UK home buyers are paying a premium for properties with higher energy efficiency rating bands. However, this is not always justified by the actual gains in energy efficiency.
This is according to
new research from the London School of Economics and Political Science (LSE) and the University of Stirling recently published in
the American Economic Journal: Applied Economics.
Before being offered for sale or rent, residential properties in the UK must undergo an energy performance audit. As part of this process, each property receives an energy label with a numerical energy efficiency score on a scale from one (lowest efficiency) to 100 (highest efficiency). This score is calculated using the property’s estimated yearly running costs for heating, hot water and lighting.
In a bid to make the energy label easier to understand, the numerical score is mapped into colour-coded rating bands, ranging from green A (most efficient) to red G (least efficient). These rating bands represent ranges of energy efficiency scores with arbitrary thresholds.
For example, rating band D covers the range of energy efficiency scores between 55 and 68, while rating band C includes scores between 69 and 80. This means that rating bands do not provide any additional information about the property’s energy efficiency or energy running costs beyond what is already known from the numerical score.
Analysing data from over 7 million residential property sales, the researchers uncovered sizeable price gaps at rating band thresholds. The price of a property jumps on average as soon as it is classified into a higher colour-coded rating band, despite the actual energy efficiency score only increasing by one numerical point. The researchers estimate that, depending on the threshold, buyers are paying excessive price premiums for higher rating bands, worth between £1,100 and £8,500, without associated gains in energy efficiency.
The authors suggest this is most likely down to the design of the energy label which diverts attention away from the underlying and more informative energy efficiency score and towards the coarser, but less informative, colour-coded rating bands.
In addition to price jumps, the researchers find that rating band thresholds influence seller behaviour. In an apparent attempt to boost their home’s market value, some owners make energy efficiency investments to their property, nudging it into a higher rating band before placing it on the market.
The study shows that, if the property’s initial energy efficiency score falls just short of the next rating band, the seller is up to almost 20 per cent more likely to make energy efficiency improvements before the sale. And this pays off - with sellers, on average, comfortably recouping this investment with estimated net returns ranging between £5,850 and £21,602.
In the paper, the authors note: “The coarse rating bands create price distortions that will benefit some market participants at the expense of others. And while the extra-marginal EE [energy efficiency] investments represent a welcome environmental benefit, this is at least partially offset by a discontinuous drop in incentives for further upgrades once a rating-band threshold has been crossed.”
While the researchers do not advocate for the outright removal of rating bands from energy efficiency labels, they call for future research that could optimise the label design and help buyers make better choices.
For many people, a house purchase will be the most significant investment of their lifetime. The fact that people’s judgements can be so easily affected shows that decisions are not always fully rational even when considerable time and effort are spent in the process.
Commenting on the findings, the main author of the paper Dr Rodolfo Sejas-Portillo, a Lecturer in Economics at the University of Glasgow and a former Fellow in the Department of Geography and Environment at LSE, explains: “When less precise but easy to understand information is made available, such as colour-coded rating bands, some people will at least partially ignore the complex metrics behind these simplified labels. When this happens, those who pay full attention to the more precise information have an opportunity to profit from those who don’t. Further research is critical to better understand this behaviour and inform policies which will not reinforce existing inequalities.”
These findings are relevant to any area where information is mapped into more accessible but less precise bands or tiers. For example, it is also relevant for energy labels on household appliances or nutritional traffic light labels for pre-packaged food.
ENDS