House prices reached the peak of the previous housing bubble, but was this the inflation of a new bubble or a true and durable recovery?

The house price rally that began in 1997 climaxed in a financial mania in 2006, the Great Housing Bubble. By definition, a financial bubble is an unsustainable increase in asset prices followed by a crash that wipes out most of the previous increase. Since prices at the bubble’s peak defy any fundamental valuation, the “recovery” from a bubble is the crash because the crash restores prices to their fundamental values (often with a downside overshoot).

After the housing crash, everyone who paid peak values wanted to see a return to the ridiculous and unjustifiable prices that characterized the peak. They felt anchored to peak prices because they incorrectly believed bubble-era prices were fundamentally sound. Rather than see the crash as a market recovery that restored rational house prices — which it was — the people who paid too much viewed prices as “depressed” and the reflation of the housing bubble was deemed a “recovery” in their minds.

Are we witnessing a new sustained housing recovery in California, or are we witnessing a new housing bubble? People express differing points of view depending on their psychological anchoring to past prices, but experts also disagree on the interpretation of fundamentals. Experts make strong and conflicting arguments that current pricing is supported by fundamentals and that current pricing is another bubble.

Some housing bulls postulate the dramatic increase in prices springs from sound fundamentals. Rents and incomes increased, unemployment dropped, and distressed property sales returned to pre-crisis levels.

Some housing bears posit the dramatic increase in prices feigns the signs of market health while the patient ails. Prices moved up far faster than rents and incomes (nearly 10 times faster), unemployment lingers, distressed properties lurk in the shadows temporarily removed by lender can-kicking, and the demand depends on fickle investors and federal reserve stimulus, both temporary measures.

So is the market fairly valued or overvalued? Depending on your point of view, the market just recovered, or we just inflated housing bubble 4.0.

May 17, 2016, By JEFF COLLINS

Orange County home prices hit their highest level in nine years last month, matching the peak price reached at the height of the housing boom, CoreLogic reported Tuesday. The median price of an Orange County home, or price at the midpoint of all home sales, was $645,000 in April.

My reports don’t show the median reaching those heights yet, but the trend is definitely up, and with mortgage rates near record lows and a strong local economy, prices should keep rising.

The last time prices were that high was in June 2007, when the median set a record. One month later, subprime mortgages melted down and prices fell $275,000, or 43 percent, over the next 19 months. Last month’s median was up 7.5 percent year over year and 54 percent, or $225,000, over the past four years. O.C. is the first Southern California county to get back to its pre-recession price peak. Home prices in Los Angeles and San Diego counties remain 5.5 percent below their peak, CoreLogic reported. Prices in Riverside County are 23.6 percent below its peak, while homes in San Bernardino County are selling, on average, for 28.9 percent below peak levels.

Some of this disparity is due to changes in buyer behavior as I outlined in Buyers drive up house prices in desirable neighborhoods, leave the rest behind. But another reason prices aren’t near the peak in Riverside or San Bernardino counties is because the bubble was more extreme there with even less justification for peak prices.

Several Bay Area counties have been back to price peaks for months, while San Francisco home prices surpassed pre-recession peaks more than a year ago, said CoreLogic analyst Andrew LePage. Despite having the lowest mortgage rates in three years, buyers are balking at paying these record-level prices.

Yes, this is a wonderful change in buyer behavior caused by the housing bust.

Orange County home sales fell 6.5 percent to 3,285 transactions in April. Sales have dropped year over year just one other time in the past 14 months. LePage attributed sluggish sales to a lack of affordability, inventory and mortgage credit.

He regurgitates the standard erroneous evasions employed by realtors. The reality is that sales are down because prices are too high and there are no affordability products to help out.

Prices were up and sales were down throughout the region last month, CoreLogic reported.

This is to be expected as we reach the ceiling of affordability. At this point, only continued low mortgage rates and increasing salaries can push prices any higher, but since that is the condition of the market, prices keep going up despite the weakening sales.

While prices continue to rise, rents are rising even faster. Rising rents and declining mortgage rates makes housing even more desirable on a cost-of-ownership basis.

Without affordability products to soften any increases in mortgage rates, the ceiling of affordability shows increasing variability with a generally upward tilt reflecting low rates and rising rents.

The rate of increase in both rents and resale prices is within normal parameters.

The ceiling of affordability has been quite rigid due to the lack of affordability products.

Since the cost of ownership on a payment basis is low relative to rent, the timing system still says it’s a good time to buy a home.

Is this another bubble?

To know whether or not today’s house prices are another housing bubble, each person must decide on the measure of value most appropriate to the task. The reports I generate use current owner cashflow and a comparison to current rents to establish value. This number incorporates real estate prices, rents, and most importantly, interest rates to establish value. While I favor this method, it isn’t perfect: It’s susceptible to swings in financing costs, and it can be distorted by manipulative federal reserve interest rate policies.

Another method of valuation considers historic relationships of price-to-income and price-to-rent. Those measures fail to consider the impact of interest rates on affordability, so when interest rates are low, these measures claim prices are overvalued when in reality, the market may be at an equilibrium with current costs. IMO, this is a fatal flaw.

The longer term view of value depends on what you believe will happen with interest rates in the future. My methodology says today’s values correspond to the stable relationship between cost of ownership and rent. The competing methodology says prices are overvalued because current interest rates are so low. If interest rates revert to their long-term mean over the next few years, house prices will decline, and current valuations will appear bubbly in retrospect. However, if interest rates revert slowly over the course of another decade or more, this slow reversion in rates will not cause a price decline, and today’s valuations will not look so bubbly in retrospect.

With the strong link between future house prices and future mortgage interest rates, predicting one requires predicting the other. Whatever you believe will happen with mortgage rates, the opposite is likely to happen to house prices unless wages really take off. Right now, that doesn’t look too likely. But then again, without pressure from wage growth, it isn’t very likely that mortgage rates will rise much either.

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