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Abstract:
Previous studies have shown that foreclosure often results in vandalism, disinvestment and other negative spillover effects in the neighborhood. This paper extends these views into a formal theoretical model through pricing based on comparables. We project that the spillover effect of a foreclosure on neighborhood property values depends on two factors: the discount of foreclosure sale and the weight placed on the foreclosed property as a comparable in the valuation. The fomer is related to housing cycles and the latter varies by time of foreclosure and its distance from the subject property. Empirical results based on a 2006 sample show that this effect is significant within a radius of 0.9km (roughly 10 blocks) and within five years from its liquidation. The most severe impact is an 8.7% discount on neighborhood property values, which gradually drops to anywhere between -1.2 to -1.7% for foreclosures liquidated within the past 5 years. These spillover effects vary slightly when the sample selection bias is taken into account. Based on an alternative sample of purchase transactions in 2003, the estimated spillover effects in booming years are reduced by half, confirming on the important role played by housing cycles.

foreclosure, spillover effect, valuation

Abstract:
Previous studies have shown that foreclosure often results in vandalism, disinvestment and other negative spillover effects in the neighborhood. This paper extends these views into a formal theoretical model through pricing based on comparables. We project that the spillover effect of a foreclosure on neighborhood property values depends on two factors: the discount of foreclosure sale and the weight placed on the foreclosed property as a comparable in the valuation. The former is related to housing cycle and the latter varies by time of foreclosure and its distance from the subject property. Empirical results based on a 2006 sample show that this effect is significant within a radius of 0.9 km (roughly 10 blocks) and within 5 years from its liquidation. The most severe impact is an 8.7% discount on neighborhood property values, which gradually drops to anywhere between −1.2 to −1.7% for foreclosures liquidated within the past 5 years. These spillover effects vary slightly when the sample selection bias is taken into account. Based on an alternative sample of purchase transactions in 2003, the estimated spillover effects in booming years are reduced by half, confirming on the important role played by housing cycles.

Foreclosure, Spillover, Valuation

Abstract:
The role of selling (or marketing) period uncertainty in understanding risk associated with property investment is examined in this paper. Using an approach developed by Lin and Vandell [2001, 2005] and Lin [2004], combined with a statistical model of UK commercial property transactions, we show that the ex ante level of risk exposure for a commercial real estate investor is aroundone and a half times that obtained from historical statistics. The risk related to marketing time uncertainty can be reduced by constructing a portfolio. We find that at least 10 properties are necessary to reduce this risk, assuming independence between marketing period risk and price risk. These findings have important implications for mixed-asset portfolio allocation decisions.

liquidity risk, commercial real estate, time on market, transaction process, UK

Abstract:
The role of selling (or marketing) period uncertainty in understanding risk associated with property investment is examined in this paper. Using an approach developed by Lin and Vandell [2001, 2005] and Lin [2004], combined with a statistical model of UK commercial property transactions, we show that the ex ante level of risk exposure for a commercial real estate investor is around one and a half times that obtained from historical statistics. The risk related to marketing time uncertainty can be reduced by constructing a portfolio. We find that at least 10 properties are necessary to reduce this risk, assuming independence between marketing period risk and price risk. These findings have important implications for mixed-asset portfolio allocation decisions.

liquidity risk, commercial real estate

Abstract:
Thinly-traded assets exhibit illiquidity and do not fit in the efficient market paradigm. Direct application of classical finance theories to illiquid assets simply ignores the illiquidity risk of thinly-traded assets. Using commercial real estate as a testing ground, this paper develops a new, closed-form ex ante risk metric that converts illiquidity risk and integrates it with real estate price risk. Such integration provides a formal and easy-to-use analytical tool for illiquid asset pricing and enables apples-to-apples comparison between the performances of real estate and financial assets. Using real estate data, we show that the conventional risk metric significantly underestimates the true real estate risk and our finding helps to explain the apparent “risk premium puzzle” in real estate.

Abstract:
This article addresses the micro-analytic foundations of illiquidity and price dynamics in the real estate market by integrating modern portfolio theory with models describing the real estate transaction process. Based on the notion that real estate is a heterogeneous good that is traded in decentralized markets and that transactions in these markets are often characterized by costly searches, we argue that the most important aspects defining real estate illiquidity in both residential and commercial markets are the time required for sale and the uncertainty of the marketing period. These aspects provide two sources of bias in the commonly adopted methods of real estate valuation, which are based solely on the prices of sold properties and implicitly assume immediate execution. We demonstrate that estimated returns must be biased upward and risks downward. These biases can be significant, especially when the marketing period is highly uncertain relative to the holding period. We also find that real estate risk is closely related to investors' time horizons, specifically that real estate risk decreases when the holding period increases. These results are consistent with the conventional wisdom that real estate is more favorable to long-term investors than to short-term investors. They also provide a theoretical foundation for the recent econometric literature, which finds evidence of smoothing of real estate returns. Our findings help explain the apparent risk-premium puzzle in real estate - that is, that ex post returns appear too high, given their apparent low volatility - and can lead to the formal derivation of adjustments that can define real estate's proper role in the mixed-asset portfolio.

Abstract:
This paper develops a formal model to examine the effect of changing market conditions and individuals' selling constraints on expected selling price and time-on-market. Using the concept of Relative Liquidity Constraint (RLC) - a stochastic variable that captures the randomness of future individual constraints and market conditions - the study presents the first ex ante analysis that extends the investigation of the issue of seller heterogeneity to the point of the buying decision, that is, from the perspective of the buyer's (future seller's) point of view. We show that seller constraint, as well as the uncertainty of such a constraint, significantly depresses the expected selling price and increases risk. Our closed-form formulas provide a set of simple quantitative tools that enable buyers and sellers to adjust the "market average" to their ex ante "individual expectations".

Home Price, Time-on-market, Seller Heterogeneity, Housing Market Conditions

Abstract:
This paper comments on the Weighted Repeated Sales (WRS) method in Case and Shiller (1989). We find that Case-Shiller’s model for step-two of WRS is conceptually mis-specified and empirically inaccurate, which are likely to cause the S&P/Case-Shiller Home Price Indices to be biased for the most critical housing markets (i.e. nine of the ten cities with housing related derivatives based on the indices). Based on our examination of real estate market risks, we propose a quadratic model for the second step of WRS and show that our specification is actually more consistent with the findings by Case and Shiller (1989).

Abstract:
This paper documents women on average pay more for mortgages than men. The disparity cannot be fully explained by traditional variables such as mortgage features, borrower characteristics, and market conditions. While the persistence of gender disparity may suggest discrimination, we offer a different explanation: women pay higher rates because they are more likely to choose lenders by recommendation while men tend to search for the lowest rate. Our empirical test confirms that search effort is rewarded in marketplace, and suggests that gender disparity in mortgage rates may be addressed by policies aimed at improving women’s financial literacy and search skills.

Abstract:
This article develops a theoretical framework and formulates a unified risk metric that integrates both real estate price risk and uncertainty of time on market (TOM). We demonstrate that real estate sellers with different degrees of financial distress face not only different marketing period risks, but also receive different return distributions upon successful sales. The major findings of this article can be summarized as follows. First, we show that real estate return and risk, which account for both price and TOM risk, are investor specific, varying over investors with different financial circumstances and holding periods. Second, the traditional valuation of real estate return and risk, which is based solely on the return distribution of a successful sale without considering the uncertainty of TOM and the investor's financial circumstances, underestimates real estate risk and exaggerates real estate return. Third, our empirical applications in both residential and commercial real estate markets show that the Sharpe ratio estimated by the traditional approach is seriously overstatedto the largest extent for investors with high financial distress. In addition, we find that, given the typical 5- to 7-year holding period for real estate, the Sharpe ratios estimated by integrating both price and TOM risk are much in line with the performance of financial assets. These findings can help to explain the apparent risk-premium puzzle in real estate.

Abstract:
This article develops a model and provides a closed-form formula to uncover the theoretical relationship between real estate price and time on market (TOM). Our model shows a nonlinear positive price-TOM relationship, and it identifies three economic factors that affect the impact of TOM on sale price. We demonstrate that conventional metrics for real estate return and risk, which are borrowed in a naïve fashion from finance theory, do not account for marketing period risk and tend to overestimate real estate returns and underestimate real estate risks. Our model provides a simple way to correct such bias. This theory helps to explain the apparent risk-premium puzzle in real estate.

Abstract:
This paper re-examines and extends the findings of Bond et al., Journal of Real Estate Finance and Economics, 34, 447-461, (2007) who consider the theoretical model of Lin and Vandell, Real Estate Economics, 35, 291-330, (2007) to determine the extent to which individual real estate asset return characteristics caused by marketing period risk disappear in a large, diversified real estate portfolio. The effects of marketing period risk are found to disappear in the limit with growth in the size of the portfolio, with ex ante variance approaching ex post variance, but only if the portfolio consists of nonsystematic risk alone, in which case both approach zero. The marketing period risk factor (MPRF), representing the ratio of ex ante to ex post variance, however, does not in general approach zero in the limit, in fact could increase or decrease depending upon the illiquidity characteristics of the individual assets and the magnitude and degree of correlation among individual property returns and marketing periods. The results suggest that even large institutional real estate portfolio managers must consider the illiquidity present in their portfolios and cannot assume that its effect will be diversified away.

time on market, real estate liquidity, portfolio performance