How Long Can the Economy Support Rising Home Prices?

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Home prices increased 1.9 percent in the first quarter of 2013, according to the latest Federal Housing Finance Agency report. This is the seventh consecutive quarterly rise in the purchase-only, seasonally-adjusted index, and indicates strong upward momentum for U.S. house prices. Home prices were up 7.2 percent on the year.

“The housing market has stabilized in many areas and homebuilding activity has strengthened in recent quarters,” commented FHFA Principal Economist Andrew Leventis. “That said, labor market weakness and still-elevated foreclosure pipelines remain hindrances to a more robust recovery.”

Like every other part of the economy, and in-line with the market fixation on monetary policy, the Fed’s quantitative easing and the headline unemployment rate that it’s chained to are key components in the housing recovery. Central bank easing has put downward pressure on interest rates, ostensibly increasing buying power in the market and assisting the climb in prices.

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The latest reading from the Standard & Poor’s/Case-Shiller index showed a 9.3 percent jump in home prices for February, compared to the prior year. Home prices in 20 major metropolitan areas rose at their fastest rate since May 2006, and beat expectations calling for a 9 percent gain. In fact, all 20 cities posted year-over-year gains for the second consecutive month, which has not happened since 2005. The Case-Shiller index is non-seasonally adjusted and uses a three-month average.

Home Price Index

Source: Federal Housing Finance Agency

The housing market recovery has been repeatedly cited as a bright spot in the beleaguered U.S. economic recovery. President Barack Obama mentioned it in his State of the Union address and has pointed to it several times since as one of the pillars of domestic growth. But while climbing prices and sales validate this claim, there is concern among some market watchers that another housing bubble could be inflating.

Due to the rebound in home prices, Trulia (NYSE:TRLA) has launched a feature called Trulia Bubble Watch. The new housing market indicator tracks whether home prices are in or nearing bubble territory by measuring how home prices are valued relative to their fundamentals. It gauges the housing market across the nation by looking at 100 of the largest metro areas.

According to Trulia, national home prices are still 7 percent undervalued. In comparison, the housing bubble of yesteryear saw home prices become overvalued by almost 40 percent in the first quarter of 2006. After the bubble popped, home prices became 15 percent undervalued in the fourth quarter of 2011. However, certain areas of the country are seeing houses become overvalued.

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FHFA Metro Areas

Source: FHFA, Honolulu, HI is not pictured.

The Trulia Bubble Watch finds that eight of the 100 largest metro areas have home prices above their fundamental value, with half of those being located in California. Cities such as Orange County, Los Angeles, San Jose, and San Francisco are all seeing home prices heat up, but still remain well below their pre-crisis peaks. Texas metros such as Austin, San Antonio, and Houston are also overvalued when compared to the fundamentals. Portland, Oregon rounds out the list.

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