Fundamental value of Korean housing price
Introduction:
Over the previous decades, we can observe a boom and bust in housing prices in South Korea. There are three different major periods of the housing market boom. From April 1988 to June 1991, the average year on year change in buying price is 15.1%. We can observe the increase in real buying price until 1991. Then, there has been a decreasing trend of real buying price because of supply surge in the housing market until 1998. As the economy recovered from the Asian currency crisis, the second boom occurred. From 2001 to 2004, the real buying price increased by 8.3% and recovered the previous peak of the boom.
The recent boom from 2006 to 2007 recorded a 6.6% increase in the real buying price. Since then, the real buying price has maintained stable condition but the continuing decreasing trend of real rent price leads to the boom of price-rent ratio nowadays. The price-rent ratio exhibits three peaks in 2005, 2016, and 2020, mainly caused by the recent boom from 2006 to 2007 and a continuous decreasing trend of real rent price.
Literature Review:
Related to the factors which can contribute to the fundamental value of the price-rent ratio, Kim and Lim figure out that expected excess returns are the largest part of the contribution. Campbell use variance decomposition of rent-price ratio in the United States by applying the dynamic Gordon growth model to 23 metropolitan markets and considering different time periods. They conclude that housing risk premium exhibits significant variance in housing fundamentals. Basic model or data construction is inspired by these two pieces of literature. Both pieces of literature are significant to analyze which factor contributes more on the fundamental value.
Data and Information On Housing Price:
This paper basically follows the data Kim and Lim (2016) examined and extends the range of analysis. The raw data used in the present paper are the monthly series of nominal housing price and chonsei (rent) prices of apartments, nominal interest rates, and core CPI, covering 1987/05 – 2020/10. To use enough data for making first-difference or year-on-year data, raw data begins from 1986/01. Different from Kim and Lim, this paper directly uses monthly latest data instead of quarterly data and adds macro variables to conduct the VAR approach. Housing price and chonsei prices are compiled by the Kookmin Bank database and are downloadable in public. Nominal interest and CPI series are downloaded from the Bank of Korea database.
The unique system of rent payment:
There exists a rental housing payment system called chonsei which makes people live in a house by paying a large lump-sum amount of deposit which is usually about 50% to 60% of the market value of the property instead of paying monthly rent payment, but it can be as high as 80%. It is also called Jeonse. From the background of housing-shortage during the 60s-70s, there was an insufficient supply of housing and then the government had implemented supply oriented construction since the 1970s. Therefore, instead of buying a house which requires a high amount of payment, there is a demand for tenants who can live the house affordable within their budget.
Conclusion:
From the present value model, the gross real return on housing price can be expressed with real house price and real rent payment. Then, by using Campbell-Shiller approximation, the log of price-rent ratio is approximated into a log of real rent growth and a log of gross return on housing, which is possible to break down into real risk-free return and excess return. The movements in the actual price-rent ratio are decomposed into expectations of housing fundamentals such as real rent growth, risk-free interest rate, and risk premium. However, there is a deviation between housing price fundamental value and actual price-rent ratio.
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