Hottest Housing Markets Overvalued

New York, NY, August 22--Roughly one-third of the market for single-family homes is extremely overvalued, according to National City Corp. However, a strong outlook for the economy, historically low mortgage rates and a fragmented market should prevent a nationwide crash in home prices, according to the Cleveland-based bank and mortgage lender. "The most likely scenario we see over the next year is a moderation of price growth, especially in the hottest markets, which would diffuse some of the price pressure in housing," said Richard DeKaser, chief economist at National City, during a conference call. However, he conceded that if prices continue to escalate in those speculative markets, "we could see some trouble." In a study examining the interval from 1985 to 2005 and focusing 299 metropolitan areas that accounted for roughly 80% of the value of U.S. single-family homes, National City found that about 31% of the market is extremely overvalued. The biggest overvaluation pockets were in California and Florida, as well as parts of New York and Boston, according to National City. The survey focused on home prices relative to income and also took into account mortgage interest rates, household population density and standards of living. Markets were considered extremely overvalued and at high risk for a correction when valuations exceeded the statistical norm by 30%. Over the past 20 years, National City found 63 major corrections in metropolitan areas where home prices fell at least 10% over a period of at least two years. The median, or typical, price correction was a 17% decline, while the typical degree of overvaluation prior to a correction was 30% -- the level that National City used to determine if a particular market is extremely overvalued. The percentage of the single-family housing market that qualified as extremely overvalued increased to 31% in 2005 from 25% in 2004 mainly on higher home prices, since incomes are up and mortgage rates have risen only slightly, DeKaser said. In about 85 of the 299 metropolitan areas examined, home prices were increasing faster than incomes by at least 10%. Still, DeKaser doesn't see signs of a housing bubble on a national scale. "There are lots of individual housing markets with tremendous differences," he said, noting that home prices are largely driven by local economies. Although the one-year outlook for the U.S. economy is solid, inventories are building and prices are softening in some of the hottest housing markets, he added. Therefore, there could be an "orderly correction" this year, although there's also the risk that speculation could heat up faster and create overvaluations that could lead to a bust, DeKaser said. Another concern is rising oil prices, which would increase heating and energy costs for homeowners, as well as adversely affect the overall economy.