“House prices are notorious for deviating from fundamentals,” states Brian M. Peterson of the Financial Stability Department with the Bank of Canada in a working paper entitled, “Fooled by Search: Housing Prices, Turnover and Bubbles.”
Some observations made in the report:
- House prices are volatile relative to fundamentals, such as income and rents…movements in house prices are much larger than fundamentals such as income or rents.
- House prices are predictable. This is the famous result of Case and Shiller (1989), where they found predictable house prices at the metropolitan level.
- House prices are sticky. In other words, they adjust slowly to fundamentals.
- House prices exhibit short-run deviations from fundamentals, but long-run reversion. This is an idea of overshooting or overreaction to fundamentals.
Mr. Peterson constructs two competing models to explain how buyers and sellers interpret past prices and the “inefficient behaviour of house prices.”
You can read the report in full here