Housing Bubble Fears Overblown
Fears of a real estate bubble are overblown, and homes remain undervalued in many markets, according to new research from a pair of Pomona College professors who developed a fresh methodology for gauging bubble trouble. By comparing the cash flow generated by owning a home to the cost of renting a comparable house, economics professors Gary Smith and Margaret H. Smith found bubble conditions in only one of the 10 metropolitan U.S. housing markets evaluated.
In a paper presented March 31 at the Brookings Institution in Washington, D.C., the husband-and-wife team concluded that buying a home generally remains an attractive long-term investment - even if buyers are conservative in their assumptions about how much home prices will rise in the future.
''Most of the country is certainly not in a bubble if you define a bubble as prices far above fundamentals,'' said Gary Smith, who is the Fletcher Jones Professor of Economics at Pomona College. ''The average person in the U.S. is still better off buying than renting.''
So why all the talk about a housing bubble? The Smiths note in their paper that as housing prices have risen dramatically in recent years, some researchers have concluded that homes are now priced well beyond their fundamental values. But the Pomona College professors question the implicit assumption that market prices previously matched fundamental values but now have exceeded them. ''Perhaps housing prices were too low in the past and recent prices have brought market prices more in line with fundamentals,'' they write.
Beyond that, the Smiths question the methodology by which some researchers have concluded that the housing market is ''bubbly.'' The report notes that ''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 anticipated cash flow.''
In a paper presented March 31 at the Brookings Institution in Washington, D.C., the husband-and-wife team concluded that buying a home generally remains an attractive long-term investment - even if buyers are conservative in their assumptions about how much home prices will rise in the future.
''Most of the country is certainly not in a bubble if you define a bubble as prices far above fundamentals,'' said Gary Smith, who is the Fletcher Jones Professor of Economics at Pomona College. ''The average person in the U.S. is still better off buying than renting.''
So why all the talk about a housing bubble? The Smiths note in their paper that as housing prices have risen dramatically in recent years, some researchers have concluded that homes are now priced well beyond their fundamental values. But the Pomona College professors question the implicit assumption that market prices previously matched fundamental values but now have exceeded them. ''Perhaps housing prices were too low in the past and recent prices have brought market prices more in line with fundamentals,'' they write.
Beyond that, the Smiths question the methodology by which some researchers have concluded that the housing market is ''bubbly.'' The report notes that ''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 anticipated cash flow.''
posted by Dan Forbes at
2:51 PM
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