Housing bubble correction could be severe
Contrary to popular belief, the housing market hasn't cooled off that much. In fact, residential real estate prices continue to soar in a number of key metropolitan areas, according to a new study released this week.
That's a good thing, right? Actually, nobecause the froth building in housing prices raises the distinct possibility of significant corrections to come in many of those regions.
In the first quarter, home prices nationwide rose an additional 7.3 percent, according to a joint study by the financial services firm National City Corp. and the research firm Global Insight. As a result, there are now 71 metropolitan areasrepresenting nearly 40 percent of all single-family homesthat can be classified as "extremely overvalued," according to the study. By comparison, only 64 metro regions were considered frothy at the end of last year and only 1 percent were classified as such in the first quarter of 2004.
The report further stated that Californians and Floridians ought to be the most concerned, as their states are home to 17 of the 20 most overvalued markets. The frothiest region in the country, according to the study, is Naples, Fla., where home prices are said to be 103 percent overvalued. Rounding out the top five markets are Salinas, Calif.; Port St. Lucie/Fort Pierce, Fla.; Merced, Calif.; and Bend, Ore., which are all more than 75 percent overvalued, according to the report. (Global Insight and National City based their judgments on valuations on several factors, including historical market premiums and discounts, household income levels in those regions, interest rates, and population density.)
"The fact that this number of metro areas representing such a large percent of the total single family marketis extremely overvalued should be a cause for concern," said Richard DeKaser, chief economist for National City.
Another worrisome sign is that the 50 most overvalued markets at the end of last year were again the biggest winners at the start of 2006. Indeed, the 50 hottest markets saw a 10.1 percent increase in home prices, on average, in the first quarter.
This study's findings would seem to contradict other housing market reports that have shown a steady decline in home prices recently. For example, the Commerce Department has indicated that the median sales price on new single-family homes purchased has fallen around 3 percent since the start of the year.
But DeKaser notes that new homes are sold by developers, not families. And developers generally don't have the luxury that regular families do of living in their homes for several more years to wait out attractive offers. Moreover, DeKaser said new homes represent only a small percentage of the total housing market. For their part, National City and Global Insight relied on national housing data collected by the Office of Federal Housing Enterprise Oversight.
Under normal circumstances, the fact that housing prices are continuing to rise would be something to cheer. But the housing boom has been going for most of this decade. And housing markets can't be overvalued for too long, as imbalances in residential real estate prices will eventually lead workers to relocate to more affordable cities.
The bottom line: Real estate prices eventually correct themselves. And unfortunately for homeowners, it often takes years before home prices start to rise again, especially after a big run up.
National City recently studied 66 major metro regions over the past 21 years that suffered through a 10 percent or greater decline in prices for at least a two-year period of time. It found that home prices, once they begin to correct, tend to decline 17 percent on average before markets heal themselves.
"And the average duration of these adjustments is 3.5 years," says DeKaser.
So what about families who recently bought into one of these "extremely overvalued" markets in hopes of turning a fast buck? "I extend them my deepest sympathies," says DeKaser.