Guaranteed rent – Guaranteed rent | More on house price fundamentals
FOLLOWING the last post, an alert reader points me to this VoxEU article on house prices and interest rates which also uses the idea that the fundamental value of houses is the discounted stream of future rents. The graphs provided by the authors suggest that house prices are still substantially overvalued on this basis in Ireland, Britain and Spain, about right in America and Switzerland and undervalued in Germany.
Rather frustratingly, the authors don’t provide a link to the original paper so we can’t see the methodology (and I can’t find it on the Swiss National Bank website). But from a look at the graphs, it does seem as if they have allowed for the issue raised in the previous post; that one cannot adjust the discount rate, without allowing for what a low discount rate implies for future growth. Clearly, the academics have marked down their assumptions for future rental growth (as well they should, given what’s happened to GDP).
Like everything else, house prices are set by supply and demand; but clearly, the supply situation in Ireland and Spain looks completely different from that of Britain. But demand is surely not an exogenous factor. I would suggest there is a three-stage process; more people will want to own their home if prices are rising and that will reinforce the boom; at some point, however, unless lending standards are not completely relaxed, people will be priced out of the market and will have to flat share/live with their parents, and the bubble will pop; at that stage, as prices fall, defaulting borrowers will send more supply into the market until eventually prices are affordable again.
What I suspect may have happened is that the US has moved more quickly to stage three, because of the greater use of foreclosure, and the wider recognition of property losses. In Britain, the number of transactions has plunged because owners have not been forced to recognise their loss; this has artificially restricted supply and propped up prices.
Source: http://www.economist.com/blogs/buttonwood/2012/04/house-prices-and-interest-rates-0