Paul Krugman on housing. Where land is cheap (either because it is easy to get to desirable places or because there are no nearby desirable places to get to) housing is cheap: it sells for its cost of production plus minimal land value:
No Bubble Trouble? - New York Times: [H]ousing in most of America remains surprisingly affordable, thanks to low interest rates.... [F]or the nation as a whole, the cost of owning the median home is still only 23.7 percent of median family income, which is higher than a few years ago but well below the peak of more than 30 percent reached in the early 1980's.... [W]e should think of America as... Flatland and the Zoned Zone. In Flatland, there's plenty of room to build houses, so house prices mainly reflect the cost of construction. As a result, Flatland is pretty much immune to housing bubbles... houses have... become easier to afford since 2000 because of falling interest rates.
But where desirable places are nearby but hard to get to because of congestion, land prices are high:
In the Zoned Zone... house prices mainly reflect the price of these lots rather than the cost of construction... slightly under 30 percent of Americans live in the Zoned Zone, which comprises most of the Northeast Corridor, coastal Florida, much of the West Coast and a few other locations....
But because Zoned Zone homes are much more expensive than Flatland homes, the Zone looms much larger in the housing story than its share of the population might suggest... more than half of the total market value of homes... the great bulk of the surge in housing market value over the last five years.
Thus we need to look at each region separately if we are to make sense of the housing market:
So if we want to ask whether housing values make sense, data on the median house nationwide are irrelevant. We need to focus on houses in the Zoned Zone. And there the numbers are anything but reassuring. In the Zoned Zone, the story that rising home prices have been offset by falling interest rates is all wrong... the cost of owning a home in the New York metropolitan area went from 25 percent of median income in 2000 to 38 percent today. In Miami, the numbers were 21 percent and 42 percent, respectively; in Los Angeles, 31 percent and 55 percent.... Roughly similar percentages of median family income were needed to afford houses in the early 1980's. But that's hardly a comforting comparison.... [T]he reason housing was so expensive in 1981 and 1982 was that mortgage interest rates were extremely high. That made recovery easy, because all it took to make housing affordable again was for interest rates to return to normal levels. This time, with interest rates already low by historical standards, restoring affordability will require a big fall in housing prices.
So here's the bottom line: yes, northern Virginia, there is a housing bubble. (Northern Virginia, not Virginia as a whole. Only the Washington suburbs are in the Zoned Zone.) Part of the rise in housing values since 2000 was justified given the fall in interest rates, but at this point the overall market value of housing has lost touch with economic reality. And there's a nasty correction ahead.