New "Price Bloat" Index Pinpoints Overvalued and Undervalued Home Real Estate Markets

A major mortgage insurer has unveiled for the first time its internal "valuation index" that red-flags real estate markets that are overvalued by historical norms and present greater underwriting risk of losses to the insurer.
By: Kenneth R. Harney: Realty Times
PMI Group's statistical model also pinpoints markets that are currently undervalued. Ken Harney reports.

Are some of the country's hottest, fastest-appreciating home real estate markets overvalued? Are others undervalued, and therefore relative bargains? Can anybody actually demonstrate such conclusions statistically?

A major player in the mortgage insurance industry - a firm facing millions of dollars in losses if it insures mortgages on properties that are seriously overvalued - says yes to all three questions.

PMI Group of Walnut Creek, Calif., has just unveiled for the first time the tool it uses for its own business purposes to red-flag markets where prices are significantly above where they should be, based on historical norms. Like other underwriters, PMI must compensate lender clients for the expenses they suffer when low-downpayment mortgages go into default. Those costs balloon when a house really wasn't worth as much as the lender thought, and must be resold at a big loss.

To protect against such losses, PMI economists created a statistical model they believe accurately detects price bloat -- and undervaluation -- in dozens of markets around the U.S. Dubbed the Valuation Index, the model tracks historical home price appreciation patterns over a several decades for each market, then evaluates the extent of current deviation from the historical norms.

Where are the most bloated prices -- and the most undervalued markets -- today? It probably comes as no surprise that among the most overvalued can be found in California, according to PMI's model. These include Los Angeles (33.7 percent over), San Jose (26.5 percent) and San Diego (22.3 percent). Las Vegas is 25.5 percent overvalued, and Phoenix-Scottsdale 22 percent.

On the East Coast, the most overvalued markets are northern New Jersey (25.6 percent), New York's Long Island (20.4 percent), Providence, R.I. (19.1 percent), Miami (20.5 percent), Tampa-St. Petersburg (23.2 percent), Orlando (19.6 percent), and Washington D.C. (18.2 percent.)

Where are the most undervalued home real estate markets -- where investors and insurers stand little loss of loss but a good chance of picking up relative bargains in real estate? PMI highlights a handful of underperformers: Denver, where the index puts property values at 4.2 percent below where they should be; Detroit (-10.3 percent), Charlotte, N.C. (-1 percent), Cleveland (-1.4 percent), and Memphis (-1.7 percent).

Other markets the valuation index concludes are relatively safe bets - at or just slightly above where they should be - include Pittsburgh, Kansas City, Mo., Minneapolis, Atlanta, and Ft. Worth, Tex. Austin and San Antonio are other relatively safe bets in Texas, but Dallas prices are a little riskier - 10.5 percent above where they should be, according to PMI.

Not everyone will agree with PMI's market-by-market conclusions, of course. But let's say for the sake of discussion that you do. Now what?

If you are a seller in an overvalued market, you need to take a hard look at your asking price. It's possible that you are out of sync with a slowdown that is already emerging - more houses sitting on the market taking longer to sell. Throttle back on your expectations just a little, and price below where you might had earlier this year.

What about buyers? If you are interested in purchasing a home in an area red-flagged as overvalued, exert extra caution and discipline in bidding. Be more aggressive in your initial offers. After all, you don't want to buy a house that mortgage insurers will tell you is already overvalued, and poised for a price correction.

Bargain tougher on price. And be prepared to walk away - pronto - if sellers refuse to budge.