Digested From "Home Prices Must Fall Far to Be in Sync With Rents"
Wall Street Journal (01/03/08) P. A2; by Greg Ip

A recent study by University of Wisconsin-Madison economist Morris Davis and Federal Reserve economists Andreas Lehnert and Robert Martin looks at the annual rent/home price ratio as far back as 1960, revealing a decline in annual rents to 3.48 percent of home prices from 1996 to 2006 from a range of 5 percent to 5.25 percent between 1960 and 1995. While the rent/price ratio is down approximately 33 percent from its long-term average, the economists calculate that, assuming rents continue to rise at the average 4-percent rate recorded during the current decade, residential prices would have to decline 3 percent annually for the ratio to return to normal. Over a period of five years, they estimate that home prices would need to drop 15 percent. Davis notes that "rapid growth in rents" is necessary to justify the current level of home prices, but an increase in unsold properties on the rental market could hinder rent increases.