What do rents tell us about house prices?

Purpose - Since 2000 house prices have risen much more rapidly than rents. This has resulted in questions being raised about the traditional relationship between residential rents and property values. The objective of this paper is to determine if changes in private sector residential rents can be used to forecast changes in New Zealand house prices. The hypothesis being that there is a strong linkage between income and value in both the share markets and commercial property markets and the same effect is likely to be true for housing. Design/methodology/approach - The relationship between changes in residential rents and changes in house prices over the period 1993‐2005 was determined by using correlation analysis. Cross correlations were calculated with rents leading and lagging house prices by seven half yearly periods. These calculations were computed for all New Zealand and the three main cities (Auckland, Wellington and Christchurch). Findings - The highest correlation coefficients between rents and house prices occurred when rents lagged house prices by six months. This finding supports the contention that rents drive house prices and not vice versa. Research limitations/implications - The main limitation with the study is the private sector data only covers a relatively short time period (1993‐2005). Longer rental time series are unreliable because they include periods when social housing rents were set at market levels and longer periods when rents were subsidised. Practical implications - Housing in New Zealand appears to be over priced because with net yields generally less than half mortgage interest rates there is an over reliance on capital gain that is not supported by rental income. Originality/value - The study identifies the effect of net migration on rents and explains why rental supply tends to lag demand.