Joumai of Real Estate Finance and Economics, 4: 395-407 (1991) 1991 KJuwer Academic Publishers

Housing Prices and Flood Risk: An Examination Using Spline Regression

JANET FURMAN SPEYRER Assistant Professor of Economics, Department of Economics and finance. University of New Orleans, New Orleans, LA 70148 WADE R. RAGAS Professor of Finance, Department of Economics and Finance, University cfNew Orleans, New Orletms, LA 70148

Abstract
This article e:uniines the impact of flood risk and nxandatory flood insurance on property values. Using a large data set of almost 2,000 homes sold in the New Orleans, Louisiana, area from 197] through 1986, the analysis confirms the finding of earlier studies that location in a floodplain does reduce property values. The present study, using spline variables to adjust for locational variation in the data and an improved measure of insurance cost, reveals that much of this reduction can be attributed to mandatory flood insurance coverage. Moreover, while unexpected flooding does increase the insurance cost capitalization, repeated flooding does not seem to reduce property values further. Key words: Flood risk. Flood insurance, Spline r^ression

Reported annual flood damage from urban flooding often exceeds hundreds of millions of dollars in the United States. In addition., flood control structures, drainage systems, and flood insurance subsidies cost billions. Not included in these costs is the reduction in property value experienced by owners in areas perceived to be flood prone. Three questions about urban rain-runoff, flood-induced reduction in value are empirically examined in this study. First, within areas with extensive flood insurance coverage and recurring actual flood risk, are property values significantly lower? Second, do differences in insurance cost explain property value reduction in flood-prone areas? Finally, does recurring urban rainrunoff flooding change the magnitude of the adverse effect on property values? The first two questions have been examined in the literature using cross-sectional analysis. Two prior articles analyze the impact of floodplain location on property values. Shilling, Benjamin, and Sirmans (1989) review the specifics of the National Flood Insurance Program and its redistributive effects on owners of different types of property. The authors study 114 transactions in Baton Rouge, Louisiana, during a 15-month period and find a significant impact of floodplain location ($4,500 for the average-valued home). They use the actual flood insurance premium to investigate the effect of higher insurance costs on property values and conclude that flood insurance cost is capitalized into house value at a discount rate of 4 percent.However, since flood insurance cost is the insurance rate times house price, the correlation between price and insurance cost m ^ make it difficult to

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JANET FURMAN SPEYRER AND WADE R. RAGAS

interpret the regression coefficient of flood insurance cost. The dummy variable approach used by the authors to estimate the effect of flood insurance on property values yields consistent results with their insurance cost fmdings. MacDonald, Murdoch, and White (1987) develop a theoretical model of willingness to pay to avoid flood risk. Using 217 observations scattered over Monroe, Louisiana, during a three-month period, they find a similar effect on house value. Locations in a flood-risk zone experience capitalization even when flood insurance coverage exists. The capitalization rate they fmd for flood insurance cost is slightly less than 3 percent. Skantz and Strickland (1987) studied the impact of extensive urban flooding on 133 homes in Houston, Texas, over a four-year period in search of an answer to the third question. Based on the sales of only 36 houses after flooding occurred, they conclude that an increase in insurance rates caused a significant decline in property values, but that the actual fiooding incidents did not affect value. We address these three questions using a unique time-series data base of about 2,000 sales drawn from the metropolitan area with the highest flood claims in the past decadeNew Orleans. Two neighborhoods of differing age and character (urban versus suburban) were studied. We also introduce spline variables into our regression equations which make it possible to isolate the impact of fiood risk from other locational variables. The cost of mandatory flood insurance enters as a rate index in the analysis to limit the correlation between flood insurance premiums and house value when trying to determine the capitalization of insurance cost. Tests for changes in flood insurance capitalization are conducted after serious flooding incidents. These improvements in data and methodology enable us better to estimate the cost of flood risk and mandatory flood insurance and therefore to determine the benefits of fiood control efforts.

1. Data This research uses a data file created from appraisal reports on single-family houses supplied l^ the majority of active appraisers in the New Orleans area to tbe Real Estate Market Data Center of the University of New Orleans. Descriptive housing characteristics have been maintained from these records since 1971. Actual transaction prices, a matter of public record, are verified on eacb appraisal and retained on the record. Regular use and review by practicing appraisers further insures the accuracy of the data. The data file is more complete than the Multiple Listing Service records typically used in this type of study. Significant urban flooding due to unusual rainfalls (8 inches to 10 inches in less than 24 bours) occurred in 1978, 1980, and 1983 in the New Orleans area. A review of all newspaper accounts of these incidents identified several geographic areas with obvious flood risk. Our study areas include two groups of neighborhoods with recurring media attention. A suburban area in Jefferson Parish encompassing three square miles with Al, B, and C fiood risk ratings and a more centrally located (urban) area in Orleans Parish of about two square miles from Al, A8, and B fiood risk ratings were selected.' From lowest to highest fiood risk, Federal Emergency Management Agency (FEMA) assigns categories ranging from C (virtually no flood risk), B, Al, and A8 to property in these areas. Technically, FEMA assigns C to areas outside of a 500-year flood ( < .2 percent

HOUSING PRICES AND FLOOD RISK; AN EXAMINATION USING SPUNE REGRESSION

397

probability offloodingin a given year), B to areas between limits of 100-year and 500-year floods (.2 to 1 percent probability of flood in a given year), and A to those areas subject
to 100-year flood ( > 1 percent chance of flooding in a given year). Within the A zone, flood hazard increases from Al to A30, with a higher suffix indicating higher flood risk.^ FEMA data reveal the extent of flood damage in these two parishes in table I. In Orleans Parish between 1977 and 1986, there were 17,552 claims totaling $75.4 million. In Jefferson, 21,867 claims totaled $121.7 million over the same 10-year period. Years of massive street flooding have inflicted losses averaging $4,300 to $5,600 per FEMA claim in these two areas. Table 2 summarizes selected characteristics of the data in each of the study areas. Means, standard deviations, and ranges of selected variables in each of these two neighborhoods are listed.
Table L Flood insurance claims: Orleans* and Jefferson** Parishes, 1977-1986. Orleans Parish Year 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 Total 1977-1986 Claims 3 3133 106 6309 967 1342 5415 5 267 5 17,552 $ Dollars 4,410 11,783.421 228.705 27.702.861 2,922,024 3,447,348 26.544.734 7,206 2.729,166 15.784 Average Claim $ 1,470 3,761 2.158 4.391 3.022 2,569 4,902 1,441 10.222 3,157 $4,295 Claims 19 4000 120 7940 327 3819 3514 71 2052 5 21,867 J Jefferson Parish Dollars 48.736 18,443,478 271,787 41,270,532 711.598 17,769.798 15.493.232 1,117 27,680,446 9.620 Average Claim $ 2,565 4,611 2,265 5,198 2,176 4,653 4,409 16 13,489 1,924 $5,565

$75,385,659

$121,700,344

Source: Mr. Wayne Firley. Regional Administrator for Federal Emergency Management Agency. Orleans Parish: 55,852 policies; $3,766,972,500 insured; $3,037,574 premium for 1985. "Jefferson Parish: 51.233 policies; $3,864,444,600 insured; $11,923,500 premium for 1985. Table 2. Selected variable means, standard deviations, and ranges.
Surburtan* Standard Deviation Minimum 37967.73 656.79 0.28

Vtrisbte Name Price Living arc* (sq, ft.) Flood Al Flood A8 Insurance rale index Central air Number of fireplaces Lot fronlage (ft.) Off-siieel parldng Condition Half baths Central heat Piers Insurance amounlt

Mean 73090.47 2183.17 0,91

Maximum 275800 5460 1 177,25 1 2

115

Mean 66961,45 2429.61 0.26 0,08 31,13 0,31 O,lt 42,10 0.38 3,13 0.29 0.39 0,92 149,64

Urban** Standard Deviation Minimum 50508,94 1112,25 0,44 0.27 46,41 0,46 0,38 14,S2 0,49 0,83 0,61 0,49
027

Maximum 300000 6932

1 1

10400
970 0 0 0 0 30 0 3 0 0

10000 807
0 0 0

81.13 0.98 0.14 62.06 0,92 5.94 0.36 0.999 0.04 148.15

33.42 0,13 0,35 10,07 0.28 0.64 0.68 0,29 0,19 75.91

156.09
1 2 150 1 7

0
0 20 0 1 0 0 0

1 7
5 1 1

0 19,50

997.50

79 59

19,69

5 1 1 430.00

No, of observations " 1,229, ' ' N o . of observations = 769, tFor properties in FEMA tloodzone A only.

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JAI^T FURMAN SPEYRER AND WADE R. RAGAS

2. Model The question of whether buyers pay a premium for homes in areas with less flood risk is theoretically represented by a bid function similar to that used by Wheaton (1977). Assume V(Fi) is the maximum utility that can be achieved with flood risk i. Then, the bid for reduction in flood risk from Fj to Fj is the gap between the minimum expenditure necessary to achieve V(Fj) with F, and the minimum expenditure necessary to achieve V(Fi) in neighborhoods with greater flood risk Fj. The bid function 6iFi, Fj) is the maximum amount that the consumer would pay to obtain flood risk F, rather than Fj. The housing market does not explicitly reveal the bids for different flood risk zones. Rather, the transactions prices of homes result from the interaction of supply and demand forces for many physical and locational characteristics in addition to flood attributes. The hedonic price approach is used to isolate empirically the impact of flood risk in house value. At any time, house value, H, can be represented by the reduced form equation; H = f(P, L, F), (1)

where: F is a vector of physical characteristics of the home, L is a vector of locational characteristics, and F is the risk of flooding from urban rain runoff. For the calculation of an bedonic price index to examine tbe value of flood risk reduction, the vector P includes lot frontage, living area, number of half-baths, condition, number of fireplaces, dummies representing off-street parking, elevation on piers, and central heating and cooling systems. Locational variables capmring urban amenities and disamenities and a measure of access to an employment center are included in L? In order to examine the impact of actual flood occurrences on house value, house sales from 1971 to 1986 are included in the sample. Introduction of significant variation in time into the cross-sectional analysis requires knowledge of the functional relationship between time and value. Dummy variables for each year from 1972-1986 are included in the regression to correct for intertemporal variation in price. The nonsimultaneity problems using time-series data are mitigated but not resolved by tbese year dummies. Several altemative specifications were tried. Other functional forms (linear, log) for time using an otherwise similar bedonic price calculation were attempted. The nonmonotonic nature of the rate of change in price over a 16-year period was best represented by the specification used here. Another altemative, deflating all house prices by the consumer price index, is not satisfactory because of the rapid increases and decreases in property value due to fluctuations in the local economy's oil and gas industry. Tbese price changes sharply differ from the national price pattem. Shorter time-series within tbe sample were tested for differences between the partial- and full-sample regressions to ascertain the stability of tbe observed coefficients. For the first set of regressions, flood risk F, is represented by dummy variables representing the most risky FEMA flood zone in each of the two geographic areas. In the urban area, a dummy variable for flood zone with highest risk, AS, is included in tbe regression to compare the property values in these areas to those of flood zones Al and B, the less risky flood zones in the area. In the suburban area, a dummy variable representing the most

HOUSING PRICES AND FLOOD RISK: AN EXAMINATION USING SPLINE REGRESSION

399

risky FEMA flood zone in the area., Al, is used to compare property values in these areas to those in flood zones B and C. In the second set of analyses, a flood insurance cost index is used to explain the influence of higher flood insurance premiums on house value. This flood insurance cost index compares the cost of insurance for each of the properties to the average effective rate for insurance in the 1971-1974 period. These mandated insurance costs are calculated from FEMA rates and coverage limits. The index is constructed as follows: Insurance _ Rate index [" unit insurance premium/unit sales price 1 1 average premium 71-74/average sales price 71-74 J -^ .

3. Empirical findings Homes in the two areas were first examined using linear and semi-log specifications of the model. Then, Box-Cox transformations of the regression equation were tested. Cassel and Mendelsohn (1985) suggest that when many of the independent variables are not continuous, Box-Cox transformation of independent variables may be misleading. Because more than half of the variables in the regressions are not continuous, transformation of only the dependent variable is reasonable. Box-Cox transformation of the dependetit variable only reveals X of .31 in the suburban area and X of .13 in the urban area. (X = 1 indicates a linear regression; X = 0, a semi-log regression.) Box-Cox findings are more difficult for the reader to interpret than are the linear and semi-log forms. Because the signs and significance of the variables of interest in the Box-Cox regression are not different than those of the semi-log regression, we have chosen not to report the Box-Cox regression coefficients. The first set of linear and semi-log regressions tests whether location in zones with flood risk reduces property values. These findings are reported in table 3. In the suburban neighborhood, location in flood-prone neighborhoods does diminish property values. The reduction in the Al FEMA zone (the riskiest in that area) is about $6,100 in the linear regression. The semi-log form of the regression reveals that location in the Al zone leads to a 4.2 percent reduction in property values. The urban neighborhood analysis reveals property value reduction for the highest flood risk zone (A8) of about $13,7(X) in the linear regression. The finding that location in the A8 zone reduces property values by 6.3 percent in the semi-log form is not significant at the 10 percent level. One possible explanation for the insignificance of this flood variable in the semi-log form is that the A8 specification of flood risk based on ground surfece elevation may not be entirely indicative of likely flooding for these homes. In the study area, significant flooding has occurred in the less risky FEMA flood zones. In addition, the homes in the urban area are much older than the suburban homes. The owners have therefore experienced many substantial rainfalls and may not have suffered much damage. Finally, further analysis to adjust for locational variables other than flood risk m ^ be needed to separate the impact of flood risk from that of other characteristics that are highly correlated with price. Before adding the geographic variables, we note that many of the other variables designed to explain differences in home values in this first set of regressions have the expected

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JANET FURMAN SPEYRER AND WADE R. RAGAS

Table 3. Effect of flood risk zone on property value. Suburban Sample Size Adjusted R-Square Durbin-Watson Intercept Condition Central air Central heat Distance from employment center Proximity to lake Frontage Half-baths Living area Number of fireplaces Linear 1229 0.7969 1.680 -49288.1** (-6.089) 4514.52** (5.172) 2650.69 (0.696) -105.68* (-2.096) 7635.19** (4.684) 10683* (1.864) 2910.91** (3.622) 25.00** (25.839) 12798.52*(7.011) 4265.86 (1.488) Off-street parking Ploodzone Al Floodzone A8 Year 1972 Year 1973 Year 1974 Year 1975 4285.99* (2.359) -6124.02*** (-3.367) 3285.17 (1.230) 9016.09** (3.404) 10086.19** (3.818) 15523.44** (5.988) Semi-Log 1229 0.7894 1.777 9.0485** (86.514) 0.0733** (6.501) 0.2044** (4.156) -0.0008 (-1.191) 0.0771** (3.661) 0.0014* (1.841) 0.0308** (2.970) 0.0003** (26.852) 0.0179 (0.758) 0.0650* (1.754) 0.1058** (4.509) -0.0415* (-1.764) 0.0828* (2.401) 0.1652** (4.826) 0.2201 (6.448) 0.2823** (8.428) Linear 769 0.7262 1.791 -57105.9** (-5.818) 6244.83** (4.521) 17566.89** (4.713) 8850.63* (2.431) -377.99** (-3.969) 729.80'* (8.805) 11804.03** (6.869) 9.95** (9.061) 12486.74** (4.280) 870.27 (0.234) -379.50 (-0.176) -13691.7** (-3.590) 2899.93 (0.498) 615.86 (0.109) 6395.14 (1.124) 5306.71 (0.916) Urban Semi-Log 769 0.8078 1.723 8.5068** (68.654) 0.1704** (9.775) 0.1817** (3.862) 0.1705** (3.710) -0.0073** (-6.748) 0.0091** (8.690) 0.1162** (5.356) 0.0002** (15.473) 0.0686* (1.862) 0.0330 (0.703) 0.0583* (2.143) -0.0634 (-1.317) 0.0733 (0.997) 0.0070 (0.099) 0.0793 (1.104) 0.0787 (1.076)

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401

Year 1976 Year 1977 Year 1978 Year 1979 Year 1980 Year 1981 Year 1982 Year 1983 Year 1984 Year 1985 Year 1986 Quarter 2 Quarter 3 Quarter 4

19377.94** (7.519) 24135.73** (8.552) 42545.69** (16.209) 48016.23** (17.927) 54889.68** (14.656) 44418.27** (4.371) 58754.64** (12.413) 66817.42** (21.537) 76288.02** (24.229) 64967.07** (18.253) 76665.38** (22.014) 1092.43 (0.740) 876.82 (0.606) 4767.65** (2.965)

0.3545** (10.646) 0.4201** (11.521) 0.6766** (19.951) 0.8007** (23.136) 0.8836** (18.259) 0.8147** (6.205) 0.9733** (15.915) 0.9788** (24.417) 1.0870** (26.720) 0.9084** (19.753) 1.0679** (23.733) 0.0033 (0.174) 0.0228 (1.220) 0.0588** (2.828)

20201.56** (3.542) 28965.75** (5,076) 41862.62** (6,802) 43502.94** (7,009) 50222.83** (6.570) 65546.12** (4.061) 62891.94** (6.154) 70086.71** (11.146) 72547.31** (11.742) 89304.29** (11.719) 74275.42** (10.608) 2774.02 (0.981) 3957.94 (1.395) 5205.47* (1.733)

0.3020** (4.194) 0.5290** (7.344) 0.6900** (8.882) 0.8038** (10.260) 0.9402** (9,744) 1.1578** (5.682) 1.0829** (8.394) 1,1202** (14.112) M465** (14.701) I.3050** (13.566) 1.1265** (12.745) 0.0520 (1,456) 0,0561 (1.566) 0.0678* (1.787)

*denotes significance at 10 percent level. **denotes significance at 1 percent level. Note: t-statistics in parentheses.

signs and are significant. The annual dummy variables reveal a general increase in property values (including the impact of inflation) through 1980. The effect of these time variables on value is less even in the post-1980 period due to the general recession in the United States and the decline in the New Orleans economy relative to that of the United States following 1983. The average rate of price increase per year from 1971 to 1986 is about 5 percent in both urban and suburban areas. As expected, distances from major centers of employment have negative coefficients in both areas. Moreover, the gradient is flatter (.08 percent per hundred block) in the suburbs than in the urban neighborhood (.73 percent per hundred block). This result is consistent with an exponential decline in property values from the central business district (CBD), because the urban area is about seven miles closer than the suburban area to the CBD.

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JANET FURMAN SPEYRER AND WADE R. RAGAS

For the suburban neighborhood, all of the physical characteristics with significant coefficients have the expected signs. In the urban neighborhood, only off-street parking has an unexpected sign in the linear specification, but the coefftcient is insignificant. In the preferred semi-log regression, off-street parking has the expected positive sign and is significant. Because FEMA flood zones are assigned to broad geographic areas, the flood zone coefficients may be making some other important locational characteristics. In order to tninimize this possibility, we assign to each address anx, y coordinate in a Cartesian plane and then use the technique called "Bezier Spline" or "Spline" curves to capture variables with purely locational variation. Simply, the .x-axis of this Cartesian plane is divided into intervals of equal length. A parametric cubic curve is fit to the data on each interval so that the curves for each adjoining interval intersect at tbe knot points (the end points of each interval). Suits and associates (1978) define a spline function of third degree as: y = [a, -^ b, (X - Xo) + C| iX ~ Xo)2 + d,iX + [a2+b2iX- XQ)^
>I

X,) + C (X - Xi)^ +d2iX~ 2

XO'] D^ ~ X2)'] D3 + U (3)

+ [613 + bsiX ~ Xi) + C3 (X - X2)2 + diiX

where D, = 1 if X,_i < X < X else >, = 0, i = 1, 2, 3. ^ By requiring all segments in a direction to be of equal length, applying appropriate constraints to insure continuity of the function and its first and second derivatives, and rearranging terms, this equation reduces to a form amenable to regression formulation. As demonstrated t^ Suits and associates (1978) for a single vector direction, the equation is reduced to:
K

Z = ai - fci (X - Xo) + Cl (X - Xo)^ +diiXH

X^)' + S (^.-M " '^.Jf^ " ^d' A* '=' (4)

where K is the nutnber of knots (points equally spaced within the boundaries) and K+\ intervals occur and D,* = 1 if X > X, and D,* = 0 otherwise. In the present regressions A = 3 in the suburban area and A" = 4 in the urban area. T The spline variables are defined for the second set of regressions as follows: Xj = X Xo; X2 = (X - Xo)=; X3 = (X - Xo)^; X4 = (X - X,)^ O,; X5 = (X - X;)^ D^; X^ = (X X3)' D3; and X7 = (X X4)' D4 (applicable only in urban area). The result is a polynomial made up of tangent segments each of which is a third order polynotnial. The model contains a linear, quadratic, and cubic parameter for the X variable and then a series of cubic representations that overlay only parts of the surface segments. Tbe regression coefficients for aj, 6], C|, and d] are directly observable while the values of </,>! may be calculated from these regression coefficients. The relative contribution of a directed distance spline can be estimated using an F-test and partial R^ for the components of a regression (Suits et al., 1978). These estimates of changes in slope are beyond the scope of this article, but have been elaborated by Anderson (1982). The accepted strengths of splines as a fonn of nonlinear-equation approximation are substantial. Splines can provide the theoretically smoothest fit of nonlinear data (McNeil

HOUSING PRICES AND FLOOD RISK: AN EXAMINATION USING SPLINE REGRESSION

403

et al., 1977). The imposition of some constraints insures that first and second derivatives of tbe surfece are continuous and the tangent vectors are continuous (Foley and Van Dam, 1982). The loss in degrees of fi-eedotn is less than that of a fourth or higher order trend surface analysis (TSA) fit. Standard measures of significance for regression models are directly applicable (Suits et al., 1978). Finally, the spline model, because of its direct consistency with the specification of regression models, allows the introduction of other hedonic variables into the model and a direct linkage with the existing literature (Suits et al., 1978).

The splines model, however, does have its weaknesses. Extrapolations of the functions
beyond the data range to which it is applied are not defined. Large gaps of missing data or clumps of data can lead to misleading and inappropriate representations as encountered with TSA. Spatial autocorrelation may still exist even in well-specified models, and no straightforward method of removing this remaining autocorrelation appears to exist (Anselin, 1986; Anselin and Griffith, 1988; Haining, 1986). The splines model should still produce less spatially biased hedonic coefficients than models with no control for spatial autocorrelation. An additional concern is that the exceptional fit of the splines model to the underlying trends in the data l^ small patches or segments of the area under study can pose serious problems for some research. If the location of an externality coincides with a patch (grid section bounded by knot points) then measuring changes in a dependent variable due to this location specific externality may not be feasible. For example, the impact of location in a fiood zone may be obscured by the splines variables which accurately measure this and any other locational variation in the data. The set of regression results including the spline locational externality variables and an insurance index cost are reported in table 4. These equations focus on the impact of mandatory flood insurance cost rather tban on location in FEMA high-risk zones because of the problem described above using the splines model with locational dummy variables. Once again, virtually all the variables have the desired sign and significance. The insurance cost index is found to have a negative significant coefficient in all but the semi-log regression in the urban area. The coefficient of the insurance cost index variable in the suburban area is .(X)18 in the semi-log model. A higher annual insurance cost of only $1.48 leads to an apparent $109.20 decrease in property value wben the equation is evaluated at the means. The implied discount rate is 1.36 percent per annum in perpetuity. Tbe linear suburban model results in a discount rate of 0.97 percent and the linear urban model yields an implied rate of 1.93 percent. A discount rate equal to a real rate of interest in the 3 percent to 4 percent range would be expected if all capitalization were due to insurance costs.^ The lower value found in this analysis suggests that some of the observed capitalization may be due to the actual incidence of flooding. A three-dimetisional graph of the data supports this hypothesis. Figure 1 depicts the regression results for the suburban area using splines and the insurance index.' The three-dimensional graph reveals the substantial locational variation in price associated with major streets which can be a positive or negative externality. Proximity to lake views, a positive externality, is also visually evident. Two areas of actual bigb incidence of flood damage (based on inspection by the authors) do have substantially lower property values per square foot than nearby areas. These two areas are prone to have impassible streets when only five or six inches of rainfell occurs over period of a few hours

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JANET FURMAN SPEYRER AND WADE R. RAGAS

Table 4. Effect of flood insurance costs on property value including locationai adjustment. Suburban Adjusted R-Square Durbin-Watson Intercept Condition Central air Central heat Frontage Half-baths Living area Number of fireplaces Piers Off-street parking Insurance cost index Linear 0,8062 1.657 -36429.9** (-4.174) 4748.05** (5,476) 3231.09 (0,861) 89.09 (1.447) 2675.55** (3.405) 23.37* (23.762) 12089.03** (6.688) 41164.86 (1.484) 3904.74* (2.188) -182.76** (-8.903) 110.76 (0.075) 105.68 (0.373) -8.75 (-0.576) 15,58 (0.768) -11.25 (-1.176) 8.03 (L261) 2885,22 (1,101) 7654,43 (2,945) 544.38 (0,196) 7598.03** (2,839) 11527.93** (4,357) 15726,64** (5,444) Semi-Log 0.7974 1.773 9.2499** (81.676) 0.0740** (6.577) 0.2072** (4.257) 0.0014* (1.801) 0.0276** (2.711) 0.0003** (24.728) 0.0069 (0.296) 0.0650* (1.786) 0.1018** (4.398) -0.0018** (-6.836) -0,0176 (-0.915) 0.0036 (0.971) -0.0002 (-0.994) 0.0003 (1.023) -0,0001 (-1,033) 0,0001 (1.445) 0.0767* (2.258) 0.1468** (4.352) 0.1222"* (3.390) 0.2016** (5.805) 0.2757"* (8.031) 0.3341** (8.913) Linear 0.7284 1,778 -57573.6** (-5.816) 6409.82** (4.638) 15977.05** (4.296) 9024.05* (2.486) 637,83** (7.583) 10868.83** (6.281) 10.40** (9.590) 12883,53** (4,393) -477,89 (-0-128) -895,6 (-0-413) -77,33** (-3.104) -4809,15(-2-127) 1392.08** (2.772) -81.94** (-2.909) 112.56** (2.901) -49.27* (-2.336) 51.25* (2.180) -153,42* (-1.892) 1109.79 (0.190) 555.92 (0.098) 4452,82 (0.778) 3744,67 (0.640) 18334.17** (3.188) 26017.95** (4.491) Urban Semi-Log 0.8135 1.738 8.4625** (68.481) 0.1711** (9.916) 0.1640" (3.534) 0.1756** (3.876) 0.0085** (8.107) 0.1058** (4.900) 0.0002** (15.878) 0.0801* (2.187) 0.0248 (0,532) 0.0535* (1.980) 0.00029 (0.928) -0.0820** (-2,906) 0,0177** (2.819) -0.0009" (-2.681) 0,0012* (2.426) -0-0004 (-1.376) 0.0005* (1.784) -0.0023* (-2.303) 0.0547 (0.751) 0.0120 (0.170) 0.0776 (1,086) 0.0703 (0,962) 0.2949** (4,108) 0-5133** (7.098)

XI X2 X3
X4 X5 X6 X7 Year 1972 Year 1973 Year 1974 Year 1975 Year 1976 Year 1977

HOUSING PRICES AND FLOOD RISK: AN EXAMINATION USING SPLINE REGRESSION

405

Year 1978

34246.58** (12.462) Year 1979 39655.28** (14.225) Year 1980 45755.27** (12.118) Year !981 41799.89** (4.199) Year 1982 54981.30** (11.875) Year 1983 62893.13** (20.390) Year 1984 72252.68** (23.064) Year 1985 60787.91** (17.226) Year 1986 76799.56** (22.533) Quarter 2 1433.22 (0.991) Quarter 3 588.54 (0.416) Quarter 4 4958.69** (3.150) denotes significance al 10 percent level, **denotes significance at 1 percent level. Note: t-statistics in parentheses.

0.5920** (16.602) 0.7152** (19.773) 0.7911** (16.147) 0.7763** (6.010) 0.9337** (15.542) 0.9339** (23.335) 1.0445** (25.697) 0.8706** (19.015) 1.0696** (24.185) 0.0086 (0.457) 0.0194 (1.059) 0.0601** (2.941)

41981.06** (6.803) 41332.14** (6.558) 51297.93** (6.710) 64445.46** (4.001) 61436.99** (5.968) 70833.24** (11.152) 70172.87** (11.313) 88395.78** (11.547) 76228.27** (10.736) 3271.12 (1.153) 4499.85 (1.575) 5449.62* (1.810)

0.7069** (9.177) 0.8056** (10.240) 0.9595** (10.054) 1.1394** (5.666) 1,0625** (8.268) 1.1163** (14.080) 1.1296** (14.589) 1.2993** (13.597) 1.1356** (12.813) 0.0552 (1.559) 0.0635* (1.780) 0.0701* (1.864)

Figure I. Neighborhood housing price contour: estimated 1986 price per square foot.

406

JANET FURMAN SPEYRER AND WADE R. RAGAS

and may be viewed by the market as an inconvenience cost that further reduces property values. Three-dimensional representations allow the researcher to see the model with any clusters of outlyers and to gain an intuitive understanding of the analysis. In order to examine the impact of flooding on the capitalization of insurance cost, the model was estimated for two time periods: the entire period and the period after the first of three significant floods. The F-tests for the semi-log regressions of the model after flooding occurred relative to the entire time period (Fj 1,94 = 5.60 in the suburban neighborhood; ^1,732 = 9.67 in the urban neighborhood) are significant at the 5 percent level.* The Ftests for the linear models in the same areas (/^i,ii94 = 96.11 in the suburban neighborhood; F1732 = 3.98 in the urban neighborhood) are also significant. These data indicate that unexpected flooding does increase the negative impact of insurance cost on house values. On the other hand, similar tests comparing the period following the third serious flooding incident with the entire period are less conclusive. The F-tests for all but the linear regression in the suburban neighborhood are insignificant. The repeated incidence of flooding does not seem to affect the capitalization of flood insurance cost into house values. There are two possible explanations for this finding. First, once flooding could be anticipated, housing markets would have already capitalized the damage. Second, our survey of homeowners in the area found little serious flood damage to homes. In feet, the most commonly reported flood-relat<xi loss was damage to automobiles. Data limitations made it impossible to study further the impact of serious flooding on individual homes. Data on actual flood claims by street address are not available fiom FEMA for the three incidents in the study areas (1978, 1980, and 1983). Damages by census tract are available, but these more aggregate data mask the impact of flood incidence by mixing homes with no flood damage with homes with significant losses.

4. Conclusions Using an extensive data set and spline regression analysis, we confinn the findings of earlier studies which suggest that location in a floodplain results in lower property values. Much of this observed property value reduction is explained by the higher cost of flood insurance which is mandatory in flood-prone areas. However, analysis of the implied discount rates for the capitalization of flood insurance cost suggests that some additional impact on property values due to inconvenience or other factors may exist. Finally, serious unexpected street flooding in areas with insurance does diminish property values. However, repeated flooding incidences do not seem to change the insurance cost capitalization. Additional research using individual claims data is necessary to confirm these findings.

Acknowledgments The authors gratefully acknowledge support from the Louisiana Real Estate Commission and the University of New Orleans Faculty Summer Scholar and Research Council Awards program. Helpful suggestions from John Benjamin and an anonymous referee are greatly appreciated.

HOUSING PRICES AND FLOOD RISK: AN EXAMINATION USING SPLINE REGRESSION

407

Notes
1. The suburban area is bounded by Causeway Boulevard, Meadowdale Avenue, Ptwer Boulevard, and Lake Pontchanrain. The urban area is bounded by Carrollton Avenue, South Claiborae Avenue, the, Mississippi River, and General Pershing Street. 2. Source: FEMA map index, 3. Distance fTom the lake is represented by a dummy variable which is one within four blocks from the lake and zero elsewhere. 4. The high cost of insuring the contents of the home, if included in the cost of insurance to be capitalired, would increase the implied discount rate found here. However, contents insurance is not mandatory and therefore not included in this analysis. 5. A three-dimensional representation of the suburban semi-log regression predicted values was prepared after convening the prices per square foot of living area for each observation to 1986 nominal dollars. The grid factor allows roughly 16 data points per square block. Using the graphing package SURfTR (4) by Golden Software of Golden, Colorado, with bezier spline smoothing, the graph can be magnified, rotated, shifted, and scaled on a microcomputer in MS DOS 3.0 or higher. 6. A value of 3.85 is required for significance at the 5 percent level.

References
Anderson, John E. "Cubic-Spline Uiban-Density Functions." Journal of Urban Economics 12 (September 1982), 155-167. Anselin, Luc. "Non-Nested Tests on the Weight Structure in Spatial Autoregressive Models: Some Monte Carlo Results." Journal of Regional Science 26 (May 1986), 267-284. Anselin, Luc, and Griffith, Daniel. "Do Spatial Effects Really Matter in Regression Analysis?" Papers of the Regional Science Association 65 (1988), 11-34. Cassel, Eric, and Mendelsohn, Roben. "The Choice of Funaional Forms for Hedonic Price Equations: Comment." Journal of Urban Economics 18 (September 1985), 135-142. Foley, James D., and \ ^ Dam, Andries. Fundamentals qf Irueractive Computer Graphics . Reading, MA: AddisonWesley Publishing Co., 1982. Haining, Robert. "Spatial Models and Regional Science: A Comment on Anselin's Paper and Research Directions." Journal of Regional Science 26 (November 1986), 793-798. MacDonald, Don N., Murdoch, James C , and White, Harry L. "Uncertain Hazards, Insurance, and Consumer Choice: Evidence from Housing Markets." Land Economics b'i (November 1987), 361-371. McNeil, Donald R., Tnissel, T.James, and Turner, John C. "Spline Interpolation of Demographic Data." Demography 14 (May 1977), 245-253. Shilling, James D., Sirmans, C.F., and Benjamin, John D. "Flood Insurance, Wealth Redistribution, and Urban Property Values." Journal of Urban Economics 26 (July 1989), 43-53. Skantz, TerranceR., and Strickland, Thomas H. "House Prices and a Flood Event: An Empirical Investigation of Market Efficiency." The Journal of Real Estate Research 2 (Winter 1987), 75-83. Suits, Daniel B., Mason, Andrew, and Chan, Louis. "Spline Functions Fitted by Standard Regression Methods." TJie Review of Economics and Statistics 60 (February 1978), 132-139. Wheaton, William C. "A Bid Rent Approach to Housing Demand." Journal of Urban Economics 4 (April 1977), 200-217.