Housing Markets

Housing Market Specificities

Households can either buy or rent dwellings. The relative weights of the owner-occupied and rental markets vary widely across countries, with home-ownership rates ranging from more than 90% in some eastern European countries to less than 40% in Japan and Switzerland. These differences are related to cultural and institutional features, including the structure of taxation and the supply of social housing as well as economic factors, notably the affordability of homeownership, the distribution of income and wealth, and the sophistication of the mortgage market. The owner-occupied and rental markets display different dynamics but are connected, as, to some extent, households can arbitrage between owning and renting, with the consequence that in the long term price-to-rent ratios tend to revert to historical averages. Nevertheless, arbitrage in housing markets is far from perfect for several reasons, including moving and transaction costs and rent regulations. In some countries, the supply of housing for rent is fairly limited, constraining the possibility for arbitrage and exacerbating house price swings. Hence, adjustments bringing rents in line with prices are usually sluggish.

Housing markets differ from other markets in several respects. Each house is unique, in terms of both amenities and location. Dwellings are long-lived, and new houses built each year represent only a very small fraction of the housing stock, typically 1% or 2%. Moreover, supply responds slowly to demand because of the time needed to build houses and associated infrastructure and because of regulatory constraints. Hence, a large share of transactions concerns secondhand units. The sluggishness of the supply response contributes to generating construction and house price cycles. Supply in some places is severely constrained, as it depends on the availability of land and is sometimes further limited by zoning or planning restrictions. Hence, housing markets are highly dependent on local conditions, though also subject to countrywide or [Page 367]global influences, such as those affecting income, unemployment, and interest rates.

Houses provide accommodation but are also investments. As a result, housing markets share some features with financial markets. House prices should reflect a discounted flow of expected rents, much as equity prices represent a discounted flow of expected dividends. But houses are also different from financial assets, in particular because they are not only investments but also places people live in, are indivisible, relatively liquid, and generally subject to higher transaction costs than financial assets. As the acquisition of a house usually involves a large share of debt financing, it provides not only a highly leveraged investment with potentially high returns but also substantial risks in case of adverse developments in house prices or interest costs.

...