Based on fundamental factors of price-to-income and price-to-rent, Corelogic produced a report that found 21 of the top 100 U.S. Cities to be overvalued.
With price-to-income being one of the fundamental drivers of housing markets, Corelogic looked to examine this metric first. The Price-to-income ratio is seen as an affordability measure for housing in a certain area and generally looks at the median cost/price of a home to the median annual household income. Historically, the national price-to-income sat at about 2.6, meaning that the median home in the U.S. cost 2.6 times more than the median annual income. However, with home values rising at such a significant rate, we’re seeing median wages struggling to keep pace. This leaves many markets with higher price-to-income ratios and homes that are potentially too expensive to afford relative to the typical wage. According to the data focused corporation, 31 of the top cities were overvalued in home price. In each market, Corelogic calculated the difference between actual home prices and their long-run sustainable levels (which are supported by local market fundamentals). Using 10 percent as the threshold, an overvalued market is defined as a market where the home price is more than 10 percent of its long-run sustainable level.
Beyond the price-to-income metric, another popular driver in housing economics is the price-to-rent factor. Price-to-rent is the ratio of average home price to annual rental rates. During the bubble years studies showed that the ratio was no more than 60 percent higher than the long-term average price-to-rent ratio, suggesting that home prices can grow 60 percent faster than rent. By inflating the rent growth rate by this 60 percent, Corelogic constructed a threshold to determine whether a market is overvalued. They determined that if a home price growth rate is above the inflated rent growth rate then the market can be declared overvalued.
Applying this metric to the 31 markets that were overvalued based on home price, they concluded 10 of them were actually not overvalued from the price-to-rent perspective. Ultimately deeming the following cities as overvalued in both rent and home price:
Figure 1: 21 Overvalued markets among the top 100 cities in the U.S. (Corelogic, 2016)