Academic journal article Real Estate Economics

Are There Investor Clienteles in Rental Housing?

Academic journal article Real Estate Economics

Are There Investor Clienteles in Rental Housing?

Article excerpt

The possible existence of investor clientele groups has received little attention in the real estate finance literature. In this paper we develop a clientele model, which in equilibrium produces a clustering of investors by tax characteristics. Low-tax-bracket investors are concentrated in low-value rental housing that attracts rents which are high in relation to property values. On the other hand, only high-tax-bracket investors will be observed in high-value rental housing, and they charge rents that are low in relation to property values. An empirical model is specified and estimated using a cross section of investors in Australian private rental housing markets. Investor clienteles are detected among property investors, though there is a weak diversification effect indicating that clientele effects may be stronger among single property investors.


This paper investigates whether investor clientele effects characterize real estate investments in rental housing. In their seminal paper concerning the valuation of shares, Miller and Modigliani (1961) acknowledge that tax-driven clientele effects could result in low-dividend-yield shares selling at a premium as returns are "packaged" in the form of capital gains that are tax advantaged. But Miller and Modigliani question the empirical significance of such effects for investors in tax brackets other than the very top bracket. A plethora of empirical studies have explored whether the separation of shareholders by dividend yield is as exact as the raw tax differentials might seem to suggest. A parallel literature has sought evidence of tax-disadvantaged dividends leaving a detectable track in the prices of shares. (1)

In physical asset markets such as real estate, where again capital gains are typically given favorable tax treatment, the possible existence of clientele effects has received relatively little attention. This is despite evidence suggesting that rates of house price appreciation differ between locations (Kiel and Carson 1990) and between higher and lower priced homes (Seward, Delaney and Smith 1992, Haurin, Hendershott and Wachter 1996, Smith and Ho 1996). (2) Mills and Kaiser (1999) find that over the 1930-1976 period the rent-to-value ratio has varied inversely and consistently with the inflation rate. They conclude that "the reason for this relationship is that landlords require a roughly constant total return to induce them to hold rental housing" (Mills and Kaiser 1999, p. 84). Since capital gains are a large part of investor returns, submarkets where expected house price appreciation is high will feature competition between investors from different tax brackets that should push down current rent-to-value ratios. In submarkets where expected house price appreciation is low, the exit of investors will force current rent-to-value ratios higher.

Steele (1993) recognizes tax-driven clientele effects in Canadian rental markets where (in the early 1990s) only 50% of investors' capital gains were taxable. Thus, the "larger the capital gain component relative to the net rental income component of rental real estate, the more attractive is investment in rental real estate to high-bracket investors relative to low-bracket investors" (Steele 1993, p. 114). Implications can be drawn for ownership of the stock. If corporations are typically subject to lower marginal rates of tax, then they will be uncompetitive with high income individual investors and displaced by the latter, particularly during inflationary periods.

Both Steele (1993) and Titman (1982) recognize that during inflationary periods rents will not keep pace with inflation because landlords' capital gains receive tax advantaged treatment. Kiefer (1978), in simulating the cost of housing services for renters and buyers at different income levels, also finds that accelerating rates of inflation benefit investors at higher income levels due to the asymmetric tax treatment of income and capital gains. …

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