The effects of age on housing prices in Hong Kong

by Yiu, Chung-yim

(Uncorrected OCR) Abstract of the thesis entitled

THE EFFECTS OF AGE ON HOUSING PRICES IN HONG KONG

Submitted by

Yiu Chung Vim

for the degree of Doctor of Philosophy

at the Department of Real Estate and Construction The University of Hong Kong

in July 2002

The coefficient of the age variable estimated in hedonic price model is commonly interpreted as the rate of physical depreciation and is often assumed to be stable over time. However, it can be shown that the estimated age effects are the intertwined effects of both age and vintage because of the linear dependence among age, vintage and time. Their inextricable relationships render the estimation of their individual effect impossible. The aim of this thesis is therefore to solve the perfect multicollinearity among age, vintage and time.

This study examines four approaches. First, the model reduction method is reviewed and shown that it will result in biased estimates and heteroskedasticity. Most of the previous attempts in solving the problem are reviewed and proved to be theoretically wrong. Second, linear dependence can be avoided by a non-linear specification of the age effects. There is, however, no theoretical justification for the convexity specification. The best alternative is to let the data determine the functional form, thus the Box-Cox Transformation is applied. The third approach makes use of additional information. This approach relies on the theoretical relationship between the real rate of interest and the age effects. Incorporating the effects of real interest rate on depreciation can therefore delineate the three effects. Finally, the fourth approach exploits the a priori information provided

by the forward contract transactions of housing to tackle the problem. Since there is no depreciation during the period of forward contract, the pure vintage effects become estimable.

The accomplishment of the aim has far-reaching implications.

First, it is shown that the market can value technical obsolescence. It provides an efficient monitoring tool for the dilapidation problem. Second, it can identifY the vintage effects in phased developments. The results show that penetration pricing strategy is commonly adopted in estate-type developments in Hong Kong. Third, it explains why sometimes positive effects of age may be found. Lastly, it allows the construction of constant quality price index, which is found to be more plausible.

Among the four approaches, the forward contract model is theoretically preferred as it allows the estimation of the vintage effects under the elimination of the effects of age a priori. However, an active pre-sale market is required to make this approach practical. Hence, it is proposed to fully utilize the three approaches and let the results from the three approaches reinforced each other.