Property Investment and Rental Rates Under Housing Price Uncertainty : A Real Options Approach

The conventional wisdom that housing prices are the present value of future rents ignores the fact that rents are not discretionary as in dividends on stocks. Housing price uncertainty can affect household property investment, which in turn affects rent. By extending the theory of investment under uncertainty, we model the renter's decision to buy a house and the landlord's decision to sell as real options of waiting and examine real options effects on rent. Using data from Hong Kong and mainland China, we find significant a causal effect of housing prices on rents and draw important policy implications