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REAL ESTATE Interesting new study on home prices

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Aug 31, 2007
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A friend just forwarded me the link for a recent article published at the University of Wisconsin-Madison with the title "The Rent-Price Ratio for the Aggregate Stock of Owner-Occupied Housing".

The main conclusion of the study is that rents for the 35 years from 1960 to 1995 were on average 5% to 5,5% of house prices. However in 1996 house prices started raising much faster than rents.

They predict that for the rent/price ratio to return to the historical average home prices would have to fall 15% in the next five years assuming rents would increase 4% per year during this period. For the balance to be reached faster home prices would have to drop more.

Interesting read and more on fact based than the usual articles. Food for thought. :coffee:

Text @ http://morris.marginalq.com/DLM_fullpaper.pdf
 

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JScott

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Certainly an interesting read (thanks for posting!)...

One thing that jumped out at my though, is that there is no reason to believe that the historical yield (rent/price) should necessarily settle at a given point. Sure, the data indicates that for the 35 year period from 1960-1995, the yield held at around 4.5-5.5%, there's no reason to believe that this range is "correct" or "normal". It's just a representation of where the range was during that period, and can't necessarily be used as a predictor of future yields.

One (admittedly not so great) analogy is the stock market. By looking at the 25-year historic pricing of the DJI average from 1930-1955, you'd have seen that it held in the $100-$300 range. For the ten years starting in 1955, it rose considerably. If you had used the logic back then that the "normal" or "correct" pricing of the DJI average was $100-$300, in 1965 you might have concluded there was a bubble. But, obviously today (40 years later), it's clear that $100-$300 isn't a "normal" range for the DJI average.

Anyway, again, not a perfect analogy (home yields have much different underlying mechanisms than the stock market), but it highlights my questions about the usefulness of this study.
 
OP
OP
Analyzer

Analyzer

Contributor
Aug 31, 2007
245
71
40
Portugal, Europe
One (admittedly not so great) analogy is the stock market. By looking at the 25-year historic pricing of the DJI average from 1930-1955, you'd have seen that it held in the $100-$300 range. For the ten years starting in 1955, it rose considerably. If you had used the logic back then that the "normal" or "correct" pricing of the DJI average was $100-$300, in 1965 you might have concluded there was a bubble. But, obviously today (40 years later), it's clear that $100-$300 isn't a "normal" range for the DJI average.
I think the problem with the analogy is not so much the different underlying mechanisms but comparing a ratio with an absolute value.

The ratio describe by the article is basically a earnings or cashflow - the rent - to price - the home price/value. I guess that if you compare one of these ratios P/E or P/CF (and specially if you take into account inflation for different periods) they should be more less constant.
 

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