The Rise and Fall of the Price-to-Rent Ratio: Why Are Superstar Cities Different?

Abstract In most countries, during the 2000s and 2010s, house prices rose substantially relative to rents. This trend, however, was not uniform across space or time. The price-to-rent ratio increased much more strongly in the countries’ superstar cities, surged during economic expansion periods, but fell during times of economic crisis. These stylised facts are consistent with a model that features spatial variation in the supply price elasticity and autocorrelated local demand changes that trigger persistent changes in rent growth expectations. The model predicts that in supply-inelastic locations, positive (negative) demand shocks trigger increases (decreases) in the price-to-rent ratio that last several years. Stronger demand change persistence and lower discount rates amplify this effect. We test our model predictions employing panel data for England. Our instrumental variable first-difference estimates suggest that over half of the 153% increase in the price-to-rent ratio between 1997 and 2018 in Greater London can be explained by our mechanism.