Saturday, January 05, 2008

Why Rent-to-Price ratios can Change

Anonymous (according to the New York Times Crossword Puzzle, the most prolific of authors) wonders why changes in expectations about house prices arising from greater land use regulation would change the rent-to-price ratio. For the answer, we need only turn to the user cost equation

Value*(r + m - g) = Rent

Where r is the after-tax cost of capital, m is the proportional maintenance/depreciation cost, and g is expected growth in prices. As g gets larger (and it should as supply becomes more contrained), the rent-to-price ratio will fall.


TStockmann said...

I'm not sure that r and g should be treated as independent variables, since over time accurate g migrates into r, either in reality if the property changes hands or in terms of opportunity cost if it doesn't. Second, while g can fluctuate, there are delimiting factors that would cause a considerable reversion to the mean.

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