On March 29, the Dallas Fed issued a report warning that for the first time since the early 2000s, a “bubble” is “brewing” in the housing market. The authors found that prices are becoming “unhinged from fundamentals” and that the buyers are showing troublesome signs of “exuberant behavior.” The revival of the "B" word by such a distinguished institution brought the report the heaviest media coverage of any academic paper on housing's future in recent memory—and for good reason. We haven't seen anything like the current takeoff since the explosive run-up from 2002 to 2007 that stoked the Great Financial Crisis. After seven flush years of well-above-average gains, U.S. home prices went on a moonshot starting in the spring of 2020, jumping an astounding 31% since then, and still raging at a 17% annual rate, according to statistics from the American Enterprise Institute's Housing Center. In the hottest metros, places like Austin, Phoenix, and Tampa are racing at almost double that speed.

At first glance, it sure looks like another craze is building. But this writer feels a duty to express his own view, for a simple reason: As far as I know, I was the first journalist to call the last housing bubble. To predict that a steep descent was at hand, near what turned out to be almost the market top, I deployed metrics similar to the ones the Dallas Fed cited to make its dire assessment, and more or less got the forecast right, down to the approximate percentage drops that actually occurred nationwide and in numerous metros. Today, my take is a lot more favorable than that of the Dallas Fed's economists. Unlike the dynamics governing the last ramp-up, the driving force isn't wild speculation. It's a whole new set of fundamentals, encompassing rising but still relatively favorable mortgage rates, record low inventories, homeowners benefiting from modest leverage, and baby boomers' hankering for keeping the big family colonial instead of downsizing to a condo or townhouse.

Most of all, what's new is the freedom to work from virtually anywhere you'd like to live and can afford a house. The home-office economy has unshackled families to leave high-cost metros on the coasts and flock to super-affordable Sunbelt cities, greatly boosting their markets. “You might call it ‘the great housing arbitrage,’” says Ed Pinto, former chief credit officer at Fannie Mae and director of the American Enterprise Institute's Housing Center. As Pinto points out, outsize gains are practically guaranteed for the rest of 2022; he's predicting that prices in March 2023 will be 15% to 17% higher than today's for the nation as a whole. But even after that escalation, the monthly costs in owning in such hot metros as Jacksonville, Charlotte, and North Port, Fla., will remain modest by national standards. Though it will inevitably slow, the appreciation in those cities should both preserve their gains and keep national prices increasing modestly once the current spike subsides. Still, it's clear that a number of metros such as San Francisco, Denver, and Washington, D.C., which were always pricey, got more expensive. And since these cities don't benefit from the huge influx to America’s Southern tier, they are unsustainably expensive. Look for their prices to lag today's raging inflation, or even fall.

Believe me, I'm always reluctant to say, “This time it’s different.” When traditionally reliable metrics point to a fall, it usually happens. Today, the measures I used to predict the last crash seem to be approaching similarly inflated levels right now, the phenomenon that triggered the Dallas Fed's red alert. So let's review how the past frenzy built early on, and examine why the metrics that looked so dangerous then are now pointing in a different direction.

The last bubble

Believe it or not, I first claimed danger ahead in 2002, in a Nov. 4 Fortune cover story called "Is This House Worth $1.2 Million?" On the cover, under the headline "Is Real Estate Next?," we ran an ominous rendering of a house poised to tumble from a jagged cliff. The theme underlined that the crash occurring in stocks—the dotcom collapse—could a repeat in residential real estate, for the same reason: prices were flying free of fundamentals. By the way, I had also called the Nasdaq bubble two years earlier. In "Is Real Estate Next?" I wrote, "No, we don't have a bubble yet. But if the frenzy doesn't end soon, we soon will," adding that "U.S. housing prices are reaching the outer limits of what's reasonable and sustainable." Shall we say my forecast was so premature as to look embarrassing? By September 2004, prices had risen another 7% to 8% and hit an accelerating curve.

Undeterred, this stubborn Irishman weighed in again as a doomsayer, penning “Is the Housing Boom Over?” (Fortune, Sept. 20, 2004). The cliff had grown even steeper, the foundation ever more cracked, and the inevitable fall looming even steeper. Instead of thinking I was mistaken, I reckoned that my view were getting righter by the month. This time, the cover showed a cartoon-like drawing of a panicked homeowner issuing the captioned wail: “They said prices would go up forever!! And we believed it!!” In the 2002 story, I said we were nearly in a bubble, but not quite “there.” This time I saw no escaping a freefall. “It looks like the ‘there’ is finally here,” I wrote, adding that “The housing market is rapidly losing touch with reality…the gap between home values and the underlying fundamentals…is greater than ever.”

Still, prices kept climbing for more than two years. The new era of seemingly endless momentum was making my nattering about "fundamentals" look hopelessly old-fashioned.

So in the Nov. 12, 2007 issue I followed up with a highly analytical opus called “Real Estate: Buy, Sell, or Hold.” By then, the market appeared to have crested and was retreating just a bit. Nationwide, U.S. homeowners were still sitting on average gains of 70% over the previous eight years, and in such hot metros as Miami, Jacksonville, Phoenix, and Las Vegas, the values of their Mediterraneans, ranches, and colonials had far more than doubled. The housing bulls contended that the new, much higher price plateau was sustainable because long-term, basic trends had set housing on a fresh, faster track. They argued that the robust household growth would continue to ensure strong demand, and that regulations limiting new subdivisions would keep tightening supply. Plus, homebuilders had learned their lessons from past busts and would avoid erecting too many dwellings even in metros open to new construction. Those forces, the enthusiasts reckoned, would keep the flush times rocking, though at a more pedestrian pace.

The naysayers, myself included, argued that the Fed's easy-money policies had unleashed a wave of reckless speculation, augmented by exotic home loans starting at super-low rates that spiked after a year or two. The bears believed that the folks who had bought homes they couldn't afford, or investors who had purchased a bunch of new houses they now couldn't rent, would throw the properties on the market, causing a spread of "for sale" signs that would send prices falling.

In the story, I presented strong evidence that the market had indeed taken leave of the basics, and that expectations of big future gains and "fear of missing out" on a big score were driving prices far beyond the properties' underlying values. The evidence? The extraordinary disconnect between home prices and rents.

Where are housing prices headed? Rents are the key metric to watch

Many factors coalesce to establish the value of a house. They include the number of bedrooms, whether it's in a prestigious neighborhood near a safe city center or a far-flung suburb, and the quality of the schools. Low mortgage rates such as the 3% to 4% bargains we've mostly witnessed in early 2019, and even today's mark of around 5%, can give prices a big lift, just as low Treasury yields boost stocks. But the overriding force governing home prices is rents. People won't pay much more per month to buy a house as to lease one that's extremely similar, or to rent a nearby apartment offering the same space. Americans have lots of choices in renting freestanding dwellings with a yard: Mom-and-pop owners and such big landlords as Amherst and Invitation Homes offer a total of 12 million houses for rent, and the industry is growing fast.

Hence, home prices make sense so long as they reflect the future trend in rents. In markets boasting potent job and population growth and little new construction—think San Francisco or San Jose—rents tend to rise fast. Same is true in markets such as Jacksonville or Charlotte that attract lots of newcomers but, though building is active, new construction doesn't match the hunger for housing. In those metros, the ratio of prices to rents, what we'll call the “P/R,” tends to be much higher than average, just as the P/E for growth stocks exceeds the S&P norm. By contrast, in an old-line metro such as Pittsburgh or Detroit where job growth is subdued, despite little new construction, the P/Rs are usually low. Put simply, the fundamentals say that buoyant markets merit, and can maintain, far-above-average P/Rs so long as their rents are rising fast.

The problem comes when prices get out of line with rents, jumping so high that families can lease similar properties at monthly payments much lower than what they'd shoulder as owners. "There's an interplay between rents and prices," says Pinto. "When houses get too expensive versus rental properties, people rent more, lifting rents and pushing down home prices until the right balance is restored." Rents exercise a kind of gravitational pull on prices. As Yale economist Robert Shiller puts it, prices to rents "behave much like the price/earnings ratios for stocks." He added that both are "mean reverting." Prices may from time to time jump way ahead of rents, but then the reverse happens: Prices slow or drop and rents catch up, restoring the usual relationship between the two.

Reviewing the lessons from the bubble

Since rents are the underlying driver, a good way to measure if houses are over- or underpriced is comparing the traditional P/R "multiple" in different markets with today's. If the current P/R looms far above the long-term standing, it's a strong possibility that prices will fall. Comparing current and historical P/Rs formed the methodology for my 2007 story. Its findings are based on data assembled by Mark Zandi, chief economist at Moody's Analytics. Zandi collected price and rental numbers from 54 markets across America covering the past 15 years.

Back then, the results were jaw-dropping. For all of the U.S., the P/R in the fall of 2007 stood 28% above the decade-and-a-half norm. Prices didn't have to drop nearly 30%, however, to restore the long-standing P/R, because rising rents then as now do part of the work. I predicted, however, that the elevated prices nationwide would need to drop 16% over the following five years to mirror the far slower trajectory in rents. A number of markets were more inflated than the nation as a whole. In some cases their P/Rs were even higher. In other metros their multiples were similar, but our estimates projected that their future rents would lag the national pace. By our estimates, reaching historical P/Rs over the next five years dictated that prices would crater by 25.1% in Washington, D.C.; 19.5% in Seattle; 23.5% in Phoenix; 24% in Jacksonville; and 34% in Miami.

Here's what actually happened. We didn't hit the precise numbers, but the direction and magnitudes were generally right on, though most of the actual decreases were greater than we anticipated. Across America, prices by November 2012 fell just over 21%, five points more than our estimate. The retreats were also bigger for Seattle (-24%), Phoenix (-38%), Seattle (-24%), Jacksonville (-34%), and Miami (-43%). Washington is a rare case where our projection exceeded what turned out to be a five-year decline of 18%.

Today looks a lot like 2007—but don’t be fooled

For this story, I asked Michael Sklarz, president of Honolulu-based real estate research firm Collateral Analytics, to mine extensive price-to-rent data. Sklarz provided P/R figures for 22 years, from the start of 2000 to the close of 2022, for 24 metros. Sklarz declined to make an estimate for the U.S. as a whole because of the difficulty in assembling reliable rental data. But the numbers for the individual markets imply that the nationwide P/R is significantly lower today than during the mania from 2005 to 2007. That's an encouraging sign. Of the two-dozen cities, 18 feature ratios below the average of those three years, some much lower, such as San Francisco, San Diego, New York, and Miami. Still, the picture varies widely by market. Phoenix, Denver, and practically all of Big Texas—Dallas, Houston, and Austin—are substantially above their 2005–2007 levels.

What's potentially alarming is that prices in most metros, though below levels of the mid-2000s furor, sit much higher than their 22-year averages. No fewer than 15 metros feature P/Rs that are 25% or more above the more than two-decade midpoints, among them Washington (+28%); Tampa, Charlotte, and Houston (all +32%); Seattle (+35%); Denver (+44%); and Las Vegas (+53%). The top three are Austin and Phoenix—each at P/Rs that dwarf their long-term norms by 63%—and Boise, a top destination for California exiles, at 72% above its norm. No cities are below their benchmarks, though Boston, Los Angeles, New York, and Detroit are higher only by single digits, suggesting they're out of danger. Keep in mind that it was just such a divergence that foreshadowed the free fall starting in late 2007. Clearly, these highfliers can keep prices rising, let alone avoid sharp drops, only if the rents rise briskly.

What’s different this time: Rents are waxing fast, too, though with a lag

While rents change more slowly than sales prices (contracts are often set for a year or more), we are seeing right now that rents now expiring are resetting at far higher numbers. "Rents are sticky," says Tobias Peter, the AEI Housing Center's director of research. "Going back to April of last year, rents were rising at 3% annually, and in July it was 9%, both much slower than the increase in home prices. But in the year ended February 2022, rents rose 17%, matching the rise for homes." That means the P/R ratios should stabilize in many markets, though at higher numbers than we've seen historically.

So why might it be different this time? Put simply, the basics of supply and demand are lifting rents and prices in tandem in many hot markets. In the bubble, speculation powered the market. The view that housing promised huge capital gains lured investors to buy bunches of homes that they put up for rent, in turn depressing the fundamental force that drives home prices. That's far from the case today. Families are buying houses to live in, not to trade. Most owners aren't holding or getting risky loans; they typically enjoy big equity cushions, courtesy of the run-up.

Buying should remain strong for two reasons. First, although 30-year home loan rates have risen from 3.5% at the start of this year to 5.1% by April 12, borrowers are still getting a great deal. The year-over-year consumer price index reading of 8.5% recorded that day means new purchasers are paying "real," or inflation-adjusted rates, of less than zero. "It would take a mortgage rate of over 7% to significantly slow demand," says Pinto. He also believes that the Fed would need to increase its base rate to 6% to 7%, driving home loan rates over 9%, "for housing to really get in trouble."

Second, the work-from-home economy is allowing people who've been stuck in San Jose or the New York suburbs because they work there, to relocate in Jacksonville, Boise, or Austin, where housing prices are much lower. By making the move, they can trade a smaller manse for a much bigger colonial or ranch, and still pocket hundreds of thousands in cash. That migration is pushing up prices at the high end in the Sunbelt cities, which are mid-priced compared with comparable neighborhoods in L.A., Boston, or Washington. In effect, the liberation sparked by the COVID crisis created a freer, more fluid market, enabling workers from everywhere to exploit the great buys in metros from Charlotte to Boise. Another potential benefit: Owning a house has traditionally proved one of the best hedges in periods of rampant inflation.

As for supply, the volume of homes for sale today stands at by far the lowest levels in half a century. The inventory of 890,000 family units is around one-third the figure of 2.5 million in 2006, and half the levels of this time last year. New construction is lagging sales by a wide margin nationwide. "Housing starts dropped sharply in the Great Financial Crisis," says Pinto. "And they've been slow to rebound. Land use laws are highly restrictive, and the increase in stock of new homes can only go up so fast. And new construction isn't keeping pace with demand, and shows no signs of doing so." That seniors are staying put instead of the old pattern of selling and moving to rentals or condos is exerting further pressure on supply.

All told, Pinto and Peter forecast that prices will rise 17% for all of 2022 and gain another 11% to 12% next year, assuming mortgage rates don't see a gigantic increase. Rents, they predict, will wax at around the same pace as prices in the strong markets. Here's the rub: Many of the metros where prices outstripped rents won’t get the rental growth necessary to keep appreciating. We're talking about a pretty healthy market overall, but we'll still see a pattern of winners and losers.

In conclusion, this veteran student of bubbles now sees a house on solid ground, its foundation intact. The problem for America is that the symbolic dwelling is a lot more expensive than a few years ago. That's great for the folks who've owned for a while. But eventually, their gain will be a loss for the youthful buyers who won't be able to afford the American dream, even in the “great arbitrage” markets where it is, or used to be, most affordable.