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The long-run relationship between house prices and rents

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Author Info
Joshua Gallin
Abstract

I show that when house prices are high relative to rents (that is, when the rent-price ratio is low) changes in real rents tend to be larger than usual and changes in real prices tend to be smaller than usual. Standard error-correction models provide inconclusive results about the predictive power of the rent-price ratio at a quarterly frequency. I use a long-horizon regression approach to show that the rent-price ratio helps predict changes in real rents and real prices over three-year periods. This result withstands the inclusion of a measure of the user cost of capital. I show that a long- horizon regression approach can yield biased estimates of the degree of error correction if prices have a unit root but do not follow a random walk. I construct bootstrap distributions to conduct appropriate inference in the presence of this bias. The results lend empirical support to the view that the rent-price ratio is an indicator of valuation in the housing market.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2004-50.

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Date of creation: 2004
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Handle: RePEc:fip:fedgfe:2004-50

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Keywords: Housing - Prices ; Rental housing - Prices;

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References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Michelle H. Dreiman & Anthony Pennington-Cross, 2004. "Alternative Methods of Increasing the Precision of Weighted Repeat Sales House Prices Indices," The Journal of Real Estate Finance and Economics, Springer, vol. 28(4), pages 299-317, 05. [Downloadable!]
  2. Mankiw, N. Gregory & Weil, David N., 1989. "The baby boom, the baby bust, and the housing market," Regional Science and Urban Economics, Elsevier, vol. 19(2), pages 235-258, May. [Downloadable!] (restricted)
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  3. Case, Karl E & Shiller, Robert J, 1989. "The Efficiency of the Market for Single-Family Homes," American Economic Review, American Economic Association, vol. 79(1), pages 125-37, March. [Downloadable!] (restricted)
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  4. Gatzlaff, Dean H & Haurin, Donald R, 1997. "Sample Selection Bias and Repeat-Sales Index Estimates," The Journal of Real Estate Finance and Economics, Springer, vol. 14(1-2), pages 33-50, Jan.-Marc. [Downloadable!] (restricted)
  5. Todd Sinai & Nicholas S. Souleles, 2003. "Owner-Occupied Housing as a Hedge Against Rent Risk," NBER Working Papers 9462, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  6. Blackley, Dixie M. & Follain, James R., 1996. "In search of empirical evidence that links rent and user cost," Regional Science and Urban Economics, Elsevier, vol. 26(3-4), pages 409-431, June. [Downloadable!] (restricted)
  7. Clark, Todd E., 1995. "Rents and prices of housing across areas of the United States. A cross-section examination of the present value model," Regional Science and Urban Economics, Elsevier, vol. 25(2), pages 237-247, April. [Downloadable!] (restricted)
  8. David Reifschneider & Robert Tetlow & John Williams, 1999. "Aggregate disturbances, monetary policy, and the macroeconomy: the FRB/US perspective," Federal Reserve Bulletin, Board of Governors of the Federal Reserve System (U.S.), issue Jan, pages 1-19. [Downloadable!]
  9. Campbell, John Y & Shiller, Robert J, 1988. " Stock Prices, Earnings, and Expected Dividends," Journal of Finance, American Finance Association, vol. 43(3), pages 661-76, July. [Downloadable!] (restricted)
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  10. John Y. Campbell & Robert J. Shiller, 2001. "Valuation Ratios and the Long-Run Stock Market Outlook: An Update," NBER Working Papers 8221, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  11. Fama, Eugene F. & French, Kenneth R., 1988. "Dividend yields and expected stock returns," Journal of Financial Economics, Elsevier, vol. 22(1), pages 3-25, October. [Downloadable!] (restricted)
  12. Hodrick, Robert J, 1992. "Dividend Yields and Expected Stock Returns: Alternative Procedures for Inference and Measurement," Review of Financial Studies, Oxford University Press for Society for Financial Studies, vol. 5(3), pages 357-86. [Downloadable!] (restricted)
  13. Case, Bradford & Pollakowski, Henry O & Wachter, Susan M, 1997. "Frequency of Transaction and House Price Modeling," The Journal of Real Estate Finance and Economics, Springer, vol. 14(1-2), pages 173-87, Jan.-Marc. [Downloadable!] (restricted)
  14. Jonathan Heathcote & Morris Davis, 2004. "The Price and Quantity of Residential Land in the United States," 2004 Meeting Papers 32, Society for Economic Dynamics.
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  15. Mark, Nelson C, 1995. "Exchange Rates and Fundamentals: Evidence on Long-Horizon Predictability," American Economic Review, American Economic Association, vol. 85(1), pages 201-18, March.
  16. Capozza, Dennis R. & Seguin, Paul J., 1996. "Expectations, efficiency, and euphoria in the housing market," Regional Science and Urban Economics, Elsevier, vol. 26(3-4), pages 369-386, June. [Downloadable!] (restricted)
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  2. Theodore Crone & Leonard I. Nakamura & Richard Voith, 2008. "Rents have been rising, not falling, in the postwar period," Working Papers 08-28, Federal Reserve Bank of Philadelphia. [Downloadable!]
  3. Theodore M. Crone & Leonard I. Nakamura & Richard Voith, 2006. "The CPI for rents: a case of understated inflation," Working Papers 06-7, Federal Reserve Bank of Philadelphia. [Downloadable!]
  4. Sean D. Campbell & Morris A. Davis & Joshua Gallin & Robert F. Martin, 2006. "A trend and variance decomposition of the rent-price ratio in housing markets," Finance and Economics Discussion Series 2006-29, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
  5. Wenli Li & Rui Yao, 2006. "Your house just doubled in value? Don't uncork the champagne just yet!," Business Review, Federal Reserve Bank of Philadelphia, issue Q1, pages 25-34. [Downloadable!]
  6. Alan G. Ahearne & John Ammer & Brian M. Doyle & Linda S. Kole & Robert F. Martin, 2005. "Monetary policy and house prices: a cross-country study," International Finance Discussion Papers 841, Board of Governors of the Federal Reserve System (U.S.). [Downloadable!]
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  7. Arthur Grimes & Andrew Aitken, 2007. "House Prices and Rents: Socio-Economic Impacts and Prospects," Working Papers 07_01, Motu Economic and Public Policy Research. [Downloadable!]
  8. David Duffy & John Fitz Gerald & Ide Kearney, 2005. "Rising House Prices in an Open Labour Market," The Economic and Social Review, Economic and Social Studies, vol. 36(3), pages 251-272. [Downloadable!]
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  9. David C. Wheelock, 2006. "What happens to banks when house prices fall? U.S. regional housing busts of the 1980s and 1990s," Review, Federal Reserve Bank of St. Louis, issue Sep, pages 413-430. [Downloadable!]
  10. Matteo Iacoviello & Stefano Neri, 2007. "Housing Market Spillovers: Evidence from an Estimated DSGE Model," Boston College Working Papers in Economics 659, Boston College Department of Economics, revised 23 Oct 2009. [Downloadable!]
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  11. Frederic S. Mishkin, 2007. "Housing and the monetary transmission mechanism," Proceedings, Federal Reserve Bank of Kansas City, pages 359-413. [Downloadable!]
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