Market rents in the US are, depending on which measure you look at, either rising slowly or falling outright. Home purchase prices, after a slight dip last year, are climbing again. Prices and rents seem to have disconnected early in the COVID-19 pandemic, and that disconnect has mostly grown ever since.
Take a longer view, with the ratio of US home prices to rents calculated by the Organization for Economic Cooperation and Development, and prices are historically high — with the price-rent ratio about 6 percentage points higher than in the lead-up to the housing price collapse of 2006 to 2011.
Rents are to house prices what dividends or earnings are to stocks — the flow of income that justifies the value of the asset. When prices and rents get out of kilter, something presumably has to give eventually. As Federal Reserve Board economist Joshua Gallin put it at the June 2005 meeting of the interest-rate-setting Federal Open Market Committee, “rents provide a loose tether for house prices; prices deviate from their long-run relationship with rents for extended periods, but not indefinitely.” About a year and a half after that, US house prices began a five-year, 26% slide, going by the S&P CoreLogic Case-Shiller US National Home Price Index.
Are we in the midst of another such housing bubble, with a price collapse on the way? The current consensus seems to be no, and while the consensus is often wrong, there are reasons to question the story told by the price-rent chart. Most have to do with the fact that accurately measuring the price-rent ratio is difficult. Thanks in large part to the methodological work of economists Karl Case and Robert Shiller, we now have a pretty good handle on developments in the sale prices of single-family homes through the S&P CoreLogic Case-Shiller indexes, the Federal Housing Finance Agency price indexes and newer private measures from Zillow and, as of last month, Redfin. Until pretty recently, though, the only high-frequency data series available on rents in the US was the rent measure in the US Bureau of Labor Statistics’ consumer price index, which is what the OECD uses to calculate its index of the price-rent ratio.
As inflation watchers have become quite aware over the past couple of years, CPI rent lags changes in market rents by a year or two because it’s intended to measure everybody’s rents and not just those of new tenants. But because the OECD also uses a lagging index for US housing prices — the FHFA all-transactions index — the effect on the price-rent ratio seems to be a wash. Economists at the BLS and Federal Reserve Bank of Cleveland last year devised a New Tenant Rent Index, based on the same survey from which CPI rent is calculated, that the BLS is now releasing quarterly, with data going back to 2005. When I calculated a price-rent index based on the non-lagging FHFA purchase-only index and the New Tenant Rent Index, it followed virtually the same course since 2005 as the OECD price-rent index.
The bigger price-rent measurement issue seems instead to be that the housing available for rent in the US is so different from the housing available for sale, with single-family houses mostly owner-occupied and units in multifamily buildings mostly rentals.
Amid a pandemic that first pushed people out of apartment-filled cities because of infection fears and the temporary halt of most activities that make cities attractive, then lured them out with the promise of continued remote work and the need for more home workspace, it shouldn’t really be a surprise that demand for housing to buy (what most single-family houses are) grew faster than demand for housing to rent (what most apartments are). Meanwhile, on the supply side, the number of new multifamily units under construction has been setting records while the number of single-family houses under construction has not.1
The recent divergence between house prices and rents might thus be a case of rational calculation rather than irrational exuberance. That’s what Lara Loewenstein of the Cleveland Fed, one of the economists behind the New Tenant Rent Index, and Paul S. Willen of the Federal Reserve Bank of Boston concluded in a working paper released earlier this year, arguing that while the early 2000s boom in purchase prices “was plausibly driven by exuberant expectations, the boom of the 2020s more likely resulted from a preference shock.” In the economic model used in the paper, the preference shock is simply more demand for housing, but the empirical results also point to a shift in demand from rentals to owner-occupied dwellings. Loewenstein and Willen constructed price indexes from property-level data that separated owner-occupied from renter-occupied housing units and found that what they called the “price-price ratio” of owner-occupied to renter-occupied properties rose in 2021 for the first time in a decade. The price-rent ratio for just the rental properties rose, too, but remains well short of its 2005-2006 peak.
That’s reassuring, although it still feels as if something has to give in the US housing market. The sharp rise in mortgage rates since the beginning of 2022 has made borrowing to buy a house much more expensive, which ought to put downward pressure on prices. But homeowners with low-rate pre-2022 mortgages face a strong financial disincentive to sell, so the supply of homes available to buy remains near its 21st-century lows, and prices haven’t adjusted to the new rate reality.
My Bloomberg Opinion colleague Matt Levine suggested last month that a way to break this logjam would be to allow homeowners with low-interest rate mortgages to buy their loans at market value — which would be much lower than their face value. Lots of readers informed him that homeowners can do this in Denmark. Guess what: In Denmark, house prices fell 8% from mid-2022 to mid-2023.
1Yes, I realize this is partly because it's been taking such a long time to complete multifamily buildings lately, but starts and completions have also been also higher relative to historical averages for multifamily than for single family.
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