Will Flagstaff Bubble Burst?

Based on a recent run up in prices, recent references to "froth" in local housing markets that could result in a regional bubble burst may apply to Flagstaff, AZ.

In 2004, the median home sale price in Flagstaff had jumped in one year by 14.4 percent, just under the national hike of 15 percent and far surpassing the 8.2 percent rise in the Valley.

While this type of investment return is enticing to many homeowners, it can be misleading when examined with a price-to-earnings ratio similar to that used in the stock market.

That index is determined by dividing the sale price of a home by the potential rental income that house could earn in a year. For example, a three-bedroom home on Leroux Street, Flagstaff, Ariz., recently listed for $649,000. This house would probably rent for about $18,000 a year -- $500 per bedroom per month, according to local real estate agents.

Comparing that figure to the list price gives the home an index of 36. By comparison, the average price-to-earnings index nationwide is about 15. Flagstaff's rating tops the average home index even in San Francisco, which is considered one of the most expensive markets and one to watch for a bursting market bubble.

Even if the currently low interest rates start to climb, the rapid population growth in the Valley coupled with the desirable living atmosphere of Flagstaff will continue to fuel the city's already tight housing market. A market drop in Flagstaff is not something investors and homeowners should worry about just yet.

Home values increasing more than rent could be due to easier home buying than what existed previously because of lower interest rates, it doesn't necessarily mean there is a bubble waiting to burst.

The average sale price inside the city limits of Flagstaff is currently $307,874, while the housing supply remains a "seller's market." Whether in the million-dollar range or the average $330,000 home, available housing in Flagstaff is tight.

So sellers are asking higher prices for their homes than ever before, and buyers are driving the sales even higher, a trend that will continue until the inventory increases or there is a drastic decline in buyer interest in the region.

With a growth rate of 10 to 15 percent and Flagstaff getting the overflow from Phoenix it's very unlikely a bubble burst will occur.

It begs the question whether Flagstaff will in time become a vacation-home community comprised of second-home owners, wealthy retirees and tourists.