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Run-up in the House Price-Rent Ratio: How Much Can Be Explained by Fundamentals?

Kamila Sommer (), Paul Sullivan and Randal Verbrugge ()
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Kamila Sommer: Georgetown University, FRB Minneapolis

No 441, Working Papers from U.S. Bureau of Labor Statistics

Abstract: This paper studies the joint dynamics of real house prices and rents over the past decade. We build a dynamic general equilibrium stochastic life cycle model of housing tenure choice with fully speci?ed markets for homeownership and rental properties, and endogenous house prices and rents. Houses are modeled as discrete-size durable goods which provide shelter services, confer access to collateralized borrowing, provide sizeable tax advantages, and generate rental income for homeowners who choose to become landlords. Mortgages are available, but home-buyers must satisfy a minimum down payment requirement, and home sales and purchases are subject to lumpy ad- justment costs. Lower interest rates, relaxed lending standards, and higher incomes are shown to account for over one-half of the increase in the U.S. house price-rent ratio between 1995 and 2005, and to generate the pattern of rapidly growing house prices, sluggish rents, increasing homeownership, and rising household indebtedness observed in the data. The model highlights the importance of accounting for equilib- rium interactions between the markets for owned and rented property when analyzing the housing market. These general equilibrium e¤ects can either magnify or reverse the partial equilibrium e¤ects of changes in fundamentals on house prices, rents, and homeownership.

Keywords: house price; rent; house price-rent ratio; housing market equilibrium (search for similar items in EconPapers)
JEL-codes: R21 R31 E21 (search for similar items in EconPapers)
Pages: 43 pages
Date: 2010-10
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Journal Article: The equilibrium effect of fundamentals on house prices and rents (2013) Downloads
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