Spatial Dispersion in Returns to Rental Housing: A Decomposition of Local Rent-Price Ratios

Abstract

What explains the significant dispersion in the rent-price ratio of rental housing units across and within US cities? Conventional urban models attribute this heterogeneity to differences in rent growth expectations, although it could also reflect a dispersion in returns earned by investors. In this paper, I construct local average ratios using administrative data on rental properties that reflect the investment decision of household real estate investors in a broad cross section of US cities and neighborhoods. A strong negative covariance between ratios and prices, along with a novel application of the Campbell-Shiller decomposition, can be used to reject the null that investors' rent growth expectations plausibly account for this dispersion. To quantify the relative importance of returns, I decompose past rent-price ratio dispersion into realized dispersion in rent growth and returns. I find that 80% of within-city and 90% of cross-city rent-price dispersion is explained by differential returns, implying large risk differentials, or barriers to arbitrage. These findings underscore the importance of integrating financial mechanisms in understanding the geography of housing markets and household finance.

Keywords: Housing, Gentrification, Housing Returns, Household Finance, Real Estate

JEL Classification: G59, R32, R12, G12