Housing Buble

Housing Buble

Bubble, Bubble, Where’s the Housing Bubble?

Margaret Hwang Smith Department of Economics Pomona College Claremont CA 91711 909-607-7897 msmith@pomona.edu Gary Smith Department of Economics Pomona College Claremont CA 91711 909-607-3135 fax: 909-621-8576 gsmith@pomona.edu

Corresponding author: Gary Smith

This research was supported by the John Randolph Haynes and Dora Haynes Foundation. We are grateful to Alan Blinder, William Brainard, Brian Chew, Jay Daigle, Daniel Harding, Edmund Helmer, Jesse Licht, Steve Marks, Chris Mayer, George Perry, Tom Renkert, John Romeo, Sam Ross, and Robert Shiller for their assistance and many helpful comments

Bubble, Bubble, Where’s the Housing Bubble?

Abstract Housing-bubble discussions generally rely on indirect barometers such as rapidly increasing prices, unrealistic expectations of future price increases, and rising ratios of housing price indexes to household income indexes. These indirect measures cannot answer the key question of whether housing prices are justified by the value of the services provided by houses. We first show how to estimate the fundamental value of a house from rent data. We then use this procedure to estimate the fundamental value of homes in ten metropolitan areas using a unique set of rent and price data for matched single-family homes. These data indicate that current housing prices are not, in fact, a bubble in most of these cities in that, under a variety of plausible assumptions, buying a house at current market prices still appears to be an attractive long-term investment. Our results also demonstrate the flaw in models that gauge bubbles by comparing movements in housing price indexes to movements in other indexes or to values predicted by regression models.

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Bubble, Bubble, Where’s the Housing Bubble? U. S. housing prices have risen by about 50% in the past five years, and more than 100% in some hot markets. Many knowledgeable observers believe that we are in the...