Hedonic Application in Real Estate

1 Wan Norhishamuddin Wan Rodi ‘Hedonic Application in Real Estate 2011’

HEDONIC APPLICATION IN REAL ESTATE

Wan Norhishamuddin Wan Rodi Department of Estate Management Faculty of Architecture, Planning and Surveying (FAPS) Mara University of Technology (UiTM) Shah Alam, Selangor Malaysia. August 2011

Abstract - Hedonic approach such as the regression analysis presents a promising benefits and advantageous to real estate researchers and practitioners. One of the benefits of hedonic approach is that it can serves as a tool to formulate a model that can assist in estimating the value or costs in a timely basis with high degree of accuracy. Review of the literatures suggest the hedonic approach can be applied in seven (7) areas of real estate such as Property Valuation and Appraisal, Property Environmental Study, Real Estate Construction, Housing Economic Analysis, Real Estate Investment, Property Taxation and Property Management. The evidence recommends that hedonic approach is applied extensively in the field of Property Environmental Study and Property Valuation and Appraisal. Purpose – This paper seeks to explore the fundamental of the hedonic approach that has been applied in the real estate related research. The study aims to: (1) review the principles and model of the hedonic approach generally being used in the real estate research; (2) examine the field of real estate research applying the hedonic approach in their analysis. Design/ methodology/ approach – This paper uses qualitative analysis whereas it reviews a selective number of real estate research papers that associated with the hedonic application from the year 1989 until 2009. These papers were then grouped according to the seven (7) fields of real estate and further analysed to derive the conclusion. Findings – Judging from the analysis of twenty eight (28) research papers applying the hedonic analysis; a large number of researchers were identified to use the hedonic approach in the real estate area such as Property Environmental Study and Property Valuation and Appraisal. While other fields recorded a small number of researchers that used the hedonic approach in their methodology. Originality/ value – the application of hedonic model in real estate research is extensive but eventually, there is a lack of review towards its’ application in the sub area of real estate such as real estate environmental study, property valuation and appraisal, property management and etc. This paper provides some form of empirical analysis on the trend of hedonic analysis in real estate from the previous research conducted by various scholars. Keywords- Real Estate, Hedonic Model, Hedonic Application


1.0 INTRODUCTION

Real estate consists of numerous branches of sector and area. Included in such area are the valuation, property management, real estate agencies, corporate real estate management and et cetera. Specifically, in valuation practice, valuers applied different types of valuation tools in estimating the market value or price of certain real estate. These methods are identified as comparison method, cost method, investment method, profit or account method and last but not least the residual approach. Some of these methods may become obsolete from time to time due to the fast technological advancement attained in the modern days.

Comparison method traditionally is the most applied method of valuation when estimating the market value of property. However, there are a lot of flaws and weaknesses occurred in this method. Traditional comparison method largely depends on the subjective judgment of the appraiser or valuer rather than strong and reliable basis of estimation. This may as well create erroneous valuation estimation and biased valuation exercise. Other issue pertaining to the traditional valuation approach particularly the comparison approach is in regards to the inflexibility when a mass appraisal is required. It is uneconomic and time consuming if a traditional method of valuing one by one property is adopted. As a result of these difficulties, researchers have long introduced one tool that can facilitate in addressing the above-mentioned problems. Hedonic analysis is a trend nowadays that can be exploited in real estate practices. The flexibility and accuracy of hedonic analysis is very much higher as it provides a strong basis and evidences to support the valuation exercises conducted by valuers. This claim is strongly supported by Lutzkendorf and Lorenz (2005) mentioned in Lorenz et.al (2006) where they agreed that the hedonic method provides a more scientific basis for the price or value adjustments whereby it is not totally reliant upon the judgment, knowledge and experience (or inexperience) of the individual valuer.

Hedonic approach such as the regression analysis presents a promising benefits and advantageous to real estate researchers and practitioners. One of the approaches of hedonic method application in real estate; Computer Aided Mass Appraisal (CAMA) has been extensively used due to the restriction of time and cost for assessing a vast quantities of property(Bonissone et al., 1998; Cesare, 1998; Ward et al., 1999) cited in Gonzalez et al. (2004). From the perspective of Hannonen (2008), hedonic method assists in minimizing a systematic error in valuation exercises as to compare with the traditional valuation approach. As far as concern, hedonic method produces the necessary quality adjustment in a proper, systematic, valid and reliable way with the formulation of differentiated nature and characteristics of the property inside the estimation (Hannonen, 2008).

In addition, hedonic approach serves as a tool to formulate a model that can assist in estimating the value or costs in a timely basis with high degree of accuracy (Stoy et al., 2006). Lutzkendorf and Lorenz (2005) cited in Lorenz et.al (2006) specified the hedonic pricing analysis as a method suitable for continuous monitoring of market behavior. It is amazing how the hedonic approach can be manipulated in real estate field. Its’ vast and extensive usage covers many real estate aspects and applications; municipal property assessment; estimating demand for housing and neighbourhood attributes; making general improvements in house price indices; analysing the impact of neighbourhood externalities; measuring housing demand in residential mobility studies; estimating the benefits to accrue from public investment programmes; and examining the capitalisation of a wide range of amenities (Bourassa et al., 2003; Can,1992b; Malpezzi, 2003) as cited in Paez et al. (2007); (Bonissone et al., 1998; Cesare, 1998; Ward et al., 1999) quoted in Gonzalez et al. (2004).


2.0 HEDONIC FUNCTIONAL MODEL The mathematical hedonic modeling is based on the statistical calculation founded by past researchers such as Hass (1920), Court (1939), Griliches (1961:1971) and Lancaster (1966) as cited in Suriatini (2005) and Hamid (2002). Additionally, the history of hedonic approach also dated back in the early 1930 when Court (1939) mentioned in Lorenz et.al (2006) embarked on introducing the first Hedonic price model in the automobile industry. Starting from that moment, hedonic model has been further expanded to household industry, and housing units (Lorenz et.al, 2006).

Model specification in hedonic is crucial to determine the accuracy and precision of the modeling results. Without proper and accurate model specification, problems of specification dilemma will arise. Based on Hannonen (2008), model specification dilemma is solved using three different ways; parametrically, non parametrically and semi-parametrically. However this literature would not addresses in detail pertaining to the specification dilemma and ways to rectify it. Hedonic approach in real estate is basically consists of dependant and independent variables. In respect, most of the literatures do not established any consensus pertaining which variables to be included in the hedonic model (Janssen et al., 2001) quoted in Lorenz et.al, 2006). Within the context of hedonic empirical studies, a various equations have been employed. Such equations included the linear, semi-logarithm, double logarithm, quadratic, reciprocal, and Box-Cox forms (Cassel and Mendelsohn, 1985; Malpezzi, 2002; Bengochea Morancho, 2003; McConnell and Walls, 2005 cited in Jim and Wendy, 2009).

Hedonic method commonly comprises of two variables; dependant and independent variables. Dependant variable is the house value measure that usually constitutes a market value/ sales price (Lorenz et.al,2006; Donnelly, 1989; Roubi and Litteljohn, 2004; Rosiers et a.l, 1999; Oszoy and Sahin, 2008; Lamond et al., 2006; Case et al., 2006; Hannonen 2008; Paez et al., 2007; Ting, 2008; Bin, 2005; Shinnick, 1997; Rosiers et al., 1999; Tak et al., 2003; Muhammad et al. 2004; Chan, 2008; Jim and Chen, 2009) or it may not even related to house value, for instance; costs (Stoy et al., 2006). It is observable in most of the research conducted. To simplified the dependant variable elements, it may consist of rents, sale price, asking price or an owner’s estimated price (Suriatini, 2005). Independent variables on the other hand are the significant aspect that will affect the measure of the house price. Generally, independent variables can be characterized into three basic categories; structural characteristics represented by the floor size and age, design of the property, social and environmental attributes of the neighbourhood, and other locational features such as accessibility to facilities and amenities, employment and services (Basu and Thibodeau, 1998; Bowen et al., 2001) cited in Paez et al., 2007; Lorenz et.al, 2006). These attributes or features expressed the function of the house price in hedonic modeling. Judging from the literature search conducted, various researchers have formulated the three characteristics or features in their hedonic research. In general, the regression model takes into the form of;-

Whereas P is the market price of the good, and x1, x2, . . ., xn are its characteristics (Jim and Chen, 2009).


Or, it can be explicated as;- Whereby, P indicates the vector of observed transaction prices, x the matrix of exogenous variables, b the vector of coefficients and the error term that is assumed to be “white noise”. In such a model the regression parameters bi reflect the price of the attribute xi and are called hedonic prices (Lorenz et al., 2006). When expanded further, the traditional regression model is as below;- Where, Yi(i = 1, 2, . . ., n) in the model represents property values, or a transformation thereof, for example, to produce a log-linear form; S is a vector of structural attributes; N is a vector representing attributes of the surrounding neighbourhood; L is a vector of variables capturing locational or proximity characteristics; and ε is a vector composed of random error terms which represents all those factors that affect sale prices but are omitted from the modeling process (Paez et al., 2007). The functional regression model can be modified according to the type of research and objectives of studies conducted by the researchers. 3.0 APPLICATION OF THE HEDONIC ANALYSIS IN REAL ESTATE Hedonic analysis is widely implemented in the real estate field. Previously explained before, hedonic approach aids in municipal property assessment; estimating demand for housing and neighbourhood attributes; making general improvements in house price indices; analysing the impact of neighbourhood externalities; measuring housing demand in residential mobility studies; estimating the benefits to accrue from public investment programmes; and examining the capitalisation of a wide range of amenities (Bourassa et al., 2003; Can,1992b; Malpezzi, 2003) as cited in Paez et al. (2007). In order to address the issue of identifying the application of hedonic approach in real estate, the writer has adopted the perspective of Bonissone et al., 1998; Cesare, 1998; Ward et al., 1999 cited in Gonzalez et al.,(2004) as a framework.

From their perspective, the hedonic application is further generalized into several real estate fields or areas whereby it comprises of; (1)property taxation, (2) property valuation and appraisal, (3) property-environmental related study, (4) real estate construction, (5) housing economic analysis, (6) real estate investment and (7) property management. Previous and present researches used within this scope of literature have been analysed and grouped according to the abovementioned fields or school of thoughts in real estate. This was done in order to ensure the objective of verifying the hypothesis in regards to the extensive use of hedonic method in real estate is realized.


4.0 LITERATURES ASSOCIATED WITH HEDONIC APPLICATION IN REAL ESTATE

The latest development and application of the hedonic method is observable from the most recent research by a few researchers. Jim & Chen (2009) conducted a research using hedonic method to estimate the value of the scenic views for public housing in Hong Kong. Using price as dependant variable with age, floor level, total floor area, number of bedroom, swimming pool, clubhouse, building view, mountain view, and sea view as an independent variables, the relationship and hedonic modeling is easily conducted to provide solution on the research problems. Furthermore, Jim & Chen (2009) have also conducted an analysis regarding the external impact of neighbourhood parks and landscape elements on high-rise residential value. Secondly, hedonic approach was applied in the research by Terol and Celia (2009) in studying the impacts of Iron and Steel Plant on the residential property values. Before the study was conducted, research pertaining to this issue is still remain silence. Specifically, this research studying the relationship between residential property values and proximity to an integrated iron and steel plant located in the fringes of Gijon, a city in the north of Spain. Another research conducted in year 2009 is regarding the impact of repeated wildfires in high risk areas towards homebuyer’s demand for homes in Southern California, US (Mueller et al., 2009). Once again, it’s more on the environmental side. Other research deals with the forecasting housing prices under different market segmentation assumptions (Zhuo et al., 2009). This research concentrates on creating a house price hedonic model for Knox County, US based on the three type market segmentation strategies; no segmentation, segmentation using statistical clustering method and segmentation using priori information. Additionally, Daniel et al.(2009) focusing on the flooding risk impacts towards housing price.

Hedonic method in real estate application from the period of 2005 to 2008 subjected to this literature comprises of using hedonic model for valuing wetland (Bin, 2005), measuring the impact of the environmental contamination on condo prices (Case et. al, 2006), impact of flooding on house prices (Lamond et al. 2006), exploring relationship between market value and sustainability of construction (Lorenz, 2006), estimating the occupancy cost (Stoy and Kytzia, 2006), Moving window approaches in hedonic price (Paez et al., 2007), studying the housing price determinant in Turkey (Ozsoy and Sahin, 2008), Predicting urban land prices (Hannonen, 2008), Heterogeneity in housing attribute price using interaction between variables (Ting, 2008), the application of hedonic in regional house prices (Wilhemsson, 2008), and estimating value of building with design features for healthy living (Chan et al.,2008). In Indonesia, one piece of research paper by Arief and Budy (2008) blend in the hedonic method inside their study to establish relationship between clean air effect and housing market rental. Lastly, hedonic method is applied as a medium to measure the economic impacts of hydropower dams towards property values in Kennebec river, Maine. The approach of hedonic related to this study is different as to compare with other environmental research provided in this literature. It uses a Geographical Information System (GIS) to obtain the results.

Respectively, in order to study the trend and pattern of hedonic application in real estate, it is inevitable to look into a few researches exercised before 2005. For this purpose of literature, about six journals are subjected ranging from the period of 1989 until 2004. During the 1989 period, Donnelly (1989) in one of the most influential papers on hedonic theory commenced a research paper pertaining to the Housing Value Assessment using hedonic method. As far as concern, this research paper deals with less complicated approach of hedonic approach as to against with present approach due to the inadequacies of technological advancement in Information Technologies (IT). However, this paper serves as a fundamental principle beneficial for present and future research. Interestingly, Hamelink and Hoesli (1996) took the hedonic approach


specifically the autoregressive model in a different way by applying it to corroborate the theory of Real Estate as a hedge against Inflation in Swiss market. Other application of hedonic approach can be scrutinized in Shinnick (1997) where he measures the Irish housing quality by taking into account all three independent variables characteristics; structural, locational/ access, and neighbourhood characteristics. What's more, Rosiers et al. (1999) in one of the very first studies which attempted to study the relationship between environment and value, condition of drinking water quality is taken into judgment. In this research beside the structural, locational/ access, and neighbourhood characteristics, Rosiers et al. (1999) have included another independent variable in which represented by the environmental variables.

Throughout the period of 2003 and 2004, about a few journals were analysed in this literature. These journals are from Tak et al.,(2003), Roubi and Litteljohn (2004), Faishal et al. (2004), Gonzalez et al.(2004), and Wilhelmsson (2004). Tak et al.,(2003) applied the hedonic method to study the impact of interest rate upon housing price. Roubi and Litteljohn (2004) however focused on establishing the hedonic pricing model to value a hotel in UK. Meanwhile, Faishal et al. (2004), attempted to study the hedonic approach in public housing resale market. Gonzalez et al. (2004), applying hedonic approach in CAMA by introducing a new Spatial analysis method. Finally, Wilhelmsson (2004) further establishes a method to reduce spatial dependency and deriving housing sub-market accordingly. These are some of the researches that have been conducted by researchers from various part of the world.

Critically, from the literature search conducted to discover the application of hedonic in real estate, the writer fully agrees with the statement by Lutzkendorf and Lorenz (2005) mentioned in Lorenz et.al (2006) that the hedonic method provides a more scientific basis for the price or value adjustments whereby it is not totally reliant upon the judgment, knowledge and experience (or inexperience) of the individual valuer. Hedonic approach blends in the characteristics and features of the building, including their structural, location, access, neighbourhood and even its’ environmental attributes inside one or many models that could be easily manipulated, adjusted, and tested. This approach closing the error and misleading gap subsist in the traditional valuation approach as a result of inexperience or incorrect judgment. Hedonic approach serves a scientific basis in sealing those gaps.

These literatures studied consist of different sets of objectives, application and it shows only one thing; hedonic method is really a flexible analysis tool appropriate in the real estate fields. Table 1 will serves as a clear and straightforward view in regards to the area or fields of hedonic application in real estate, analysed from the subjected research journals in this coursework.


5.0 FINDINGS From the analysis of the literatures subjected to this study, it can be observed that from the total of 28 researches, out of 11 research papers deals with the property-environmental externalities studies. Meanwhile, the second highest application of hedonic analysis is in the field of property valuation and appraisal. Other researches concentrate on Housing Economic Analysis (3), Property Taxation (2), Real Estate Construction (1), Real Estate Investment (1) and Property Management (1). Refer Table 1.0 and Table 2.0.

Table 1.0: Result of the Analysis Source; Writer (2010)

Area of Application Total No. of

Research Property-Environmental

study 11 Property Valuation and

Appraisal 9

Housing Economic Analysis 3

Property Taxation 2

Real Estate Construction 1

Real Estate Investment 1

Property Management 1


No. Author Year Location Area of Hedonic Application

PE PVA HeA PT REC RI PM 1 Jim & Chen (1) 2009 Hong Kong √

2 Jim & Chen(2) 2009 Hong Kong √

3 Daniel et al. 2009 US √

4 Terol & Celia 2009 Spain √

5 Mueller et al. 2009 US √

6 Zhuo et al. 2009 US

√

7 Ozsoy & Sahin 2008 Turkey √

8 Arief & Budy 2008 Indonesia √

9 Bohlen & Lewis 2008 US √

10 Hannonen 2008 Finland √

11 Ting 2008 China √

12 Wilhemsson 2008 Sweden √

13 Chan et al. 2008 Hong Kong √

14 Paez et al. 2007 Canada √

15 Case et al. 2006 US √

16 Lamond et al. 2006 UK √

17 Lorenz 2006 Germany

√ 18 Stoy & Kytzia 2006 Switzerland

√

19 Bin 2005 US √

20 Roubi & Litteljohn 2004 UK √

21 Muhammad et al. 2004 Singapore √

22 Gonzalez et al. 2004 Brazil

√

23 Wilhelmsson 2004 Sweden

√

24 Tak et al. 2003 Hong Kong

√

25 Rosiers et al. 1999 Canada √

26 Shinnick 1997 Ireland √

27 Hamelink & Hoesli 1996 Switzerland

√

28 Donnelly 1989 US √

Table 2.0; Area of Hedonic application applied in each of the literatures. Source:Writer (2010)

Where;-

PVA Property Valuation & Appraisal

PT Property Taxation PE Property-Environmental study

REC Real Estate Construction HeA Housing Economic Analysis RI Real Estate Investment PM Property Management


6.0 CONCLUSION AND RECOMMENDATION

In a nutshell, hedonic application scattered throughout the globe not only in the context of real estate, but also in other fields such as pharmaceutical, human behavior and et cetera. This coursework specifically tries to come across into the application in real estate through analyzing the research journal performed by researchers throughout a particular period. If the recent pattern is taken into account, what the readers can infer from it is regarding the use of hedonic in environmental externalities affecting the real estate market. With environmental issues such as contamination, pollution and the force of mother-nature; wildfire, earthquake, land slide, flood, beginning to ensue frequently, the use of hedonic method to study the positive and negative externalities cannot be taken lightly. Hedonic approach able to explains and helps researchers in formulating the solution and recommendation to reduce the effect of negative externalities arising from these incidents. Application of hedonic analysis in real estate is broadly being used in overseas especially in US and UK. Nevertheless, the writer has experiencing the difficulty in finding the hedonic related literature exercised in Malaysia. Implicitly, this explained the lack of awareness of the Malaysian researcher on the benefits of hedonic approach in real estate. Writer’s experience suggest the hedonic method in Malaysia is not widely employed except in the public sector whereas it is restricted only to derive the housing index and the assessment for local authority taxation. The fact is clear; Malaysia is still lagging behind those European and US counterpart. Even Malaysian researchers lose out to other Asian countries such as Hong Kong and Singapore in terms of the number of research accomplished using hedonic approach.

Still, another area of real estate research; Environmental externalities studies using

hedonic is still remain unheard and unfamiliar in Malaysia. There are heaps of research potential areas in Malaysia appropriate for hedonic application waiting to be explored. With the localized issues such as flooding in various place i.e in Kuala Lumpur, Land slide tragedy turned out in Bukit Damansara, environmental issues; pig and bird rearing activities in certain places, construction of worship places that may affect the land value, hedonic approach cannot be taken lightly. It can be used to provide a proactive solution judging from the result of analysis. The hypotheses that the researcher established can be tested with high degree of precision using hedonic approach as to compare with other research methodology alternatives.

As a recommendation, all public and private sector must acknowledge the benefits of

hedonic method in real estate. Real estate bodies such as the Institution of Surveyor (ISM), Board of Valuers, Appraisers and Estate Agent and Royal Institution of Chartered Surveyor (RICS) should exercised some measures to increase the awareness of hedonic approach in private sector through a series of seminar, staff training and discussion for the advancement of hedonic approach. Moreover, the participation of universities and higher institution are very much anticipated. These academic bodies can play a role by introducing a specific course or subject pertaining to the hedonic method in real estate. In relation to this, the government should increased the financial assistance to hedonic researchers in higher institution by providing more research grant and support services so as to ignite their interest towards the hedonic research. Without the participation and cooperation of these bodies, all the efforts of increasing the awareness of application of hedonic remain fruitless. Optimistically, Malaysian researchers in the future will take substantial efforts in initiating and creating awareness so that the hedonic approach application will become widely accepted in the public and private sector specifically and to the whole Malaysia’s real estate context generally.


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Hedonic Application in Real Estate

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