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Rental Adjustment and Housing Prices: Evidence from Hong Kong's Residential Property Market

Honglin Wang (), Chu Zhang and Weihang Dai
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Chu Zhang: The Hong Kong University of Science and Technology and Hong Kong Institute for Monetary Research
Weihang Dai: The Chinese University of Hong Kong and Hong Kong Institute for Monetary Research

No 12013, Working Papers from Hong Kong Institute for Monetary Research

Abstract: This paper investigates the interaction between housing prices and housing rentals. Standard economic models treat housing prices as the present discounted value of future rentals with the latter treated as exogenous. Casual observation, however, suggests that changes in rental prices often follow housing price changes. Economic theory also supports the view that rental prices may not be exogenous. Extending the user-cost model of house price determination, we propose that expected returns on alternative investments contribute positively to the rental adjustment process. We estimate an empirical model for Hong Kong house prices and show that a 1% change in the gap between rental yields and equilibrium whole economy capital returns, the return gap, implies a 0.30% change in real rents. One policy implication is that price changes in the housing market can impact the rental adjustment process by changing the return gap. Consequently, variation in the price-to-rent ratio, which is often used to measure the divergence of housing prices from their equilibrium level can underestimate the size of any housing market 'bubble'.

Keywords: Rental Adjustment; Residential Property Market; Price-To-Rent Ratio (search for similar items in EconPapers)
Pages: 29 pages
Date: 2013-01
New Economics Papers: this item is included in nep-ure
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