Valuation of Long-Term Property Rights Under Political Uncertainty

Abstract

We empirically analyze the pricing of political uncertainty in long-term property rights, guided by a theoretical model of housing assets subject to contract extension in the remote future. To identify exposure to political uncertainty, we exploit a unique variation around land lease extension protection beyond 2047 in Hong Kong's housing market due to the historical arrangements under the “One Country, Two Systems” design. A reduced-form approach reveals that relative to properties that have been promised an extension protection, those with legally unprotected leases granted by the current Hong Kong government are sold at a substantial discount of around 8%. Similar contracts issued during the colonial era suffer an additional discount of about 8% due to their reneging risk. Our parsimonious model matches well these empirical discounts across long-term lease horizons, and the estimated structural parameters imply that to extend their leases homeowners expect about an additional 20% ground rent after 2047. The discount is higher when people's confidence declines and where residents feel more uncertain of the city's future, but lower when the transaction involves a mainland buyer and a local seller.

Institutional subscribers to the NBER working paper series, and residents of developing countries may download this paper without additional charge at www.nber.org.