Housing Quality in the Forward Contracts Market

15 Pages Posted: 11 Oct 2006 Last revised: 3 Jan 2013

K.W. Chau

The University of Hong Kong - Ronald Coase Centre for Property Rights Research - Economics

Siu Kei Wong

University of Hong Kong

Chung Yim Edward Yiu

Chinese University of Hong Kong - Department of Geography and Resource Management

Date Written: 2007

Abstract

Developers often conduct forward sales (or presales) before building completion to relieve financial risk and burden. However, there are worries that housing units sold in this way will turn out to be substandard because developers, who have been paid for the unfinished units, may have incentives to cut costs by lowering the quality. This is a typical moral hazard problem. Nonetheless, forward sales have been very popular in some Asian cities such as Hong Kong, Singapore, and Taiwan. A plausible explanation is that the market has efficiently adjusted the forward price for this potential quality problem according to developers' reputations. This paper aims to theoretically explain and empirically test 1) whether reputation is reflected in forward prices and 2) whether the expected quality level matches with the actual quality level. Using the forward and spot sales data of the Hong Kong real estate market, we found that even though housing quality was not observable during pre-sales, the market was able to capitalize developers' reputations into forward prices accurately. This suggests that the optimal strategy for developers is to stick to the quality level implied by their regulations.

Keywords: real estate forward sales, moral hazard, reputation, market efficiency

JEL Classification: L15, R00

Suggested Citation

Chau, K.W. and Wong, Siu Kei and Yiu, Chung Yim Edward, Housing Quality in the Forward Contracts Market (2007). Journal of Real Estate Finance and Economics, Vol. 34, No. 3, 2007. Available at SSRN: https://ssrn.com/abstract=936427

Kwong Wing Chau (Contact Author)

The University of Hong Kong - Ronald Coase Centre for Property Rights Research - Economics ( email )

Ronald Coase Centre for Property Rights Research
Pokfulam Road
Hong Kong
Hong Kong
(852)28592128 (Phone)
(852)25599457 (Fax)

Siu Kei Wong

University of Hong Kong ( email )

Pokfulam Road
Hong Kong, HK
China

Chung Yim Edward Yiu

Chinese University of Hong Kong - Department of Geography and Resource Management ( email )

Shatin
the New Territories
Hong Kong
Hong Kong

HOME PAGE: http://www.grm.cuhk.edu.hk/eng/people/ppl/fac_YiuEdward.html

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