research@hec - Issue #26 - (Page 6)

real estate finance research hec Real estate finance How demographics drive housing prices What drives housing returns? What predicts changes in housing prices? According to Dragana Cvijanovic and her real estate finance research, much of the dynamics of house prices can be explained by fundamentals such as demographic change. Dragana Cvijanovic B IOGRAPHY Dragana Cvijanovic received her PhD in finance in 2011 from the London School of Economics and Political Science and is currently assistant professor of finance at HEC Paris. Dragana Cvijanovic’s research interests include empirical corporate finance, real estate finance, and empirical asset pricing. In the aftermath of the extreme boom and bust of the American real estate market over the past 15 years, Dragana Cvijanovic and her research partners set out to explain movement in house prices at the state level in the United States using fundamentals, or market drivers “other than forces like speculation.” More specifically, they focus on explaining house price appreciation using one key fundamental variable: population growth. “The earth is becoming much more populated, creating more demands for assets,” explains Cvijanovic. “Previous literature focuses on demographics and consumption, but not so much on real estate finance; meanwhile, real estate assets constitute 54% of the world’s wealth.” Demographics are a particularly useful angle of study for explaining house price appreciation, explains Cvijanovic, because of the simplicity of the concept. “The demographics angle is so logical. It really illustrates the basic economic equation: higher demand in combination with a limited or inelastic supply equals higher prices. In that way, it is a simple story.” time, and non-natural population growth, or immigration, which by contrast occurs quickly and unexpectedly. “In terms of what we call the ‘non-natural’ component of demographic change (immigration), an essential factor to take into account is that market shocks drive people to immigrate en masse from lesser to hotter economic areas.” The key difference between the two components significant to this study is thus degree of predictability. Population growth through natural causes (birth and death) follows an expected course, but, due to its sudden and market-driven nature, population growth via immigration does not. PREDICTABLE AND UNPREDICTABLE DEMOGRAPHIC CHANGE Cvijanovic and colleagues divide their study’s explanatory variable of demographic change into two basic components: natural population growth, or higher birthrates in combination with lower mortality rates, which takes place slowly over longer periods of IMMIGRATION DRIVES HOUSE APPRECIATION “We ultimately find that population growth drives house price appreciation,” reports Cvijanovic, “but also that this effect is predominantly driven by the non-natural component rather than the natural. Differences in immigration from state to state were found to determine differences in housing prices at the state level.” The researchers attribute this effect to the unpredictability of immigration. “Builders can anticipate a fraction of population growth, the fraction that is due to natural causes (birth and death), but the portion that is due to immigration cannot be predicted, which is at least partly why immigration drives house appreciation — because of its unanticipated shock to the market.” In other 6 • April-May 2012

Table of Contents for the Digital Edition of research@hec - Issue #26

Cover & Contents
Two-tier competition Putting an end to oligarchies
Kaizen We can see clearly now!
Real estate finance How demographics drive housing prices

research@hec - Issue #26