Is Denver real estate overvalued?  Is there a crash coming?

 

A new report from CoreLogic, a national data analysis firm, finds that homes in metro Denver are overvalued even as prices continue to rise.  As of April, the median home price in Denver hit a record $612,000 a 25% increase from last year.  Will Denver real estate values continue to go up or will we hit a tipping point with values declining?

 

What was in the data from Corelogic on Denver Real Estate?

As for why home prices here are considered overvalued, Nothaft, the chief economist at Corelogic, explains that “the measurement is based on comparing the Denver metro HPI to Denver metro per capita income currently to a benchmark period — the 1976 to 2003 period. Based on this benchmark, the price relative to income is more than 10 percent above the benchmark” — the standard CoreLogic uses to establish whether home prices are overvalued. In other words, he says, “Prices appear high relative to the income of current residents.”

Nothaft offers several possible reasons for this, including “record-low mortgage rates enabling local residents to ‘buy more house’ than during the benchmark period,” “new residents who have moved to Denver from elsewhere in the U.S. that may have higher income and wealth than local residents, and home prices are higher as a result,” and “there is a price bubble (prices are disconnected from the properties’ intrinsic value).”

In Denver’s case, Nothaft believes “the first two reasons explain why prices are high relative to the income of local residents.”

Is Denver truly overvalued?

There are various economic tools that try to predict whether houses, stocks, or any other asset is truly valued via statistical modeling.  Unfortunately, the models are never truly spot on so I take any study that comes out with a grain of salt.

If you would have asked me a year ago if Denver were overvalued, I would have said that values were getting a bit high, but the huge demand to live in Denver and the front range was continuing to drive this trend.  It is amazing how much has changed in a year.

Since last year, in Denver County, the average sales price is almost $760,000 a whopping 26% increase from last year.  Furthermore days on the market has dropped over 40% to just 16 days.  The price of a home in Denver has almost doubled in the last five years.

Unfortunately, median income has not doubled in the last five years in Denver.  Historically houses move in tandem with wages.  This relationship of wages to house prices has broken, not just in Denver but throughout the country.  The impetus for the break in house prices to wages is interest rates.  Ove the past 5 years, interest rates have dropped substantially from their previous highs.  For example, in 2018 the average rate was around 5% for a 30-year fixed, the rate now is around 3%.  This equates to a 40% drop in mortgage rates and in turn mortgage payments.

Rising Interest rates impact on Denver real estate

Before I can answer the question: Is Denver overvalued, it is important to discuss the number one driver of not only Denver, but the huge run up in appreciation throughout the country due to interest rates.  Wages are flat, but lower rates have enabled buyers to purchase substantially more house for the same amount of money.  As mentioned above buyers can purchase a house with payments 40% less than in 2018, this has led them to buy more expensive houses for the same payments.

Unfortunately, rates will not stay low forever.  Based on the recent jumps in inflation (I wrote an extensive article recently on the huge run up in the consumer price index).  As rates rise purchasing power declines.  Based on the trajectory of rates (and treasuries), I see the 30-year fixed rate rising back to the 5% level in the next 18 months.    A jump in rates will cause Denver real estate to come to a screeching halt as purchasing power declines substantially due to the higher rates and incomes fail to keep up.

Denver real estate  is “Frothy”?

I am going to go out on a limb (and likely ruffle some feathers) that the Denver market is very “Frothy” and somewhere near a peak with considerably more downside risk than upside.  As interest rates climb, purchasing power declines, and the market will “reset”.  Do not get me wrong, Denver is a desirable city and will continue to remain desirable, but the huge jump in prices over the last five years and last years 26% increase is not sustainable under any metric.

Will the Denver real estate market fall?

Fortunately, I do not see an 08 type crisis unfolding.  Underwriting is considerably tighter and there is little spec building and excess inventory.  Furthermore, to build new houses is extremely expensive in Denver due to land costs, labor costs, building supply costs, etc…  I don’t see any of the factors changing substantially.  I do think the market will slow substantially as interest rates rise  I expect to see this late 2021 or early 2022.   This could lead to a reset in prices with a moderate downside risk (10-15%).

 

Summary

Although I do not see a “bubble” in Denver real estate currently that does not mean that there is not the possibility of trouble ahead.  If interest rates remain at historically low levels and the government stimulus continues unabated there is substantial risk of a fall.  Denver is at a peak currently, if we have another year like the last twelve months with a 26% increase in prices, we need to be worried about how/when the bubble will pop.  The Federal reserve is already starting to raise red flags that: “Asset prices may be vulnerable to significant declines should risk appetite fall.”  It would be wise to heed this advice.

 

Additional Reading/Resources

• https://www.westword.com/news/denver-home-prices-overvalued-report-says-11875988
• https://abcnews.go.com/Business/wireStory/fed-warns-us-financial-system-remains-vulnerable-threats-77540802?cid=clicksource_4380645_6_heads_posts_headlines_hed
• https://abcnews.go.com/Business/wireStory/fed-warns-us-financial-system-remains-vulnerable-threats-77540802?cid=clicksource_4380645_6_heads_posts_headlines_hed

 

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Written by Glen Weinberg, COO/ VP Fairview Commercial Lending.  Glen has been published as an expert in hard money lending, real estate valuation, financing, and various other real estate topics in Bloomberg, Businessweek ,the Colorado Real Estate Journal, National Association of Realtors Magazine,  The Real Deal real estate news, the CO Biz Magazine, The Denver Post, The Scotsman mortgage broker guide, Mortgage Professional America and various other national publications.

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