Pricing of presale properties with asymmetric information

Abstract

Property developers have increasingly used forward contracts to pre-sell their properties that are under construction in order to enhance their financial viability. With reference to the forward property market in Hong Kong, this research investigates how the specific hidden risks arising from asymmetric information embedded in forward property markets affect the pricing mechanism of presale properties. A review of the forward property markets identifies that presale property buyers have to bear not only the additional market risk and the extra capital cost of finance transferred from the developers during the construction period compared to buying a spot property, they also have to bear the hidden presale risks arising from asymmetric information embedded in the forward property markets. Six hidden presale risks are found in Hong Kong and ranked with decreasing seriousness as unethical presale tactics, exaggeration of floor areas, features mismatch, building defects, delayed delivery and development default. This study has examined the roots of the problems which undermine the effectiveness of the presale policies to mitigate the hidden presale risks. The study also identifies the factors which are critical to the development of a forward property market. To examine the price movement of presale properties with respect to the additional risks embedded in the forward market, a Forward Property Repeat Sales (FPRS) Model using forward-spot pair sales data was developed. This has been found to be a more efficient model in reflecting the general price change of the forward property market. In addition, the study compares the FPRS Index and the spot price indices. It shows the price movement of presale properties in the forward market reconciled that of the spot properties during the study period from 1993 to 2005. However, in some years when the market was booming, the spot price indices were found to have fallen slightly behind the FPRS Index. This suggests that buyers had paid a premium on presale properties in order to hedge against the anticipated price appreciation, particularly when the market was booming. A pricing model, the Forward-Spot Index Tracking (FSIT) Model encompassing the Hedonic Pricing Model, the Repeat Sales Price Model and the Single Index Model, was also developed for studying the pricing mechanism of presale properties containing asymmetric information. Statistical analyses of the FSIT Model show that presale property buyers had paid a price approximately 5% higher than those spot buyers for comparables properties, because of the hidden risks embedded in presale properties. This supports the proposition that developers are able to acquire a wealth transfer from presale property buyers to them on pricing of presale properties taking advantage of the asymmetric information inherent in the forward property market. The study is the first research of its kind to provide a comprehensive pricing framework for presale properties with asymmetric information. It also offers valuable findings to property practitioners, showing the extent of the extra amounts that buyers might have paid for the presales in order to get the properties that they desired.