A Trend and Variance Decomposition of the Rent-Price Ratio in Housing Markets

48 Pages Posted: 13 Dec 2006

See all articles by Joshua Gallin

Joshua Gallin

Board of Governors of the Federal Reserve System

Morris A. Davis

Rutgers Business School

Robert F. Martin

Federal Reserve Board - International Finance Division

Sean D. Campbell

Board of Governors of the Federal Reserve System

Date Written: August 2006

Abstract

We use the dynamic Gordon-growth model to decompose the rent-price ratio for owner-occupied housing in the U.S., four Census regions, and twenty-three metropolitan areas into three components: The expected present value of real rental growth, real interest rates, and future housing premia. We use these components to decompose the trend and variance in rent-price ratios for 1975-2005, for an early sub-sample (1975-1996), and for the recent housing boom (1997-2005). We have three main findings. First, variation in expected future real rents accounts for a small share of variation in our sample rent-price ratios; variation in real interest rates and housing premia account for most of the variability. Second, expected future real rates and housing premia were so strongly negatively correlated prior to 1997 that changes to real interest rates did not affect the rent-price ratio. After 1997, rates and premia have been positively correlated, and the decline in the rent-price ratio that has occurred in almost every geographic area in our sample since 1997 reflects both declining real rates and declining premia. Third, we show that in the recent housing boom, 65 percent of the decline in the aggregate rent-price ratio is due to a declining housing premium.

Keywords: Rent-price ratio, house price, housing rents, interest rate

JEL Classification: C22, C53

Suggested Citation

Gallin, Joshua and Davis, Morris A. and Martin, Robert F. and Campbell, Sean D., A Trend and Variance Decomposition of the Rent-Price Ratio in Housing Markets (August 2006). FEDS Working Paper No. 2006-29, Available at SSRN: https://ssrn.com/abstract=950990 or http://dx.doi.org/10.2139/ssrn.950990

Joshua Gallin (Contact Author)

Board of Governors of the Federal Reserve System ( email )

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Morris A. Davis

Rutgers Business School ( email )

Rutgers Business School
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Robert F. Martin

Federal Reserve Board - International Finance Division ( email )

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HOME PAGE: http://www.rfmartin.com

Sean D. Campbell

Board of Governors of the Federal Reserve System ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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