HOUSING PRICES HAVE risen by about 50 percent in the past five years, and more than 100 percent in some hot markets. Many knowledgeable observers believe that the United States is in the midst of a speculative bubble in residential real estate prices that rivals the dot-com bubble of the 1990s and that will have a similarly unhappy conclusion. In December 2004 UCLA Anderson Forecast's Economic Outlook described the California housing market as a bubble, repeating their warnings made in previous years. Robert Shiller has issued similar alarms for several years and, in June 2005, warned that, "The [housing] market is in the throes of a bubble of unprecedented proportions that probably will end ugly." (1) Shiller suggests that real housing prices might fall by 50 percent over the next decade. In August 2005 Paul Krugman argued that there was definitely a housing bubble on the coasts and that, indeed, the air had already begun leaking out. (2) Evidence of a housing bubble has been suggestive but indirect, in that it does not address the key question of whether housing prices are justified by the value of the services provided by a home. We first show how to estimate the fundamental value of a home from rent data. We then use this procedure to estimate the fundamental value of homes in ten urban housing markets using a unique set of rent and sale price data for matched single-family homes. Our evidence indicates that, even though prices have risen rapidly and some buyers have unrealistic expectations of continuing price increases, the bubble is not, in fact, a bubble in most of these areas: under a variety of plausible assumptions about fundamentals, buying a home at current market prices still appears to be an attractive long-term investment. Our results also demonstrate that models that gauge a housing bubble by comparing movements in housing price indexes with movements in other indexes or with the values predicted by regression models are flawed, because they assume that market prices fluctuate randomly around fundamental values. Those models must assume that prices were close to fundamentals in the past in order to conclude that the 2001-05 run-up pushed prices above fundamentals. But maybe prices were below fundamentals in the past and the 2001-05 run-up pushed prices closer to fundamentals. Defining a Bubble Charles Kindleberger defined a bubble this way: a sharp rise in price of an asset or a range of assets in a continuous process, with the initial rise generating expectations of further rises and attracting new buyers--generally speculators interested in profits from trading in the asset rather than its use or earning capacity. The rise is usually followed by a reversal of expectations and a sharp decline in price often resulting in financial crisis. (3) Researchers often focus on a single specific aspect of this general concept: rapidly rising prices, (4) unrealistic expectations of future price increases, (5) the departure of prices from fundamental value, (6) or a large drop in prices after the bubble pops. (7) Shiller and Karl Case write that, "A tendency to view housing as an investment is a defining characteristic of a housing bubble." (8) To the contrary, we believe that housing is an investment and that the correct way to gauge a bubble is to compare actual home prices with the value of homes as an investment calculated from fundamentals (and that one of the main sources of mispricing in the housing market is that almost none of the participants estimate the fundamental value of their home). We define a bubble as a situation in which the market prices of certain assets (such as stocks or real estate) rise far above the present value of the anticipated cash flow from the asset (what Kindleberger called the asset's use or earning capacity). This definition suggests many of the features noted above: prices rising rapidly, a speculative focus on future price increases rather than the asset's cash flow, and an eventual drop in prices. …