FARGO - When Lei Zhang and her husband began house-hunting a couple of years ago, they made sure houses they looked at were outside the floodplain.
"My husband and I are the type of persons with strong risk aversion," she said.
Early that year, the Federal Emergency Management Agency put into effect a new 100-year floodplain, which shows areas with a 1-percent chance of flooding each year for federal flood insurance purposes.
Zhang, an economist at North Dakota State University, said she couldn't help but notice houses in the floodplain seemed to cost less than those outside. That makes economic sense, but she was curious how much the floodplain discount rate was.
What she found was the discount rate was very large the year after a major flood - larger than justified by the flood insurance premiums homeowners must pay - and rather small a few years later, as if homebuyers overreacted and then went back to underestimating the risk of flooding as they had before.
"I don't think people are rational in looking at the flood risk," Zhang said. "If people are rational, we should expect the premium to be equivalent to the discount but, from the data, we cannot see that."
She also found the discount rates were much larger for homes in poorer neighborhoods than for homes in wealthier neighborhoods. That also seemed irrational because there's a $250,000 cap on flood insurance coverage, so homes in wealthier neighborhoods would more likely not have their full values covered.
According to Zhang, her research could help homebuyers and home-sellers better understand pricing for homes in the floodplain.
Zhang's report, published in September in "Regional Science and Urban Economics," used data from 28,000 home sales in Fargo-Moorhead between 2000 and 2013. Of these, 600 were in the 100-year floodplain, which was smaller than it is now.
Zhang looked at the sale prices and used statistical analysis to determine how different factors affected them. For example, how much was one bedroom worth? How much was an attached garage worth? How much did the home's age affect the sale price? And, ultimately, how much did being in the floodplain affect the sale price?
Before the 2009 flood, a floodplain home sold for 4 to 6 percent less than the equivalent home outside the floodplain.
In 2010, the year after the biggest flood Fargo-Moorhead had seen, the floodplain discount rate was 11 to 36 percent. But in all the years after that, the discount rate essentially returned to pre-flood levels as if homebuyers forgot their fear of flooding.
These were big swings but they were not matched by big swings to flood insurance premiums, which stayed the same.
Zhang found the floodplain discounts were often way out of proportion to the premiums.
The average sale price during the study period was $140,000 and the average premium was $1,022. Zhang calculated what that money could earn if, instead of going towards insurance, it were invested in some way.
Under several earnings scenarios, she demonstrated that the amount taken off the price of the average home by the pre-flood discount rate was less than what $1,022 could earn.
That means the homebuyer didn't demand a steep-enough discount to offset the cost of flood insurance. Under Zhang's scenarios, the homebuyer could've justified $5,900 to $28,400 in additional savings, but didn't.
But the year after the flood, when the discount was steep, the amount taken off the price of the average home was often more than what $1,022 could earn. That means the homeseller gave a steeper discount than is needed to offset the cost of insurance. In six of nine scenarios, the homeseller could've justified sale prices that were $362 to $35,800 more, but didn't. In the remaining three scenarios, the homeseller got sale prices that were $6,700 to $19,100 more than justified.
Unusually, the steepest discount rates were in poorer neighborhoods, according to Zhang. The discount rate in wealthier neighborhoods were much lower.
"Lower-priced homebuyers respond the most to flood risk, while higher-priced homebuyers also respond but not as much as lower-priced home buyers," she said in her report.
That is, the sellers of homes in poorer neighborhoods are at the most risk of losing value from being in the floodplain.
Since 2013, when Zhang's study period ended, flood insurance premiums have gotten more complex, making it even harder for homebuyers and home-sellers to determine the right price. Insurance agents have reported that FEMA requires surveyors to determine a home's actual elevation and its design, especially how vulnerable the basement is to flooding, before a premium can be calculated.
As for Zhang and her husband, wishing to avoid flooding and flood insurance, they chose a home in the southwest part of town.
It's not only out of the current floodplain, she said, it also has a flood-proof basement.