A measure of the rental yield on residential property derived from the national accounts rose further above its long-run average in the first quarter of 2013, suggesting that house prices are becoming increasingly undervalued relative to rents.

The national accounts yield measure is calculated by dividing the sum of actual rental payments and imputed rents of owner-occupiers by the value of the housing stock. The yield is calculated on a trailing 12-month basis, i.e. its first-quarter value equals rents in the year to end-March divided by the end-March value of the housing stock.

The rental yield has averaged 4.26%* since 1965, moving well below this level during the house price bubbles of the early 1970s, late 1980s and 2000s associated with monetary laxity overseen respectively by Lords Barber, Lawson and King.

The yield reached a low of 3.34% in the third quarter of 2007, suggesting that house prices were then overvalued by 28% relative to rents (i.e. the percentage deviation of 4.26 from 3.34). It has since risen steadily, reflecting a fall in prices in 2008-09 and sustained solid growth in rents.

The yield was an estimated** 4.89% at the end of the first quarter, consistent with house price undervaluation of 13%.

Houses remain expensive in terms of earnings but bubbles are characterised additionally by an overshoot of prices relative to rents, as rose-tinted perceptions of capital gains potential distort assessments of the merits of owning rather than renting. Government policies designed to stimulate home-buying are ill-advised but current prices are far from bubble territory.

*The yield series has shifted higher as a result of a recent change in national accounts methodology; specifically, imputed rents are now measured on a gross basis before subtracting estimated repairs and maintenance costs.
**The value of the housing stock at end-March was estimated by linking a published end-December reading to the change in the official house price index between December and March.