Report: Home Prices 3% Undervalued Nationally

Despite inching closing to the tipping point, home prices still haven't reached a stage where fears of a bubble are justified, says Trulia.

The company recently released its third quarter Bubble Watch report, which measures whether home prices are over- or undervalued relative to their fundamental value. Comparing current movements to long-term trends, the report suggests home prices nationally remain 3 percent undervalued, a step up from 5 percent in the second quarter.

During the housing bubble of the last decade, house prices surged to 34 percent overvaluation at their peak (in Q1 2006) before diving to 13 percent undervaluation in their trough (Q1 2012).

As of the third quarter, seven of the nation's top 100 markets were more than 10 percent overvalued, five of which are located in the inventory-starved state of California. The top overvalued market at the moment is Austin (19 percent overvalued), which—like most Texas metros—avoided the worst of the crash and has actually bounced back higher than it was in 2006.

On the other hand, while a number of California's major markets—Los Angeles, Orange County, San Francisco, Riverside-San Bernardino, San Jose, and Oakland—are high on the list of overvalued metros, they're all still well short of the peaks they hit during the last bubble.

What's more, a scatterplot measure of annual price changes (as of August) suggests little relationship between the most overvalued markets and the markets where prices are rising fastest—a positive sign, says Trulia Chief Economist Jed Kolko.

"Price gains in overvalued markets are a sign that we're headed for danger, while price gains in undervalued markets are probably just a sign of getting back toward normal," he said.

He concluded: "All this means that bubbles should not be our top housing worry today. Our latest Housing Barometer shows that weak construction and subpar young-adult employment are the recovery's big red flags. By contrast, prices are slowing to a sustainable pace and staying within striking distance of normal."