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A Present Value Approach to Analysing Residential Property

Author/s: Peter Rickwood, Angelo Karantonis

Date Published: 1/01/2007

Published in: Volume 13 - 2007 Issue 3 (pages 298 - 321)

Abstract

We adopt a simple Present Value (PV) methodology to investigate the interaction between interest rates, inflation and taxation on the fundamental value of residential real estate for a rational investor with varying degrees of risk-aversion. This approach allows the calculation of the fair present value of residential real estate from only a small number of macro-economic variables, and avoids the need to use historical data to calibrate a model. A PV approach can explain some of the more perplexing results obtained in prior work on residential real estate, such as the inability to consistently find a strong negative correlation between property prices and interest rates. Actual property prices are broadly supported by underlying fundamental value (as determined by our PV model) prior to the mid 90s. Our model suggests that the global policy shift to independent central banks with inflation-targeting mandates has important implications for property values.

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Keywords

Inflation - Present Value Methodology - Real Interest Rates - Residential Property

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