Capitalization of Residential Energy Efficiency

The uncertainty regarding the financial return of energy efficiency (EE) investments may be a reason for households not to undertake profitable investments in energy efficiency. Therefore, it is important to identify the market value of energy efficiency in the housing sector. Previous literature provides some empirical evidence on the impact of energy efficiency on sale prices in the building sector. However, the most common methodological drawback of the evidence provided by the available literature is the potential bias that may arise due to the omission of unobserved dwelling characteristics that are correlated with the EE.In this study, using a large representative dataset from the Netherlands, we propose an instrumental variable approach in order to correctly identify the capitalization of energy efficiency in the housing market. We benefit from a continuous energy efficiency measure provided by Energy Performance Certificates (EPC), which enables us to estimate the elasticity of house price with respect to its energy efficiency. As well as including detailed dwelling characteristics in the hedonic model, we use an instrumental variable (IV) approach to deal with the potential omitted variable bias. The 1973-74 oil crisis, which created an exogenous discontinuity in the EE levels of the dwellings constructed before and after this date, and the evolution of building codes are used as instruments for energy efficiency. Our results indicate that the standard OLS estimates are downward biased. By using an IV approach, we find that as the energy efficiency level increases by 50 percent for an average dwelling, the value of the dwelling increases by around ten percent. In order to examine whether the value of EE increases by the disclosure of EPC, we create a common energy efficiency measure for certified and non-certified dwellings, which is based on actual energy consumption. Our findings do not suggest a larger capitalization rate for the dwellings that are transacted with EPCs. Finally, in order to examine the over-time variation in the capitalization of EE, we estimate the hedonic model for each year separately from 2003 to 2011. We document that the value of EE has doubled from 2003 to 2011, which might be partly explained by the increase of energy prices, the relative decrease in house prices.