Efficiency in the Real Estate Market: Case of Energy Efficiency

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Efficiency in the Real Estate Market Case of
Energy Efficiency

• Ari Laitala
• Doctoral student

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Efficient market hypothesis (EMH)

• EMH, classical view of the market efficiency
  (Fama 1969, 1970)
• Concludes that there are three different forms of
  market efficiency weak, semi-strong and strong
• Focuses on the financial market and especially to
  the stock market
• Focuses lot of macro-level approach
• How about the micro level approach?
• Probably some transactions are more efficient
  than the others?
• What kind of buyer is efficient? (or when)
• What kind of seller is efficient? (or when)
• Are prices alone a relevant scope to the
  efficiency? How about the value and value/price
  ratios
• What is actually meant by the efficiency and what
  could be the meaning of it?

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What is efficiency?

• Efficiency is largely used in physics,
  engineering and in economics e.g.
• Pareto efficiency, Kaldor-Hicks efficiency,
  market efficiency
• Mechanical efficiency measured performance /
  ideal performance
• We define Efficient Market
• Market is efficient if transactions in the market
  are efficient
• (Market efficiency is a function of single
  transactions efficiency)
• We define Efficient Transaction (Efficiency of a
  transaction)
• Transaction is efficient if value creation of
  buyer and seller is maximised
• (Transaction efficiency is a function of value
  creation)

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Subjective value for the buyer (SVB)
Detected features (value factors)
Alternative consumption possibilities
-
Subjective value for pb1
Willingness to buy WTB increases
Value judgement process
Estimation of the probable price
Ability to buy ATB
Object p1
Subject pb1
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Subjective value for the seller (SVS)
Object p1
Subject ps1
Value judgement process
Estimation of the probable price
Willingness to sell WTS increases
Alternative consumption possibilities
-
Subjective value for ps1
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Valuing value factors

• Object can be understood as a set of features

• Single buyer detects some of them
• If a subject believes that a feature has an
  capability to satisfy the needs and wants the
  feature has an effect to the subjective value
• If a feature has an effect to the subjective
  value we define the feature as a value factor
• Some features can be hard to value
• Like cosiness of neighbourhood
• Potential buyer may realize that all the relevant
  value factors are maybe not detected at all

? ?
-
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Efficient buyer and seller

• It is believed that buyer prefers best subjective
  value (SVB) / price ratio
• Finding best value offer in the market causes
  transaction costs
• According to Kotler they are
• Financial, psychological, energy and time related
• Accruing searching costs limit the benefits of
  finding the best value offer (value proposition)
• Buyer is efficient to the point where increasing
  transaction costs exceed the probable benefits
  finding better value offers
• Case of efficient seller is very same seller is
  believed to prefer highest offer and searching
  the best offer causes transaction costs as well
• Seller is efficient to the point where increasing
  transaction costs exceed the probable benefits of
  finding higher bids

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Value creation process
SVB
Value can be maximised in this transaction!
Value increases
SVS
MV
SVB
MV
MV
SVS
SVS
SVB
Value creation value detecting value
capturing
(finding best negotiation
power value proposition
)
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Conclusions so far

• The more efficient the transactions in the market
  are the more efficient the market is
• The more efficient the buyers and sellers are the
  more efficient the transactions are
• The more the buyers and sellers are able to
  create subjective value the more efficient they
  are

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Case of pipe repair
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Game of sell and buy in the suburban housing
market
Efficient buyer Average buyer
Average buyer Inefficient buyer
Pipe repair has been done in the apartment you
are buying Pipe repair has not been done in the
apartment you are buying
Pipe repair has not been Pipe repair has
been done done in the apartment you in the
apartment you are selling are selling
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Some results of the energy efficiency survey
within Finnish professional commercial property
valuers (3/2013)
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Some indicative conclusions related to energy
efficiency in the Finnish commercial property
market

• Energy efficiency is quite clearly a detectable
  value factor (agreed to some extent)
• Related to the earlier and general results
• Energy efficiency has been very largely reported
  to have a positive effect to the market values
• Yes, of course, but energy efficiency seems to
  have its price, benefits dont necessarily exceed
  the costs
• Energy efficiency has an effect to the value
• Effect to the cost based investment value is more
  significant than to the market values
• Hereby, market mechanism seems to smooth the
  differences between subjective and objective
  values
• Even though commercial property market is
  believed to be totally cash flow driven
• There seems to be a possibility to make efficient
  and inefficient transactions in relation to
  energy efficiency

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So what?

• Does invisible hand of the commercial property
  market have enough power to speed up the market
  transformation?
• No!
• We are going to see more new regulation which
  highlights the pros and cons of the energy
  efficiency (sustainability)
• It is very problematic with the existing
  buildings
• If our real goal is to decrease CO2 emissions,
  our journey is in its beginning
• Thanks, questions and comments
• ari.laitala_at_aalto.fi

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References / Further Reading

• Maier, G. Herath, S. 2009. Real Estate Market
  Efficiency A Survey of Literature. Vienna
  University of Economics and Business
  Administration. Department of City and Regional
  Development. Saatavissa SRE-Disc
  sre-disc-2009_07
• Quan, D Quigley, J. 1991 Price Formation and
  the Appraisal Function in Real Estate Market