Contribution of this article: Do real estate prices reflect all the risks to which a property is exposed? Their evolution following a natural, industrial, or terrorist disaster shows that housing prices react strongly to the perception of a new risk, with the extent and duration varying according to its nature. This poor integration of information into real estate prices seems to be due to the existence of insurance mechanisms andbuyers’ignoranceof the seriousness of these risks.
Abstract:
·Housing prices react strongly to the perception of a new risk and, for example, fall after a natural or industrial disaster, even if the housing has not been directly affected.
·In the case of natural disasters, the impact can be as much as a 20% drop in housing prices.
·Industrial risks appear to have a more heterogeneous effect: -1-2% in France after the AZF disaster, -3.4% in Germany after the Fukushima disaster, but 0% in Sweden for housing exposed to similar risks.
·In some cases, terrorist risk also appears to have an effect of up to 6% on housing prices.
Housing prices on the real estate market reflect the advantages and disadvantages associated with the location of these homes. Thus, the quality of schools (see, for example, Gabrielle Fack and Julien Grenet (2010); this article was already discussed on BSI Economics) or the noise level (Pope, 2008) in a neighborhood will impact housing prices.
Will the prices of these homes also reflect the risks associated with certain locations, such as natural and industrial risks? In theory, they should: a rational, informed, and risk-averse agent must be « compensated » for exposing themselves to risk. As a result, a house located in a flood zone should sell for less than an identical house located in a safer area.
However, the reality is sometimes more complex than the previous paragraph suggests. First, there are insurance mechanisms. Second, actors, particularly buyers, may be unaware of these risks or unable to assess them correctly. Pope’s article (2008) is revealing in this regard. Pope studies the impact on real estate prices of a measure requiring an airport (Raleigh–Durham in North Carolina) to disclose the level of noise in its surroundings in a more transparent manner. He shows that the negative effect of noise on housing prices increased by 37% after the measure was implemented (a home located in the noisiest area sold for 7.8% less than a similar home outside the noise zone before the measure was implemented. The price drop is 10.9% after the measure), suggesting that it was previously underestimated. Similarly, in the case of natural or industrial disasters, it is often after an « event » that real estate prices react to these « dangers. »
This article lists a number of studies showing the relationship between « risks » and real estate prices, focusing in particular on (1) natural risks, (2) industrial risks, and (3) terrorist risks.
Natural risks
As A. Mauroux (2015a,b) points out, although economic literature has long raised the question of the impact of natural hazards on housing prices, studies on this subject remain rare in France. This is a relatively paradoxical situation in a country where approximately 6.8 million people live in flood-prone areas (A. Mauroux, 2015a).
However, there are a few studies, such as that by Deronzier and Terra (2006) on the city of Charleville-Mézières, which experienced a major flood in 1995. The purpose of this article is to show that during the period 1984-1994, i.e., before the Meuse flood, the difference in housing prices between flood-prone and non-flood-prone areas was negligible. A. Mauroux (2015a) explains that in some cities, housing prices can sometimes even be higher because the risk of flooding is correlated with living near a river, which may be valued by buyers.
However, after the Meuse flood, housing prices in flood-prone areas in Charleville-Mézières were more than 20% lower than those in non-flood-prone areas (approximately €23,000 for the average home). Furthermore, this price difference persisted over time (at least until 2004, the last year considered in the study by Deronzier and Terra), perhaps because a risk prevention plan adopted in 1999 and a second flood in 2001 served as reminders of the risks to the public.
Another interesting point highlighted by A. Mauroux (2015a) is that the estimated amount seems to be much higher than the average cost of a disaster. This could reflect an extremely strong risk aversion among the public. In summary, this example suggests that the public is very risk averse but generally too ignorant of the risks to take them into account in the absence of a strong signal (in this case, a recent flood).
Industrial risks
The previous paragraph shows that the real estate market does not clearly factor in natural risks. The question arises as to whether the same is true for industrial risks. Several recent economic studies have used industrial accidents, such as the Fukushima disaster in Japan or the AZF disaster in Toulouse, to measure whether housing prices near other nuclear power plants or chemical factories react to the occurrence of an industrial risk.
Bauer, Braun, and Kvasnicka (2017) show that after the Fukushima disaster, the sale prices of homes near German nuclear power plants that continued to operate after the disaster fell by an average of 3.4%. While this effect is not insignificant, it contrasts with the 9% decline in prices around German power plants that were shut down after the Fukushima disaster. The authors attribute the latter effect to a negative shock on the local labor market (since these plants were shut down, they no longer represent a « risk »). This result suggests that while awareness of a « risk » has a significant effect on prices, this impact is nevertheless less than that resulting from an economic shock. It should also be noted that the effect of risk awareness can be heterogeneous. For example, Ando, Dahlberg, and Engström (2017) found no impact of the Fukushima disaster on the sale prices of Swedish homes near the three Swedish nuclear power plants. We can therefore assume that the effect of these risks may depend on several factors, such as the confidence of stakeholders in their government, the age of the power plants, etc., which may differ between Sweden and Germany. However, these variables are not discussed in the articles and it is difficult to estimate their impact.
Using the AZF disaster in 2001 as an example, Bléhaut (2015) shows that the effect of an industrial disaster on real estate prices is not limited to the nuclear industry. She finds a price difference of 1-2% in risk areas. She also shows that the vacancy rate for housing located in risk areas increases by 0.3 percentage points. Once again, it should be noted that this effect can be very heterogeneous: Grislain-Létrémy and Katossky (2014) show that the effect on prices of proximity to chemical plants can vary greatly depending on the area studied. Studying three areas (Bordeaux, Dunkirk, and Rouen), the authors find a negative impact only in the case of Rouen.
The risk of terrorism
Terrorist risk is widely reported in the media today. This raises the question of whether the perception of this risk influences the real estate market. Two recent articles draw on (a) the 2005 London bombings (Maneleci, 2017) and (b) the 2006 rocket attacks in Israel (Elster, Zussman, and Zussman, 2017) to measure whether « at-risk » housing experiences a decline in prices.
After the London attacks, Maneleci (2017) shows, for example, that housing prices in the immediate vicinity of major subway stations in London and Manchester fell by 6% and 14% respectively (the difference between the two can be explained by various factors and technical reasons) and that this decline in prices lasted for several years (one year in London, at least three years in Manchester).
Elster, Zussman, and Zussman (2017) also found a marked decline in prices in the areas most affected by rocket attacks carried out by the Lebanese Hezbollah during the Second Israeli War in Lebanon (-6-7%), an effect that lasted for more than six years (until 2012, the last year observed by the authors). It should be noted, however, that in both cases, the measured effects are the result of both an increased perception of risk and an economic shock. Indeed, the risk of terrorist attacks may deter companies from setting up in these areas, thus making them less attractive to buyers.
Conclusion
This article discusses the impact of natural, industrial, and terrorist risks on real estate prices. It shows that after an event that « reveals » these risks, buyers are willing to pay less to purchase (or rent) housing in these areas.
The significant effects of natural and industrial disasters on real estate prices in « risky » areas highlight the importance of information on real estate markets and, in this case, often the importance of buyers’ ignorance of the seriousness of these risks. In addition to environmental, safety, and public health reasons, this once again justifies action by public authorities to inform the public about the nature, frequency, and danger of these risks.
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