in the course of the early 2000s, which was the highest share in the country, but in 2013 that share was only 5.1 percent, as restricted supplies and distressed properties competed with the new home sales market.