Interest Rates And Home Prices

 A couple of quick thoughts on recent home price appreciation.

In graph 1, I estimate a national median gross rent/price yield from Zillow rent and price data. I compare it to the 30 year TIPS (real) interest rate (plus 8%). Certainly, a case can be made that some of the recent price movement has been related to declining real long-term yields. However, without more historical data, this doesn't tell us much. Two measures both moved in a certain direction over a period of time, and so it's easy to match them up on the y-axis.

Here is a longer series with similar measures. Here, I estimate the national average gross rent/price level with total rent/total residential real estate value for owned homes. I also used the CPI rent inflation measure with the Case-Shiller national home price index, with a scaling constant as a second version of the estimate. Both estimates of rent/price yields follow similar trends.

Here, I use a 30-year TIPS bond issued in 1998 and then in more recent years the general estimate for 30-year TIPS yields. Here I only added a 3% spread to the TIPS yields.  Part of the difference is that the mean yield is lower than the median yield. (Price/rent is not the same across the market.  It is systematically higher where rents and prices are higher.) Part of the difference is that we imposed a one-time shock on housing during the financial crisis, adding a 2-3% spread on housing yields compared to other assets, so the spread in the first graph from 2014 onward is much higher than it had been before.

Source.

When I first started looking at these things years ago, I excused the pre-2006 price increases with this relationship. I still more or less stand by that. It isn't controversial to say that home prices are related to interest rates. In fact, I think it helps clarify the analysis to show that it is specifically real long-term rates that seem to correlate with housing yields. But, even in 2005, that doesn't tell the whole story. Rent/price yields are not uniform across cities. They decrease systematically where rents are high. Some of that might be attributed to expectations of future rent increases.  Some of it might be attributed to lower cost of ownership where rent is a product of location rather than structures and services. In any event, before 2000, gross housing yields had been between 6-7% for some time, and after 2000 they continued to be in that range in most cities. In some cities like LA or NYC, they declined to more like 3-4%. The aggregate yield of around 5% was an average of a country increasingly becoming bifurcated into at least two different stories.

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