(FORTUNE Magazine) – Xerox executive Bill Skinner camped out at a construction site one night in July 1996 to get a shot at buying a three-bedroom townhouse in Sunnyvale, Calif., the heart of Silicon Valley, for $215,000. Today his neighbors are turning down offers of $300,000. "It's bizarre, it's crazy," says Skinner. And it's happening throughout the San Francisco Bay area, where a strong economy and stock option riches are driving up already high housing prices. It's also happening in Manhattan, where big Wall Street bonuses helped drive up condominium prices about 15% in 1997. Real estate kingpin (and high-end condo salesman) Donald Trump crows, "This makes the 1980s look like child's play."

Yikes. In the 1980s real estate prices in California and the Northeast made a similar ascent--and then came crashing back to earth, taking local economies with them. Are we being set up for another painful fall?

Could be. Real estate, especially on the coasts, has always been subject to boom-bust cycles. And it has definitely been booming lately: U.S. housing prices rose 5.8% last year, twice the rate of inflation. In Albuquerque, Anchorage, Denver, Salt Lake City, and Portland, Ore., homeowners who in 1991 put 20% down on a typical house have tripled their money--outperforming the record bull market in stocks.

But there are signs that the current cycle is a little saner than the last. For one thing, thanks to the long and widespread economic expansion, housing prices have gone up more evenly across the country this time around, reducing disparities between the most and least expensive cities.

What's more, real estate players remember the hard lessons learned in the last cycle: Toll Brothers, the nation's premier luxury-home builder, approves only projects that will be profitable even if housing doesn't appreciate, says CEO Robert Toll. Regulators also are more careful. While banks have been easing their lending standards--as they always do in good economic times--the FDIC and the Office of the Comptroller of the Currency have been issuing warnings to get them to slow down.

Perhaps the most hopeful sign is this: Despite the rising prices, housing is, on average, still more affordable today than it was at the beginning of the decade. Thanks to lower interest rates, a buyer of a typical house today pays a monthly mortgage payment of only $1,080, $120 less per month than in 1990. And thanks to the coastal real estate crashes of the late 1980s and early 1990s, even fast-rising San Francisco and New York prices have only recently surpassed the tops of the last cycle. Meanwhile, incomes are about 30% higher now.

The higher incomes are key. As long as housing prices rise in tandem with economic indicators like job growth, GDP, and household income--as is the case now in much of the country--homeowners' gains are usually sustained.

The problem comes when house-price gains overshoot economic reality. That can happen because the real estate market is even more irrational and inefficient than, say, the stock market. Explains Ohio State University economist Patric Hendershott: When a one-time shock, such as a drop in interest rates, gives a boost to housing prices, people extrapolate and expect prices to rise again the next year, even if there is no reason for them to do so. Expectations alone can drive up house prices for a year or two, but something always happens to bring them back to reality. It's a bubble that eventually must pop. Hendershott's research shows that in recent years such bubbles have developed only in coastal cities, where adding new houses is difficult, thus lengthening the time it takes for supply to respond to new demand. Which brings us back to New York and San Francisco.

In New York, where housing price appreciation has been driven almost entirely by Wall Street profits (job growth has been anemic), the biggest gains have been limited to communities where rich Wall Street types live--Manhattan and a few snazzy suburbs. The rest of the metro area has seen only modest increases. So while a crash could certainly come, its impact would be limited.

In the San Francisco area, high-tech workers' stock option jackpots, coupled with a vibrant overall economy and a shortage of land to build on, have driven up prices across the board. The effects have been especially pronounced in Silicon Valley, where even the wealthiest tech companies are beginning to find formerly middle-class towns like Palo Alto--where the average house now goes for $500,000--too rich for their blood. It's telling enough that computer maker Sun Microsystems, based just south of Palo Alto in Mountain View, has an executive who goes by the title "director of real estate and the workplace." When that executive, David Raduziner, complains that "it is becoming very difficult to recruit talent into the Bay Area," you can be sure that something has got to give.

--Kim Clark