Further Evidence on Real Estate Market Efficiency

Abstract

This article investigates the extent to which condominium apartment prices in Vancouver, British Columbia are set in an efficient asset market. The empirical results provide strong evidence against market efficiency. A number of instruments, including lagged annual returns and a measure of the deviation of price from fundamental or intrinsic value, to some extent predict future returns. This suggests that a sharp run-up in house prices is due in part to irrational expectations, and thus signals a future correction as prices ultimately reflect market fundamentals. These findings have important implications for appraisals and the mortgage underwriting process. In a booming market, property may be overvalued and hence market value appraisals may exceed intrinsic or fundamental values. Given the inevitability of a market correction in the near term, a potentially useful complement to the standard valuation process would be an assessment of the likelihood of a market correction.