Does high-end housing always have a premium luxury value? A theoretical and numerical study
Abstract
Using the real options approach, we try to evaluate the luxury value inherent in high-end housing and estimate its premium returns based on the simulation of the model. The key finding of the paper is that the luxury premium from the value of the high-end housing can be identified by the real options model, which is rarely documented in the literature. In addition, the luxury value per unit size of high-end housing can be imputed through the model simulation. Based on the results, we find that the changes of the estimated value per unit size can explain the dynamic housing market behaviour in the recessions and expansions over the business cycle. The luxury value will even become negative during the recession period. In summary, the luxury premiums of high-end housing are higher than those of general housing, but not all highend housing has positive luxury premiums. If sellers and/or builders of high-end housing cannot meet the conditions that maximize the utility of high-end housing buyers, negative returns will accrue from selling high-end housing.
Keyword : luxury value, high-end housing, luxury premium, high-end housing value, real options
How to Cite
Hung, C.-H., Chen, M.-C., Tzang, S.-W., & Cheng, C.-C. (2023). Does high-end housing always have a premium luxury value? A theoretical and numerical study. International Journal of Strategic Property Management, 27(4), 246–260. https://doi.org/10.3846/ijspm.2023.20257
This work is licensed under a Creative Commons Attribution 4.0 International License.
References
Arrondel, L., & Lefebvre, B. (2001). Consumption and investment motives in housing wealth accumulation: a French study. Journal of Urban Economics, 50(1), 112–137. https://doi.org/10.1006/juec.2000.2209
Bagwell, L. S., & Bernheim, B. D. (1996). Veblen effects in a theory of conspicuous consumption. American Economic Review, 86(3), 349–373. https://www.researchgate.net/publication/4980724_Veblen_Effects_in_a_Theory_of_Conspicuous_Consumption
Bain & Company. (2021, December 20). From surging recovery to elegant advance: the evolving future of luxury. https://www.bain.com/insights/from-surging-recovery-to-elegant-advance-the-evolving-future-of-luxury/
Bloom, N. (2009). The impact of uncertainty shocks. Econometrica, 77(3), 623–685. https://doi.org/10.3982/ECTA6248
Bloom, N., Bond, S., & Van Reenen, J. (2007). Uncertainty and investment dynamics. Review of Economic Studies, 74(2), 391–415. https://doi.org/10.1111/j.1467-937X.2007.00426.x
Bourassa, S. C. (1995). A model of housing tenure choice in Australia. Journal of Urban Economics, 37(2), 161–175. https://doi.org/10.1006/juec.1995.1009
Brueckner, J. K. (1997). Consumption and investment motives and the portfolio choices of homeowners. The Journal of Real Estate Finance and Economics, 15(2), 159–180. https://doi.org/10.1023/A:1007777532293
Campbell, J. Y., & Cocco, J. F. (2015). A model of mortgage default. Journal of Finance, 70(4), 1495–1554. https://doi.org/10.1111/jofi.12252
Chay, K. Y., & Greenstone, M. (2005). Does air quality matter? Evidence from the housing market. Journal of Political Economy, 113(2), 376–424. https://doi.org/10.1086/427462
Childs, P. D., Ott, S. H., & Triantis, A. J. (1998). Capital budgeting for interrelated projects: a real options approach. Journal of Financial and Quantitative Analysis, 33(3), 305–334. https://doi.org/10.2307/2331098
Crowder, K. D. (2000). The racial context of white mobility: an individual-level assessment of the white-flight hypothesis. Social Science Research, 29(2), 223–257. https://doi.org/10.1006/ssre.1999.0668
Cutler, D. M., Glaeser, E. L., & Vigdor, J. L. (1999). The rise and decline of the American ghetto. Journal of Political Economy, 107(3), 455–506. https://doi.org/10.1086/250069
Dixit, A., & Pindyck, R. (1994). Investment under uncertainty. Princeton University Press. https://doi.org/10.1515/9781400830176
Downes, T. A., & Zabel, J. E. (2002). The impact of school characteristics on house prices: Chicago 1987–1991. Journal of Urban Economics, 52(1), 1–25. https://doi.org/10.1016/S0094-1190(02)00010-4
Gallin, J. (2008). The long-run relationship between house prices and rents. Real Estate Economics, 36(4), 635–658. https://doi.org/10.1111/j.1540-6229.2008.00225.x
Grenadier, S. R. (1995). Valuing lease contracts: a real-options approach. Journal of Financial Economics, 38(3), 297–331. https://doi.org/10.1016/0304-405X(94)00820-Q
Henderson, J. V., & Ioannides, Y. M. (1983). A model of housing tenure choice. American Economic Review, 73(1), 98–113. https://ideas.repec.org/a/aea/aecrev/v73y1983i1p98-113.html
Hung, M. W., & So, L. C. (2012). How much extra premium does a loss-averse owner-occupied home buyer pay for his house? Journal of Real Estate Finance and Economics, 45(3), 705–722. https://doi.org/10.1007/s11146-010-9293-9
Hung, C.-H., & Tzang, S.-W. (2021). Consumption and investment values in housing price: a real options approach. International Journal of Strategic Property Management, 25(4), 278–290. https://doi.org/10.3846/ijspm.2021.14914
Kiel, K. A., & Zabel, J. E. (2008). Location, location, location: the 3L approach to house price determination. Journal of Housing Economics, 17(2), 175–190. https://doi.org/10.1016/j.jhe.2007.12.002
Kishor, N. K., & Morley, J. (2015). What factors drive the price-rent ratio for the housing market? A modified present-value analysis. Journal of Economic Dynamics and Control, 58, 235–249. https://doi.org/10.1016/j.jedc.2015.06.006
Lee, K. O., & Mori, M. (2016). Do conspicuous consumers pay higher housing premiums? Spatial and temporal variation in the United States. Real Estate Economics, 44(3), 726–763. https://doi.org/10.1111/1540-6229.12115
Leguizamon, S. J. (2010). The influence of reference group house size on house price. Real Estate Economics, 38(3), 507–527. https://doi.org/10.1111/j.1540-6229.2010.00275.x
Leland, H. (1994). Corporate debt value, bond covenants, and optimal capital structure. Journal of Finance, 49(4), 1213–1252. https://doi.org/10.1111/j.1540-6261.1994.tb02452.x
Levy, D., & Snir, A. (2018). Here lives a wealthy man: price rigidity and predictability in luxury housing markets. https://doi.org/10.2139/ssrn.3142656
Mikhed, V., & Zemčík, P. (2009). Testing for bubbles in housing markets: a panel data approach. Journal of Real Estate Finance and Economics, 38, 366–386. https://doi.org/10.1007/s11146-007-9090-2
Myers, C. K. (2004). Discrimination and neighbourhood effects: understanding racial differentials in US housing prices. Journal of Urban Economics, 56(2), 279–302. https://doi.org/10.1016/j.jue.2004.03.006
Qian, W. (2013). Why do sellers hold out in the housing market? An option-based explanation. Real Estate Economics, 41(2), 384–417. https://doi.org/10.1111/j.1540-6229.2012.00345.x
Turnbull, G. K., Dombrow, J., & Sirmans, C. F. (2006). Big house, little house: relative size and value. Real Estate Economics, 34(3), 439–456. https://doi.org/10.1111/j.1540-6229.2006.00173.x
Titman, S. (1985). Urban land prices under uncertainty. American Economic Review, 75(3), 505–514. https://www.jstor.org/stable/1814815?typeAccessWorkflow=login
Uhrig-Homburg, M. (2005). Cash–flow shortage as an endogenous bankruptcy reason. Journal of Banking & Finance, 29(6), 1509–1534. https://doi.org/10.1016/j.jbankfin.2004.06.026
Veblen, T. (1899). The theory of the leisure class. Penguin Books.
Wang, H., Yu, F., & Zhou, Y. (2020). Property investment and rental rate under housing price uncertainty: a real options approach. Real Estate Economics, 48(2), 633–665. https://doi.org/10.1111/1540-6229.12235
Yao, R., & Zhang, H. H. (2005). Optimal consumption and portfolio choices with risky housing and borrowing constraints. The Review of Financial Studies, 18(1), 197–139. https://doi.org/10.1093/rfs/hhh007
Zahirovic-Herbert, V., & Chatterjee, S. (2011). What is the value of a name? Conspicuous consumption and house prices. Journal of Real Estate Research, 33(1), 105–126. https://doi.org/10.1080/10835547.2011.12091294
Bagwell, L. S., & Bernheim, B. D. (1996). Veblen effects in a theory of conspicuous consumption. American Economic Review, 86(3), 349–373. https://www.researchgate.net/publication/4980724_Veblen_Effects_in_a_Theory_of_Conspicuous_Consumption
Bain & Company. (2021, December 20). From surging recovery to elegant advance: the evolving future of luxury. https://www.bain.com/insights/from-surging-recovery-to-elegant-advance-the-evolving-future-of-luxury/
Bloom, N. (2009). The impact of uncertainty shocks. Econometrica, 77(3), 623–685. https://doi.org/10.3982/ECTA6248
Bloom, N., Bond, S., & Van Reenen, J. (2007). Uncertainty and investment dynamics. Review of Economic Studies, 74(2), 391–415. https://doi.org/10.1111/j.1467-937X.2007.00426.x
Bourassa, S. C. (1995). A model of housing tenure choice in Australia. Journal of Urban Economics, 37(2), 161–175. https://doi.org/10.1006/juec.1995.1009
Brueckner, J. K. (1997). Consumption and investment motives and the portfolio choices of homeowners. The Journal of Real Estate Finance and Economics, 15(2), 159–180. https://doi.org/10.1023/A:1007777532293
Campbell, J. Y., & Cocco, J. F. (2015). A model of mortgage default. Journal of Finance, 70(4), 1495–1554. https://doi.org/10.1111/jofi.12252
Chay, K. Y., & Greenstone, M. (2005). Does air quality matter? Evidence from the housing market. Journal of Political Economy, 113(2), 376–424. https://doi.org/10.1086/427462
Childs, P. D., Ott, S. H., & Triantis, A. J. (1998). Capital budgeting for interrelated projects: a real options approach. Journal of Financial and Quantitative Analysis, 33(3), 305–334. https://doi.org/10.2307/2331098
Crowder, K. D. (2000). The racial context of white mobility: an individual-level assessment of the white-flight hypothesis. Social Science Research, 29(2), 223–257. https://doi.org/10.1006/ssre.1999.0668
Cutler, D. M., Glaeser, E. L., & Vigdor, J. L. (1999). The rise and decline of the American ghetto. Journal of Political Economy, 107(3), 455–506. https://doi.org/10.1086/250069
Dixit, A., & Pindyck, R. (1994). Investment under uncertainty. Princeton University Press. https://doi.org/10.1515/9781400830176
Downes, T. A., & Zabel, J. E. (2002). The impact of school characteristics on house prices: Chicago 1987–1991. Journal of Urban Economics, 52(1), 1–25. https://doi.org/10.1016/S0094-1190(02)00010-4
Gallin, J. (2008). The long-run relationship between house prices and rents. Real Estate Economics, 36(4), 635–658. https://doi.org/10.1111/j.1540-6229.2008.00225.x
Grenadier, S. R. (1995). Valuing lease contracts: a real-options approach. Journal of Financial Economics, 38(3), 297–331. https://doi.org/10.1016/0304-405X(94)00820-Q
Henderson, J. V., & Ioannides, Y. M. (1983). A model of housing tenure choice. American Economic Review, 73(1), 98–113. https://ideas.repec.org/a/aea/aecrev/v73y1983i1p98-113.html
Hung, M. W., & So, L. C. (2012). How much extra premium does a loss-averse owner-occupied home buyer pay for his house? Journal of Real Estate Finance and Economics, 45(3), 705–722. https://doi.org/10.1007/s11146-010-9293-9
Hung, C.-H., & Tzang, S.-W. (2021). Consumption and investment values in housing price: a real options approach. International Journal of Strategic Property Management, 25(4), 278–290. https://doi.org/10.3846/ijspm.2021.14914
Kiel, K. A., & Zabel, J. E. (2008). Location, location, location: the 3L approach to house price determination. Journal of Housing Economics, 17(2), 175–190. https://doi.org/10.1016/j.jhe.2007.12.002
Kishor, N. K., & Morley, J. (2015). What factors drive the price-rent ratio for the housing market? A modified present-value analysis. Journal of Economic Dynamics and Control, 58, 235–249. https://doi.org/10.1016/j.jedc.2015.06.006
Lee, K. O., & Mori, M. (2016). Do conspicuous consumers pay higher housing premiums? Spatial and temporal variation in the United States. Real Estate Economics, 44(3), 726–763. https://doi.org/10.1111/1540-6229.12115
Leguizamon, S. J. (2010). The influence of reference group house size on house price. Real Estate Economics, 38(3), 507–527. https://doi.org/10.1111/j.1540-6229.2010.00275.x
Leland, H. (1994). Corporate debt value, bond covenants, and optimal capital structure. Journal of Finance, 49(4), 1213–1252. https://doi.org/10.1111/j.1540-6261.1994.tb02452.x
Levy, D., & Snir, A. (2018). Here lives a wealthy man: price rigidity and predictability in luxury housing markets. https://doi.org/10.2139/ssrn.3142656
Mikhed, V., & Zemčík, P. (2009). Testing for bubbles in housing markets: a panel data approach. Journal of Real Estate Finance and Economics, 38, 366–386. https://doi.org/10.1007/s11146-007-9090-2
Myers, C. K. (2004). Discrimination and neighbourhood effects: understanding racial differentials in US housing prices. Journal of Urban Economics, 56(2), 279–302. https://doi.org/10.1016/j.jue.2004.03.006
Qian, W. (2013). Why do sellers hold out in the housing market? An option-based explanation. Real Estate Economics, 41(2), 384–417. https://doi.org/10.1111/j.1540-6229.2012.00345.x
Turnbull, G. K., Dombrow, J., & Sirmans, C. F. (2006). Big house, little house: relative size and value. Real Estate Economics, 34(3), 439–456. https://doi.org/10.1111/j.1540-6229.2006.00173.x
Titman, S. (1985). Urban land prices under uncertainty. American Economic Review, 75(3), 505–514. https://www.jstor.org/stable/1814815?typeAccessWorkflow=login
Uhrig-Homburg, M. (2005). Cash–flow shortage as an endogenous bankruptcy reason. Journal of Banking & Finance, 29(6), 1509–1534. https://doi.org/10.1016/j.jbankfin.2004.06.026
Veblen, T. (1899). The theory of the leisure class. Penguin Books.
Wang, H., Yu, F., & Zhou, Y. (2020). Property investment and rental rate under housing price uncertainty: a real options approach. Real Estate Economics, 48(2), 633–665. https://doi.org/10.1111/1540-6229.12235
Yao, R., & Zhang, H. H. (2005). Optimal consumption and portfolio choices with risky housing and borrowing constraints. The Review of Financial Studies, 18(1), 197–139. https://doi.org/10.1093/rfs/hhh007
Zahirovic-Herbert, V., & Chatterjee, S. (2011). What is the value of a name? Conspicuous consumption and house prices. Journal of Real Estate Research, 33(1), 105–126. https://doi.org/10.1080/10835547.2011.12091294