Causal Relationships between the Price-to-Rent ratio and macroeconomic factors: A UK Perspective

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Abstract

House price-to-rent ratios are among the most widely used measure of housing market conditions. Given the theoretical and apparent bi-directional, causal relationships and imbalances between the housing market, broader economy and financial market determinants, it is important to understand the relationship between macro- and micro-economic characteristics in relation to the price-to-rent ratio to enhance the understanding of housing market dynamics. This paper studies the joint dynamics and persistence of house prices and rents and examines the temporal interactions of the price-to-rent ratio and economic and financial determinants.
We examine the lead-lag relationships between the price-to-rent ratios and a spectrum of macroeconomic variables using bivariate cointegration and causality methods, initially at the aggregate position, and also across housing types within the Northern Ireland housing market to establish whether there are subtle differences in how various housing segments react to changes in economic activity and market fundamentals.
The findings reveal price switching dynamics and some very distinct long- and short-run relationships between macroeconomic and financial indicators and the price-to-rent ratios across the various housing segments. The results exhibit monetary supply, foreign exchange markets and the stock market to be important drivers of the P-t-R ratio, with price to rent movements seemingly tied, or are in tandem, with the overall economy, particularly with the construction sector.
The study shows that the price-to-rent ratio can be used as an early measure for establishing the effects of macroprudential policy changes and how these may manifest across housing tiers and quality, which can further act as a signal for preventing or at least mitigating future irrational price cyclicity. These insights serve to inform housing and economic policy and macroprudential policy design, principally within lending policy, and the effect of regulatory interventions and further enhance the understanding of the price-to-rent ratio on housing market structure and dynamics.
This study is the first in the housing literature that examines the causal relationships between the price-to-rent ratio and macroeconomic activity at the submarket level. It investigates whether and how money supply, inflation, foreign exchange markets, general economic productivity and other important macroeconomic factors interact with the pricing of different property types over time.
Original languageEnglish
JournalJournal of Property Investment and Finance
DOIs
Publication statusAccepted/In press - 6 Jan 2022

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