Potential Benefits in Remapping the Special Flood Hazard Area: Evidence from the U.S. Housing Market
The precise pricing of flood risk in property markets is crucial for managing the economic impact of flooding, which has cost the United States more than $650 billion since 2017, highlighting the need to include risk in property prices. However, the main source of information about flood risk in the United States, the National Flood Insurance Program (NFIP), fails to convey proper flood risk signals to buyers due to flaws in how Special Flood Hazard Area (SFHA) zones are defined and updated. We used a countrywide spatially restricted triple difference identification approach to identify factors influencing flood risk capitalization in the U.S. single-family house property market. This was achieved by analyzing local spatial interactions between the SFHA, houses exposed to flood hazards based on First Street Foundation data, and state disclosure laws about flood history.
The analysis indicates substantial variation in the implicit flood risk price in the US single-family housing market that previous analyses fail to account for. Accounting for this variation suggests that previous estimates of flood risk internalization are underestimated. These results highlight the potential economic benefits of currently considered policy updates. First, extending SFHA boundaries to include more homes exposed to flooding can improve the effectiveness of FEMA’s new insurance pricing method, Risk Rating 2.0, in conveying signals about flood risk to prospective home buyers. Second, expanding flood disclosure laws for sellers may minimize the socialized costs of flooding, providing a pathway for strengthening the capacity of the housing market to internalize flood risk.
A typical U.S. homebuyer's understanding of whether a property faces flood risk is based on whether the property is located inside the National Flood Insurance Program's (NFIP) Special Flood Hazard Area (SFHA). The SFHA boundary, however, may bias homebuyers’ perceptions of flood risk relative to unobserved true risk because the SFHA is an incomplete and sometimes inaccurate representation of flood hazards. Using a national dataset of property transactions, flood hazard data from the First Street Foundation, state-level measures of flood disclosure laws, and a spatially restricted triple-difference design, we distinguish capitalization effects of policy-driven (SFHA) versus quasi-objective (First Street) indicators of flood hazard. We identify these effects by assessing thousands of local spatial interactions between property SFHA designations, measures of quasi-objective flood hazard, and being in a state that mandates flood history disclosures. Being inside the SFHA generates a risk discount, but the signal is muted relative to underlying hazard exposure. Further, the SFHA signal can result in inefficient discounts for properties erroneously mapped in the SFHA. Disclosure requirements about flood history accentuate price effects for hazardous properties and result in more adequate risk internalization. In the absence of disclosures, however, we find either no or a weak risk signal for houses outside the SFHA that face flood hazards. Our results highlight the potential benefits of updating SFHA boundaries to include all houses that may experience flooding and argue in favor of requiring flood-related disclosures from sellers to improve the market's ability to internalize flood risk.