Discussion of Randal Verbrugges: The Puzzling Divergence of Aggregate Rents and User Costs, 19782001

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Discussion of Randal VerbruggesThe Puzzling
Divergence of Aggregate Rents and User Costs,
1978-2001

• Leonard Nakamura
• Federal Reserve Bank of Philadelphia
• My views, not the Feds

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Back to basics

• Paper points out that because interest rates and
  asset prices are volatile, short-term real rates
  of return can vary substantially from real rental
  rates
• This is certainly true
• Applies to all long term assets, not just
  residences
• This paper is a useful reminder of what
  economists dont understand
• And a valuable challenge to economists
• I am not so sure that it puts statistical
  agencies in a quandary Empirically, they should
  use rental equivalence
• Rents are understood at least somewhat
• User costs are (empirically) not

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Owner occupied homescosts and equivalent rents

• Stock of housing is large, and adjusts slowly
• Households adjust their use of housing slowly
• Implied real stream of housing services must
  change only slowly
• User costs are too volatile compared to this
  shadow price
• Not just true for housing user costs of capital
  are too volatile (Shiller)

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Implication real quantity of housing services
changes slowly

• At the margin in equilibrium, the rent summarizes
  the information in the user cost.
• Empirical question are rents or user costs
  closer to the truth?
• Good evidence that rents are reasonable
• Hedonic estimates (Crone et al, Kurz and Hoffman)
• Rents and housing prices are cointegrated J.
  Gallin, BoG, Long horizon of house prices and
  rents
• Real rents move with real net stock of
  residential fixed assets
• Ratio is relatively constant over past 60 years
• Particularly if we adjust BLS residential rents
  for response bias (Crone et al, CPI for rents, a
  case of understated inflation)

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Minor problems in Verbrugge measure of user costs

• To get user cost right, very hard work
• Risk premiums? Shouldnt use deterministic model
• Hard to measure
• Expected appreciation 4 quarter horizon or 40
  quarter horizon?
• Relevant interest rate Mortgage rate includes
  refinance option
• The exercise cost has changed over time
• Type of mortgage used varies over time (ARMs when
  rates are high)
• Cost of maintenance and repairs
• These are minor problems in the sense they are
  very unlikely to influence the result
• User costs too volatile to know whether trend is
  right

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Explaining rents

• Are rents related to theoretical variables?
• Another valuable question
• Rents ß(user cost)
• User costs are measured with error
• ß likely biased downwards
• Detached units rental rates not very reliable
• Too many special cases
• Possibly better to use regular rental units
• Also, adjust rent inflation rates for 1978-1985 a
  la Crone et al

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Bottom line a valuable and difficult line of
research

• This is an important issue for economics
  Residential assets very large share of total
  wealth
• How useful are rents to measure the shadow price
  of owner occupied housing services?
• Why are user costs so volatile?
• Why dont house prices appear to be martingales?
• What are the returns to owner-occupied housing
  and are they reasonable?
• Is there a equity premium puzzle for housing
• Need stochastic GE model (Luengo-Prado, Nakajima)