Academic journal article Journal of Real Estate Literature

Review Articles: Contingent Valuation and Real Estate Damage Estimation

Academic journal article Journal of Real Estate Literature

Review Articles: Contingent Valuation and Real Estate Damage Estimation

Article excerpt

Abstract

Real estate appraisal practice stresses three traditional approaches (cost, sales comparison, and income) to value contaminated properties. This paper discusses a fourth approach: the contingent valuation method (CVM). This method is useful in the estimation of losses for contaminated properties when market data are not available or market failure is suspected. Transactions of impaired properties often represent a small sample of all properties under consideration; efficient market assumptions, such as an adequate level of information, are usually not met. In such circumstances, stated values derived from surveys may offer complementary and valid evidence of market value. Where transactional evidence and survey results differ, further analysis of market conditions may be helpful to determine which represents the most credible value conclusion.

Suppose that a buyer who recently paid $500,000 for a home puts that same home up for sale after contamination is discovered on the property. It is often the case with impaired property that no buyers can be found; or if buyers bid for the property, there is a lack of information about the specifics of the property. In such situations, value evidence from other arms-length transactions may be scarce, making it difficult for potential buyers, the seller, and real estate appraisers to determine the market value of the home. Eventually, after some period of time, assume a buyer and the seller agree on a purchase price of $200,000 for the property. In the interim, however, suppose that a real estate researcher uses the contingent valuation method (CVM) to establish an estimate of $350,000 for the property based on a description of the property and its contamination issues. That is, survey respondents express a willingness-to-pay (WTP) of $350,000 after the scenario is described in detail.

Which valuation is more reflective of the property's value-the first $500,000 price (an actual payment based on incomplete information) or the $350,000 price obtained via the CVM (showing a stated preference based on information presented to the survey respondent) or the second sale at $200,000 (possibly a panic sale in a market far from equilibrium)? Market value depends on information, time, and market conditions, all of which are important issues to address when dealing with contaminated properties.

Stated preference methods were initially developed for the valuation of public goods in the fields of resource and environmental economics and in market research to estimate demand and prices. Stated preference methods consist of a family of survey techniques where individual respondents answer questions about what they would be WTP or willing to accept (WTA). For example, respondents might express WTP to avoid some environmental degradation or to accept compensation for some environmental degradation that has already occurred. These methods require the use of surveys to collect data.

Mundy and McLean (1998) provide one of the first introductions to the CVM in the real estate appraisal literature. They outline the major issues associated with the method and, among other things, discuss the kinds of survey questions one might ask depending on the particular contamination situation. Despite the limitations of the CVM, even Roddewig and Frey (2006, p. 280), who are critics of the use of CVM to value real estate, admit that "There may indeed be situations in which application of contingent valuation techniques may be useful, for example, when dealing with noneconomic goods or in real estate situations involving special-purpose or limitedmarket properties for which there are few, if any, actual sales transactions that can be analyzed." We contend that the potential uses of the CVM are more expansive than this. We argue that the CVM is especially applicable in situations where properties suffer from contamination or other impairment where market failure may occur for various reasons, including the lack of information and knowledge. …

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