Real Estate Market Efficiency: A Survey of Literature

Gunther Maier, Shanaka Herath

Research Institute for Spatial and Real Estate Economics

SEITE 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

SEITE 3

Introduction

Research question:

“What is the evidence in the literature concerning efficiency or inefficiency of the real estate market?”

SEITE 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

SEITE 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

SEITE 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.

SEITE 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

SEITE 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

SEITE 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

SEITE 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?

SEITE 11

What is the Real Estate Market?

Types: residential, business, commercial and land Each type is heterogeneous in itself

Example: Residential real estateSingle-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

SEITE 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?

SEITE 13

Information and Real Estate Market Efficiency Weak Form Efficiency Tests

SEITE 14

Information and Real Estate Market Efficiency Semi-strong Form of the EMH

SEITE 15

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

SEITE 16

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

SEITE 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

SEITE 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

SEITE 19

Thank you.

VIENNA UNIVERSITY OF ECONOMICS AND BUSINESSAugasse 2-6, 1090 Vienna, Austriawww.wu.ac.at

SPATIAL AND REAL ESTATE ECONOMICS RESEARCH INSTITUTENordbergstraße 15 (UZA4, Kern B, 4. Stock)A-1090 Vienna, Austriahttp://www.wu.ac.at/immobilienwirtschaft

UNIV.PROF. DR. GUNTHER MAIER SHANAKA HERATH T +43-1-31336-4780 T +43-1-31336-5764F +43-(0)1-31336 705 F +43-(0)1-31336 705gunther.maier@wu.ac.at Shanaka.herath@wu.ac.at