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Is US housing 20% overvalued?

Commissions are crumbling... |


| Why Are Young People Leaving Vermont?

March 07, 2006

Is US housing 20% overvalued?

Dean Foust

Jan Hatzius, an economist at Goldman Sachs & Co., just wrote an interesting report that should make anyone who bought at the top in a bubble market feel a little queasy. By his calculations, Hatzius believes that given the sharp rise in housing prices, coupled with the rise in mortgage rates, that home prices are about 20% overvalued at present. Hatzius isn’t predicting an outright plunge in prices. He believes the bubble could be unwound either through a stretch of time where prices stay stagnant until incomes catch up (which is what he calls, in econo-speak, his “baseline assumption”), or a significant drop in interest rates. Or through an outright decline in home prices.

Of course, all markets aren’t created equal. Hatzius believes the biggest overvaluations are in overheated markets like California, which he believes are overvalued by 30% to 40% based on the historical relationship between housing prices, interest rates and incomes. (Going city by city, he thinks Boston is 27% overvalued, Chicago 20%, Las Vegas 34% overvalued, LA and Miami are both...

...LA and Miami are both 40% overvalued. New York is 29% overvalued and in Washington DC , prices are roughly 32% too high, he estimates.)

In Texas, Atlanta and Cleveland, he finds no meaningful overvaluation, though he notes that’s partly because in cities like Atlanta and Dallas, the abundance of space has allowed developers to just throw up new houses left and right – creating supply that, if demand cools sharply enough, could create a supply-demand imbalance in itself.

Hatzius believes this has implications for Fed policy. Given the deterioration in housing affordability, he believes the Federal Reserve will end its tightening campaign at 5%. He believes that the deterioration in housing will become more pronounced in coming months, which will give the Fed pause.

06:14 PM

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I don't get the conclusion of this article. "He believes that the deterioration in housing will become more pronounced in coming months..." Does this mean that Hatzius believes that housing prices will continue to increase??

Posted by: Tracy at March 7, 2006 07:01 PM

He means that as the housing market becomes more obviously weak, the fed will take notice and stop increasing the prime rate (past 5%). Currently in New York, for example, the housing market is not weak in the sense of falling prices - when this becomes more apparent, then the fed might take action.

I'm curious about the status of the income tax deduction changes - I haven't heard about that for a while.

Posted by: Steve at March 8, 2006 10:08 AM

I agree with Tracy's comment. What exactly does he mean? The fed's will continue to increase rates? Housing prices will increase or fall?

Posted by: Joel at March 8, 2006 03:35 PM

He's right about Boston. Go to and look at what you can get in towns like Weston or Dover or Wellesley, MA for amounts like $800k and lower; most of what you see will be run down capes around 1,300 s.f. or lower. If your heart is set on living in Boston the value is at least 30 percent overvalued; if you're willing to relocate, you would get almost 100 percent more value. Think I'm kidding? Look at what you can get for 400k in other nice towns in other areas of the country and you will see that they offer more than those twice as much in the Boston market. I think the soft/hard landing will depend on where you live. Our Realtors are very skillful at interchanging local and national statistics when they want to "spin" the data. Think I'm still kidding, look at Massachusetts Realtor's website and read their reports where they try to debunk the real estate bubble theory.

Posted by: John P at March 8, 2006 09:21 PM

There is a housing bubble in Reno, NV. We have houses that have been sitting for months. We have had big drops in prices by those who really are interested in selling. There is a bubble in the west. However, I believe that the author is being too hopeful regarding the fed and rates. I believe the fed is deliberately ignoring the bubble, and will do just what the fed did in 2000. They ignored the stock bubble until after it crashed. This policy of ignoring the bubble is the only way that the fed can protect the dollar without being distracted. They cannot ease too soon or the dollar will lose value. The housing market will be cooked both by short term rates being high and by long term rates being high as global credit tightens. It is not a good time to be owning a house with some exotic mortgage in a bubble area. Sad thing is, it may be too late for those guys, and they may have to walk away from their houses.

Posted by: Gary Anderson at March 9, 2006 11:10 PM

Don't count on the Fed halting at 5%. Historically, they always overshoot. Watch consumer spending. That's what the Fed will be watching - but they won't change course unless it plunges.

Posted by: James McCarthy at March 15, 2006 11:25 AM

"I don't get the conclusion of this article. "He believes that the deterioration in housing will become more pronounced in coming months..." Does this mean that Hatzius believes that housing prices will continue to increase??" --Tracy

Not likely. I think that he means that as interest and mortgage rates continue to increase that the weakness in the housing sector will become more pronounced. The housing sector has slowed considerably over the past 4-5 months without interest and mortgage rates increasing much, so it is likely that the slowing results mainly from housing price increases eroding affordability and thus demand from prospective home buyers.

Given a continued stalling in home price appreciation and an increase in interest/mortgage rates over the coming months demand/affordability deterioration can be expected to continue, and this will likely contribute to an end to the FED's current tightening cycle.

Posted by: CT at March 15, 2006 03:51 PM

I guess the big question is whether it will be a soft landing, or a bloodbath. The condition of the economy will play a big factor in that.

The Home Price / GDP Ratio is much higher than the long-term historical average. A 10%-15% drop in home prices seems very reasonable.

Posted by: Tom at March 15, 2006 05:38 PM

Finally some honesty from Wall Street on what's really going on.

Soon builders will be having AUCTIONS to sell their houses!

Posted by: Tony T. at March 15, 2006 06:00 PM

Although the article spells doom and gloom, I believe it underscores the long term values to be had in the South.

While I agree that many of the coastal regions (California and Florida) have seen significant price appreciation relative to other more central markets in the MidWest and the South, I believe this creates a significant opportunity for a rebalancing of undervalued markets (e.g., Houston, Texas) where:

1. Median and average values are far below national averages

2. There is still strong population growth of the top 10 major cities

3. Home building has led to sub-urban developments but not in pace with growth expectations

4. Where transportation costs increases continue to drive a flight towards housing within central city boundaries

By all metrics, cities such as Houston are seeing a resurgance from its glory days in the early 80s (in part due to the return of the energy sector) but also simply because the population is expected to grow (in absolute numbers) faster than any other city (per the census bureau).

Additionally, by examining mortgage structures taken on by various states (e.g., California and its strong share of Interest Only, Option ARMs, and short-term ARM financing) relative to states like Texas where the vast majority of loans are structured as conforming & government loans with far less risk of default or impact from near term rises in interest rates, it is hard to imagine the "doom and gloom" scenario for Texas.

This, combined with rising incomes in Texas, a desire for affordable housing (which can't be found in skyhigh areas such as California anymore), and a resurgance in demand (both rental and ownership) as a result of Katrina displacements spells only a bright outlook for places such as Houston.

I have viewed Houston as the Turtle with many hares racing ahead (e.g., California, New York, Arizona, Nevada, Massachusets and Florida). All in all, Houston has averaged a respectable 7% return and is showing no signs of slowing down with healthy cap rates for would-be investors.

In summary, I still believe there is still gold out there to be had despite the national forecasts, and the old maxim for land "there not making any more of it" still holds true for places such as Houston which will emerge from the froth or real estate bubbles for real estate investors and homemakers looking to find stable grand.

Posted by: Jameson Thottam at March 15, 2006 08:38 PM

I think Mr. Hatzius is rather clear in what he means. He seems to be saying that the slowdown is here and that further price depreciation will occur, especially in the bloated areas, but that it might take one of three forms: Values simply not moving up as wages and earnings slowly try and catch up, a drop in interest rates (which he doesn't clearly tie into taking air out of the bubble), or a downright drop of prices (which is actually occuring). As for the Feds stopping at 5%, I think that's wishful thinking regardless of the pain it causes in the housing market and through it to the broader economy. Interest rates are rising throughout the world, Europe (Euro), Japan (Yen), etc. as credit tightens around the world and the Feds will raise rates to support the dollar or face a dollar collapse, the consequences of which are global depression. Anyone counting on interest rates stopping anytime soon are dreaming in my book.

Posted by: MoMark at March 16, 2006 07:54 PM

I agree that many of the coastal regions (California and Florida) have seen significant price appreciation relative to other more central markets in the MidWest and the South, I believe this creates a significant opportunity for a rebalancing of undervalued markets..This is totally a true statement.

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Posted by: vain at March 17, 2006 11:25 AM

What people need to watch is the BOJ base rate.

That is the global driver for central banking monetary policy, not US consumer spending.

Posted by: RAL at March 20, 2006 10:57 AM

I have seen numerous houses dropping their price by 4-15% over a month of period here in the space coast of Florida. Often I am the only one visited the open house that day. I got phoned afterwards for interest or deals. Panic starts to kick in. I wonder what is going to be like during the summer, the hurrican season.

Posted by: Sara at March 21, 2006 01:37 AM

I believe the bubble is minor. There are many reasons for rising housing markets that are very realistic. Low interest rates, increased percentage of families with duel income, women in work force making higher income on average, baby boomers cashing out of stock market, dollar value being lower then European and Asian investors money and finally new creative financing (When the 30 year loan came out in the U.S. many years ago housing increased substantially too and those who jumped in early won big!) Only one reason for a slight bubble that I can see is as follows: As a result of the previously mentioned information a good rate of return was noticed by investors. Therefore, people jumped into the game and drove it a bit further up which caused the slight bubble that I am speaking of. However, what the news doesn't explain is that while 20% mol (in a giving market) of homes bought and sold are by investors there were always investors and the number that matters is the difference today than the number before. Therefore, I believe the market could pop as a result of mass panic not a huge bubble, however, the reality is the market could stay fairly strong if mass panic doesn't get in the way as the past typically displays of human nature. After all, it is only natural in the real-estate market for housing to slow in the winter/early spring. If you analyze numbers in almost all local MLS markets 2005 vs. 2006 for the months of December, January and February you will see the approximate same number of homes sold last year as this and same number and those that went under contract very similar as well. The number that is out of control is due to the mass panic that I am speaking about and this is the number of listings taking place as a result of a natural slow period and mass media panicking home owners into overlisting their homes. The number of listings is up over 100% in almost every local MLS county market that I ran comparisons on from last year to this. Look it up under local MLS research sites. You will see similar statistics. Sales and Contracts almost the same as 2005 with the number of listings up up up! Yes, this will force listings to sit longer if inventory rises due to panic. Panic, ((False Panic)) will be the only thing capable of toppling this market right now. By the way when state governments amend tax consequences of selling a home and buying a new one the market will adjust upwards again. This is already in the making in some states. When selling an existing home the newly purchased home will only have a slight increase in your taxes not based the old fashioned way on the purchase price since house prices have gone up a lot. Look it up. This is not current law but it is being debated heavily as I am writing this blog. Good luck and I hope the false panic doesn’t end up hurting us too much.!

Posted by: Jeff at March 24, 2006 11:20 PM

One thing that's bringing prices down is that people were only willing to spend 40-50-60% of their gross income on housing (1) in the expectation of a big profit and (2) because they were afraid that if they didn't buy now, they'd never be able to afford a house.

Now both reasons (1) and (2) are gone. Even the Realtors' website says their economists are expecting appreciation "a little in excess of inflation." Hell, I can get a 4.5% 8-month CD and beat inflation. I can beat inflation with a savings account. I don't need to pay a real estate agent 6% and take out $500K in debt to beat inflation.

Asset bubbles are all the same: they have psychology as the root. Remember late 2004-early 2005? Everyone - renters, homeowners, buyers, sellers, real estate agents - was in a slight panic. Prices were rising so fast, everyone couldn't help but think "how can I get in on this? I'd be an idiot to sit this out!" People bought houses they never would have considered living in a few years before, just to own SOMETHING.

But now a house is a house. Isn't that the way it should be? But "just a house" isn't worth risking your credit and paying out 50% of gross income on mortgage payments.

Posted by: Brodsky at March 25, 2006 12:24 PM

I think the only winners in this so called HOT MELTING ICE MARKET is brokers/Real estate agents/lenders/builders/developpers. I don't think people can ADD Up or do the math.

these days they think they got a wow great Rate but a wow they overpaid double price and cost for the house. most Americans are really broke from the already high debt from credit cards now they have combination and a perfect formula for that bubbles is about to burst a real bad specialy with high gas prices we can't afford anything anymore.

Posted by: JOE at April 13, 2006 01:44 AM

I have to question the source of this conclusion. The stock markets main competitor is housing and we have a stock market person telling us to bail out of housing. Let me guess....we should be buying mutual funds?

Posted by: Peter at April 28, 2006 02:45 PM

The assumption that Fed will put a halt on increasing interest rates -because of sluggish housing market- is simply not true. I have heard few Fed spokesmen talk about their concerns over inflation and how they are worried about inflation more so than a soft economy. When inflation is out of control it is out of control . Fed knows it and will not risk the whole economy for the sake of housing bubble. The rates will go up, slowly but surely to balance the US Dollar supply/demand and to prevent inflation [especially when everybody around the world is reducing their USD stocks with alternate investment means: gold, Euro etc].

Housing will become less afordable at the current overpriced levels. Market will have to readjust to it by lowering the prices.

It may be a sudden decline however it could be a slow one as well where supply of houses and demand levels during a few years course.

In any event this bubble needs to go away, burst or a slow deflation is unknown. However over the long haul select states (due to warmer climate or high paying jobs) will keep their appeal for many people. I believe it is an upward trend however, it needs to be healthy and in line with people's buying power.

Posted by: Ismail Sahin at May 11, 2006 02:46 PM

We are seeing some interesting downward movement despite the buying season of summer. The old talk of bubbles bursting seems to have been replaced by bubbles deflating. In the coastal west we have seen many condo conversions from apartment complexes, yet the developers have found themselves in a situation with high inventory and declining prices. This is a great example of the downward trend. Yet despite all this, many people are still waiting in the wings for the slightly unobtainable homes to become affordable. So the question becomes one of whether the demand of frustrated potential buyers will be able to keep up increasing inventory on the market. Most inland cities can always build out. But coastal cities can only build two or three directions and that makes them all the more valuable. It seems unlikely that we'll see a dramatic change in prices in the limited inventory of coastal western property.

Nonetheless, as ARMS expire, we will see more people who will be selling and moving into rental properties. Another interesting point is the influence of property tax on purchase decisions. With many of the homes that have appreciated dramatically, the property tax has become a significant percentage of the monthly committment of the purchaser. This may sway the balance farther towards rentals which will also hurt the market in terms of property value. Yet even that factor can only correct so much before it loses its impact.

Posted by: Alan expects more rental houses at June 27, 2006 03:40 AM

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