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Article Excerpt
How do markets value relative house size in a neighborhood? The literature offers differing rationales: atypical houses sell for less, capitalization of property taxes penalizes larger and benefits smaller houses in mixed neighborhoods and conspicuous consumption reinforces the value of relatively larger houses and reduces the value of relatively smaller houses to consumers. Using a simultaneous price-liquidity model that controls for neighborhood supply and demand conditions, this article finds a dominant tax capitalization effect on price and marketing time that appears to override any extant atypicality or conspicuous consumption effects.
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Which does the market more highly value, the smallest house in a neighborhood of large houses or the largest house in a neighborhood of smaller houses? Real estate agents often give seemingly conflicting recommendations, arguing that the best deal is to buy into a nicer neighborhood by buying in on the low end while also maintaining that buying the largest house in a neighborhood gives more house for the money. And regardless of one's personal view, casual conversation about the answer to this question will quickly illustrate the wide range of opinions that exists.
The academic literature also offers differing rationales on this point. One hypothesis attributable to Haurin (1988) is that atypical houses by definition do not fit the neighborhood and so are priced to sell for less. Another, originally developed by Hamilton (1976), is that the capitalization of the property tax for a given public service bundle penalizes larger houses and benefits smaller houses in mixed neighborhoods, thereby leading to differential capitalization effects on each. Yet another is that conspicuous consumption reinforces the value of relatively larger houses and reduces the value of relatively smaller houses to consumers. While these separate hypotheses are not mutually exclusive, they do lead to different answers to the question of relative house size and value. Which, if any, of these notions corresponds to what we observe in the housing market?
This article is the first to empirically examine these alternative explanations of how neighborhood composition affects house value. The study is motivated by the recognition that, while the underlying theoretical arguments generate differing comparative static predictions, the issue resolves to a simple empirical question: When comparing two otherwise identical houses, does the house surrounded by smaller houses sell for more or less than a similarly sized house in a homogeneous neighborhood? A similar question pertains to the value of houses that are smaller than those surrounding them.
The discussion is organized as follows. The next section summarizes the different hypotheses regarding the role of relative house size in the neighborhood context, focusing on how atypicality, fiscal capitalization and conspicuous consumption each lead to alternative hypotheses about price and selling time differentials. The empirical analysis and results are discussed in the third section. The fourth and final section presents the conclusion.
Relative House Size and Price
In this section, we summarize three alternative, though not mutually exclusive, rationales for how markets value house size relative to the surrounding neighborhood composition: atypicality, conspicuous consumption and fiscal capitalization. We consider each, in turn.
Atypicality Effect
The first model draws from Haurin's (1988) atypicality notion. Haurin's model offers an explanation for why houses with unusual attributes take longer to sell (Haurin 1988, Jud, Seaks and Winkler 1996). Basically, there are fewer buyers who strongly prefer atypical houses (after all, that is why they are atypical), and so it takes longer to match these fewer buyers in the population with the atypical houses that are for sale. Our explanation here, however, abstracts from selling time to focus on price effects.
We take liberties with Haurin's original formulation in order to cast the atypicality effect within a simple framework that can also be used to illustrate the effects of conspicuous consumption and fiscal capitalization. To begin, consider a particular neighborhood comprising a variety of house sizes. Suppose that the type of buyer most attracted to this neighborhood is the type of buyer who most prefers the average-size house in the neighborhood j, [bar.H.sub.j]. Let P denote this type of buyer's valuation of a particular house with size H, which may or may not differ from [bar.H.sub.j]. The indirect utility function for this type of buyer is V(P, [delta]), where the difference in house size H from the average for the neighborhood is reflected in the parameter [delta] = H - [bar.H.sub.j]. The assumption of the atypicality model is [partial derivative]V/[partial derivative][delta] [ ] for [delta] [>=<] 0, or equivalently
[partial derivative]V/[partial derivative]|[delta]| < 0, (1)
so that both larger- and smaller-than-average houses in the neighborhood (i.e., |[delta]| > 0) generate lower offers from typical buyers. The competitive pricing condition is
V (P, [delta]) = [U.sup.0], (2)
where [U.sup.0] is the buyer's opportunity cost, the expected utility from buying elsewhere in this or another market. To compare the value of a given house in a heterogeneous neighborhood with an otherwise identical house in a homogenous neighborhood, implicitly differentiate the competitive pricing condition (2) and use the properties of indirect utility functions ([partial derivative]V/[partial derivative]P = -H). This yields the pricing effect of atypicality as
[partial derivative]P/[partial derivative]|[delta]| = [partial derivative]V/[partial derivative]|[delta]|/H < 0, (3)
so that houses that are larger or smaller than typical for the neighborhood sell at a discount, as summarized in the first row of Table 1. Intuitively, if both larger and smaller houses in the neighborhood are considered atypical by potential buyers, then it is harder to find buyers for such properties. We expect them to sell at a discount when compared with the same size houses in homogeneous neighborhoods, holding selling time constant.
Conspicuous Consumption Effect
The theory of conspicuous consumption also relates to the question of relative house size and value when applied to real estate. We note that this is the familiar "pride of ownership" effect associated with having the showcase house in a particular neighborhood, a pricing effect widely believed by real estate professionals. We can construct an underlying economic rationale drawing from the ideas originally developed by Veblen (1899) and brought to the attention of mainstream economic literature by Leibenstein (1950). In the conspicuous consumption model, consumers obtain additional utility from demonstrating their (presumably) greater affluence by buying a house that is larger than surrounding houses. In terms of the capitalization model, the conspicuous consumption assumption is
[partial derivative]V/[partial derivative][delta] > 0. (4)
Differentiating the competitive pricing...
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