Assessing High House Prices: Bubbles, Fundamentals, and Misperceptions

Abstract

We construct measures of the annual cost of single-family housing for 46 metropolitan areas in the United States over the last 25 years and compare them with local rents and incomes as a way of judging the level of housing prices. Conventional metrics like the growth rate of house prices, the price-to-rent ratio, and the price-to-income ratio can be misleading because they fail to account both for the time series pattern of real long-term interest rates and predictable differences in the long-run growth rates of house prices across local markets. These factors are especially important in recent years because house prices are theoretically more sensitive to interest rates when rates are already low, and more sensitive still in those cities where the long-run rate of house price growth is high. During the 1980s, our measures show that houses looked most overvalued in many of the same cities that subsequently experienced the largest house price declines. We find that from the trough of 1995 to 2004, the cost of owning rose somewhat relative to the cost of renting, but not, in most cities, to levels that made houses look overvalued.

A Review of Volume 5 of the Handbook of Regional and Urban Economics, Parts III and IV

“…Extremely low interest rates have amplified the difficulty of calling “bubble” in such markets identified by Himmelberg et al. ().…”

“…Among the early Cassandras in the profession, Krugman () argued that elastic supply means that demand shocks are capitalized into quantities rather than prices. As Himmelberg, Mayer, and Sinai () emphasize, rapid price growth, particularly in inelastically supplied markets with falling real interest rates, need not reflect a bubble, rational or otherwise. Prices are convex in cap rates, so as real bond yields get close to zero, small changes in capital costs have large impacts on value…”

Household Interest Rate Risk Management

“…The negative excess return on housing is at odds with the current popular perception that the housing investment is a sure bet with a high return. Himmelberg, Mayer and Sinai (2005) discuss the up‐ and downswings in U.S. house prices and argue that about one‐third of the recent run‐up in house prices merely reflects a return to the house price levels prevalent before the downswing in the early 1990s 20 . Notice that the average total excess return on the house, θ′λ, is still positive as long as the imputed rent is larger than 0.53%.…”

Is Inequality Underestimated in Egypt? Evidence from House Prices

“… Under a non‐arbitrage condition, house prices and rental values are expected to move in parallel (see, e.g. Himmelberg et al ., ). …”