The Impact of Flood Risk on the Price of Residential Properties: The Case of England Philippe Bélanger & Michael Bourdeau-Brien 1 Department of Finance, Insurance and Real Estate, Université Laval Email: [email protected] [email protected] Areas / Paper type – Change and Risk - Issues for Property Valuation work? ABSTRACT This paper examines the impact of flood risk on the value of England residential properties. We find that being located within a flood zone significantly lowers property values once we control for the proximity to a watercourse that often increases house prices. Interestingly, the effect of flood risk is predominantly associated with the post-2003 period which can be rationalized by changes in insurance practices and availability of detailed information on flood zones. Moreover, people in richer areas appear to better incorporate available flood risk data while people in poorer areas seem to associate flood risk with proximity to the water. Keywords: Floods; Real Estate; Housing; Household behaviour JEL Classification: D12, H31, Q54, R31 Proceedings: ERES2016 pp. xx-xx 1. Introduction Change and Risk - Issues for Property Valuation Floods and other major natural hazards have a far-reaching impact on the economies of work? affected regions. According to a 2015 study from the United Nations’ Food and Agriculture Organization1, natural disasters caused more than $1.5 trillion in damage 2 and 1.1 million deaths worldwide between 2003 and 2013. These numbers may yet get worse because of global warming that tends to increase the frequency and intensity of extreme weather events (Francis and Vavrus, 2012, Rahmstorf and Coumou, 2011, Douglas et al., 2010, Kazmierczak and Bichard, 2010, Thorne et al., 2007). Still, the negative effects of catastrophes are often circumscribed to emerging countries (Mechler, 2009) and studies focussing on developed economies obtain mixed results. On the one hand, many papers report a decline in economic growth (Hochrainer, 2009, Raddatz, 2009, Strobl, 2011, Noy and Nualsri, 2011). On the other hand, an almost equal number of studies see extreme weather events having a neutral or positive effect on productivity (Skidmore and Toya, 2002, Leiter et al., 2009, Baker and Bloom, 2013, Bernile et al., 2015). We observe similar conflicting conclusions in the housing markets literature. On the negative side, Shillings, Sirmans and Benjamin (1989) study the effect of flood risk on residential houses in Baton Rouge, Louisiana, and observe that the risk of being flooded significantly lowers the selling price of a house. Harrison, Smersh and Schwartz (2001) examine the valuation of homes in Alachua County, Florida, and find evidence that houses located within a flood zone sell for less than homes located elsewhere. Bin, Kruse and Landry (2008) investigate the effect of flood risk on property values in Carteret County, North Carolina, and also show a meaningful negative premium for houses located in flood-prone localities. On the neutral or positive side, Small, Newby and Clarkson (2013) compare the actual performance of the housing market before and after the 2011 flood in Rockhampton, Australia, and fail to notice any impact on house values. Zimmerman (1979) studies the effect of a floodplain location on home in three towns in New Jersey and finds no variation for flood prone and non-flood prone lands. Bialaszewski and Newsome (1990) run a similar study on residential properties in Homewood, Alabama and detect no effect associated with a location within a floodplain location. Last, Morgan (2007) observes that houses in Santa Rosa County, Florida, that are located within a floodplain benefit from a positive premium. The most popular explanation that has been put forward to rationalise the dichotomous results is associated with risk awareness and imperfect information. Lamond and Proverbs (2006) and Lamond, Proverbs and Hammond (2010) empirically show that flood-relate premiums in United Kingdom are essentially associated with flood events and not flood risk per se and that the premiums slowly fade away as flood episodes are forgotten. Others obtain similar findings for Netherland, United States and Australia (Husby et al., 2014, Bin and Landry, 2013, Atreya et al., 2013, McKenzie and Levendis, 2010, Bin and Polasky, 2004, Eves, 2002, Harrison et al., 2001). Pryce, Chen and Galster (2011) show how market participant’s myopia and amnesia behaviours 1 The Impact of Disaters on Agriculture and Food Security. Available at http://www.fao.org/3/a-i5128e.pdf. (page consulted on May 30, 2016). affect the perception of flood risk through a theoretical model and discuss how and when location within flood-prone areas are expected to lead to substantial premiums. Other plausible explanations for the divergent impact of flood risk on housing include Daniel, Florax and Rietveld (2009) who argue that previous studies often fail to adequately take into account the positive effect of a location close to the water and that the literature would benefit from alternative methodologies that better incorporate this 3 confounding variable and Fielding (2007) who observes an unequal distribution of households in floodplains with respect to their social class in the United Kingdom where poorer households have a higher propensity to live in flood zones than wealthier families. Moreover, one limitation of most previous papers derives from their rather small geographic coverage, usually confined to one or a few counties or municipalities located in a given region that may be susceptible to share a common urban organisation and similar housing market characteristics. Hence, it is unclear if previous findings correctly portray the general housing market and if the results are of interest to regional or national authorities and geographically diversified insurance companies. This paper addresses this shortcoming and investigates the effect of flood risk on residential property values spread across multiple localities in England. We perform our analysis using a sample of over 100,000 transactions from the U.K. Land Registry between 1995 and 2015. We use available geocoding services to locate individual properties. We superpose several layers of geographical data in order to distinguish between properties within and outside flood zones, to calculate distances from the nearest body of water and to group properties on the basis of census-based output area boundaries defined in a way that recognises homogeneous environments. Building on existing literature, our approach allows us to control for the confounding effects associated with the proximity to the water and to control for the interaction between flood risk and levels of economic deprivation. Yet, expanding the geographic coverage to hundreds of localities comes with a price. We are no longer able to obtain enough individual house characteristics to employ a classic hedonic model and must resort to another, less frequently used, econometric framework. We opt for a linear mixed-effects model that permits to take into account the expected correlation between house prices in each small local area. We make sure our inferences are not biased by heteroscedasticity or by departure from the normality in the residuals using a the wild bootstrap methodology of Liu (1988) to assess the statistical significance of our regressors. We benchmark our main results by examining the effect of flood risk on various subsamples and implement some additional robustness checks. Our findings indicate that location within a flood zone commands a price premium but that the distribution of the premium is contingent on the proximity to the water and on the area wealth. In high wealth areas, households appear to rely on official information on flood zones. Properties throughout flood zones exhibit lower house values and the price discount is of about 1.5 percent in average. Still, the negative effect of flood risk is more than offset by the positive premium of being located close to the water. Without an effective control for that countervailing variable, neither the proximity to Change and Risk the water nor flood risk would appear as significant. The negative effect of flood risk is even more obvious in economically deprived areas where the drop in value exceeds 2 - Issues for percent. Opposing the situation in wealthier localities, lower house prices are only Property Valuation observed in the immediate vicinity of a body of water. work? 4 These results suggest that the myopia behaviour, or more generally the issues related with incomplete information, may be restricted to poorer neighbourhoods and hint that the U.K. Environment Agency flood awareness campaign that follows the major floods of 2000 better succeeded in rich than poor regions. The findings also strongly emphases the need to adequately control for the proximity to the water and for the distribution of wealth when examining the effect of floods on housing as these factors act as effective confounding variables. The rest of the paper is structured as follows: Section 2 portrays the England housing market and discusses household flood risk awareness. Section 3 describes the linear mixed-effects model approach and the data. Section 4 presents and discusses the main results. Section 5 concludes. 2. Housing Market, Flood Risk and Risk Awareness in England The England housing market is relatively mature. In some urban regions such as London, house prices are often considered as out of reach for first buyers2. These high prices underline an enduring demand imbalance as England new housing offer do not meet the need of population growth. Thus, it is not surprising that only 5% of the transactions involve the purchase of new dwellings. Moreover, England is characterized by the fact that several large urban centres are partially located within floodplains. Lamond et al. (2010) discuss extensively the effects of floods on the UK housing market and argue that the consequences of floods are expected to rise in the future. Hence, urban planning issues are directly connected to flood risk and this situation has many policy implications.