The Rent-Price Index in U.S Housing Markets

Abstract

In this paper, the relationship between house prices and rents across eight major metropolitan areas in the U.S. is examined, and a rent price index to provide the framework of our analysis is developed. Adjustments in the rent-price ratio can theoretically occur through the numerator, the denominator, or both. Intuitively, rents are stickier than prices, and therefore, prices are expected to do most of the adjusting when the ratio significantly deviates from historical norms. Our results support this intuition. Our analysis shows that low rent-price ratios are associated with subsequent periods of low or negative house price changes. This implies that house prices overshoot fundamental values associated with capitalization of future rents, and revert to equilibrium through subsequent price correction. Based on rent-price index levels across the eight regions we analyzed, the current housing market correction has already unwound much of its previous overshooting, but it is important to note that the overshooting process may work to the downside as well as the upside. For house price data, we utilize the S&P/Case-Shiller Home Price Indices. For rent data, we utilize the Bureau of Labor Statistic's metro area owner's equivalent rent indices, an input to the Consumer Price Index (CPI).

Keywords: rent-price ratio

JEL Classification: C30