Thursday, October 15, 2009

Rent & House Prices-Substitutes

After having risen relatively much, the "rent" (and "owner's equivalent rent"-component) in the CPI falls for the first time in 17 years, after having been stagnant for several months. This shift comes interestingly enough after house prices started to recover, after a long time of significant drops.

Add to that the fact that rent increases were relatively modest during the bubble, and it becomes clear that the cost of the different forms of housing costs are negatively and not positively correlated.

This need not be the case. If there is a general increase in demand for housing, due to for example an increasing population or increased preference among the young for moving from their parents, or an increased preference among the wealthy for having multiple homes, then this should raise both rents and house prices.

However, if we look at another theoretical scenario where the focus is on housing consumers having big shifts in relative preference for owning and renting, then the two prices should indeed move in opposite direction. When the preference for owning increased due to low interest rates then demand for rented housing fell, putting a downward pressure on rents.

After the housing bubble bursted, people became increasingly reluctant to own houses and instead increasingly preferred renting their homes something which helped push up rents.

Now the preference for owned housing is again increasing, pushing upward pressure on house prices and downward pressure on rents.

So, we have two different theoretical scenarios, one concerning general demand for housing and one concerning relative demand for owned and rented housing. While it under under circumstances would be possible for the first scenario to be more important, it is clear that in the recent decade the second has been more important in America.


Blogger Henry said...

House prices comprise two components: the building value and the site value. Building values are broadly speaking closely tied to the price of building materials and builders' wages. The fire insurance value is a reasonable guide to the value of a building.

Land or site value is the component that bubbles up and implodes, apparently cyclically. The primary value of land is its annual rental value, which in the case of land occupied by an owner is an imputed income ie rent which would otherwise have to be paid.

Land price is best thought of as the price for the purchase of a revenue stream. It will be determined by several factors in addition to rental values, including interest rates, the availability of credit or other forms of finance, expectations of interest rate changes, expectations of rental value changes and expectations of changes in land prices themselves. Thus a substantial element of land prices is speculative, which makes them relatively volatile.

Amongst the implications are that land and property prices should not be used as a base for property tax assessments, which unfortunately they almost always are these days, with a few honourable exceptions including the British national non-domestic rate (NNDR) which is based on current annual rental values with a quinquennial review.

11:35 PM  

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