Rents Must Rise to get in Sync With Home Prices
The benchmark ratio of rents to home prices is slowly returning to its long-run average but it could be at the expense of home prices, according to a study by Federal Reserve Board economists and a University of Wisconsin professor suggests.
The ratio, which compares imputed rents of home owners to the value of owner-occupied housing, is a valuation of residential housing that is equivalent to the earnings-price ratio used to value stocks.
The rent-price ratio ranged between 5 percent and 5.5 percent between 1960 and 1995 but fell rapidly after that, hitting a historic low of 3.5 percent by the end of 2006 as home prices grew rapidly.
In the first half of 2007 the ratio started to climb again, and incoming data suggests that the rent-price ratio has continued to increase, the authors note.
The study, however, suggests housing prices would have to fall 15 percent over five years, assuming rents rose 4 percent a year, to be back in sync.
Economist Morris Davis of University of Wisconsin-Madison says that “rapid growth in rents” is crucial to justify the current level of home prices. However, he adds, an increase in unsold properties on the rental market could hinder rent increases.
Source: Reuters News and The Wall Street Journal, Greg Ip (01/03/08)