New Paper from Brookings Institution Points to Bubble Formula

Here’s an excellent story that covers a new paper being put forth to estimate whether there is a "bubble" in a particular market. Here’s the germ of the story, "Is there a bubble? Do the math":

They concluded that not only was the Los Angeles region not in a bubble, but also that many markets others were calling overpriced, including Chicago and Boston, were probably underpriced.

Their findings are at odds with other surveys that use the relationship of home prices to income to determine whether home buyers are overreaching. Homes in Orange County were fairly priced, the Smiths found. Some cities like Dallas, Indianapolis and Atlanta were screaming bargains. Homes they surveyed in San Mateo County, south of San Francisco, were, however, overpriced by about 54 percent.

The key to their work is a paper published here:

In a paper presented at the Brookings
Institution last month, “Bubble, Bubble, Where’s the Housing Bubble?”
they said that even though prices had risen rapidly and some buyers
unrealistically expected the trend to continue, “the bubble is not, in
fact, a bubble in most of these areas.”

They argued that the value of a home is
determined by the rent it could fetch. Calculate the future rents,
subtract mortgage payments, taxes and other costs, factor in a good
annual rate of return of 6 percent or more, and one should be looking
at the proper price of a house or condo.

Their bottom line: “Buying a house at current market prices still appears to be an attractive long-term investment.”

See text version of the paper here.

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