Should I Buy or Should I Rent: And What is an Appropriate Discount Rate for Housing Consumption in Household Finance?

Abstract

The Gordon Growth Model is used to derive widely differing fundamental values of the same gross rental yield for six hypothetical housing purchasers listed in declining order of magnitude: a fully funded consumer with a marginal tax rate of 40%, a fully funded buy to let investor with a marginal tax rate of 40%, a fully funded tax exempt consumer, a tax exempt buy to let investor, a tax exempt consumer with a 50% loan to value ratio and a buy to let investor with a 50% loan to value ratio and 40% marginal tax rate. Fundamental values are higher for wealthy and risk tolerant purchasers because lower discount rates are applicable to this group. Thus when aggregate wealth is high, and unequally distributed, wealthy consumers and investors will have a disproportionate effect on market prices making them higher than the fundamental values that are applicable to non-wealthy or risk-averse home purchasers. At such times, it is financially preferable for non wealthy households to rent their housing needs, as their discount rates are higher relative to wealthy investors and consumers who have exhausted their investment tax shelters and or are fully funded.

Keywords: House Prices, Property Prices, Real Estate, Valuation, Behavioural Finance

JEL Classification: D1, D84, G10, G12, G14, L85, P36, P46, R21, R31