onsider a vacation in Spain during the annual
running of the bulls in Pamplona. Pretend that
the price of this vacation package depends on the
airfare, trip length, dinner menu, number of bulls and
likelihood of surviving. Your likelihood of surviving, in
turn, might depend on other factors such as age, agility,
shoe choice and alcohol intake the night before. Appraisers
and other real estate experts apply a similar approach
when attempting to decompose the price of real estate
into the marginal price of different independent variables.
In valuation and real property damage economics, such
a study is known as hedonic regression analysis. Hedonic
regressions are statistical models that estimate the impact
of different characteristics on the price of a good or service.
Understanding Hedonistic Regression Analysis
Real estate professionals (and recipients of junk mail
in general) are familiar with real estate agency fliers
effusively announcing three bedrooms, two bathrooms
and maybe even a peekaboo cityscape view (if the buyer
has a stepladder). Marketing campaigns in real estate
illustrate a common-sense idea that some attributes
contribute to house values more than others. To quantify
the contribution of each attribute, valuation professionals
and real estate economists often turn to hedonic regression
analysis, a statistical method that allows us to estimate
the marginal contribution of various characteristics to the
overall price of an item.
In simple terms a hedonic regression analysis requires first
collecting a sufficiently large sample of property sales data
and property characteristics data, and then selecting and
testing different characteristics—such as room counts,
floor size, year built and waterfront access—to measure the
marginal contribution of each characteristic to the prices
of homes in the sample. It is intuitive to most of us that ten
bathrooms in a three-bedroom house do not necessarily
add to market value. For many reasonable buyers, the
time and effort involved in grouting the tile floors of ten
bathrooms would outweigh any benefits. Similarly, those
that have bought or sold homes may know that the cost of
building a pool does not increase market value dollar-for-dollar, but rather contributes to market value at a much
lesser amount. On the other hand, a larger residential lot
and an ocean view are usually both a plus, at least here in
BY ORELL C. ANDERSON, MAI AND ALEXANDER R. WOHL
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