Search Costs, Behavioral Biases and Information Intermediary Effects

Abstract

In many markets, buyers, sellers and their agents have differential information about the quality of heterogeneous assets. We study negotiated transaction prices in the commercial real estate market, which is characterized by heterogeneous assets, illiquidity and highly segmented local markets, all of which increase the importance of asymmetric information in negotiated pricing outcomes. We posit that the magnitude of search costs and asymmetric information is increasing in the geographic distance between the buyer's personal residence and the transacted property. Using 114,588 industrial, multi-family and office sale transactions that occurred during 1997-2011, we document that distant commercial real estate buyers pay, on average, premiums of 4% to 15% relative to local buyers, controlling for individual property characteristics as well as time fixed-effects. Our results suggest the observed price premiums are explained by distant investors who face higher search costs and are at an information disadvantage compared to investors who face higher search costs and are at an information disadvantage compared to investors located in closer proximity to the property. In contrast, anchoring plays a more muted role in explaining observed premiums. The use of an intermediary (broker) increases, on average, the acquisition prices of buyers and decreases the disposition prices of sellers by 3% to 8%. This result is consistent with the incentive real estate agents have to convince sellers to dispose of their properties too quickly and to convince buyers to search less and therefore pay higher prices.