Local residents who bought second homes earned more from their properties ... than out-of-town investors.
Out-of-towners may have the cash to buy second homes, but they may not be as savvy as investors who focus their attention locally, according to Alex Chinco and Christopher Mayer in Misinformed Speculators and Mispricing in the Housing Market (NBER Working Paper No. 19817). Local residents who bought second homes earned more from their properties, and tended to sell them in stronger markets, than out-of-town investors.
Despite their arguably poorer information, out-of-town speculators can have a substantial impact on local housing values in boom cities. The study finds that a 10 percentage point rise in a city's fraction of sales to out-of-town second house buyers was associated with a 6 percentage point increase in house prices and a 9 percentage point boost in the implied-to-actual rent ratio (IAR) over the next year. The authors conclude that increases in nonresident second-home-buyer interest appear to drive markets upward, not the other way around.
Using the property address as well as the tax bill mailing address for every single family house purchase in 21 cities from January 2000 through December 2007, the authors find that in key markets such as Las Vegas, Phoenix, Miami, and Tampa, out-of-town buyers earned lower capital gains on their second homes compared with local second home investors. Out-of-town buyers who purchased homes in Las Vegas in March 2004, for example, earned an average 8 percent per year capital gain on their investment before they sold their property. Local second house buyers purchasing in the same month earned a 17 percent per year capital gain on average. Out-of-town second home buyers were notably less successful than local buyers in timing their exit from the market in Las Vegas and other "boom" markets.
From the information they can glean about out-of-town buyers, the researchers conclude that they are not drawn from the ranks of the ultra rich. The median value of their primary homes was lower than the median sale price in many of the cities into which they bought. They also find that the out-of-town buyers did not obtain much diversification with their purchases. At the peak of the boom, the typical second home buyer in places like Los Angeles and Jacksonville already owned two investment properties in metropolitan statistical areas (MSAs) with very similar price dynamics.
Chinco and Mayer address the difficult question of causality: were out-of-towners driving fundamental changes in local real estate markets, or were fundamental changes in these markets driving price increases and luring out-of-towners to invest? They conclude in favor of the former explanation. "If changes to fundamentals were driving both price dynamics as well as out-of-town second house buyer demand, we would expect to see large jumps in house price and IAR appreciation rates preceded by increases in out-of-town second house buyer demand from across the country," they write. "The data do not display this..."
The authors find that the effect of out-of-town buyers on local markets depended in part on where these long distance investors are from. For example, an increase in nonresident purchases of homes in Phoenix by residents of Los Angeles was associated with a larger run-up in subsequent prices than an increase in purchases by Milwaukee residents. The researchers point out that where the buyers are from should not matter if these buyers are all reacting to the same underlying market information. They conclude that something else, for example a favorable review of the Phoenix market in a local newspaper in another city, or the airing of a television program about real estate investing in Phoenix in a few media markets, must explain the behavior of these non-resident buyers and affect the strength of their demand. "Our econometric approach allows us to identify price movements that can't be solely explained by shocks to fundamentals," the authors write. "It completely sidesteps the thorny problem of instrumenting for misinformed speculator demand across assets."