Jan 20, 2020

What is the economics of imposing a seller's-warranty upon the homeowner?

Beatty v. Wei, 2018 ONCA 479 (CanLII)

Beatty v. Wei, 2018 ONCA 479 (CanLII),

Beatty sold a house to Wei. Apparently unknown to Beatty, the house had been a grow-op sometime in the past. The motion judge construed the purchase and sale agreement to impose a warranty that carried over to closing upon the seller. The Court of Appeal said no, the warranty didn't carry past the date that the agreement of purchase and sale was signed.


What makes real estate sales more efficient generally? If judges impose risk upon sellers, to the extent that a house sale carries implied warranties (such as a warranty that the house was not a grow-op), does shifting the majority of the risk to the seller, somehow increase the overall efficiency of the real estate market?

Large, liquid, transparent markets are optimal. Multiple buyers and sellers drive prices down, quality up. The first principle of economics 101 is that there are gains strictly from trade. This simple statement implies that more trades are better than fewer trades in overall social welfare. The first thing an economics student learns is that the existence of a trade implies that both parties are better off post-trade than pre-trade.

This is the thing that drives courts to adopt rules about how markets are going to work. For example when the judges absolved the directors of a company for false statements in a prospectus, the UK parliament, realizing the critical place that the prospectus plays in the capital market, responded by reversing Derry v Peek (1889) 13 App.Cas 337 (HL) and imposing truth upon prospectuses. (see: Swan and Bala,Contracts (9th ed) p.767)

Get to the point:

So when the seller takes on all or substantially all of the risk as to house-quality, does that transfer of risk increase market efficiency? This would be equivalent to all sellers in Ontario warranting to quality (i.e. that the house wasn’t a grow op).

An empirical assessment of forcing the seller to carry the risk of housing quality(i.e. what the motion judge did and what Brown J.A. did not do, in Beatty v. Wei) is provided by Nanda and Ross, The Impact of Property Condition Disclosure Laws on Housing Prices, J. Real Estate Finan Econ (2012) 45:88-109

Looking at 291 US cities across 50 states over the period 1984-2004, and isolating only the disclosure requirement that came into law in certain states, Nanda attributed roughly 1% a year increase in home prices to the owner-disclosure statutory requirement. Keep in mind that the effect was de-trended. The normal monotonic increase in housing prices was taken out. Other factors were accounted for and still the disclosure-requirement upon sellers led to an increase in market activity.

Why is an increase in overall housing sale price an unambiguous benefit?

An organic 1% increase in prices makes sellers better off, without making buyers worse off because buyers are simply paying (in price) what they otherwise would not pay because of uncertainty fear. Buyers were equally well off trade more money for less uncertainty.