Efficiency in the Real Estate Market: Case of Energy Efficiency

1. Efficiency in the Real Estate Market: Case of Energy Efficiency Ari Laitala Doctoral student Ari Laitala

2. Efficient market hypothesis (EMH) Ari Laitala 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?

3. What is efficiency? Ari Laitala 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)

4. 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 Ari Laitala

5. 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 Ari Laitala

6. 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 ? ? + = - Ari Laitala

7. Efficient buyer and seller Ari Laitala 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

8. 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 ) Ari Laitala

9. Conclusions so far Ari Laitala 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

10. Case of pipe repair Ari Laitala

11. Game of sell and buy in the suburban housing market 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 Ari Laitala

12. Some results of the energy efficiency survey within Finnish professional commercial property valuers (3/2013) Ari Laitala

13. Some indicative conclusions related to energy efficiency in the Finnish commercial property market Ari Laitala 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 don´t 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

14. So what? Ari Laitala 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@aalto.fi

15. References / Further Reading Ari Laitala 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