A few ways that housing can continue to increase as a percentage of income:
1.) Go from a single income supporting to a house to multiple incomes supporting a house. This is actually happening, with the shift from single-earner households in the 1950s to dual-income households to groups of unmarried professionals living together as roommates. The preponderance of post-1950s data can also overweight this effect: historically, the norm was far large extended families to live together in one household, and the single-earner U.S. nuclear family was an aberration created by suburbanization.
2.) Have reset points. How can real estate continue to return 7% real returns for 120 years? Well, return 7% for 40 years, at which point your investment is up 15x. Then bomb the house and kill the owner. Then give the land to the guys who helped you kill the owner at a low, low price, help them build a house on it cheap, and start the 7% appreciation calculator over again from a new low baseline. This is also very close to what actually happened over those 120 years, between WW1, WW2, the Russian/Ottoman/Austrian revolutions, the fall of the Warsaw Pact, the Chinese Civil War / Cultural Revolution / Great Famine, and so on.
3.) Have a smaller percentage of people owning houses. The average housing price can absolutely escape the confines of the median income, if the median person does not own a house. The study's use of rent and imputed rent partially controls for this, but the broad answer for "Housing prices can't outstrip incomes forever, can they?" is "Sure they can, if nobody can afford houses."
4.) Have more people. If you're talking the returns to an asset class, and you own all that asset class, and then suddenly there are more people that need that asset, you're going to make money. This, to a large degree, actually happened during those 120 years.