so a house just sits there, generating money. This means that it has an investment value. That value is "determined" by the cost of comparable investments because of arbitrage. If I have some money invested making less than 1 rent/month (minus expenses and so forth), then I will happily buy the house for that money. Likewise if there is some cheaper investment which will give me the same return on my investment, I will sell the house and switch, pocketing the difference.
One example of such an investment is the mortgage itself. as a bank, by signing a mortgage with someone, I am extracting the interest rate on the value of that house every month (plus some portion of the principle).
I mean, you can sit there all day and say "well, it doesn't make sense that people would buy instead of rent if it were economically disadvantageous, so the market must be relatively balanced." But that's simply not the case. You can look at actual numbers to show you this.
What's your source for this? I've rented in and around the Boston area for 10 years now, and my husband and I just purchased a home last week. Our rent for a 975 sqft 2br apartment on the seventh floor of a large complex out in the suburbs was $2,100/month. No balcony, no yard, no storage, although utilities are included. We definitely weren't getting a good deal, but our rent had increased from $1800 over the last 3 years.
Our house is in a better location (more convenient to public transportation, better schools, "cooler" restaurants), much bigger (1410 sqft, 3br/1.5 bath, office, plus unfinished basement with 6'6" ceilings, attic, front and back decks, backyard, 2 car detached garage), and our monthly costs -- INCLUDING taxes and estimated utilities are $3,200/month. Renting a house like this would run you $2400-$3400 month, if Craigslist is any indication (searched for 3br full houses in the same neighborhood as ours -- near a college, lots of rentals).
So, yes, we're on the higher end of rent, and we have to do our own repairs, but the costs of rent are paying for far more than just interest on a mortgage. The tax benefit is nice icing on the cake, but it barely factored into our decision to buy, rather than rent.