There Is No Housing Bubble, Says Wharton Professor Todd Sinai Wall Street Journal Op-Ed Studies Annual Costs of Home Ownership
“The market sure feels like a bubble,” says Todd Sinai, Associate Professor of Real Estate at Wharton and Associate Director of Wharton’s Zell/Lurie Real Estate Center, in a recent Wall Street Journal op-ed piece about the housing market.
“Yet basic economic logic,” continues the article, “suggests that this apparent evidence of a bubble is anything but. Even in the highest-price cities, housing is, at most, slightly more expensive than average.”
Fighting conventional wisdom that “the sky — or the ceiling — is about to fall on the housing market,” Sinai’s article, co-authored with Prof. Chris Mayer of Columbia Business School and published in the Journal on September 19, argues that the “annual cost of owning, not the price of the house itself, is what homebuyers should … consider when contemplating a purchase.”
Using the Right Lens to View the Housing Market
“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?” That’s the basic question posed by Sinai and Mayer, who adapted their Journal essay from a longer study in the Journal of Economic Perspectives that they wrote with Charles Himmelberg, a senior economist at the Federal Reserve Bank of New York.
For Sinai, the diagnosis of a housing bubble results from using the wrong methodology in the first place. “People were not applying proper analysis to the issue,” he explains, “and we thought it was important to educate people on a more appropriate metric for evaluating the temperature of the housing market. I don’t really care what it tells you — but it tells you the right thing. These other measures are incorrect and are giving you the wrong answer.”
Specifically, Sinai and his co-authors looked at the annual cost of owning a home in 46 housing markets between 1980 and 2004, especially as compared to annual incomes and the cost of annual rents if one didn’t own a home. Their conclusion: “While house prices over the last decade have gone through the roof, the annual cost of owning a house has not.”
In fact, even in such hot markets as New York, Boston, Los Angeles, and San Francisco, the ratio in 2004 between the cost of owning a home and the cost of renting a home varied no more than 3% from its historical averages. And a similar pattern prevailed when comparing a city’s cost of housing to its mean family income.
“By contrast, in the late ‘80s,” they write, this same ratio “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. Even allowing for growth in house prices during 2005, it is clear that while owning a house is not cheap, it is not inordinately expensive by historical standards.”
Explaining the Bubble
If housing costs are not in fact above historical averages, why do people think there is currently a housing bubble? Low long-term interest rates are the main reason.
“At a lower cost-per-dollar of housing,” they write, “families are willing to spend more for a house, bidding up prices.” In other words, as Sinai elaborates, “When you’re thinking about how much you’re willing to pay for a house, a low interest rate means at a visceral level that you’re thinking there’s no better place to put my money — I might as well buy housing with it. I’ve got nothing better to invest my money in. And that factor alone explains almost all the recent run-up in those markets.”
So what are the prospects for the future of the housing market? “We obviously don’t think the sky’s the limit for house prices,” they explain. “But … 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.”
In other words, it’s not that housing prices are not high — it’s just that the high prices are not unreasonable, not outside of historical averages, and therefore present no evidence of an unsustainable economic bubble.
Having drawn much attention around the world for this controversial research, how does Sinai feel about it several weeks after the article’s publication?
“There are a lot of people who read it and are trying to think hard about it,” he says. “Some agree with it and some don’t. I think we succeeded in getting people to think about how they should think about housing bubbles.
We’re not trying to convince anyone, we’re trying to educate them. That seems to me to be the essence of an academic’s contribution to society.”
