Discount Shock, Price–Rent Dynamics, and the Business Cycle

Abstract

The price-rent ratio is highly volatile and predicts future returns for commercial real estate. Price-rent variations in commercial real estate also tend to comove with investment and output. We develop a general equilibrium model that explicitly introduces a rental market and incorporates collateral constraints on production as a key ingredient. Our estimation identifies discount-rate shocks as the most important factor in (1) driving price-rent variations, (2) producing the long-horizon predictability of real estate returns, and (3) linking the dynamics in commercial real estate to those in the production sector.