Reversion to the Mean Versus Sticking to Fundamentals: Looking to the Next Five Years of Housing Price Growth

Abstract

The keen interest of the media, and by extension, the public, in the future of house price growth in the United States centers on the question of whether there is a house price bubble nationally or regionally. Even among those who concede that a bubble per se may not be present, many worry that they may experience a decline in home prices in their metro area due to the very high and unsustainable rise in values over recent years in many parts of the United States. We examine this potential by forecasting the likely change in prices under three models - one that asserts a mean reversion correction on regional markets to return the national average gain in prices to the 50-year annual growth rate of 5 percent over the period 1998-2010; the second and third base future regional and national home price growth on economic fundamentals. We also discuss recent findings by Chang, Cutts and Green (2005) and perform a simple extension of their work applied to 22 major cities. In all cases, we find the predicted worst-case outcomes to be much less dire than the doomsday predictions reported in the mainstream press and elsewhere.