Between 2009 and 2014, prices on the Dutch housing market fell. Among the numerous worrying reports, home owners being ‘under water’ was one of the most striking consequences of the credit crisis that broke out in 2007. “The economy was hit by many negative shocks in those years”, says researcher Dorinth van Dijk, who relates the fall in prices to the fact that the market ‘dried up’ as it were. As a result of these shocks, buyers lowered their asking price. Sellers, however, were less willing to adjust their prices downwards, the reason for this being, among other things, that a number of them had taken out mortgages at the top of the market. As the gap between supply and demand increases, liquidity in the market comes under increasing pressure. Marketability will therefore fall, ultimately resulting in an even further drop in transaction prices.

Ambiguous standards

Liquidity is the core concept of the thesis titled Commercial and residential real estate market liquidity that Van Dijk defended on 1 February 2019. Van Dijk started his PhD research in 2014 and combined this with a job at the Dutch Central Bank (DNB). Prior to this, he obtained a bachelor's degree in Social Geography and Planning from the University of Utrecht and a master's degree in Finance from the Amsterdam Business School of the University of Amsterdam (UvA). Van Dijk is now a full-time economist at DNB’s Economic Policy and Research Division.

'Liquidity says something about how easy it is to trade an investment. However the standards for determining liquidity are not unequivocal.'

'Liquidity says something about how easy it is to trade an investment,' explains Van Dijk. However, the standards for determining liquidity are not unequivocal, and certainly not in the world of real estate where the goods traded are heterogeneous. A commonly used measure is the average time-on-the-market required to sell a property. According to Van Dijk, however, this criterion has its limitations, partly because the figure is obscured by the fact that sellers sometimes decide to withdraw their property from the market.

Therefore, in order to measure liquidity on the property market, Van Dijk primarily uses the ‘reservation price’ concept. For the buyer, the reservation price is the highest price that they are willing to pay for a property, and for the seller, it is the lowest price they are willing to accept to sell it. The concept is in fact similar to the bid-ask spread in stock trading: the amount by which the ask price exceeds the bid price for an asset in the market. If there is a considerable difference between the reservation prices of the two parties, this means that buyers and sellers have a relatively strong difference of opinion about the actual value of the property. In such a situation, the probability that a transaction will be completed is low, which is an indication of low liquidity.

Relationship between price and liquidity

The reservation price by itself cannot be measured, but it can be derived from transaction volumes and transaction prices. A rise of transaction prices as such is no indication of the marketability of real estate. It is only when the difference between the reservation prices of buyers and sellers becomes smaller that liquidity and volume increase’, says van Dijk. Usually, buyers adjust their reservation prices more quickly to changes to the market sentiment than sellers. This applies to upward as well as downward changes of sentiment.

Van Dijk’s research shows that liquidity and prices are closely related and that rising prices are usually preceded by increasing liquidity. 'As buyers are the first ones to adjust their reservation prices after an economic shock, the first consequence of a shock is a change in volume, followed by a change in price in the same direction. These economic shocks cannot always be predicted and have many causes, such as changes in the average income or higher or lower interest rates. In this respect, changes in liquidity have a procyclical effect on the more fundamental price movement. In this way, the concept of liquidity contributes to an understanding of the market’s driving forces and, to a certain extent, improves the ability of making predictions. More insight can help policymakers to take timely measures aimed at absorbing shocks in the property market.'

'An increase in the number of clicks on Funda is followed by an increase in liquidity and then by rising prices.'

Search behaviour on Funda

Van Dijk added another element to his research: the search behaviour on Dutch property site Funda. “In a study covering all of the Netherlands, I analysed the number of clicks per property by municipality. The idea was that, for example, an increase in the number of clicks in a region is indicative of a rise in its popularity. The research did indeed show that an increase in the number of clicks is followed by an increase in liquidity and then by rising prices. So, search behaviour seems to be an even earlier predictor of price movements than liquidity, but more research will be needed to confirm this conclusion.”