Both bubbles (rents and housing) are vulnerable to popping.
Here is the conventional narrative about rents and housing valuations:
1. Rents have soared because people can’t afford to buy a house and have to rent
2. Based on soaring rents, housing is fairly valued
In other words, rents and housing are tautological: rents are rational because housing values are rational, and housing values are rational because rents are rational.
Nice, but wrong: rents and housing are self-reinforcing bubbles: rents are soaring because housing is unaffordable, i.e. echo-bubble valuations. Soaring rents then justify bubblicious home prices.
Is the Echo Housing Bubble About to Burst?
One way to establish fair value of a home is to multiply the rental income the house can fetch in the open market. Multiply gross rents (before expenses, property taxes, etc.) by 8 to 15 (depending on the desirability of the locale and property) and you get an investment-based valuation.
So if a property earns $50,000 annually in gross rental income, the property is worth around $500,000, with premiums being added for low vacancy rates, desirable neighborhood, well-maintained home, etc.
Another approach is to calculate the net rent (total rent minus all expenses except mortgage) and base the value on the net rental income. Any property yielding 5% after expenses (i.e. 20 times net income) is an attractive investment in a world of negative short-term interest rates and 3% returns on 30-year bonds.
Rental demand is reflected by vacancy rates; low vacancy rates reflects high demand. Vacancy rates are low, but not at historic lows except in certain high-demand urban zones.