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 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

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 Fundamentals Price Volatility, Price Cycles, and Price Bubbles

SEITE 16 Tests of Efficiency using Market Fundamentals Price 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 BUSINESS Augasse 2-6, 1090 Vienna, Austria SPATIAL AND REAL ESTATE ECONOMICS RESEARCH INSTITUTE Nordbergstraße 15 (UZA4, Kern B, 4. Stock) A-1090 Vienna, Austria UNIV.PROF. DR. GUNTHER MAIER SHANAKA HERATH T T F +43-(0)