Home prices have risen in nearly all parts of the nation over the last few years. While price gains vary considerably across urban markets, some places have had especially rapid appreciation that put values above their pre-Great Recession peak, even after controlling for inflation. With prices setting new records, it’s natural to wonder whether the housing market is on the verge of another valuation bubble.
The CoreLogic Market Conditions Indicator provides a gauge to identify urban areas that may be overheating. The Indicator is based on straightforward intuition: home prices should generally rise in line with income growth of local residents. If prices grow too fast, then homes are less affordable and price growth should slow while incomes catch up.
We found that 32 percent of MSAs in the U.S. were potentially ‘overvalued’ by our metric in March. (Figure 1) The last time that one-third of metro areas were overvalued in a rising price environment was Spring 2003. While many metros were frothy 15 years ago, the valuation bubble was still localized and not national; however, rapid price growth during the following three years led to 67 percent of markets overvalued by 2006. Thus, while we do not have a national valuation bubble today, continued rapid price growth raises the specter of a new bubble forming within the next few years.
When viewed by location, most of today’s frothy metros are along the seacoast or in the western mountain states. (Figure 2) To illustrate, the CoreLogic Home Price Index for the Denver metro area was about 30 percent above the pre-Great Recession peak, even after netting out inflation. In contrast, real per capita income in Denver has grown by less than that pace since 2006.
The CoreLogic Market Conditions Indicator is an early warning signal for bubbly markets. It should be used in concert with other metrics, such as a comparison of prices with local rents, to determine if values have become untethered to market fundamentals. And while it shows that the U.S. is not in a valuation bubble yet, there are many urban areas where prices appear to have become delinked to their long-term relationship with income.
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