Forecasting Changes on the Housing Front

Cloud_CottageReal Estate Professor Todd Sinai With Unconventional Wisdom on Cooling Home Prices

By Nancy Moffitt

Todd Sinai is a master of understatement, describing his explosive research on the recent residential real estate downturn as little more than “a fairly fortuitous time to be undertaking this exercise.”

Indeed. The Wharton real estate professor and two colleagues set off a torrent of media attention with their September 2005 op-ed in the Wall Street Journal, a piece that disputed widely held beliefs about recent sky-high housing prices.

“For the past several years, Chicken Littles have squawked that the sky—or the ceiling—is about to fall on the housing markets,” Sinai wrote with Columbia professor Chris Mayer and Fed research economist Charles Himmelberg in the article, titled Bubble Trouble? Not Likely. “And it’s tempting to believe them… The rampant growth of house prices over the past decade, the rising price of houses relative to rent and the astonishing gap in many cities between price and income are almost unprecedented in recent history. The last time things felt this way, in the late 1980s, real house prices subsequently dropped by one-third in cities like Boston and Los Angeles.

“Yet basic economic logic 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. Here’s why: While house prices over the last decade have gone through the roof, the annual cost of owning a house has not,” Sinai wrote in the Wall Street Journal article, which was based on a study of 46 singlefamily housing markets from 1980 to 2004 that has since been published in the Journal of Economic Perspectives.

Todd_SinaiFrom MSNBC to Bloomberg Business News, the financial press swarmed on the story, most reporting Sinai’s research the way he intended it—as information that would reassure skittish buyers and make sense of recent real estate trends. A few, however, such as BusinessWeek Online columnist Peter Coy, took issue, arguing with Sinai’s conclusions, insisting that the bubble was real. “It feels to me like San Francisco, San Diego, Los Angeles, New York, Miami, Boston, and other costly markets are pricing themselves out of reach,” he wrote. “It seems at least possible to me that other people will start to reach that conclusion. If they stop expecting rapid house appreciation, their willingness to pay will fall. And the market could drop rather suddenly.”

Sinai has been studying housing markets long enough to be unfazed by the business press’s view-of-the-moment. He explains that he and co-author Mayer didn’t begin their research thinking they would prove or disprove the widespread media reports of a real estate bubble. Instead, they’d simply hoped to create a measure that could be used, down the road, to gauge whether real estate markets were overheated. In fact, he admits, he’d even sarcastically advised a friend in 1999—before doing research on house prices—that buying a boat was a better investment than a house in San Francisco. “Whoops!” he laughs.

“We didn’t have an agenda or any idea really how things would look when we started this research,” he says. “I’ve been studying housing markets for a long time, and while I’ve learned to be skeptical of media reports, house price bubbles do happen.”

But what Sinai and his colleagues found after looking at housing data in various markets going back 25 years was that recent growth in housing prices are largely explained by basic economic fundamentals such as low interest rates, strong income growth among high-income Americans, and unusually low housing prices in the mid-1990s—not a bubble.

Further, their research found no evidence that most buyers were bidding up housing prices based on unrealistic expectations of future price increases, and that the conventional metrics for assessing the housing market—such as price-to-rent ratios and price-toincome ratios—ignored the effects of lower real, long-term interest rates, thus failed to accurately reflect the state of housing costs.

Disspelling Common Misconceptions

Each year, Sinai teaches a second-year MBA segment on real estate markets. His work on house price bubbles grew from teaching this course—and wanting to be able to give students good advice on whether to buy a house when they graduated.

“When I put together these classes, the holes in our knowledge of housing markets became very clear,” says Sinai, who earned his PhD from MIT and his BA degree from Yale. “How can one teach about the relative riskiness of owning versus renting if the conventional wisdom is wrong and no one has done the research to figure out the right answer? How could I tell students whether a housing market was too pricey or not if no one had correctly calculated the true cost of owning? Realizing that the ‘conventional wisdom’ is frequently wrong and wanting to convey the correct way of reasoning to my students has motivated a large chunk of my research agenda.”

In his “Bubble Trouble” study, Sinai and his co-authors hoped to dispel several common misconceptions, including the belief that the rising price of housing necessarily means that home ownership is becoming more expensive. The study calculated the actual cost of owning a house relative to rents and incomes, and found that the ratios were well within historical norms. During the mid-1990s, after the bubble of the late 1980s burst, housing prices were actually somewhat undervalued.

He also addressed the view that soaring prices imply a bubble, explaining that when the real cost of long-term borrowing is low, as it has been in recent years, changes in long-term interest rates have a disproportionately large effect on housing prices. Given the trend in recent years toward declining long-term interest rates, the surge in housing prices is not surprising, Sinai argues.

“If you think of a house like a bond, when the yield is low, the price goes up,” he explains. “So what we had in the early to mid 2000s is a historical low in after-inflation interest rates, and people are willing to pay more for a house when they don’t require as much yield on their money. A low yield in the marketplace drives the prices of housing just like all of the other assets have high prices. And that effect gets magnified as interest rates continue to decline.”

The bottom line according to Sinai: for many markets, housing prices were just where they should have been. “What does that mean today? It means that you really can’t expect continued growth in housing prices unless that growth is explained by rising incomes or further declines in interest rates,” he says. “Additional increases in real interest rates, if other fundamentals don’t compensate, could lead to a decline in house prices especially in the hottest markets.”

And not surprisingly, the red-hot market has begun to cool. “To my eye, prices have leveled off,” Sinai says. “My sense is that when people are putting houses on the market this year, if they are extrapolating previous growth and marking up their houses by 10 percent, they are not selling. But if they are putting them up for sale at prices of 12 months ago, then they are selling. We have seen an increase in real interest rates as well, but we’ve also seen the economic fundamentals doing OK.”

Back to Normal

“The market as a whole has returned to normalcy,” he continues. “But we’ve not seen normalcy for the last decade, we’ve not seen houses sitting on the market for several months before they sell. Normalcy means not getting multiple bids on your house, that there’s no bidding war, houses don’t sell in a day—all these things that many people have become used to. You should see ‘For Sale’ signs on your street, and they should be there for a while. That is a normal real estate market.”

Sinai also challenges the belief that “superstar” markets—those with the highest price increases such as San Francisco, Boston, New York and San Diego—are the most overvalued. These cities, Sinai argues, have enjoyed higherthan- the-national-average appreciation for at least 60 years. In cities with higher long-term price appreciation rates, the annual cost of owning is lower, hence house prices should be higher (relative to rents or incomes). But house prices in pricier cities are also more sensitive to real long-term interest rates because more of the value of owning a house comes in the future, he adds.

“I believe that large differences in house prices across locations in the U.S. not only can be sustained, but can grow even larger, as the growing population has to bid ever-higher amounts for desirable places to live,” Sinai says. “If you don’t believe that, if you believe at the end of the day that no one is going to be willing to pay a larger premium to live in San Francisco versus living in Cincinnati, then you would say that all houses in the U.S. have to over the long run appreciate at the same rate.”

Sinai’s current research will tackle this issue, explaining the hows and whys of long-run house price growth in superstar cities such as San Francisco, and that for these cities, prices may well be above the national average in perpetuity. Some startling consequences can follow this trend, he believes. In a city like San Francisco, for example, which has essentially run out of land to house its growing population, the rich have begun to crowd out the poor. “For most of the country’s history, there was plenty of room in any housing market,” Sinai says. “It’s only a fairly recent phenomenon that certain cities have begun to fill up and people have to compete to live there.”

And while most people have long accepted the reality that only very wealthy can afford to own a home in a “fancy resort town” like Nantucket Island, the very same phenomenon—wealthy people outbidding one another for a limited supply of homes—is now taking place in several U.S. cities. “It raises lots of questions,” Sinai says. “If you keep replacing low-income or moderate-income people with high-income people, what kind of place does that city turn into?”

Overturning Conventional Wisdom

Sinai’s other research has touched on topics from owner-occupied housing as a hedge against rent risk to geography and the Internet. Much of his research evolves from a personal epiphany, Sinai says, when he realizes that the conventional wisdom on some topic is not right.

His high-profile research on airline delays, for instance, came after Sinai and colleague Chris Mayer found themselves sitting in the Philadelphia Airport, waiting for their delayed flight to depart. “The conventional wisdom was that airport delays were due to many airlines scheduling flights that overcrowd airports,” Sinai explains. “Since each airline has no incentive to reduce delays for their competitors, they schedule flights even though the resulting congestion will delay other planes. There is a clear policy prescription for solving that problem, too—you impose landing fees on aircraft to disincent airlines from scheduling too much.”

But as he looked out the window at the Philly airport, Sinai and Mayer counted 16 planes waiting in line to take off, and 15 of them belonged to USAir. And that reality didn’t fit with conventional wisdom, since USAir “knew that scheduling too many planes would delay its own airplanes, and it was choosing to do so,” Sinai says. Why would it do that? Answering that question (using data on 67 million plane flights) led Sinai and Mayer to conclude that most congestion delays are due to hubbing: USAir overschedules an airport so passengers can have quick connections and reach more destinations, and delays are a price one pays for frequent service to lots of destinations. The two published their conclusions in a 2003 American Economic Review article. “In that case, you do not want higher landing fees because the airline already is taking the delay cost into account because the delays accrue to its own passengers,” Sinai explains. “For me, it’s tremendously useful and fun to find something like this. It’s why I love what I do.”


Associate Professor of Real Estate


PhD, Massachusetts Institute of Technology, 1997;
BA, Yale University, 1992


Risk and pricing in housing markets; taxation of real estate and capital gains; commercial real estate and real estate investment trusts; air traffic delays; real estate and public economics


Faculty Research Fellow, National Bureau of Economic Research, 1999-present; Visiting Scholar, Federal Reserve Bank of Philadelphia, 2000-present; Co-organizer, Public Policy and Real Estate sessions at NBER, 1999-present


Edwin S. Mills Best Paper Award, 2004 Post-Doctoral Fellow, Homer Hoyt Institute, 2001; Ballard Teaching Award, 2001; HUD/AREUEA Best Paper Award, 2001

Frequent contributor Nancy Moffitt is a former editor of the Wharton Alumni Magazine.

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