So taking another angle on our look at the housing real estate market... Price-to-Rent Ratio.
From the good people at CalculatedRisk comes a excellent article and a even more excellent graph (yes, I love pictures). Based on the brainy but understandable letter to the SF fed regarding the housing bubble in 2004 by economist John Krainer (which you can find here and I suggest you read if you have a chance), the price-to-dividend ratio used to value equities in finance can be applied to the housing market in by way of the Price-to-Rent Ratio.
Krainer says, "The finance paradigm holds that an asset has a fundamental value that equals the sum of its future payoffs, each discounted back to the present by investors using rates that reflect their preferences. For stocks, the payoffs requiring discounting are the expected dividends. This approach can extend to housing by recognizing that a house yields a dividend in the form of the roof over the head of the occupant. The fundamental value of a house is the present value of the future housing service flows that it provides to the marginal buyer. In a well-functioning market, the value of the housing service flow should be approximated by the rental value of the house."
Makes sense doesn't it? So lets look at the graph:
From the good people at CalculatedRisk comes a excellent article and a even more excellent graph (yes, I love pictures). Based on the brainy but understandable letter to the SF fed regarding the housing bubble in 2004 by economist John Krainer (which you can find here and I suggest you read if you have a chance), the price-to-dividend ratio used to value equities in finance can be applied to the housing market in by way of the Price-to-Rent Ratio.
Krainer says, "The finance paradigm holds that an asset has a fundamental value that equals the sum of its future payoffs, each discounted back to the present by investors using rates that reflect their preferences. For stocks, the payoffs requiring discounting are the expected dividends. This approach can extend to housing by recognizing that a house yields a dividend in the form of the roof over the head of the occupant. The fundamental value of a house is the present value of the future housing service flows that it provides to the marginal buyer. In a well-functioning market, the value of the housing service flow should be approximated by the rental value of the house."
Makes sense doesn't it? So lets look at the graph:
Pretty interesting, huh? So we can use this information in a couple of ways.
1) Historically speaking 0.9 is the approximate average ratio for this market. And right now we seem to be about 10% above the historical average...which (surprisingly?) corresponds with the data from my previous post on housing prices. Nice!
2) We should really keep an eye on this particular metric in the future for bubbles (which you know are going to happen again sometime, somewhere).
1) Historically speaking 0.9 is the approximate average ratio for this market. And right now we seem to be about 10% above the historical average...which (surprisingly?) corresponds with the data from my previous post on housing prices. Nice!
2) We should really keep an eye on this particular metric in the future for bubbles (which you know are going to happen again sometime, somewhere).
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