Will Home Price Hikes Hamper Market Health?

Despite the softening of economic growth in other sectors, home prices continue to surge in most major metropolitan markets. Some analysts are concerned, however, that the expanding prices represent a "bubble within a bust" that could bring more trouble to the housing recovery in the months to come.

Recent surges in home prices should continue to provide the housing market's recovery with forward motion, but other indicators are hinting at larger problems that could slow progress throughout the year.

Home prices in every city measured by the S&P Case-Shiller 20-City Composite Index posted year-over-year increases in February, the second consecutive month of unanimous gains, according to an April 30 report. The 10-City Composite gained 8.6 percent and the 20-City Composite rose 9.3 percent, and in 16 of the 20 cities, the annual growth rate was higher in February than January. Ten of the 20 cities posted double-digit positive changes, led by Phoenix, San Francisco, Las Vegas and Atlanta.

"The 10- and 20-City Composites recorded their highest annual growth rates since May 2006," said David Blitzer, chair of the Index Committee at S&P Dow Jones. "Seasonally adjusted monthly data show all 20 cities saw higher prices for two months in a row – the last time that happened was in early 2005."

Home prices for both city composites are back up to autumn 2003 levels, only about 30 percent off their peaks in June and July 2006.

The housing recovery was a bright light for the economy in 2012, contributing to positive growth for the first time in 2007. However, traditional homebuyers still face tight mortgage underwriting restrictions, and many potential homeowners have little or no equity in their current homes, limiting attempts to move up in the market. Combine the stagnant larger economy and rising home prices with these constraints, and a 17-year low in the national homeownership rate appears.

According to an April 30 Census Bureau report, the rate of homeownership nationwide declined to 65.2 in the first quarter, falling from 65.6 in the fourth quarter of 2012. The first quarter 2013 rate is the lowest rate since the fourth quarter of 1995, when it was 65.1.

Other market indicators remain far from normalcy – the rate of construction starts on new homes barely reached one million units in March for the first time in nearly five years; economists consider a 1.5 million-unit rate healthy – the rapid growth of housing prices has raised concerns of a "bubble within a bust," as described in a commentary from Wells Fargo Bank's Economics Group, also released in April.

"The influx of investors into the housing market may be exaggerating the extent and magnitude of the recovery in home sales and home prices," the commentary said.

The Wells Fargo report cites several reasons to be skeptical of the recovery's strength. Progress for key economic indicators, including retail sales, non-farm employment, and consumer and homebuilder confidence has slowed or even receded in recent months, and economists have scaled back projections for the second quarter.

The housing market's recovery should continue, the commentary says, though likely at a slower and more fitful pace for the rest of the year. "Too much of the financial infrastructure related to housing finance and new construction remains impaired to clouded to allow sales or new construction to get ahead of themselves," the report said.