Housing prices have risen rapidly over the past three years. Between December 2007 and August 2010, prices rose by 35 percent in real terms – an average annual rise of 12 percent, much faster than their long-term rate of increase. Given this surge in prices, concerns have been raised that the price rise is unrelated to market fundamentals and has been driven by expectations of capital gains, which suggests the development of a bubble in house prices.
The purpose of this article is to assess whether a bubble has developed in house prices in this period. To that end, we first review the course of prices retrospectively over the last few decades relative to rents and income; and then use three different approaches to derive the "fundamental price” from a standard asset-pricing equation. Our analysis suggests that while the prices at the end of the examined period are somewhat high relative to market fundamentals, from a long-term perspective their level is not exceptional in comparison with past episodes of rising house prices. According to various measurements, the actual price is between 3 percent below and 10 percent above the fundamental price. We therefore do not find evidence of a bubble in house prices (as of August 2010). If a bubble exists, it is at an early stage, and cannot yet be detected from the data.

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