Do peer effects shape property values?

Abstract

PurposeBoth hedonics and the traditional sales comparison approach are derived from a similar paradigm with respect to how prices, hence market values, are determined. While the hedonic approach can provide reliable estimates of individual attributes' marginal contribution, it may – unlike the sales comparison approach – underestimate the prominent influence that surrounding properties exert on any given nearby housing unit and sale price. This paper seeks to develop a simple method for reconciling the two approaches within a rigorous conceptual and methodological framework.Design/methodology/approachPeer effect models, an analytical device developed, and mainly used, by labour economists, are adapted to the hedonic price equation so as to incorporate nearby properties' influences, thereby controlling for non‐observable neighbourhood effects. In addition to basic, intrinsic, building and land attributes, the ensuing model accounts for three types of effects, namely endogenous interactions effects (i.e. comparable sales influences, or peer effects), exogenous, or neighbourhood, effects and, finally, spatial autocorrelation effects.FindingsPreliminary findings suggest that integrating peer effects in the hedonic equation allows bringing out the combined impacts of endogenous, exogenous and spatially correlated effects in the house price determination process, with spatial autocorrelation of model residuals being significantly reduced, even without resorting to a spatial autoregressive procedure.Research limitations/implicationsFurther investigation is still needed in order to find out which submarket delineation should be used to obtain optimal model performances.Originality/valueThe paper leads to the conclusion that the comparable sales approach, as used in traditional appraisal practice, is valid, although its application is typically flawed by the too small sample size generally used by appraisers. Further investigation is still needed, however, in order to find out which submarket delineation should be used to obtain optimal model performances. This raises the paramount question as to whether the peer effect variable is adequately measured and addresses the tricky issue of kernel determination in spatial statistics and related applications, such as GWR.