Net Present Value and The ERE, Help needed.

Economics Economics Questions
1

I thought I had this all down, until I started crunching some numbers, now I am abit confused.

So the basic austrian line is that, in the Evenly Rotating Economy the price of an asset is its risk adjusted net present value.

Ohkay well, now for a real life scenario.

In australia the interest rate for borrowing/lending is like 7%/6.5% respectively.

Thus if a house generates net income of say 18,000 a year profit before tax. Then based on its NPV it should be worth roughly 475,000. This is quite realistic, and generally representative of the market.

(Rents increase by inflation - 3%, interest rates 7%, expenses 1650 per year, rent 400 a week, vacancy rate 5%) All, pretty fair assumptions.

But thats only a 4% return on investment. you can get 7% in the bank.

To compare, if you left the money in the bank you would outperform houses by 3x over 20 years.

Obviusly there wouldnt be a risk premium on money in the bank.

So to simplify my question.

How can an asset such as houses be “fair valued,” yet be underperforming cash in the bank?

What forces or mechanism would push the yields, so that we return back to the ERE.

2

Wait I think I got the solution to my own question.

Because their is a risk premium on houses, no-one would ever pay the NPV, thus in the ERE the house would be like (1-0.25)*NVP where 0.25 is the risk premium.

This would push up yields to the point where houses are getting like 10-12%

So that the average investor was indifferent to investing in a house or in the bank (abset his appetite for risk.)

But because this isnt the case in Australia. (house prices get half the yield of a bank account,) That is some sort of sign that people are overly optimistic on housing, because they are factoring in a negative risk premium (i.e. an appreciation premium.)

I think that answers my question, its leaving me a bit confused tho.