Creative Financing and House Prices: A Theoretical Inquiry into the Capitalization Issue

Jan Brueckner

Real Estate Economics, 1984, vol. 12, issue 4, 417-426

Abstract: Since buyers offer a premium for access to creative financing (CF), creatively‐financed houses will sell for more than otherwise identical houses purchased with standard financing. A commonly suggested method for adjusting house values to eliminate the effects of CF is the “cash equivalence” method, where the CF premium is assumed to equal the present value of savings from CF. This paper shows that in a world with active housing speculators, the cash equivalence approach gives the right answer: In an “arbitrage” equilibrium, house values must differ by exactly the present value of CF savings. Further analysis shows that when capital markets are perfect, each consumer is indifferent between CF and standard financing when arbitrage equilibrium obtains. Without perfect capital markets, however, consumers will strictly prefer one financing mode or the other.

Date: 1984
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