U.S. Home Price Update

The OFHEO data for the second quarter show the smallest quarterly gain for the United States (an annualized 4.7%) this decade. This is no surprise in light of the well-documented cooling of housing markets this year. The regional distribution of appreciation rates is of most interest now, owing to the pronounced regional differences in appreciation earlier this decade. This has led to well-founded fears that a home price bubble is set to burst in California, Florida, and the Northeast.

We focus on quarter-over-quarter appreciation, as we hit a turning point, because year-over-year appreciation is largely the result of 2005 market activity, and the indices are not subject to seasonal variation. There is scattered evidence of outright declines in home prices, though appreciation has clearly slowed to a crawl in most areas.

New England, anchored by a Boston market that has been in the forefront of bubble concerns since the tech boom, had the smallest appreciation, just 0.17%. Boston itself saw a 0.6% decline and has appreciated less than 3% on a year-over-year basis. Though it has modest employment growth prospects, its real estate market had already cooled somewhat in the latter years of the boom and is not seen to be as overvalued as the California and Florida markets. Further south, the New York and New Jersey metros continue to exhibit modest appreciation of between 1% and 2%. The results are similar for the Washington-metro area.

The largest number of metros with home price declines is indeed in the Midwest, especially Michigan, Ohio, and Indiana. These metros had not seen overheated real estate markets; modest gains have given way to losses as mortgage rates rise and economic conditions soften.

In many ways, the most overheated markets have been in the hot-weather resort, vacation, and retirement home meccas of Florida, Nevada, and Arizona, where speculative investment demand teamed with rapid population growth. Most of the Florida metros have peaked, with a few small negatives and gains of less than 1% for the quarter. Las Vegas similarly had a quarterly gain of just 0.6%. But Miami and Phoenix are large exceptions, with persistent double-digit annualized gains.

In many respects, the California market has been the trendsetter in this cycle. Appreciation has fallen statewide to the 5% annualized range. Within the Golden State, San Diego was the first to see appreciation stall, in the spring of 2005. Yet, it continues to see level home prices, with 0.2% gains in the quarter. Orange County, San Jose, and San Francisco have also crested, with small price gains between 1% and 2% for the quarter. Los Angeles, which had the steepest slump in the last bubble 15 years ago, is slightly stronger at 2.2%. An interesting dynamic taking place though is in the secondary metros—those for instance in the Central Valley-where prices escalated following the appreciation in the major coastal metros, directly as a result of the flight to affordability. These metros, without the same fundamental advantages, have seen sharper slowdowns, with declines this quarter in Sacramento (0.4%) most notable.

Today's release does not change our outlook. The real estate market has crested and there remains significant risk of large price declines. Despite much negative anecdotal reporting, these have not yet been observed in the data. The July sales transaction data thus far available does, however, indicate further deterioration in most markets. Third-quarter data will show a further slowing, with a greater number of declines a likely possibility.