Assessing High House Prices: Bubbles, Fundamentals and Misperceptions

How does one tell when rapid growth in house prices is caused by fundamental factors of supply and demand and when it is an unsustainable bubble? In this paper, we explain how to assess the state of house prices—both whether there is a bubble and what underlying factors support housing demand—in a way that is grounded in economic theory. In doing so, we correct four common fallacies about the costliness of the housing market. For a number of reasons, conventional metrics for assessing pricing in the housing market such as price-to-rent ratios or price-to-income ratios generally fail to reflect accurately the state of housing costs. To the eyes of analysts employing such measures, housing markets can appear…