House Prices and Rents in the 21st Century
This paper introduces a framework for interpreting fluctuations in house prices using a new data set of transactions involving single-family and small multifamily homes. The data set includes information on owner- and renter-occupied properties, and it includes sale and rent transactions. The data enable the authors to measure price growth on both types of properties and to calculate a price-to-rent ratio using only renter-occupied properties—properties that are explicitly comparable.
The authors look at the potential drivers of house-price and rent movements during their sample period of 2001 through 2021. These include increases in preferences for housing (preference shocks) and beliefs about future house-price price growth (expectation shocks). Expectation shocks, which generate self-fulfilling price increases, are often the cause of housing bubbles.
While each of the shocks that the authors examine can increase house prices, their implications for the prices of renter-occupied housing, owner-occupied housing, and rent differ. By examining changes in rent, in the price-to-rent ratio, and in the ratio between the prices of owner-occupied houses and renter-occupied houses (the price-to-price ratio), the authors assess which type of shock can best explain the house-price booms of the early 2020s and the early 2000s.
- The sources of growth in house prices varied during the sample period. Early in the period, the price-to-rent ratio and the price-to-price ratio determined house-price growth, while rent growth was relatively minimal. But in the latter years, rent growth became more important and was the main driver of house-price growth during the boom at the start of this decade.
- According to theory, positive expectation shocks raise the price-to-rent ratio as households and investors buy houses partly in anticipation of future capital gains. Expectation shocks are a plausible explanation for the boom of the 2000s but not for the boom of the 2020s.
- An increase in preferences for housing raises both rents and houses prices, according to theory, leaving the price-to-rent ratio unchanged. As noted above, rent growth was the main driver of house-price growth at the start of this decade. The authors find that of the 15 percentage point growth in house prices in 2021, about two-thirds came from nominal rent growth and only about one-quarter came from growth in the price-to-rent ratio. They therefore conclude that a preference shock is a plausible explanation for the boom.
This paper’s result point to the importance of using data on renter-occupied house prices and rents as well owner-occupied house prices when analyzing potential overvaluation in the housing market. An absence of data on renter-occupied properties could prevent the construction of a reliable price-to-rent ratio. This could result in mistaking an increase in the price-to-price ratio for an increase in the price-to-rent ratio or vice versa and in turn lead to the misidentification of the cause of a house-price boom.
We study the joint evolution of prices and rents of residential property. After constructing rent and price indices for renter- and owner-occupied properties, we decompose the change in the price of occupant-owned property into (1) changes in rent, (2) changes in the relative prices of investor- and occupant-owned properties, and (3) changes in the price-rent ratio. Via a simple model, we link our decomposition to different sources of variation in house prices. We argue that while the 2000s boom was plausibly driven by exuberant expectations, the boom of the 2020s more likely resulted from a preference shock.