Monday, March 31, 2014

Coastal Real Estate Prices and Climate Change

Last summer, Rolling Stone magazine published a thought provoking piece about the future of Miami in the face of climate change.  Devin Bunten and I both read this piece and started talking about rational expectations. If it is "common knowledge" that Miami is doomed, why have coastal Miami real estate prices been rising recently and rising faster than the state's average?  After all, a coastal home's value is the expected present discounted value of its future rents and if Miami is flooded in 2050 and we all agree, won't this expectation be capitalized now?

Over the last few months, we kept talking about this issue. It fits into part of my research agenda on how urbanized nations will adapt to climate change.   Within a nation, there are dozens and sometimes hundreds of cities to choose to live and work. Climate change will move these cities in "attribute space".  Some Canadian cities will be warmer in winter while other coastal cities will face new serious risks. As these anticipated risks play out, how will migration and local real estate prices  be affected?  Who will lose and who will win (Canadian land owners?) due to climate change.

We have written a new paper that is available here;  

The Impact of Emerging Climate Risks on Urban Real Estate Price Dynamics

Devin BuntenMatthew E. Kahn

NBER Working Paper No. 20018
Issued in March 2014
NBER Program(s):   AP   EEE   PE 
In the typical asset market, an asset featuring uninsurable idiosyncratic risk must offer a higher rate of return to compensate risk-averse investors. A home offers a standard asset's risk and return opportunities, but it also bundles access to its city's amenities|and to its climate risks. As climate change research reveals the true nature of these risks, how does the equilibrium real estate pricing gradient change when households can sort into different cities? When the population is homogeneous, the real estate pricing gradient instantly reflects the "new news". With population heterogeneity, an event study research design will underestimate the valuation of climate risk for households in low-risk cities while overestimating the valuation of households in high-risk areas.