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Is the U.S. Real Estate Market Overvalued?



Introduction

At the beginning of the COVID crisis, I did a back study statistically predicting the magnitudes of real estate price downturns post the Global Financial Crisis, across the full set of U.S. states and counties. The results of it are published in the following article: Real Estate Market Valuations: Predicting Downside Risk, A Back Study.


I argued, with real estate being a fundamental asset, for the usage of market valuation metrics as predictors of downside risk, as has been historically done in financial markets, at least prior to the latter being significantly driven by the technology sector. Specifically, percentage deviation from historical price/income ratios against a well-selected moving average window, revealed high correlation vs subsequent actual price drops. Correlation was higher at the state level, than the county level.


I hereby include the results for U.S. real estate market valuations as based on the latest pulled governmental data, at end 2020. The results are given at the state level as well as for large U.S. cities, the latter based on county data for counties best mapping to each city.


Real Estate Market Valuation State-Level: Is the U.S. Real Estate Market Overvalued?

A Bloomberg Wealth article based on data by economist Niraj Shah, labeled World’s Bubbliest Housing Markets Flash 2008 Style Warnings, showed Scandinavia, Oceania, Canada, and UK significantly overvalued in Q1 2021 based on Price/Income ratio, as well as several other indicators. The U.S. nevertheless appeared fairly valued.


My study shows U.S. real estate market under- to fairly valued, with several overvalued markets present. Below are the results at state-level, with data is as of Oct 2020.

Tables below include projected drops at future peak, based on linear regression off the Global Financial Crisis estimated set. This is effectively a worst case price correction scenario (an overvaluation could resolve absent a correction as well), and also there is no prediction made as to when a future peak in prices would occur, timing wise. Also included is price performance since the latest fair valuation, to be compared against the current state of valuation in each region.


Overvalued U.S. States

States that experienced 'excessive' price performance and showed > 10% valuation include: Idaho, Nevada, Arizona, Colorado, the District of Columbia, Texas, and Washington.


Idaho appears to be the only sharply overvalued state at > 20%.


Fairly Valued U.S. States

Fairly valued U.S. states experienced price performance in line with underlying fundamentals, and showed 0-10% valuation.


These include the states of Florida, Utah, Oregon, closer to the overvalued range, as well as Georgia, North Carolina, Michigan as near perfectly valued.


An assumed market cycle end may be followed by material price drops, albeit not as high as for overvalued states.


Undervalued U.S. States


The majority of U.S. States in undervalued territory, having negative valuation. The include the states of California, Delaware, Kansas as close to fairly valued, as well as the deeply depressed and also undervalued states of West Virginia, Connecticut and Illinois.

Note a market being under- or overvalued, in itself, does not make it a candidate for higher or lower price appreciation, as the variable being predicted by valuation metrics is price downturn post a peak. Importantly, valuation metrics serve estimates of downside risk, rather than appreciation.


Market Selection: Best Performing Undervalued U.S. states


Certain U.S. states experienced strong appreciation since their latest fair valuation, yet are still under- or close to fairly valued. These include the states of Massachusetts, South Carolina, New York, Kansas, Indiana, Kentucky among others. Price growth in those albeit strong, did not exceed its underlying fundamentals.




Valuations in Largest U.S. Cities, Based on County-level Data as of YE 2020

The below is based on county data, for counties best mapped to each of top 100 U.S. cities.

Out of the 100 largest cities, Boise, Spokane, Plano and Phoenix were the top four most overvalued.


Tampa, Fort Worth, Las Vegas, St. Pete, Austin, Charlotte some well known cities in overvalued, >10% valuation, territory.


Boise the only sharply overvalued, >20% valuation, U.S. city in the top 100.



Out of the 100 largest cities, Chicago, El Paso, Baltimore, Toledo were the top four most undervalued cities.


Cleveland, Cincinnati, St. Louis, Greensboro, Louisville, some other well known cities in undervalued territory.


As discussed, being undervalued, in itself, is not a measure of market strength, not an appreciation predictor. It is though an estimate of low downside risk assuming a broad-based correction to U.S. real estate prices was to happen.


Cities in the top 100, that experienced strong price appreciation since their latest fair valuation, though are still undervalued include: Oakland, Jersey City, Atlanta, Pittsburgh, Fort Wayne, Louisville among others.







Summary

In conclusion, U.S. real estate near the end of 2020, was under- to fairly valued, with few states and cities in overvalued territory. The state of Idaho and city of Boise, appear strongly overvalued. Valuation as here defined is not a predictor of appreciation before market peak, rather only downturn post the peak. At present, most of the states and counties in overvalued territory are ones that possess strong growth fundamentals as well. U.S. real estate went from fairly valued in 2002, to extremely overvalued by 2005. It seems prudent to follow real estate market valuations as they unfold, to be cognizant of any potential shift away from the present, broadly speaking, fair valuation of U.S. real estate.


Data Sources

Federal Reserve Bank of St. Louis, Federal Housing Finance Agency, Bureau of Economic Analysis


About the Author

Stefan Tsvetkov is the founder of RealtyQuant, a company that brings data-driven and quantitative techniques to the real estate industry. On a mission to add massive industry value through education, investment, technology, and analytics.


Financial engineer turned multifamily investor, analytics speaker, and live webinar host. He holds a Master's degree in Financial Engineering from Columbia University, and during his finance career managed ~ $90 billion derivatives portfolio jointly with colleagues.

Featured on multiple Podcast and Webinar events including InvestUp, Best Ever Real Estate Show, Discovering Multifamily etc. Organizer of Finance Meets Real Estate live webinar series.