Rent to Purchase Price Ratio
According to calculations by The Economist (with the help of Julian Callow of Barclays Capital), house prices are at record levels in relation to rents (ie, yields are at record lows) in America, Britain, Australia, New Zealand, France, Spain, the Netherlands, Ireland and Belgium. America's ratio of prices to rents is 32% above its average level during 1975-2000. By the same gauge, property is “overvalued” by 60% or more in Britain, Australia and Spain, and by 46% in France.
The ratio of prices to rents is a sort of price/earnings ratio for the housing market. Just as the price of a share should equal the discounted present value of future dividends, so the price of a house should reflect the future benefits of ownership, either as rental income for an investor or the rent saved by an owner-occupier. To bring the ratio of prices to rents back to equilibrium, either rents must rise sharply or prices must fall. Yet central banks cannot allow rents to surge as this would feed into inflation. Rents directly or indirectly account for 29% of America's consumer-price index, so rising inflation would force the Fed to raise interest rates more swiftly, which could trigger a fall in house prices. Alternatively, if rents continue to rise at their current annual pace of 2.5%, house prices would need to remain flat for over ten years to bring America's ratio of house prices to rents back to its long-term norm. There is a clear risk prices might fall.
See: The Economist - Still Want to Buy?
http://economist.com/printedition/displayStory.cfm?Story_ID=3722894
The ratio of prices to rents is a sort of price/earnings ratio for the housing market. Just as the price of a share should equal the discounted present value of future dividends, so the price of a house should reflect the future benefits of ownership, either as rental income for an investor or the rent saved by an owner-occupier. To bring the ratio of prices to rents back to equilibrium, either rents must rise sharply or prices must fall. Yet central banks cannot allow rents to surge as this would feed into inflation. Rents directly or indirectly account for 29% of America's consumer-price index, so rising inflation would force the Fed to raise interest rates more swiftly, which could trigger a fall in house prices. Alternatively, if rents continue to rise at their current annual pace of 2.5%, house prices would need to remain flat for over ten years to bring America's ratio of house prices to rents back to its long-term norm. There is a clear risk prices might fall.
See: The Economist - Still Want to Buy?
http://economist.com/printedition/displayStory.cfm?Story_ID=3722894
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