Predicting Returns and Rent Growth in the Housing Market Using the Rent-to-Price Ratio: Evidence from the OECD Countries

Abstract

We conduct a comprehensive international study of predictability in housing markets using the rent-price ratio as a predictive variable. On data from 18 OECD countries we generally find return predictability in accordance with time-varying risk-premia, but we also document two puzzles. First, there is a highly unstable predictive pattern in rent growth across countries and time periods. Second, the predictive patterns are highly dependent on whether housing returns and rents are measured in nominal or real terms. These results are difficult to reconcile with fully rational expectations. Among other things, the results indicate that housing markets in many countries suffer from money illusion.

Keywords: Housing market predictability, dynamic Gordon growth model, rent-price ratio, VAR model, expectations, money illusion, OECD countries

JEL Classification: C32, G12, R31