LOS ANGELES -- Housing prices in certain California markets are unsustainable, Fitch Ratings analysts said in a commentary.

“Fitch Ratings believes the recent home price gains recorded in several residential markets are outpacing improvements in fundamentals and could stall or possibly reverse,” according to the commentary released Tuesday by the residential mortgage arm of the rating agency’s U.S. Structured Finance group. “Many of these areas are in California, which has seen price increases of 13% over the last year. “

The two metropolitan statistical areas that have seen the biggest jump in housing prices are Los Angeles, which stretches north into Ventura County and south to Long Beach, and the Bay Area, namely Oakland and San Jose, analysts said.

In many markets, Fitch analysts said, fundamentals are improving as unemployment rates continue declining, while low prices and low interest rates have kept affordability high. However, especially in cities that never fully unwound from the mid-2000s bubble, rapidly increasing price levels are a potential cause for concern.

For example, analysts said, in Los Angeles prices are up more than 10% in the past year despite a stubborn unemployment rate that remains above 10% and real incomes that have declined over the past two years. Prices are now more than 75% above pre-2000 levels.

Several factors are combining to form an environment supportive of brisk home price growth, but few are capable of providing long-term support to sustain the recent pace of improvements, according to the report. Restricted supply and bolstered demand factors are bidding prices up.

The supply is artificially low, the report said, because recent regulations have limited the pace of foreclosure sales and a large percentage of underwater borrowers continues to hope for further price increases to be able to sell their homes at a profit.

“We don’t think this is sustainable,” said Suzanne Mistretta, a Fitch analyst and co-author of the report. “We think it will go back to lower sales prices.”

It’s unclear how much assessed valuations of homes, which speak directly to repayment on a municipality’s general obligation bonds, would be impacted, said Karen Ribble, an analyst in Fitch Ratings’ public finance group.

There is typically a year’s lag between price increases and assessed valuation, because of how taxes are collected in California, Ribble said.

California’s Propositions 13 and 8, which limit growth in a property’s assessment unless it’s sold, also limit the upside benefits to local governments, but exposes them to downside almost immediately, according to a Fitch report published in October 2012.

Assessed values increase more slowly than home values during booms, but adjust downward quickly during busts. The propositions also act as a stabilizer, because the failure to immediately reflect  the upside of home price inflation creates a cushion when home prices decline, according to the October 2012 report.

Many homes verging on foreclosure never hit the market, because of the California attorney general’s settlement with the banks that resulted in servicers having to call back foreclosures on some homes while they implemented new practices and procedures, Mistretta said.

This resulted in a supply-demand imbalance as homebuyers, institutional investors and retail investors began looking for homes to purchase in those markets, Mistretta said.

Quite simply, there are fewer homes on the market than there are buyers, she said, adding that the lack of supply caused prices to increase despite continued weak economic indicators.

Chris Thornberg, an economist and partner in Los Angeles-based Beacon Economics, disagrees with the notion that the supply-demand imbalance in Los Angeles will go away.

“We don’t have enough housing in Los Angeles to support the population,” Thornberg said. “Until new housing stock is added, pricing will remain high here.”

The high cost of housing in Los Angeles is what is unsustainable and affordability continues to be an issue, Thornberg said.

If the drop in price that analysts Mistretta and Stefan Hits predicted in their reports occurs, it will also impact municipalities by creating volatility, which impacts bonds, Ribble said.

Since the final reports on assessed valuations for 2013 don’t come out until July, Ribble wasn’t able to comment specifically on how the findings from her colleagues’ report regarding pricing might impact assessed valuations. It partly depends on how many homes change hands, which would cause assessed valuations to reset based on higher prices, she said.

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