Rationality And Irrationality In Romanian House Prices

In the last three years Romanian housing market has boomed, average prices climbing over 300%. A traditional explanation relies on the growing popularity of mortgage finance. Cheaper and less bureaucratic loans have made a house affordable for more households and caused a sharp increase in demand. The inelastic supply and other market imperfections have generated a price bubble. This paper examines three market imperfections that could have facilitated extreme price movements. Firstly there may be a Giffen anomaly in Romanian urban housing market. Secondly, adaptive expectations and a risk-seeker behavior on ownerís side could also have fuelled a price bubble. Last but not least, the prices swiftly climbed due to a poor regulated real-estate brokerage sector prone to moral hazard. Giffen goods have long been a controversial topic to microeconomic theory. Since the publication of Principles of Economics by Alfred Marshall in 1895, the literature has strived (mostly unsuccessfully) for strong empirical evidence. This paper does not attempt either to support or to reject the Giffen hypothesis but rather to appraise the possibility of a fulfillment of standard Giffen preconditions. To the best of our knowledge this is the first application of Giffen theory in real estate markets. Another original contribution is the consideration of an emerging risk-seeker behavior in the housing market of a country whose population largely lacks appropriate investment education. The asymmetric information and the exposure of real estate intermediaries to moral hazard are well known and intensively researched topics. Therefore the original contribution of this paper in this field is some new evidence from a less investigated real estate market, focusing on the linkage between poor regulation and price bubbles. For drawing its conclusions this paper uses formal observations and some statistical evidence. The examination is focused on a sound discussion of relevant facts, data and generally accepted theoretical results. The main application of conclusions is a better understanding of real estate developments in a former-communist emerging market. Thus, these results should enhance the knowledge in this field and help potential investors. A major part of Romanian urban housing market consists of flats in multi-family panel apartment blocks built in the 1970s and 1980s. A legacy of the communist era, these low-quality flats provide poor housing conditions and almost all inhabitants would be happy to leave them. Unfortunately, for most people this is not an option in a country where the housing and heating costs in the winter can reach 80 percent of average income. The few families able to ìescapeî typically have incomes close to the purchasing power of an average Western-European household. Due to poverty and very few affordable new houses, the old flats have almost no substitutes and seem to fulfill standard Giffen preconditions, i.e., they are inferior goods, lacking close substitutes and comprising a substantial percentage of the buyerís income and wealth. Therefore, we conclude that as the prices went up, demand became even stronger causing a further price increase. Another conclusion of the paper is that due to speculative myopia general risk acceptance increased, bringing sellers close to a risk-seeking behavior. Finally we bring strong legal evidence that the real estate brokerage is very poorly regulated in Romania. The consequence is an overcrowded market for these services, the survival fight increasing the moral hazard exposure of intermediaries. In order to boost the fees, real estate brokers have usually persuaded owners and buyers to increase reservation prices.