RDP 2014-06: Is Housing Overvalued? 8. Conclusion

Real house prices have increased at an average annual rate of slightly less than 2½ per cent since 1955. If this rate of appreciation is expected to continue then our estimates suggest that houses are fairly valued (see Table 1 or Figure 3). As we discuss in Section 7.1, forecasting house price growth is subject to considerable uncertainty. That said, many observers have suggested that future house price growth is likely to be somewhat less than this historic average. In that case, at current prices, rents, interest rates and so on, the average household is probably financially better off renting than buying.

Several extensions of our results would be interesting. First, although our paper only reports results for owner-occupiers, we have also examined whether buying a house is worthwhile for investors. This question is complicated by taxes and we have not found a simple way of summarising this. Second, to infer expected capital gains from existing house prices, we assume that the rental premium is constant. Variations in credit restrictions might help to explain variations in the premium over time. Third, whereas we have focused on variations in the user cost over time, cross-section variation could explain who owns and who rents. Fourth, the implications for lending standards might be worth considering. When financial institutions set loan-to-value limits, should the denominator be the fundamental value or the market value? Fifth, and perhaps of most use to potential owners, would be guidance regarding likely capital appreciation. Related to that, our measures of overvaluation may help to predict future house price growth, but that remains to be tested.