The Real Interest Rate Effect on the Price Elasticity of House Supply

Eric Levin and Gwilym Pryce

ERES from European Real Estate Society (ERES)

Abstract: A dramatic fall in the annual rent to house price ratio and long real interest rates during a period of relatively static real rents in the UK suggests that the stream of future imputed rents became discounted at successively lower interest rates from 1995 onwards. This paper argues that the decline in long real interest rates over this period likely contributed not only to rising house prices but also to the inelastic supply response. We develop a simple algebraic model that demonstrates how the price elasticity of house supply is lower when interest rate movements (rather than demography or income changes, for example) cause the change in house prices. Our empirical results show that a fall in the long term real interest rates significantly increases the annual growth rate in residential land prices. It is this increased cost of land ñ and hence the cost of building a house ñ that depresses the price elasticity of supply.

JEL-codes: R3 (search for similar items in EconPapers)
Date: 2007-01-01
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Persistent link: https://EconPapers.repec.org/RePEc:arz:wpaper:eres2007_200

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