A new report suggests that homes are no longer overpriced in the vast majority of markets, but concludes prices will continue to fall in areas hard hit by foreclosures — in many cases overshooting market fundamentals on their way down.
IHS Global Insight’s quarterly report, House Prices in America, looks at historical home-price-to-income ratios in 330 metro areas. The latest report concludes that homes were fairly valued in all but 33 of those markets at the end of September.
Only three markets in the entire nation — Bend, Ore.; Atlantic City, N.J.; and St. George, Utah — are "extremely overvalued" and at risk of substantial price decline of 10 percent or greater, the report said. That compares with a peak of 52 extremely overvalued markets in 2005.
That might sound like good news for prospective homebuyers worried about buying into a declining market. But the report looks primarily at affordability and does not directly consider factors that may send prices in a given market down further, such as rising unemployment, tightened lending standards, shrinking homeowner equity, or delinquencies and foreclosures.
In other words, by looking at historical data and past price corrections dating back to 1985, the report attempts to determine what home prices should be if they behaved the way they have in the past — not where they may actually be headed.
The report noted that 73 percent of markets saw price declines in the third quarter, and its authors acknowledged that in areas where foreclosed homes are bloating inventories, prices will continue to fall.
"With no end in sight to the downward spiral of house prices, it is likely that long-anticipated market correction will now overshoot fundamental valuations on the downside," said James Diffley, group managing director of IHS Global Insight’s Regional Services Group, in a statement.
In fact, the report suggests, prices may already be falling below what the market might otherwise bear. Homes are fairly valued in 226 markets, the report said, and undervalued in 71 markets — including places that have become synonymous with price declines and foreclosures such as Las Vegas, Nev., and Stockton, Calif.
"In this study we are not trying to forecast prices," Diffley told Inman News. IHS Global Insight expects to see double-digit price declines in many markets in 2009, he said — price declines directly correlated with foreclosures, subprime lending, rising unemployment, and tight credit.
"Our study, though, leads to the conclusion that the prices required to clear real estate markets in this down-cycle are in many cases below long-term fundamental value," Diffley said.
Other studies
Other recent studies that take into account local economic conditions and wild ups and downs in housing prices suggest that while affordability may be improving in many markets, it’s too soon to expect an end to the cycle of delinquencies, foreclosures and falling prices.
In October, PMI Mortgage Insurance Co. concluded that 24 of the 50 largest U.S. housing markets are at risk for price declines in the next two years.
Assessing the risk of price declines is critical to PMI, because the company insures mortgages for borrowers who can’t come up with a 20 percent down payment and may end up "upside down" if home prices fall.
PMI looks at past price acceleration and volatility, local unemployment and affordability to calculate its Market Risk Index score. The score is a prediction of the likelihood of price declines within two years for homes purchased using loans purchased or guaranteed by Fannie Mae and Freddie Mac.
In its Fall 2008 U.S. Market Risk Index, PMI said the risk of price declines increased in 359 of 381 metropolitan statistical areas during the second quarter. The chance of price declines for the country as a whole rose from 22 percent to 28 percent — "still moderately low," PMI said.
But the chance of price declines was high — greater than 70 percent — in 16 of the 50 largest U.S. markets, PMI said.
According IHS Global Insight’s analysis of historical price-to-income data, none of the 16 markets considered by PMI to be at the greatest risk for price declines in the next two years are overvalued.
In fact, prices have fallen so far in Las Vegas and three California markets PMI considers among the most risky — Sacramento, San Diego and Oakland — that they are now undervalued, IHS Global Insight’s report concluded.
PMI’s second-quarter analysis, released in October, crunched numbers through the end of June. IHS Global Insight’s third-quarter report included data up to the end of September, and therefore took into account more recent price declines.
But the IHS Global Insight report also clashes with an analysis of third-quarter statistics released Nov. 21 by First American CoreLogic. The property information company said its Core Mortgage Risk Index, which forecasts delinquency risk, was up 12 percent from a year ago and 54 percent since 2002, at the tail end of the last U.S. recession.
First American CoreLogic said that although the annual rate of home-price declines has stabilized at around 11 percent, deteriorating economic fundamentals — including flat or declining wages and increasing job losses — have spread the risk of delinquencies to more areas.
Home-price declines are still the biggest risk factor for delinquency in the most stressed markets, the company said, but economic fundamentals "will likely return as a critical force driving increased risk" over the next year.
The 10 markets First American CoreLogic identified as having the highest risk of delinquency included eight on PMI’s list of 16 large markets facing the highest risk of price declines.
But IHS Global Insight concluded homes weren’t overvalued in any of those markets. According to House Prices in America, homes were "fairly valued" in six of FirstAmerican CoreLogic’s 10 riskiest markets and "undervalued" in four — Sacramento, San Diego, Oakland and Stockton, Calif.
First American CoreLogic’s data shows nearly one in five homes with mortgages were underwater in September, meaning their owners owe more on their mortgages than their property is worth. That’s a factor ”also weighing heavily on mortgage risk," the company said.
Homes with negative equity are at a higher risk of foreclosure because their owners are less likely to be able to sell or refinance their home if they lose their jobs or face an interest-rate reset on an adjustable-rate mortgage.
The percentage of upside-down homes was highest in Nevada (48 percent), Michigan (39 percent), Florida (29 percent), Arizona (29 percent), California (27 percent), Georgia (23 percent) and Ohio (22 percent), First American Core Logic said.
Like PMI, First American CoreLogic factors in local economic conditions like unemployment when calculating its Core Mortgage Risk Index. Other factors tracked by First American CoreLogic include foreclosures and fraud and collateral risk.
Affordality returning
While PMI’s report is geared at gauging the likelihood of price declines, and First American CoreLogic wants to know the risk of borrowers in a given market defaulting on a loan, IHS Global Insight’s report is focused on affordability.
The report looks at price-to-income ratios and price corrections dating back to 1985, using a statistical model developed by lender National City Corp. to determine whether home prices are currently undervalued, fairly valued or overvalued.
The model assumes most of the variation in price-to-income ratios can be explained by four factors: household population density, mortgage interest rates, relative income levels, and historical premiums or discounts buyers have expected to pay in a given market in the past.
Those premiums or discounts for housing in a given market can reflect factors such as the availability of jobs or the scarcity of housing. National City claims the model can account for 76 percent of the variation in house-price-to-income ratios over time. Because the model has a standard deviation of plus or minus 14 percent, markets that aren’t above or below their historical trend line by more than that are classified as "fairly valued."
Markets where the model determines homes are 14 to 35 percent above the trend line are classified by IHS Global Insight as "overvalued," while those that are elevated more than 35 percent are "extremely overvalued." Homes where the model determines prices are more than 14 percent below the historical range are considered "undervalued."
The report concluded that only three of 330 markets evaluated were "extremely overvalued" and that 30 were "overvalued." The markets that are now overvalued are mainly located in the Pacific Northwest, while southern metros from Mississippi through Texas are among the 71 undervalued markets.
Weighting each metro area by their share of the total housing market value, the overall U.S. housing market is undervalued by 3.8 percent, compared with peak overvaluation of 24.5 percent during the second quarter of 2006, the report concluded.
From the homeowner or homebuyer’s perspective, one problem with looking at home values at the national, state or even metropolitan statistical area is that a macro analysis may not pertain to their home or the neighborhood they are considering purchasing in.
"The more local the data, the better," said Leslie Appleton-Young, chief economist for the California Association of Realtors, speaking last month at a real estate and economics symposium sponsored by the U.C. Berkeley Fisher Center for Real Estate and Urban Economics.
National, state and county level (data) can all give misleading signals, Appleton-Young said, pulling up a map of a neighborhood in Stockton. The map, which relied on data from ForeclosureRadar, showed a newly built neighborhood hard-hit by foreclosures, while an older, more established neighborhood on the other side of Route 99 was largely immune.
"This is a bipolar market — we have a distressed market, and the other market," with heavy discounts and higher sales volume on delinquent, foreclosed and real estate-owned properties, Appleton-Young said.
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