The equilibrium effect of fundamentals on house prices and rents

Using a dynamic equilibrium model of housing tenure choice with fully specified markets for homeownership and rental properties, and endogenous house prices and rents, this paper studies the effect of fundamentals on equilibrium house prices and rents. Lower interest rates, relaxed lending standards, and higher incomes are shown to account for approximately one-half of the increase in the U.S. house price–rent ratio between 1995 and 2006, and to generate the pattern of rapidly growing house prices, sluggish rents, increasing homeownership, and rising household indebtedness observed in the data.