Home Prices Overvalued by 18%: Fitch

In a new report on home prices and economic risk, Fitch Ratings estimates that home prices today are overvalued, raises serious concerns about the long term viability of the current housing recovery and concedes that significant price declines are unlikely though declines in real terms are not.

Fitch estimates that current prices currently are overvalued in real terms by approximately 18% nationally, led primarily by exuberant gains in the West, lingering economic weakness may hamper demand as the housing market normalizes and approaches a new equilibrium.

“The current housing market is buoyed by a unique set of market forces that include tightly restricted supply and the short-term effects of both investor money and the pent-up demand of individual owners.  Long-term housing demand originates from a strong base of workers, measured both in wages and employment. With today’s economy lagging on both indicators, Fitch continues to have concerns about the sustainability of the rapidly rising housing market,” the report said.

However, significant price declines are unlikely due to a number of factors such as continued government market support and the high likelihood of an extended economic recovery, but growth rates are expected to slow significantly over the next year. With home price growth expected to stagnate, there is a potential for declines in real terms, especially if economic growth couples with low interest rates to produce higher levels of inflation, the report said.

Housing demand rebounded across the country as stabilizing prices encouraged borrowers to re-enter the market. With a restricted housing supply, a relatively modest boost in demand has been able to send prices skyrocketing, although Fitch expects markets to cool as more supply comes on-line.

Several factors are contributing to the supply constraints. After the downsizing of the construction industry following the price collapses of the mid 2000s, building rates have been slow to recover as homebuilders try to expand. Since 2011, the rate of housing starts has nearly doubled, but construction times and pipeline constraints have caused the increase in new homes ready for sale to lag by approximately a year. Fitch expects completions to increase steadily over the next several years, which will ease supply constraints and help in the return of a more normally functioning market.

“The national unemployment rate continues to fall and is now down to 6.7%, its lowest level since 2008. However, this aggregate number masks ongoing difficulties in the employment market. Unemployment gains have been largely driven by workers dropping out of the labor force and the overall participation rate is at record-low levels. Without a strong employment base, it is difficult to find sustainable support for the rapid growth in home prices across much of the country,” Fitch said.