Testing the Present Value Relation for Housing Prices: Should I Leave My House in San Francisco?

We examine the efficiency of residential housing markets by examining price, rent, and cost of capital indices generated from a transactions level data base for Alameda and San Francisco Counties in Northern California. We can reject both constant and nonconstant discount rate versions of the housing price present value relation in the short run. Long-run results are consistent with the housing price present value relation when we adjust the discount factor for changes in both tax rates and borrowing costs that characterize our 1970–1988 sample period. Our preferred explanation for the short-run rejection of, but long-run consistency with, the present value model is the high transaction costs that characterize the housing market. However, we cannot rule out the possibility that deviations of actual and present value price are due to asset market bubbles or nonrational expectations.