Here is a graph of the Price to Rent ratio for housing, from CalculatedRiskblog.com . That really looks like irrational exuberance. A case of national insanity, which has fallen back to reality.
What if we flipped this over, so that it is in terms of yield, like a bond? Here is a graph of Rent to Price Ratio for housing. (Here I am using annual data from the BEA for rent and the Federal Reserve for real estate values, which has similar behavior to the Case-Shiller National index in the first graph.) I have also included two other real financial indicators - real GDP growth and real 20 year treasury bond rates. I have also included a Net Rent to Price ratio, in order to provide a more accurate comparison between the bond returns and the net returns to homeownership.
No more insanity. It was that easy.
Here's what happens when I try to create a Price/Rent version of 20 Year TIPS bonds and real GDP growth rates. I added a 1% "premium" to the GDP growth rate and the treasury bond, before inverting them.
The treasury bond market and the residential real estate market are similar in size. Could it be that long term TIPS should be yielding about 2%, nominal long term treasuries about 4%, and homes about 3%? And, the dislocation in the housing market is keeping capital out of housing, and pushing it into treasuries, pushing home returns up (prices down) and treasury yields down?
This is a reason why, while I think a big inflationary boost would help get housing back in order, if we aren't going to get that, I am fairly sanguine about near term interest rate movements. The demand (investment) end of the credit market would probably be pulling long term treasury rates up to 4% or so if we didn't have this supply (savings) glut. And, rates would really have to jump before it would move home returns below the alternatives.
By the way, here is a graph of YOY changes in home prices, adjusted for rent inflation. There is nothing unusual about the 2000s. And, we can see from the graph above that Price to Net Rent ratios in the late 1970's were not substantially lower than they were in the 2000's. Real interest rates and real GDP growth were also relatively low in the late 1970's. There is no mystery to solve here.
I just don't understand why sophisticated, numerate observers are so insistent on finding a cause to the non-existent problem of the housing boom. (I do think that homes have moved to permanently higher prices because of tax issues, which should be reversed, but this is simply another explanation for the price level. There is still no mystery.)
Look at the first Fred chart above. Net rent to price has been above real GDP growth almost permanently since the late 1980's. Before that, real GDP regularly pushed well above implied returns to homeownership during expansions. This suggests that home prices have been too low for the past 30 years, if anything.