Report Determines Housing in Boise “Moderately Overpriced”

The recent report for the fourth quarter of 2007 found the price of housing in Boise “moderately overpriced.” So what does that mean with regard to the risk of future price declines? Before I begin, I would like to emphasize that I adhere to the advice of the sixth century Chinese sage Lao Tzu. My intent is simply to share a little knowledge and offer a few observations. I am not making any predictions. National City Corporation and Global Insights, an economic research firm, publish a Housing Valuation Analysis in which they evaluate single-family house prices in 330 metro areas to determine the extent to which housing in those markets is under or overvalued. That report designated the Boise metro area “moderately overvalued.” Metro areas with valuations below the historically normal range, that is below -15 percent, are considered “undervalued.” Twenty-six of the 330 metro areas (7.8%) were actually considered “undervalued” in the 4th Quarter of 2007. Metro areas with valuations in excess of +32 percent are designated as “overvalued.” Twenty-one of the 330 metro areas (6.3%) were considered “overvalued” in the 4th Quarter of 2007, but this was down from a peak of 58 metro areas during the fourth quarter of 2005 and the second quarter of 2006 (a reduction of 11.2%). “Overvalued” markets present a risk of substantial future price declines (10 percent or greater). Metro areas with valuations between ±15 percent are consistent with the study’s standard deviation of the historically normal distribution and are considered “fairly valued.” Metro areas between “overvalued” and “fairly valued” are areas above the historically normal range of +15 percent, like Boise, and are designated “moderately overvalued.” While “moderately overvalued” markets have values above the historically normal range, they present very little or no risk of substantial future price declines. National City Corporation and Global Insights employ a statistical technique to evaluate single-family house prices to determine “fair value” in the housing market. “Fair value” contrasts with financial asset valuation or “intrinsic value.” Unlike the Case/Shiller index which only considers the 20 largest housing markets in the U.S.. the National City Corporation and Global Insights study evaluates 330 metro areas which collectively account for 93 percent of all existing single-family housing units and 78 percent of all related real estate value, as of the fourth quarter of 2007. Their approach is statistical in orientation, examines a particular historical period — Q1/1985 to Q4/2007 — and accepts that house prices, on average, adhered to some normal relationship to underlying determinants during that time. The study examines the ratio of home prices to household incomes and attempts to explain the variation in that ratio as a function of four key determinants: Household Population Density, Conventional Mortgage Rates, Relative Income Level, and something they refer to as Constant. Constant is a value they calculate for each metropolitan area to control for historically observed differences in metro area price-to-income ratios that are not explained by the other three determinants. These values reflect a variety of difficult to quantify, but nonetheless important, factors that influence prices including pollution, climate, expected property price appreciation, cultural amenities, school systems, miscellaneous costs, (e.g. tax and utility rates) and geographic location. The data for the Boise MSA suggests that housing in the 4th quarter of 2007 was overvalued by 26.1%. But the study cautions against assuming that a particular degree of overvaluation implies that house prices are destined to decline by that amount. For example, the observation that Boise, Idaho is overvalued by 26.1% should not be assumed to imply that prices here are headed for a 26.1% drop. They explain that this is not necessarily correct for the following reasons: • Housing markets tend to adjust very gradually and price declines, when they occur, have historically averaged 18 quarters in duration. Because house prices determinants generally improve over that time (especially population density and incomes), price declines are typically about one-half the initial degree of overvaluation. • Historically normal dispersion of valuations is quite wide and their model has a standard deviation in house price valuations of +/-15 percent, meaning that any valuation between 15 percent overvalued and 15 percent undervalued should be considered statistically normal. The report includes data on past price corrections in metropolitan areas over the past 23 years. It defines price corrections as declines of at least 10% over a period of at least 8 quarters. Only 102 of the 330 markets have experienced severe enough price corrections to be included in the report. The peak valuation in those 102 markets ranged from 98.5% in Midland Texas in the 2nd quarter of 1986 to a -0.9% for Merced, California in the 4th quarter of 1990. The price corrections ranged from a decline of 35% over 20 quarters in Anchorage, Alaska from the 2nd quarter of 1985 through the 1st quarter of 1990 to a decline of 10% over 23 quarters in Napa, California from the 3rd quarter of 1991 through the 1st quarter of 1997. For the 102 markets, the median or typical degree of overvaluation was +32.1% and the typical correction episode saw a median decline of 17% over a median duration of 16 quarters. Chuck Miller GMB CGB MIRM CMP MCSP CSP President / Builder – Chuck Miller Construction Inc. (208) 229-2553 www.chuckmillerconstruction.com