USA (By Martin Wolk, MSNBC) February 14, 2004 - For years economist Richard DeKaser dismissed speculation of a housing bubble, but the astonishing price gains of 2004 have forced him to reconsider his position.

One recent federal report showed that U.S. home prices have risen about 13 percent over the past year, and many cities showed gains of 25, 30 and even 40 percent.

What seemed like “a highly tenable situation” as recently as a year ago suddenly started to raise red flags, said DeKaser, chief economist for National City Corp. in Cleveland.

After examining 25 years’ worth of data on home prices, income and other factors in 99 of the nation’s biggest metropolitan areas, DeKaser has concluded that prices are seriously out of whack in 16 markets, which he calls “bubblettes,” mainly in California and Florida.

“Even to this day, I can state that there is not a housing bubble in America for the nation as a whole,” DeKaser said. “But there are isolated areas where there could be housing bubbles.”        

No. 1 on DeKaser’s list was Chico, Calif., a rapidly growing college town about 90 miles north of Sacramento where home prices have doubled over the past five years.

In itself, that sharp price growth is hardly unheard-of in these days of superheated home sales. But based on DeKaser’s analysis of historical prices in the region, incomes, population density and interest rates, prices are 43 percent above “normal” in Chico.

Other California cities high on the list included Los Angeles, San Francisco, San Diego and Stockton.

In Chico, local Realtors association President Rodney Krebs said he was surprised to hear the city hit the top of the national list, saying that while home prices rose 15 percent last year that represented a slowdown from 23 percent in 2003. At $277,000, the median price of an existing home is not outrageous by California standards and is low enough to attract retirees and telecommuters from costlier cities to the south.

“For the very edge of the bell curve it doesn’t feel that weird on the street,” he said. “It doesn’t feel bubbly to me, and I'm a conservative guy.”

One reason prices might seem out of line is that Chico is a historically agriculture community with relatively low average household income, he said.

“It's not the greatest broad-based economic base, and that is something we have to work on,” he said.

Price-earnings approach

DeKaser took a modified price-earnings approach to figuring out which markets are too hot and which are not.  The theory is that housing affordability is determined mainly by income, although DeKaser also made an allowance for low interest rates, which increase affordability, and calculated an expected premium for highly desirable markets like New York and San Francisco.

Any prices that fell within 10 percent of their historical norm should be considered “fair value,” DeKaser said. Prices more than 20 percent above normal could be subject to a correction, especially if mortgage interest rates rise, as most economists have been expecting for months.

DeKaser said his figures do not necessarily mean prices will fall in the overpriced markets he has identified. Income levels and other fundamentals could improve enough in coming years so that home prices would no longer be so badly misaligned.

In any event prices are unlikely to drop overnight.

“Historically you experience corrections over two or three years, sometimes four or five years,” he said. “It’s not likely to be something that happens over a period of months.”

Neither DeKaser nor other analysts were particularly surprised to find California cities at the top of the list.

“It’s not surprising that any analysis of housing prices is going to find that California as a whole and many of the places in California are outliers,” said Hans Johnson, senior demographer at the Public Policy Institute of California. “They have much higher housing prices than could be understood even looking at the historical premium California has had over the rest of the country.”

He said sky-high housing prices in the San Francisco Bay area and other big California cities have pushed tens of thousands of workers into the state's booming central  valley, where many commute an hour or more each way by car or train.

Johnson cited the example of Mountain House, Calif., the first new city to be developed in California in decades, which is projected to have a population of up to 50,000 people in two decades.  The Web site for the nascent city boasts that it “is poised to become among the Bay Area’s most desirable locations to reside in,” although the city is more than 50 miles from the water.

With 30-year fixed-rate mortgages still available at well under 6 percent, the housing industry is celebrating a fourth straight year of record sales, but there are signs that demand may have peaked.

A weekly index published by a mortgage industry group has stayed below its one-year average for six straight weeks, the first time that has happened since 2003, said Tony Crescenzi, chief bond market analyst for Miller, Tabak & Co. But he noted that housing inventories remain tight by historical standards.