Chris Mayer of Columbia Business School and Todd Sinai of Wharton argue there is no housing bubble, though a few of the 46 markets they study look a bit frothy. Jim Hamilton comes to a similar conclusion (see here, here, and here):
Bubble Trouble? Not Likely, by Chris Mayer and Todd Sinai, WSJ Commentary: For the past several years, Chicken Littles have squawked that the sky -- or the ceiling -- is about to fall on the housing market... Yet basic economic logic suggests that this apparent ... bubble is anything but. Even in the highest-price cities, housing is, at most, slightly more expensive than average. Here's why: ... The annual cost of owning, not the price of the house itself, is what homebuyers should (and do) consider when contemplating a purchase. And when comparing the cost of owning with annual rent … annual cost is the right measure to use. That cost is simply the net cash outflow required to own a house for a year... We ... computed annual housing costs for 46 housing markets from 1980 to 2004 in a study due to be published this fall in the Journal of Economic Perspectives. Our findings are striking. In none of the hottest housing markets did the ratio of the cost of owning to rent in 2004 exceed the average over the sample period in their own market by more than 13%... the ratios in the other oft-cited "bubble" cities such as Boston, L.A., New York and San Francisco were no more than 3% above their long-run averages. A similar pattern arises when we compare a city's cost of housing to its mean family income. By contrast, in the late '80s, immediately prior to the large house-price declines of the early '90s, the ratio of the annual cost of owning to rent peaked 52% above the long-run average in San Francisco and New York. Boston and L.A. topped out, respectively, at 37% and 42% above the long-run average. ... Portland and Miami, and to a degree San Diego, are cities where we have a nascent concern...
The number one reason the current cost of owning differs so much from the price of a house is the historically low level of real, long-term interest rates. ... At a lower cost-per-dollar of housing, families are willing to spend more for a house, bidding up prices. ... We obviously don't think the sky's the limit for house prices. But when you combine the annual cost concept with recent growth in rents and incomes, today's pricing looks justifiable in most of the U.S. Despite all the talk of a bubble, we find little evidence that house prices are being bid up based on unreasonable expectations of future price growth. ... Of course, the same logic that says today's market price of housing is reasonable also implies that house prices are especially sensitive to real, long-term interest rates. In the absence of an offsetting increase in housing demand, an unanticipated rise in real mortgage rates could cause appreciable declines in house prices. For this reason we don't think speculation is justified in the housing market -- gambling on above-average capital gains is simply an interest-rate bet.
I need to get my hands on this paper because I must be missing something. This is not their only or their primary argument, but I don’t see why renting is the right opportunity cost to use to measure to cost of housing. For example, suppose that the owning to renting ratio is $1200/$1000, or 1.2. Now let both prices double but all other prices remain the same. Then the ratio is $2400/$2000 and the relative price is still 1.2 – housing is no more expensive in terms of renting. But, in terms of, say, food and clothing, housing in general (i.e. owning or renting) is a lot more expensive. I also don't see why, at least theoretically, speculation can't cause both prices to rise in proportion during a bubble. However, the other measure they use, the cost of owning relative to income, does not have this problem and it shows a similar trend to that reported for the owning to renting ratio. And their conclusions regarding the real interest rate agree, as noted above, with other analysts who note the sensititvity of prices to interest rates.