Abstract
Studies have typically adopted the price-rent ratio to determine whether housing exuberance exists and the periods of imbalance between house prices and rental costs. Using the price-rent ratio to conduct tests without considering the effects of mortgage interest rates on user costs may overestimate episodes of exuberance. This study uses data of the overall housing market and those of 10 major metropolitan statistical areas (MSAs) in the United States from 1979Q1 to 2018Q1 to evaluate whether housing exuberance exists in the markets; the results indicate that all the MSAs experienced episodes of exuberance at different times and the overall housing U.S. market was overheated from 1998Q2 to 2007Q3. By considering mortgage rates and using the user-cost-rent ratio, we further determine that short-term housing exuberance emerged in only two MSAs, Los Angeles and Miami, in 2006Q2, which was followed by immediate corrections. Thus, the research results of this study signify that only use the price-rent ratio to determine whether or not rational housing tenure choice made by traders exists is not sufficient. This study provides evidence showing that the method incorporating mortgage interest rates tends to obtain an equilibrium relationship between the rental and housing markets, indicating interest rates play an important role in housing tenure choice.
Highlights
Research on the correlations between house prices and rental costs has predominantly employed two types of methods: one is to test the stationary sequence of the price-rent ratio to verify the balance between house prices and rental costs, and the other one is to estimate the rent-price ratio to examine house price misvaluations
From the perspective of housing tenure choice, this study proposes that the user–cost–rent ratio that incorporates mortgage interest rates can be tested to determine if housing markets are overheated relative to rental markets to further identify episodes of exuberance in housing markets
By referring to the theory developed by Poterba (1984, 1991), the researchers posit the rent-price ratio to be equivalent to the difference between the user cost and the expected growth rate of house prices; when the rentprice ratio is less than such difference, it means a housing market is in a bubble and has deviated from its fundamentals
Summary
Research on the correlations between house prices and rental costs has predominantly employed two types of methods: one is to test the stationary sequence of the price-rent ratio to verify the balance between house prices and rental costs, and the other one is to estimate the rent-price ratio to examine house price misvaluations. If rents cannot adjust dynamically in the short term, whereas house prices change with the other fundamental factors in the housing market, only use the price-rent ratio to determine whether housing exuberance exists may. By referring to the theory developed by Poterba (1984, 1991), the researchers posit the rent-price ratio to be equivalent to the difference between the user cost and the expected growth rate of house prices; when the rentprice ratio is less than such difference, it means a housing market is in a bubble and has deviated from its fundamentals. A recent study by Pavlidis et al (2016) constructs dynamic indicators to evaluate whether the price-rent ratio is out of balance These indicators assume that rent is a fundamental factor that effectively measures changes in house prices. The results of this study can be used to better determine whether an equilibrium exists between housing markets and rental markets and explain whether nonfundamental housing bubbles contribute to the imbalance between house prices rental costs
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