Friday, May 09, 2008 on Rents and House Prices

by Calculated Risk on 5/09/2008 01:53:00 PM

The Economist has a great overview on housing: Map of misery. There is a good discussion on the differences between the OFHEO index (used by Fed Chairman Bernanke) and the Case-Shiller Home Price indices. The story also discusses the huge overhang of inventory (see story for discussion).

At the bottom of the story (hat tip Eyal) is this graph of rents as % of house prices:

Rent as percent of price

[This] chart shows ... the relationship between house prices and rents. This is a sort of price/earnings ratio for the housing market ...

A recent analysis by Morris Davis of the University of Wisconsin-Madison, and Andreas Lehnert and Robert Martin of the Fed, shows that the rent/price yield in America ranged between 5% and 5.5% from 1960 to 1995, but fell rapidly thereafter to reach a historic low of 3.5% at the height of the boom. Given the typical pace of rental growth, Mr Feroli reckons house prices (as measured by the Case-Shiller index) need to fall by 10-15% over the next year and a half for the rent/price yield to return to its historical average.
Note that the shaded area is the forecast. I think it will take longer for prices to return to the normal ratio.

Note: I covered this paper in January with some graphs. Here is the paper from Morris A. Davis (Department of Real Estate and Urban Land Economics, University of Wisconsin-Madison), Andreas Lehnert, and Robert F. Martin (both Federal Reserve Board of Governors economists): The Rent-Price Ratio for the Aggregate Stock of Owner-Occupied Housing