Do House Prices Reflect Fundamentals? Aggregate and Panel Data Evidence

Abstract

We investigate whether recently high U.S. house prices are justified by fundamental factors such as personal income, population, house rent, stock market wealth, building costs, inflation, and mortgage rate. The standard unit root and cointegration tests with aggregate data indicate that house rent is the only fundamental which has the same order of integration as the price, but these two variables are not cointegrated. This implies that house price does not align with the fundamentals. Nationwide analysis potentially suffers from problems of the low power of stationarity tests applied to relatively short series and the ignorance of dependence among regional house markets. Therefore, we conduct panel data stationarity tests which are robust to cross-sectional dependence and have greater power than univariate tests. Contrary to previous panel studies of the U.S. housing market, we consider several, not just one, fundamental factors. Our findings are consistent with results using aggregate time series. While this time it is inflation and income that have the same order of integration as house price, they are not cointegrated with it, even if combined with the aggregate stock index. It appears that the real estate prices take long swings from their fundamental value and it can take decades before they revert to it.