Real Estate Market Efficiency: A Survey of Literature

1. Real Estate Market Efficiency: A Survey of Literature Gunther Maier, Shanaka Herath Research Institute for Spatial and Real Estate Economics

2. Outline of the Presentation • Introduction • The Conceptual framework • What is the “real estate market”? • Efficiency of the real estate market • Information and real estate market efficiency • Tests of efficiency using market fundamentals • Conclusion

3. Introduction • Research question: “What is the evidence in the literature concerning efficiency or inefficiency of the real estate market?”

4. Introduction (contd.)Real Estate and National Economy • Real estate • A considerable portion of an individual’s wealth • A considerable share of a national economy • in real estate value  in financial, construction sectors  in unemployment • in real estate sales  real estate prices  value of homes  available home equity loans  consumer spending • Beyond doubt: close relationship between real estate market and financial markets

5. Introduction (contd.)Real Estate and Spatial Economy • Real estate is an essential element of a spatial economy • Most decisions in a spatial economy involve rental or acquisition of real estate in some form. • Also more aggregate concepts involve real estate aspects. • Inefficiencies in the real estate market may spill over into the spatial economy • inefficient spatial structures • disinvestments, waste of resources

6. Introduction (contd.)Real Estate and Environment • Real estate is important in an environmental context • Perfect anticipation and incorporation of energy costs of buildings by the market • Other things equal, more energy efficient buildings would have a higher value/ rents.

7. The Conceptual Framework:What is an Efficient Market? • “Efficient market hypothesis” (EMH) (Fama et al., 1969) – stated for financial markets: „The prices of traded assets already include/reveal all known information“ • Implication: “random walk hypothesis” • as long as fundamentals do not change, fluctuations are random  follow a random walk

8. The Conceptual Framework (contd.):What is an Efficient Market? • Three versions of the EMH • weak: prices reflect previous price information • semi strong: prices reflect all publicly available information (incl. past prices) • strong: also non-public information is reflected in the prices • Efficiency with respect to some set of information

9. The Conceptual Framework (contd.):What is an Efficient Market? • Tests of the EMH (financial markets) • only indirect tests via its implications • all tests require some reference model that links information and fundamentals to asset prices. (“bad model problem”) • Early evidence strongly supporting EMH • Later evidence more controversial – evidence for market inefficiencies

10. What is the Real Estate Market? • Real estate market: the market where supply and demand for real estate meet and where real estate is traded. • Usually segmented into various submarkets along different dimensions: e.g., type of real estate, location, time. • Where are the boundaries? • How close (type, location, time) the transactions are, to be considered the same market?

11. What is the Real Estate Market? • Types: residential, business, commercial and land • Each type is heterogeneous in itself • Example: Residential real estate Single-family homes, multi-family houses, condominium, co-op housing, income generating residence, and residential construction market • Single physical object or portfolio of objects?, packaging of a portfolio (holding/management company), or trading of shares of a real estate management company (financial market) • Potential implications for judging the efficiency of the real estate market • Relationships between levels, types, submarkets

12. Is the Real Estate Market Efficient? • Two ways of testing: • market model approach: does the real estate market work according to some idealized model? Which is the right model? • forecasting approach: Can prices be predicted from past prices / information?

13. Information and Real Estate Market EfficiencyWeak Form Efficiency Tests

14. Information and Real Estate Market EfficiencySemi-strong Form of the EMH

15. Tests of Efficiency using Market FundamentalsPrice Volatility, Price Cycles, and Price Bubbles

16. Tests of Efficiency using Market FundamentalsPrice Dispersion and Positive-feedback Hypothesis

17. Summary of Results • Most studies use aggregate market data in an urban context • Results • Two third of weak form efficiency tests support inefficiency • Semi-strong form: inconclusive (with some mixed results) • Tests of price volatility, price cycles, and price bubbles: more support for inefficiency • Older studies: efficient; newer studies: inefficient

18. Conclusions • weak support (at best) for an efficient real estate market • result of aggregation? • possibility for spatial distortions (spatial bubbles) resulting from the inefficiencies of the real estate market – disinvestments

19. Thank you. VIENNA UNIVERSITY OF ECONOMICS AND BUSINESS Augasse 2-6, 1090 Vienna, Austria www.wu.ac.at SPATIAL AND REAL ESTATE ECONOMICS RESEARCH INSTITUTE Nordbergstraße 15 (UZA4, Kern B, 4. Stock) A-1090 Vienna, Austria http://www.wu.ac.at/immobilienwirtschaft UNIV.PROF. DR. GUNTHER MAIER SHANAKA HERATH T +43-1-31336-4780 T +43-1-31336-5764 F +43-(0)1-31336 705 F +43-(0)1-31336 705 gunther.maier@wu.ac.atShanaka.herath@wu.ac.at