Trulia (TRLA) Chief Economist Jed Kolko says that despite the current deceleration in home prices worrying some, and claims from others that home prices are too high, home prices nationally are actually 3% undervalued in the third quarter of 2014.

“In 2006 Q1, during the past decade’s housing bubble, home prices soared to 34% overvalued before dropping to 13% undervalued in 2012 Q1,” Kolko writes. “One quarter ago (2014 Q2), prices looked 5% undervalued; one year ago (2013 Q3), prices looked 6% undervalued.”

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Source: Trulia Bubble Watch

This is his conclusion in the latest Trulia Bubble Watch. Bubble Watch shows whether home prices are overvalued or undervalued relative to their fundamental value by comparing prices today with historical prices, incomes, and rents.

When home prices are overvalued relative to fundamentals, the housing market approaches a bubble, with the consequent bigger risk of a price crash.

“Sharply rising prices aren’t necessarily a sign of a bubble. By definition, a bubble develops when prices look high relative to fundamentals,” Kolko says.

Kolko says that three out of five Housing Barometer measures are getting close to normal. But the two measures that hitch housing to the broader economy are still struggling, so the job market and housing market aren’t helping each other as they should.

The Bubble Watch report posts the following conclusions:

Texas and California Metros Look Most Overvalued

The most overvalued market is now Austin, at 19%, followed by the California metros of Los Angeles, Orange County, San Francisco, and Riverside-San Bernardino. The California metros on the top-10 list were all significantly overvalued during the past bubble, ranging from 46% overvalued in San Francisco to a dizzying 87% in Riverside-San Bernardino. By contrast, Austin and Houston are the only metros out of the 100 largest that look more overvalued today than in 2006. Texas markets avoided the worst of the housing bubble during the past decade. Recently, they’ve had double-digit home-price increases.

Almost all of the most undervalued metros today are in the Midwest and New England, led by Dayton and Cleveland. One year ago, Las Vegas and two Florida metros, Lakeland-Winter Haven and Palm Bay- Melbourne-Titusville, were on the most-undervalued list. Since then, price gains have lifted them off this list. In the past year, price gains in the undervalued Midwestern markets like Detroit have outpaced price gains in the undervalued New England markets like New Haven.

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Source: Trulia Bubble Watch

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Source: Trulia Bubble Watch

“…[B]ubbles 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,” Kolko concludes.