Reconciling user costs and rental equivalence: Evidence from the US consumer expenditure survey

Abstract

JEL classification: C81 C82 D12 E21 E31 E32 R29 Keywords: User costs House price appreciation Forecasting Rental equivalence a b s t r a c t Previous research [Verbrugge, Randal, 2008a. The puzzling divergence of aggregate rents and user costs, 1980-2004. The Review of Income and Wealth 54 (4), 671-699] demonstrated that housing rents and ex ante user costs diverge markedly for extended periods of time, a finding with profound implications for income and inflation measurement. But the primary data sources in that study were various indexes, based upon largely disjoint data sources, constructed using different aggregation techniques, and each subject to various criticisms. This raised doubts about the quality of the comparison. The relationship between user costs and rents might well be much tighter at the micro level; after all, house prices and rents (and their growth rates) can vary dramatically within cities, and rents are notoriously sticky. Furthermore, the use of indexes precludes both cross-sectional and dollar cost comparisons. In this study, we use Consumer Expenditure Interview Survey (CE) data to examine the relationship between user costs and rents at the individual unit-level, in dollars, using unit-level information on house value, rent, taxes, and the like. This allows us to accurately estimate unit-specific user costs and to control for unobservables like structure and neighborhood quality. We also make the point that in theory, after-tax user costs should equal net rent, i.e., expected rental income, rather than gross rent.Our findings are striking. In keeping with most previous research, we find tremendous divergence between conventional measures of user costs and net rents, thus ruling out index construction errors as a possible explanation. This divergence does not result from a faulty rent measure: we find that reported rents are sensible, in that they move similarly to official rent indexes, and are not simply out-of-pocket expenses. Instead, and most perplexing, we find a surprisingly close correspondence between net rents and a particular estimate of user costs, one implicitly assuming zero transactions costs and constructed using an appreciation measure that is both theoretically suspect and empirically a poor predictor of actual appreciation.Published by Elsevier Inc.

House Prices and Rents: Microevidence from a Matched Data Set in Central London

“…The finding that more expensive properties have higher price-rent ratios is consistent with Garner and Verbrugge (2009) who use answers from the US Consumer Expenditure Survey to compare self-reported rents and house values. In the UK, reports from several sources, such as the Joseph Rowntree Foundation (1996) and the Association of Residential Letting Agents (2012), also show that price-rent ratios are higher for bigger properties (houses against flats) and expensive regions (London against the rest of the UK).…”

“…This is because the stylised fact illustrated in this paper has been shown elsewhere in the UK (Joseph Rowntree Foundation, 1996; Association of Residential Letting Agents, 2012) and in the US (Garner and Verbrugge, 2009). Thus, any satisfying explanation cannot be London-specific.…”

Distributional effects of imputed rents in five European countries

“…Last but not least, it has been argued that the inter-temporal volatility of house values, especially in case of house price bubbles, may cause a problem in this context (Garner and Short, 2009;Garner and Verbrugge, 2009). Thus, while investments in owner-occupied housing may be seen as a hedge against fluctuations in housing costs, such investments may 8 Applying a nominal interest rate, i, to home equity, thus calculating IR as i(V-M), may confound the effect of inflation on returns.…”

Natural Expectations and Home Equity Extraction

“…Annual income, y, is standardized at the level of 1. We assume that the rental rate, γ, is 5 percent of the current value of the housing stock, thus implying a price-to-rent ratio equal to 0.05, which is consistent with the setting in Garner andVerbrugge (2009) andin Hu (2005). Finally, we assume that when the household defaults, the bank is able to recover only 20 percent of the value of the house.…”