Comment: The US housing puzzle

A new NBER working paper finds that there is "little evidence" of housing bubbles in the US. The authors argue that even in the highest-price cities, housing is perhaps only slightly more expensive than average.
A new NBER working paper finds that there is "little evidence" of housing bubbles in the US. The authors argue that even in the highest-price cities, housing is perhaps only slightly more expensive than average.


Conventional metrics for assessing prices in a housing market, such as price-to-rent ratios or price-to-income ratios, generally fail to reflect accurately the state of housing costs.

The authors start by admitting that "the market sure feels like a bubble". The rampant growth of house prices over the past decade, the rising price of houses relative to rent and the astonishing gap in many cities between price and income are almost unprecedented in recent history. "Yet", the authors argue, "basic economic logic suggests that this apparent evidence of a bubble is anything but".

In explaining how to assess the state of house prices, the authors point to four common fallacies: first, the price of a house is not the same as the annual cost of owning. So it does not necessarily follow from rising prices of houses that ownership is becoming more expensive. A correct calculation compares the value of living in that owner-occupied property with what it would have cost to rent an equivalent property and with the lost income that one would have received if the owner had invested the capital put into the house in an alternative investment. The comparison should also take into account differences in risk, federal and state tax benefits, property taxes, maintenance expenses, and any anticipated capital gains.

Second, high price growth is not evidence per se that housing is overvalued. In some local housing markets, house price growth has consistently exceeded the national average rate of appreciation for very long periods of time. Third, considerable variability in the ratio of house prices to rents across housing markets can be the result of reasonable differences in expected gains in house prices and in taxes. Finally, the sensitivity of house prices to changes in fundamentals is higher at times when real, long-term interest rates are already low and in cities where expected price growth is high. Therefore, accelerating house price growth and outsized price increases in certain markets are not intrinsically signs of a bubble.

The bottom line for policymakers, however, is that this does not mean that house prices cannot fall. An unexpected rise in real, long-term interest rates or a decline in economic growth could cause trigger such a fall, the authors suggest. "Indeed, because real, long-term interest rates are currently so low, our calculations suggest that housing costs are more sensitive to changes in real, long-term interest rates now than at any other time in the last 25 years," they conclude.

Policymakers may take comfort from the findings of this paper. But from an analytical perspective, the underlying message may be a cause for concern: conventional metrics overstate price changes so that they "may appear exuberant by these metrics, even when they are in fact reasonably priced". House price dynamics are a local phenomenon. So national-level data can obscure important economic differences among cities.

Click here to read the paper "Assessing high house prices: Bubbles, fundamentals, and misperceptions"

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