A study released last week by Global Insight and National City Corporation titled House Prices in America concludes that in 71 metropolitan areas representing 39 percent of the total value of single family homes in the country those homes were extremely overvalued in the first quarter of 2006. This is an increase from the fourth quarter of 2005 when 64 markets representing 36 percent of national home value earned this designation. It is even more striking to compare the most recent data to the first quarter of 2004 when this same study deemed that overvaluation was insignificant and only three metropolitan areas and only 1 percent of all single family home values were thought to be out of line with reality. The study's designers consider that areas where home prices are in excess of 34 percent over what they determine to be real prices are excessively overvalued.

The study examined 317 metropolitan areas containing 84 percent of single family house values in the United States. Eighteen metropolitan areas were recently added to the 299 for which data had been accumulated since 1985. The study determines what house prices should be by taking into account not only house prices and interest rates but also population density, household incomes, and any historical premiums or discounts exhibited by metropolitan areas over time. These "statistically normal house values" are then compared to actual prices to determine the extent of over- or under-valuation.

The study quotes the most recent Office of Federal Housing Enterprise Oversight (OFHEO) same-house price report as stating that single-family house prices appreciated at a 7.3 percent seasonally adjusted annual rate during the first quarter of this year. This continues a pattern of steady erosion in increases since the second quarter of 2005 when appreciation peaked at 12.1 percent. The current rate of home price increases, while strong by historical standards, is the weakest since the third quarter of 2003. In other words, prices are still going up, just not as fast as they have over the last few years.

The Global/National City report states that this rate of appreciation is actually highest in the areas which are already the most overvalued. Of the 50 metropolitan areas most overvalued during the recent quarter, the average pace of appreciation was 10.1 percent while the 50 most under-valued areas averaged an increase of 2.7 percent. In other words, "the imbalance in prices is exacerbating." However, the study concludes that "quarter-to-quarter price appreciation is slowing in most metro areas, and is nearly flat in San Diego and Boston."

Over-valuation is, no surprise here, most notable in Florida and California. Of the 71 metropolitan areas considered excessively over-valued, 17 are in Florida and 26 in California. Oregon, Washington State, New York, and Arizona also have multiple metropolitan areas on the list. Interestingly, as recently as the first quarter of 2003 18 of the top 71 areas were considered to be undervalued by the study.

Holding the dubious honor - by a huge margin - of being the most overvalued area is Naples, Florida which, with an average price of $383,000 was considered to be over-valued by 102.6 percent. As a measure of how rapidly Naples' prices have increased, in the first quarter of 2002 it was considered only 1.9 percent overvalued and one year ago 53.3 percent. In second place is Salinas, California with an average price of $608,600 - 79.1 percent higher than the study designers consider to be the real value or homes in the area. Salinas actually decreased since the previous quarter when the average value was $614,100, 81.4 percent over-value. Following the 71 most overvalued areas are 45 others with over-values exceeding 20 percent.

At the other end of the scale, the most undervalued area is College Station-Bryan, Texas with an average price of $94,200, considered 23.7 percent under-valued, followed closely by Dallas, Texas and Fort Worth, Texas, both under-valued by slightly over 18 percent, and five other generally large Texas cities such as Houston, El Paso, and Midland. Texas metropolitan areas, in fact, represent 20 of the bottom 50 on the list. Alabama, Oklahoma, Louisiana, and Indiana also have multiple SMSAs on the list.

The study lists 66 instances of price corrections of 10 percent or more over the last 20 years, most notably a 39 percent nose-dive in Lafayette, Louisiana starting in the first quarter of 1985. The median correction was 17 percent and half of those areas suffering these corrections were overvalued by 34 percent or more prior to the downturn. The median period of the correction was 14 quarters. The more severe the overvaluation, the shorter the duration of the correction tended to be but the larger the decline in price.
National City Corporation is one of the nation's largest financial holding companies. Its core businesses include commercial and retail banking, mortgage financing and servicing, consumer finance and asset management. Global Insight is a forecasting company providing economic, financial, and political data acquisition and analysis in over 200 countries and 170 industries.

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