A Theory of Rational Housing Bubbles with Phase Transitions

We analyze equilibrium housing prices in an overlapping generations model with perfect housing and rental markets. We prove that the economy exhibits a two-stage phase transition: as the income of home buyers rises, the equilibrium regime changes from fundamental only to coexistence of fundamental and bubbly equilibria. With even higher incomes, fundamental equilibria disappear and housing bubbles become inevitable. Even with low current incomes, housing bubbles may emerge if home buyers have access to credit or have high future income expectations. Contrary to widely-held beliefs, fundamental equilibria in the coexistence region are inefficient despite housing being a productive non-reproducible asset.