The consensus view that housing remains significantly overvalued reflects the high level of the house price to average earnings ratio. A national accounts version of this metric is the value of the housing stock divided by aggregate household disposable income. This stood at 4.31 at the end of 2010, 52% above the average of 2.84 since 1965 – see first chart.

The "equilibrium" level of prices relative to earnings, however, has trended higher over time as rising demand – due to an expanding population, a fall in average household size and the tendency to spend more on accommodation as income increases – has clashed with inelastic supply. The housing stock / aggregate income ratio at the end of 2010 stood 5% below a log-linear regression line – first chart.

A superior valuation metric is the ratio of prices to rents or its inverse, the rental yield. Rents already incorporate fundamental influences on housing demand and supply. People need to live somewhere – the choice is between buying your own home or renting, not between spending money on housing or retaining income for other purposes.

A national accounts version of the rental yield is the sum of actual and owner-occupied imputed rents divided by the value of the housing stock. This finished 2010 at 3.56% – almost exactly in line with its average since 1965, of 3.57%.

The yield reached a low of 2.77% in September 2007, consistent with house prices being overvalued by 29% (the percentage deviation of 3.57 from 2.77). This excess, however, has been eliminated by a combination of a 5% fall in prices – according to the Department of Communities and Local Government index – and a 24% rise in rents.

The statement that housing is not expensive does not, of course, preclude a fall in prices to an undervalued level, for example if a shock to household income resulted in forced selling. Displaced owner-occupiers, however, would add to the demand for rented accommodation. Any downside for prices from current levels is likely to be temporary and limited as long as rents continue to increase solidly.