Tests on Real Estate Market Efficiency
Two forms of market efficiency on the property market were tested, the weak form hypothesis was tested using a constructed index and the semi strong form was tested using a trading rule.
The Weak Form Efficiency test of the residential property market in Auckland, New Zealand, showed that capital appreciation in properties were predictable even when discounted by the relative inflation rate, and so the hypothesis of a “random walk” in prices can be rejected. But on the basis that the resulting excess returns from the risk free rate, were in fact unpredictable, we still cannot fully reject the hypothesis that the residential property market is inefficient in this form.
The tests on the Semi Strong form of the residential property market showed that some properties were not correctly priced to the market throughout this period, and that all publicly available information is not immediately reflected in the prices. Although there is evidence to imply that the residential property market in Auckland is inefficient in this form, by following a trading rule as used above, the extra returns may not be justifiable since high search costs will be involved. And in practice the entire under priced property portfolio has to be purchased throughout the course of ten years in order to gain this implied extra return. An investment of this magnitude is impossible, and so the Semi Strong form Efficiency of the real estate market cannot be fully rejected.
Both concepts of market efficiency cannot be fully rejected by the fact that the abnormal returns cannot be exploited. But, as suggested by Londerville (1998), if investors are well informed of the current Real Estate Market and its fundamentals. By applying a similar trading rule as a screening process and after a thorough analysis, some truly under priced properties can be identified. The resulting abnormal returns are in fact possible since it is shown that underpriced properties yielded higher than normal returns. In addition the proven fact that property prices do exhibit some inertia, as shown from the results above. The WRS Price Index, a more accurate representation than the Median Price Index, can be a useful tool to understand the market better and to identify cyclical patterns.
The overall analysis provided some insightful outcomes such as the non random walk of property prices, and the proof of market imperfections in pricing. The significant differences in the portfolios analysed also prove that the hedonic pricing model used in the study, performs quite well for pricing and as a base line for identifying underpriced properties. This kind of pricing model and the results obtained throughout this paper can be useful to assist investors in making more informative decisions and with some diligence, exploit these inefficiencies in the property market.