CoreLogic’s latest Home Price Insights report has been released for April 2018 and the biggest news is that CoreLogic reports that half of the 50 largest metro housing markets in the United States are “overvalued.” That’s a word that may have many homebuyers running for the hills shouting about bubbles and crashes but it’s far from that simple.
So what does “overvalued” mean?
It does not mean the same thing as a bubble. Though it is obviously true that in order for a bubble to exist some commodity has to be overvalued it does not necessarily correlate that an overvalued commodity is, necessarily, a sign of a bubble.
Bubbles always occur because of some kind of rampant fraud when it comes to housing. Though in some cases, when involving a highly specialized product, there is no fraud if a single company controls the production of the product. In those cases, the company helps falsely inflate the value by only producing a limited amount. Beanie Babies, remember them? Maybe you don’t.
Yes, Beanie Babies were like a bubble. There was overwhelming demand and then there wasn’t. So the value washed up, the bubble burst, and the people with Beanie Babies in their hands were the ones who lost out the worst. Beanie Babies, however, are not a necessity for living and at worst, their peak price was hundreds and, in a couple of cases, thousands of dollars. It’s hard to compare that to the housing market. True there was no fraud but that’s because the commodity is priced relatively low, it isn’t a necessity, and it was controlled by a single company.
When it comes to housing the only way that home prices are able to be falsely inflated during a bubble is due to large-scale fraud that must be allowed to occur at multiple levels. Mainly, the type of fraud that occurs when government regulations on the financial industry are relaxed and removed.
So if it isn’t a bubble, then what does overvalued mean and what are the consequences of that?
If a market is overvalued it means that homes in that area are more expensive than most people can afford in that area based on the prevailing wages for that area. It’s really more about wages than it is about home values. In this type of market, it is the buyer who can extend themselves to the highest price point in order to purchase who ends up setting the value of homes. It doesn’t mean that homes are being sold for more than they are worth because the only value that you can ascribe to any home is the dollar amount that a buyer is willing and able to pay for it. Home prices are “high” because wages in the area haven’t been growing commensurate with home prices. Were wages increasing alongside the housing market, it would be unlikely that most people would be complaining about the market being expensive, except that buyers will ALWAYS be complaining that prices are too high ;)
So in an overvalued market, it is the buyers who are the ones creating the overvaluation. It is not the sellers. Here’s an example. If you put your home on the market in a “hot” area and you decide that you want to be fair and offer your home for sale for a reasonable price (which no one actually ever says). So you list the home and you get 27 offers ranging from asking price to well above asking price. Do you choose the lowest priced offer because you want to be fair? If you truly wanted to be fair you would accept the lowest price as the purchase price and then do a random pick to choose the offer that “wins”. That’s “fair”.
But you’re not going to do that, and neither is anyone who is actually selling their home. Everything in life costs money and homes cost the most money. When YOU sell your home you want to be rewarded for your hard work and persistent upkeep. You put tens or hundreds of thousands of dollars into the home (on top of paying for it) and every seller expects the biggest reward possible for that hard work. That’s how you would feel if you were selling your home.
But again, Sellers can only accept the offers they receive.
When you have a housing crisis it means you need to make more living spaces and you need to produce them in a manner that doesn’t cause prices to soar even further.
What happens when a market is overvalued?
Well if there isn’t any fraud involved then the market will do what every market does when it is overvalued. The market will respond by slowing home price increases until they more strongly align with incomes. This is called “price correction” and this is what is supposed to happen in an overvalued market. It didn’t happen in 2005 (when it should have) because the banking industry was busy collecting huge paychecks by committing the most elaborate, although ultimately quite transparent, fraud that has ever been perpetrated. Well, maybe not “ever”.
The result we’re hoping to see in overvalued markets is a slowing of price increases and in some markets small drops in value, so that home prices can return to prices that a larger number of people can afford based on their incomes.
You shouldn’t be worried about a bubble, they’re extremely rare actually, even in real estate. And they’re even rarer when everyone is worried about a bubble happening. Side note; the time to worry about a bubble, is when no one is worried about a bubble happening because they’re so busy making money. What could possibly go wrong?
You should be worried about what your government (especially state and city) is doing to incentivize increased housing production and you should be equally worried about what your government is doing to make it easier for fraud to be perpetrated and go undetected. Regulation is the only tool that exists to prevent the financial industry from doing only what is in their best interests, even when that means breaking the law.
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