Oligopolistic bidding and pricing in real estate development. Experimental evidence
| Pages | 154-189 |
| Date | 01 April 2003 |
| Published date | 01 April 2003 |
| DOI | https://doi.org/10.1108/14635780310469120 |
| Author | Seow Eng Ong,Fook Jam Cheng,Boaz Boon,Tien Foo Sing |
| Subject Matter | Property management & built environment |
JPIF
21,2
154
Journal of Property Investment &
Finance
Vol. 21 No. 2, 2003
pp. 154-189
#MCB UP Limited
1463-578X
DOI 10.1108/14635780310469120
ACADEMIC PAPERS
Oligopolistic bidding and
pricing in real estate
development
Experimental evidence
Seow Eng Ong, Fook Jam Cheng, Boaz Boon and
Tien Foo Sing
Department of Real Estate, National University of Singapore, Singapore
Keywords Real estate, Development, Bidding, Pricing
Abstract Real estate developers often operate in oligopolistic environments. Pricing strategies
must be made in an interactive framework that makes empirical evaluation difficult. This study
appeals to economic experiments to examine how developers price their properties, especially when
there is an option to market pre-completed units. In addition, the interaction between bidding for
land and pricing the end product is examined. The results indicate that competitor actions are
important considerations in pricing decisions. In particular, the profit maximizing pricing
strategy depends critically on being competitive, not necessarily being the most aggressive.
Interestingly, pre-completed units sell only at prices that incorporate future price expectations, and
successful bids tend to precipitate more aggressive pricing. Finally, competitive bidding and
pricing strategies appear to the best profit maximizing strategy.
Introduction
The real estate development industry in many countries operates under
conditions akin to oligopolistic markets. The industry is dominated by a few
large players where pricing is often used as a competitive instrument.
Moreover, some developers consistently market their properties at higher- or
lower-than-average prices. In the 1997-1998 property downturn in Singapore,
developers were reluctant to cut prices for fear of a ``price war'', yet many did
eventually resort to price-cutting.
The question of how developers price their properties and how they bid for
land is largely neglected in the literature. This question is moot if developers
operate in a competitive market where there are many sellers and many buyers,
but this assumption is invalidated in many real estate markets. If there are only
a few major developers selling to many buyers, then the real estate market is
oligopolistic. Classical economic theory suggests that oligopolistic sellers
exercise price control to a varying extent, and at the same time, they are acutely
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The authors wish to acknowledge research funding from the National University of Singapore
(RP 3981036). In addition, we thank Guan Pei Tan, Raymond Tan, Chai Hoon Lim and Poh Har
Neo for their research assistance. Please direct all correspondence and comments to Seow Eng
Ong, email: seong@nus.edu.sg
Academic papers:
Real estate
development
155
sensitive to the actions of other developers. In any oligoplistic market, pricing
strategies cannot be made without regard to other developers' actions.
Game theory and modeling allow the determination of optimal pricing
strategies for oligopolistic players in a reactive framework. However, empirical
research into oligopolistic behavior is often hindered by the lack of empirical
data. This study overcomes the data problem by engaging in a series of
economic experiments.
The uncertainty associated with oligopolistic pricing of newly developed
properties adds to the risk faced by developers when they bid for land. In other
words, developers who bid for land not only face uncertainty in the stochastic
variables that affect future property price, but also the uncertainty that arises
from the pricing functions of other developers.
This study is motivated also by the need to understand the linkage between
bidding and pricing behavior. The reason is that developers often acquire land
through competitive bidding, in addition to land privately sourced. Bidding
behavior and its sometimes, dire consequences in the form of the winner's curse
has been well understood. However it is not clear how bidding decisions
influence the pricing outcome. It is intuitive to hypothesize that a developer
who is overly aggressive ± and in being doing, incurs higher land costs ± may
end up being disadvantaged against other competitors in terms of pricing the
completed properties. How do bidding and pricing interact? Surprisingly there
is not a whole lot of research in examining the relationship between pricing and
bidding behavior.
In the Singapore context, as in other counties, the issue of oligopolisitic
pricing for property development is complicated by off-plan sales where
properties are marketed prior to completion. Off-plan sales are good for
developers when they envisage property prices to fall subsequently, but why
do we observe off-plan sales when the property market is on the uptrend as
well? Clearly the pricing for off-plan marketing for oligopolistic developers
depends on the interaction between developers, not only in a one-off game, but
also in repeated games.
A related question is how do property buyers choose between buying off-
plan and completed properties? Purchasing off-plan properties subject the
buyers to adverse selection and moral hazard problems (Ong, 1997, 1999), yet
could their actions be optimal or Nash given the actions of other buyers?
Oligopolistic pricing is a well-studied subject in the literature. However, it is
not clear how oligopolistic developers interact when off-plan marketing is
permitted. This study examines the behavior of oligopolistic developers and
atomistic investors in an experimental framework.
The next section examines the specific research questions and hypotheses
and motivates the use of economic experiments. The experimental design is
discussed in the following section, and details are furnished in the section on
structure of the game. The results from the games are then analyzed and the
final section concludes.
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Research methodology and hypotheses
Experimental economics provide the ideal platform to examine these questions.
The advantages of experimental economics are first, experiments can be useful
for policy implications and decision making. Experiments have been conducted
to generate data that might influence a specific decision (Plott, 1982, 1987).
Second, experiments allow researchers to discover empirical regularities in
areas for which existing theory has yet to be fully developed (McCabe et al.,
1993; Friedman, 1993). Third, experiments provide an ideal platform to test
competing theories and predictions (Fiorina and Plott, 1978). Finally,
experiments test for alternative conditions under which the existing theory can
account for empirical data and thus test the robustness of the theory (Isaac and
Smith, 1985).
Concerns on external validity of experiments have been raised (Loewenstein,
1999), but research has also shown that, given the correct incentive structure,
behavior in a simulated environment corresponds well to actual real world
setting (Brookshire et al., 1987). In addition, experiments may often achieve
more efficient social outcomes than that predicted by non-cooperative game
theory (Hoffman et al., 1998). Experimental economics is now an established
area of study in mainstream economics. For instance, Econometrica has specific
guidelines for the submission of experimental papers (Palfrey and Porter, 1991).
The American Economic Review has published several influential articles on
experimental economics.
Other than the theoretical treatment by Ong (1997, 1999), there is a dearth of
literature on the empirical effects of off-plan marketing on developers' strategic
behavior within an interactive repeated game framework. We contend that in
the absence of empirical data pertaining to developers and investors behavior
within such a market structure and institutional arrangement, an experimental
setting is the best framework to examine these issues and policy implications.
While the use of students may be a cause for concern, Dyer et al. (1989)
contrasted the behavior of professionals or experts with naõÈve students and
find that the experts were as prone to the winner's curse as the naõÈve subjects.
For a fuller discussion, see Hey (1991).
Pricing and price competition
The first research question we seek to address is how oligopolistic developers
price their property units. Given that there are only a small number of
developers, it is interesting to evaluate to what extent developers view
competitor's actions. In our experimental design, we standardize the quality of
properties constructed, and to some extent, the quantity as well. Thus the
framework is a Bertrand-type model of price competition. To evaluate the
importance of factors affecting developers' pricing decisions, participants are
asked to fill out a Likert scale of importance and to do a pair-wise comparison
of factors (Saaty, 1994).
The underlying assumption in any study on oligopolistic setting is that,
given the small number of sellers, each seller exercises some market control.
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