The value of energy efficiency in residential buildings – a matter of heterogeneity?!

peer reviewedEnergy efficiency ratings of residential buildings are intended to remove assessment errors from real estate markets to increase energy efficiency – the key to fully decarbonizing the building sector. Price premiums of rated buildings should reflect capitalized future energy savings, but instead are nonlinear (1), can exceed savings (2) and are correlated with buyer's characteristics (3). We explore these anomalies with a hedonic model of product differentiation, which is adapted to efficiency valuation in the housing market. The model implies that buyers with high willingness to pay for efficiency “sort” themselves to efficient buildings (and vice versa) and drive their premiums above average discounted energy expenditures - if the market share of the efficient buildings is below average. In this sense a non-linear scarcity premium explains findings (1) and (2). Furthermore, it is revealed that the results from (3) require average buyer's characteristics to vary spatially, but neither their variance nor the variance of buildings stocks efficiency – strong assumptions. The model explains measured premiums of the UK well and shows that as well as buyer heterogeneity and supply structure, the prebound effect - the overestimation of energy costs in inefficient buildings by ratings – also plays an important role in determining efficiency premiums