Property investor decisions using income and rental ratio signals
| DOI | https://doi.org/10.1108/JPIF-03-2020-0031 |
| Published date | 19 February 2021 |
| Date | 19 February 2021 |
| Pages | 2-13 |
| Subject Matter | Property management & built environment,Real estate & property,Property valuation & finance |
| Author | Billie Ann Brotman |
Property investor decisions using
income and rental ratio signals
Billie Ann Brotman
Economics, Finance and QA, Kennesaw State University,
Kennesaw, Georgia, USA and
Billie Ann Brotman, Atlanta, Georgia, USA
Abstract
Purpose –This paper, a case study, aims to consider whether the income ratio and rental ratio tracks the
formation of residential housing price spikes and their collapse. The ratios are measuring the riskassociated
with house price stability. They may signal whether a real estate investor should consider purchasing real
property, continue holding it or consider selling it. The Federal Reserve Bank of Dallas (Dallas Fed) calculates
and publishes incomeratios for Organizationfor Economic Cooperationand Developmentcountries to measure
“irrational exuberance,”which is a measure of housing price risk for a given country’s housing market. The
USA is a member of the organization. The income ratio idea is being repurposed to act as a buy/sell signal for
real estate investors.
Design/methodology/approach –The income ratio calcula ted by the Dallas Fed and thi s case study’s
ratio were date-stamped and graphed to determine whether the 2006–2008 housing “bubble and burst”
could be visually detec ted. An ordinary least squares regression wit h the data transformed into logs and
a regression with structural data breaks for the years 1990 through 2019 were modeled using the
independent variables in come ratio, rent ratio and the Un iversity of Michigan Consu mer Sentiment
Index. The descriptive statistics show a gradual increase in the ratios prior to exposure to an
unexpected, exogeno us financial shock, which took several months to gr ow and collapse. The regression
analysis with breaks ind icates that the income rat io can predict changes in ho using prices using a lead
of 2 months.
Findings –The gradual increases in the ratios with predetermine limits set by the real estate investor may
trigger a sell decision when a specified rate is reached for the ratios even when housing prices are still rising.
The independent variables were significant, but the rent ratio had the correct sign only with the regression with
time breaks model was used. The housing spike using the Dallas Fed’s income ratio and this study’s income
ratio indicated that the housing boom and collapse occurred rapidly. The boom does not appear to be a
continuous housing price increase followed by a sudden price drop when ratio analysis is used. The income
ratio is significant through time, but the rental ratio and Consumer Sentiment Index are insignificant for
multiple-time breaks.
Research limitations/implications –Investors should consider the relative prices of residential housing in
a neighborhood when purchasing a property coupled with income and rental ratio trends that are taking place
in the local market. High relative income ratios may signal that when an unexpected adverse event occurs the
housing market may enter a state of crisis. The relative housing prices to income ratio indicates there is rising
housing price stability risk. Aggregate data for the country are used, whereas real estate prices are also
significantly impacted by local conditions.
Practical implications –Ratio trends might enablereal estate investors and homeowners to determine when
to sell real estate investments prior to a price collapse and preserve wealth, which would otherwise result in the
loss of equity. Higher exuberance ratios should result in an increase in the discount rate, which results in lower
valuations as measured by the formula net operating income dividend by the discount rate. It can also signal
when to start reinvesting in real estate, because real estate prices are rising, and the ratios are relative low
compared to income.
Social implications –The graphical descriptive depictions seem to suggest that government intervention
into the housing market while a spikeis forming may not be possible due to the speed with which a spike forms
and collapses. Expected income declines would cause the income ratios to change and signal that housing
prices will start declining. Both the income and rental ratios in the US housing market have continued to
increase since 2008.
Originality/value –A consumer sentiment variable was added to the analysis. Prior researchers have
suggested adding a consumer sentiment explanatory variable to the model. The results generated for this
variable were counterintuitive. The Federal Housing Finance Agency (FHFA) price index results signaled a
change during a different year than when the S&P/Case–Shiller Home Price Index is used. Many prior studies
used the FHFA price index. They emphasized regulatory issues associated with changing exuberance ratio
JPIF
40,1
2
The current issue and full text archive of this journal is available on Emerald Insight at:
https://www.emerald.com/insight/1463-578X.htm
Received 31 March 2020
Revised 3 October 2020
7 December 2020
6 February 2021
Accepted 7 February 2021
Journal of Property Investment &
Finance
Vol. 40 No. 1, 2022
pp. 2-13
© Emerald Publishing Limited
1463-578X
DOI 10.1108/JPIF-03-2020-0031
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