U.S. Home Prices Must Drop to Get Back In Sync with Rents

Madison, Wis.–House prices would have to lower by a significant amount to rebalance with U.S. rents, according to a study by two current and one prior Federal Reserve economists.Assuming rents rose 4 percent a year, home prices would need to drop 15 percent over the next five years, The Wall Street Journal reports.The study, which tracks rents and home prices back to 1960, is by Andreas Lehnert and Robert F. Martin, staff economists at the Fed, and Morris Davis, an economist at the University of Wisconsin-Madison and a staff economist at the Fed until 2006.Rents historically have been around 5 to 5.25 percent of home prices–until 1995, when the average annual rent hit $6,600 and the average home price settled around $134,000.From 1996 on, home prices began to increase faster than rents; by the close of 2006, home prices had more than doubled to $282,000. However, during the same period, the average rent was up only 48 percent to $818, decreasing the rent/price ratio to 3.48 percent–roughly a third below its long-standing average.A correction would require home prices to drop and rents to rise. The survey suggests home prices would need to decrease 3 percent a year if rents continue their current 4 percent annual growth rate.