What determines rent prices of houses? Does it depend only on interest rates?

Question

My hypothesis: the renting is determined by the opportunity cost of selling the house and gaining interests in a bank or some investment company. That is, instead of renting, sell it, put the money in a bank, and gain interest on them.

In other words, the renting prices of real state are determined by only two factors: The price of the house + the interest rates.

However, it has been my observation here where I live, in very few houses (thus lacking some statistical weight), that house renting for commercial entities is around the same as selling the house and gaining interest, but, house renting for a physical person is around half than selling house and gaining interest.

Questions:

• The hypothesis of renting determined by interest rate is a good one in the context of theoretical microeconomics, or merely simplistic understanding?
• In the real world, is renting primarily determined by interest rate and house price? In other words, is the relationship causal? Or just a correlation? Is there a correlation anyway?
• Are there more mechanisms for determination of the prices of renting a house?
• Why sometimes the renting price can be lower than if gaining on interest? Why would anyone prefer to keep the property of the house, if they could gain more by selling it and gaining interest?

Answer 1

What you're referring to is called the "rental yield", i.e. income generated from rentals as a portion of the amount you have invested in the house.

The interest rate is definitely one of the factors determining rental prices. Most other factors would be included in the house price (e.g. how big and nice the house is, how many bedrooms, are there many workplaces around, crime rate, etc.)

Other things that might be left out apart from the interest rate and house price is how competitive the house rental market is. You could imagine a neighborhood where there's only a few houses that are for rent. If there's demand, there's no reason the rental yield should be lower than another neighborhood with more competitive rental market.

If a person buys a house as an investment, then he/she would have taken into account the return he/she would get if this money was invested elsewhere. Say the average stock market return is about 7%, then it makes no sense for a person buying a house as an investment to seek for rental yield lower than that.

Having said that, of course, you need to take into account property price increase as well. You might be ok getting lower rental yield than your next best option if you foresee that the house price in your neighborhood would rise in the future.

Lastly, if you have a house and need to move away for a few years knowing that you'll eventually move back, it might be a good choice to rent it out in the meantime. For this, your primary reason of owning that house is not for investment, so you might be ok with getting lower rental yield (perhaps in exchange for being able to select suitable renters).