Americans Are Paying $34 Billion Too Much for Houses in Floodplains

(Bloomberg) -- At least 3.8 million U.S. homes lie in floodplains. Together, they may be overvalued by $34 billion.

New research published today in a National Bureau of Economic Research working paper shows that markets fail to incorporate risks from flooding and climate-related catastrophes. Losses from extreme weather events are rising, a function mostly of people and wealth becoming more concentrated where they're most vulnerable. If home prices more accurately reflected risk, the researchers say, there'd most likely be less development in floodplains. 

“The additional risk created by these investments is likely growing due to climate change and the long-lived nature of housing and infrastructure,” write Miyuki Hino of University of North Carolina at Chapel Hill and Marshall Burke of Stanford. “Such concerns extend to other climate hazards as well: both flood-prone and fire-prone locations have experienced substantial development in recent years.” 

This new study has not been released into a vacuum: Last week, a joint hearing between the U.S. House of Representatives subcommittees on investigations and oversight and on the environment looked at how to improve the science and communication of flood-risk to property owners. The U.S. government already promotes awareness by publishing maps showing what areas of the country face a flood risk greater than 1% in any given year. Floodplain homes bought with federally backed mortgages must be insured. But researchers disagree on the extent to which—or in some cases, if—homes rise or fall in value when they're zoned in or out of a floodplain.

To help address that question, the authors of the NBER paper have assembled what they say is the first nationwide look at the effect of floodplain designations on property values. While the scope of the paper is broad, the data are quite granular: “the floodplain often splits houses on the same block or divides one side of the street from another,” Hino and Burke write. Once they'd compiled a database of floodplain maps going back to 1996, they compared that with “detailed proprietary data” on real-estate transactions. This allowed them to compare the prices of individuals houses as their floodplain status changed over time.

Making sure buyers are aware of climate risk helps close the valuation gap. “Very few buyers would know about flood risk before they make their offer,” the study's authors write. Just a few states require sellers to disclose how much they pay in flood insurance. Low-lying Louisiana is singled out in the paper for having “an extremely comprehensive policy,” mandating that sellers disclose if a house has ever flooded, is in a flood zone, carries flood insurance, has ever had federal flood-related assistance, and more. Commercial buyers are generally much more adept at sussing out that information, and therefore tend to pay amounts that are more aligned with climate risk. 

Their research has implications well beyond the real estate marker, Hino and Burke add. Home-buying is far from the only kind of transaction where sellers may have more information than buyers. Recent proposals that require corporations to disclose climate risk, for instance, are “critical for enabling investments in resilient assets,” the authors write, and “ultimately limiting damages in a changing climate.”

To contact the editor responsible for this story: Jillian Goodman at jgoodman74@bloomberg.net

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