In This Chapter We Discussed the User Cost of Capital

Essay

In this chapter we discussed the user cost of capital and PE ratio (the home price to annual rental ratio): where user cost = (1 ? t)(r + p) + m + ? + ? ? ?^e where t is the personal tax rate, r is the borrowing cost of financing a home, p is the property tax rate, m is the cost of maintenance, ? is the risk premium on property, ?^e is the expected appreciation of property values and ? is the depreciation rate on residential property (all expressed in nominal percent).
a. If in the United States, home prices are expected to increase by 3 percent r = 4 percent, the tax rate is 25 percent, property tax is 1 percent, the maintenance fee is 0.5 percent, depreciation is 3.5 percent and the risk premium is 2 percent, calculate the PE Ratio.
b. If some Chinese cities have a PE of let's say 30, calculate the implicit value of ??. Provide justification for the other numbers that you used in the formula for the China case. Do you think ?? is based on rational or adaptive expectations?
c. In this chapter, Schramm suggests that the housing market price surge in China represents fundamental factors and not a bubble. Buyers may still end up losing money over the long term, however. Explain using basic supply and demand curves. If Schramm is correct, then why haven't rental rates risen as dramatically as home prices? Is Schramm wrong? Explain.