Loan-to-value and the price-rent ratio

Abstract

Purpose The purpose of this paper is to highlight the relation between the loan-to-value (LTV) ratio and the price-rent (PR) ratio. The paper intends to relate the PR-ratio to housing return and the potential for a leverage gain in housing investments by considering the funding structure of housing investments. Design/methodology/approach Combining a PR-ratio approach with the housing return in the case of mortgage-financed housing, as presented by Borgersen and Greibrokk (2012), this paper relates LTV to the PR-ratio. Findings When formalising the relationship between leverage and housing return, as given by Muellbauer and Murphy (1997), the paper finds the effect of a higher LTV on the user cost of housing as the net effect of a higher borrowing cost and the associated leverage gain. The latter depends on the relationship between house price growth and the mortgage rate and, because the leverage gain has an ambiguous effect on the user cost of housing, the relation between the LTV-ratio and the PR-ratio is context-specific. Originality/value The paper aims to contribute to the literature on PR ratios in two ways. First, by explicitly including the LTV-ratio in the user cost of mortgage financed housing and, correspondingly, in the PR-ratio derived from the user cost. Second, by including the funding structure of housing investments the expression for the capital gain, which often is discussed in the PR-ratio literature, is related to the funding structure and includes both a price gain and a leverage gain.

The Preferences for Housing Loan Demand in Indonesia Before and After the Loan-to-Value Policy Change

“…The findings of this study indicate that borrower-specific LTV limits affect household debt, wealth inequality, and consumption volatility in different ways mediated by changes in the housing market transaction pattern of the model. Borgersen (2020) finds the effect of higher LTV on housing user fees as a net effect of higher borrowing costs and the associated leverage advantage.…”

Causal relationships between the price-to-rent ratio and macroeconomic factors: a UK perspective

“…Indeed, housing literature contends that housing market frictions such as non-convex transaction costs, tax advantages to homeownership and higher depreciation of rental properties relative to owner-occupied properties are likely to be important determinants of housing demand and rental supply (Sommer et al, 2010) and in the determination of the P-t-R ratio. Further Borgersen (2020) illustrates that the context-specific effect of LTV on the P-t-Rratio links housing markets to mortgage markets and monetary policy. These changes signal a possible deviation from the underlying market and economic fundamentals, and it has long been considered that divergence from long-term values of prices in relation to rents is a cause for concern (Sommer et al, 2010).…”

“…Accordingly, the Price-to-Rent (P-t-R) ratios offer important housing market insights (Begley et al, 2019), providing information about local real estate markets, including future market expectations and speculative market behaviour and asset pricing bubbles. In this regard, the P-t-R ratio is frequently used as an indicator for assessing housing market equilibrium (Borgersen, 2020;Kishor and Morley, 2015), with departures from equilibrium detected by comparing the P-t-R ratio with the user-cost equilibrium condition (Hill and Syed, 2016). Indeed, housing literature contends that housing market frictions such as non-convex transaction costs, tax advantages to homeownership and higher depreciation of rental properties relative to owner-occupied properties are likely to be important determinants of housing demand and rental supply (Sommer et al, 2010) and in the determination of the P-t-R ratio.…”

“…It also noted that the local SME construction sector was unable to match demand. Statistics produced by the Northern Ireland Statistical Research Agency (NISRA) also highlight the persistently low level of new housing construction showing that private sector housing productivity has dropped from circa 9,200 per annum to circa 8,300 per annum over the period of 2011-2020(NISRA, 2020. In a similar vein, the Housing Supply Forum published a report in 2016 highlighting the many challenges facing the sector, including a lack of suitable land, a sluggish planning system, inadequate infrastructure, access to finance and limited capacity within the SME construction sector.…”

“…Consequently, given the theoretical and apparent bidirectional, causal relationships and imbalances between the housing market, broader economy, financial environment and market fundamentals, it is important to understand the relationship between macro-and micro-economic characteristics in relation to the P-t-R ratio to enhance the understanding of housing market dynamics. As Borgersen (2020) emphasises, although the P-t-R ratio is widely used as a measure of over-and undervaluation in the housing market, surprisingly Price-to-rent ratio and macroeconomic factors little is known about the theoretical relationship between the P-t-R ratio and market fundamentals such as interest rates and down payment requirements. This paper therefore examines the temporal interactions of the P-t-R ratio and economic and financial determinants.…”