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House prices trends

Dissertation : House prices trends. Recherche parmi 241 000+ dissertations

Par   •  1 Août 2012  •  Dissertation  •  650 Mots (3 Pages)  •  404 Vues

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As explained earlier, house prices trends can only be fully understood if considered as a consumable good but also as an investment. In this perspective, a user-cost approach is used to reflect that housing is an asset, which actually represents the opportunity cost of holding and using a house, less the increase of its value. In other words, rather than renting their house from a landlord, users are investing in the house and are renting it to themselves thus incurring opportunity cost (as they choose not to invest this amount in an alternative safe investment). As suggested by Poterba in 1992, the UCC should takes into account the financial returns of holding a house, differences in risk, property taxes, depreciation and maintenance costs, as well as any expected capital gains from holding this asset. This results in this specific formula:

UCC = Nominal mortgage interest rate + rate of property taxation + maintenance and depreciation – expected rate of nominal capital gain

The nominal mortgage interest rate represents the cost of investing in housing instead of any alternative investment. This first component has been computed by selecting the average rate on a typical mortgage for a typical household. As explained by John Kiff , the typical Canadian mortgage loan in 2011 is a five-year fixed-rate loan amortized over 25 years. As a result, this term has been computed with the variation of a 5-year mortgage rate during the period.

The second term represents the property taxes on owner-occupied houses. It has been computed by selecting 5 main Canadian cities (Vancouver, Halifax, Montreal, Calgary and Toronto) from which an average property tax rate was calculated. This average property tax rate results from this calculation, which takes into account both the Council Property rate and the Scholar rate, which together represent the city property tax rate . To be able to track this average rate over time, the rate was calculated in 2011, and the moving average was computed by using the Property Tax Index which allows us to estimate its change over time.

The third component represents the recurring holding costs, meaning the depreciation, the maintenance as well as the risk premium on housing. A rate of 2% has been used as a reference.

The last component takes into account that the appreciation in the price of the asset is reducing the cost of owning it. In addition, it seems obvious that an expected appreciation in the price of houses would increase the attractiveness of owning his house rather than renting it (in order to benefit from this appreciation of value). This is the reason why the expected rate of nominal capital gain should be computed. As is usual, capital gain should be computed as the increase in price of a house over the base year. Therefore, we have decided to use the annual variation in the New House Price Index as an estimate of the overall change in house prices over the reference year, thus representing the expected rate of nominal capital gain following the method outlined by Poterba (1992).

The graph tracking the User Cost of Capital values over time is as follows:

The graph seems to demonstrate the increasing financial incentive in investing in housing. Indeed, a decreasing UCC reveals that it becomes


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