Are Home Prices A Bubble?

In September, as the stock market continued to struggle, there was unsettling news about what has been one of the few economic bright spots: the real estate market. New housing starts dropped in August for the third straight month, and in the Midwest the plunge for single-family homes was a dramatic 20%. For those who consider the recent relentless growth in real estate prices a bubble bound to burst—remember technology stocks in 1999?—this latest data may look like the beginning of the end. But before you try to time this market by selling your home at the peak and renting while prices plummet—a move that a handful of homeowners have reportedly taken—it makes sense to consider the larger picture.

Houses are still affordable. In July, the Housing Affordability Index, an indicator compiled by the National Association of Realtors, stood at 132.5, reflecting that the median national income of $52,602 was 132.5% of the amount needed to qualify to buy a home for $162,800, the median price. The index was 5% higher in 1999, but considering that home prices have risen 22% since then, the falloff seems negligible.

Current price increases are part of a long-term trend. Since World War II, nationwide average nominal house prices (that is, excluding the impact of inflation) have never dipped. While there have been painful regional declines, particularly in parts of Texas, California, and the Northeast, the national average has inched ever upward.

The housing market has solid fundamentals. Irrational exuberance may have inflated the stock market bubble, but that’s not what is fueling the rise in home costs. Across the country, a trend toward tighter land-use controls is starting to limit the number of desirable building sites just when the population of potential homeowners is swelling and interest rates have hit rock bottom. That adds up to a situation in which the supply of homes is near historic lows, pushing prices to historic highs. Though mortgage rates will eventually rise, and home prices may level off or even retreat in some areas, most economists discount the likelihood of a housing market meltdown anytime soon.