Morning Report – House Prices Overvalued? 7/18/14

Markets are higher this morning after yesterday’s bloodbath. Bonds are down, but still firmly below the 2.5% level. This has the feel of a summer Friday, where the senior traders are bolting for the beach around noon and the rest of the traders are watching the British Open and not their screens.

The catalyst for the sell off yesterday was the Malaysian jetliner that was shot down over Ukraine. Ukraine and Russia are blaming each other for the incident. We had a typical “risk off” trade, where investors sold stocks and bought Treasuries. Yesterday was the first – 1% down day in the market since April. The VIX spiked to 14.5, again the highest reading since April.

Merrill Lynch thinks home prices are overvalued and will go nowhere over the next few years. Home prices were undervalued about 6% relative to incomes at the end of 2011, and have now rebounded to levels that are 9.7% overvalued. Of course all real estate is local, and there is always the possibility that incomes begin to rise as the labor market tightens.

case-shiller fair value

For what its worth, I kind of come to the same conclusion, using the median income to median price ratio. The historical ratio of median house price to median income has been in the low 3s. Current median income is around $53,300. The median home price according to NAR is 213,400, so the ratio is 4x, a bit higher than its traditional 3.15 – 3.55x range.

Median House Price to Median Income Ratio

One note of caution with this analysis: the extremes of the housing market (distressed and luxury) have accounted for the majority of transactions. In other words, the median house price is distorted. That said, I do not think we will see meaningful home price appreciation until incomes start rising.

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