Flooding and Liquidity on the Bayou: The Capitalization of Flood Risk into House Value and Ease-of-Sale

Real Estate Economics (Spring 2013 V41 n1 pp. 103–129;DOI: 10.1111/j.1540-6229.2012.00338.x) / by Geoffrey K. Turnbull, Velma Zahirovic-Herbert and Chris Mothorpe
http://onlinelibrary.wiley.com/doi/10.1111/j.1540-6229.2012.00338.x/pdf

[Abstract] The existing literature focuses on how perceived flood risk affects house value. Search theory, however, implies that flood risks will be capitalized into both house price and liquidity. This article draws on search theory to develop an empirical approach for estimating flood risk capitalization into both price and selling time. The results show the mix of price and liquidity capitalization varies by level of flood risk as well as across housing market phases. Regardless of the specific capitalization pattern, the results illustrate that focusing solely on price without allowing for concomitant liquidity capitalization can yield estimates that understate the full impact of flood risk on house transactions.

All of the base model estimates exhibit the expected signs and the estimates for the base model variables are robust across the extended models. Following Kennedy (1981), the coefficient estimates imply that houses in the Highest Risk Zone exhibit significant price discounts of about 2.8% and longer expected selling times. The price discount is consistent with the bulk of the existing empirical literature (except Morgan (2007)) concluding that flood risk reduces property value. Nonetheless, the estimates reported here clearly illustrate that focusing solely on price capitalization understates the full impact of being in a higher flood risk zone, as it overlooks the significantly greater difficulty of selling property so situated. In any case, the estimates are consistent with the notion that if flood insurance benefits are underpriced, they are not sufficiently underpriced to fully compensate for the perceived costs of flooding in the highest risk areas of Baton Rouge. [H/T: Environmental Valuation and Cost Benefit News]

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