House Price Expectations, Labour Market Developments and the House Price to Rent Ratio: A User Cost of Capital Approach

The user cost of capital model is a popular tool for assessing the sustainability of house price movements. However, a number of issues typically arise when the approach is applied including the absence of information on consumer price expectations, differences in quality between owner-occupied and rented dwellings and whether agents expectations are rational. In this paper, using a new, unique database of regional housing variables we address these issues in assessing the sustainability of Irish house price changes between 2010 and 2018. We draw on a regular and timely survey of subjective house price expectations amongst Irish households to compile regional-specific user cost of capital variables. In examining the relationship between the user cost of capital and house price to rent ratios, we use developments in local labour markets to establish whether these expectations are determined by economic ``fundamentals” and, hence, not subject to a ``bubble”. Drawing on finance theory, we also present a series of indicators aimed at evaluating the sustainability of price movements.