Property Value Theory, Part 1: People-Productivity

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Continuing from my earlier post on Transportation Theory, today I wanted to take a look at property values, and what creates value in land. Again, these are my own words, but are drawn from the extensive graduate research I did as well as my professional experience as a real estate consultant.

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Two Kinds of Productivity

Fundamentally land value is driven by its productivity, and at a root level there are only two kinds of land productivity. Land can be resource-productive, or what I call “people-productive”.

Resource-productive land includes any kind of agricultural land, mining areas, fisheries, etc. It is the simplest, most basic form of land value, determined almost exclusively by the market value and quantity of resources that any piece of land can produce. This is the biggest component of rural land valuation. (By rural, I mean genuinely rural, not exurban or small town, but land that people are living off of in one way or another.)

People-productive land is non-rural land. This can be in small towns, suburbs, or big cities. This is land that people use to house improvements (structures) such as homes, offices, and even factories. This land is not valued because of the natural resources that can be extracted from it, but because of its ability to attract human investment and use.

Basic Examples of People-Productivity and Land Values

The simplest example of how people-productivity determines land values are home prices and retail rents.

Let’s look at home prices: where are they the most expensive? Any place that lots and lots of people want to be. So, for instance, most waterfront property is expensive. If they had a choice, almost everyone would prefer a house looking over a lake or the ocean than a house that didn’t. More people are competing for that limited land, therefore it’s price increases.

Where is retail rent the highest? In places that are busy. Any place that is packed full of people, especially people with money, is going to have very high rental prices, especially for retail space. Why? Because there are more businesses that want to be in a highly visible, high-traffic location, so they’ll compete on price which drives up rent. Think of Times Square, or Piazzo San Marco in Venice. You know, it costs like $20 for a coffee in Piazza San Marco, because that’s where everyone wants to sit and have coffee.

Any place that people are drawn to is worth more than any place people are not drawn to. For the best local example, look at Discovery Green. Land prices on the parking lots around the park have shot up in the last couple years because more people want to be there now than before.

What’s true for Times Square is true for every piece of property in the world. Even factories are subject to the same value-economics. More businesses are willing to compete for places with access to freight shipping than places without it, and for places with more workforce to draw from, and so on. Therefore the most expensive industrial land is the land that draws the most human competition.

It’s important to note that the built environment, if well designed, creates value by attracting people. This is why the idea of the “planning tax” doesn’t hold up to scrutiny very well. Highly planned places like Portland, Oregon and Boulder, Colorado are more expensive than other similar sized cities because MORE PEOPLE WANT TO LIVE THERE than other similar sized cities.

There certainly can be higher costs for developing in highly regulated cities, and there would certainly be a greater quantity of development if they were totally unrestricted. However, this is as true for Portland as it is for Dallas or San Antonio, which are highly regulated but do not see a significant price difference with less regulated competitors like Houston.

The other way of looking at the impact of good planning is that it creates wealth for citizens by making their communities more desirable to live in which increases their property values. However, it is important to keep in mind that while certain kinds of planning can be good, it’s easy for over-regulation of the market to occur, which causes major problems.

The Case of American Downtowns

houston-downtown-surface-parking

The phenomenon of people-productivity can produce some unusual results, however. In Downtown Houston there are dozens, maybe hundreds of blocks that are vacant, or used only for surface parking. Why would these prime lots sit for so many years underused? There are two side-effects of people-productivity at work that explain what has happened in most American city centers in the last 100 years and why they look they way they do today. The first is “price-out”, the second is “hold-out.” Transportation choice also plays a big role, which we’ll look at later.

Price-Out

The City of Houston, like all American cities, was originally built as a people-attractor. The Allen Brothers were staking their fortunes on the idea that they could attract waves of immigrating population to settle in their city, and followed traditional town planning principles to attempt this. They laid out the city in a simple and elegant grid, they left spaces for parks and a courthouse, they provided a basic dock for boats coming up the bayou, and they sold lots. Property owners did the rest, building simple homes and shops in what would become Downtown Houston.

Houston thrived and grew. As the competition for this land grew more and more intense, certain uses were no longer economically productive enough to survive in what was becoming Houston’s Downtown. For instance, single-family housing has no place there any more, because the value of the land is so great that property taxes become a strong force to move people out. Houses were converted into businesses, warehouses, or multi-family residential developments. This is the normal pattern of growth for cities.

However, as technology changed a new phenomenon emerged: businesses began tearing down buildings and creating parking lots. When smaller businesses or homeowners decided they wanted to sell, the big businesses that were competing for land in Houston’s most accessible location, were the often highest bidders, valuing the land that had once been housing as a spot to put their cars during the day.

This caused a problem. In most cities (and especially a city like Houston that doesn’t have a major environmental attractor at its center, such as a huge lake or river) the built environment is the primary attractant, which either:

A. Creates crowds of people by housing them and offering them a place to work, or

B. Attracts people from outside who want to see the crowd (and use services that cater to it).

So, when more and more houses and shops (not productive enough to live next-door to hi-rises) were converted to parking lots, it began to reduce the human activity of the area from a 24 hour environment into an 8 hour environment. The retailers and restaurants still had good crowds for lunch because of the office workers, but without residents to dine and shop in the evening it became harder for them to survive.

Initially there was still a lot of people coming in from the surrounding neighborhoods, and many of them took advantage of the increased parking availability to access the remaining commercial areas. This kept retail alive in Downtown for a while. But eventually enough of the old city was torn down that it’s people-attracting power was lost. Nobody is excited about going to see the parking lot, or hang out in the empty office-tower district.

Thus, in most American cities, especially cities that were still pretty small in the early 1900′s, Downtowns began to decline as transportation became more auto-centric.

Hold-Out

The next logical question is, why do vacant lots persist even in areas where the need for surface parking has disappeared? If there’s all that competition to be in ‘that place’, wouldn’t somebody buy the vacant lots and build something on them?

The reason this often doesn’t happen is that property owners, especially speculative buyers who bought in a long time ago in anticipation of increasing demand, hold out for very high prices. They often ‘smell blood in the water’ when one project is developed on a formerly vacant lot, and buy up as much vacant land as they can in the surrounding area. They then attempt to sell the property at a similar valuation to the developed property nearby.

The seller wants to make the most money possible, and is ‘holding out’ for everyone else to sell so that finally someone who “just has to be in that spot” will come and pay a super-premium price for the last empty lot.

The problem is, when lot of people do this (which usually happens the moment there’s any kind of public hype about an area beginning to redevelop) and everyone holds-out, and the area never redevelops. Developers are being asked to pay for a lot as if it were the last one, which means they’d have to charge extremely high rents, which they can’t do yet because the area hasn’t fully become the place that it could be some day.

This is magnified when there is fragmented property ownership, which is especially the case in area of Houston like Midtown. The blocks in Midtown were mostly small houses a long time ago, and often there are still six or eight different owners for little pieces of a vacant lot. That magnifies the difficulty of negotiating for a reasonable price on the land.

Transportation Impact

Cars are a great thing for providing access to rural land. In the early 1900′s America was a predominantly rural nation, and unsurprisingly we fell in love with the freedom that cars could offer us. In their love affair with the car, urban planners in the early to mid 1900′s became frustrated by the ‘problems’ they saw in cities. There’s never enough space to park, they decided. It’s too slow driving in the city, they decided. And so, they decided to make it illegal to build any more cities.

Property owners were required to build buildings far back from the street (to leave room for future widening), to provide outrageously excessive parking for the time, which is still too much today. The effects of this have been catastrophic, and offer resounding evidence of the damage of over-regulation by the government. For a bit of further reading on the problems high parking requirements, check here, here, and here.

Cars are not a great thing for providing urban mobility, because as the number of cars increases the people-productivity of land decreases. This is because nobody wants to be near ten lanes of fast-moving traffic. The noise and the smell are major problems, as well as the very real dangers to drivers, passengers, and pedestrians.

Giving Away Land

There is a trade-off at work. In an auto-only transportation system, businesses must provide a certain amount of parking or they become unreachable. At the same time, successful businesses attract traffic, which causes congestion, which deters further growth.

Road widening can help the local congestion, but offers diminishing returns: each successive road widening increases accessibility less than the previous one, because as the roads get too big, access must be reduced in order to prevent gridlock, until you eventually need a limited-access road like a freeway to handle the volume of cars.

So, while a road like Westheimer attracts a lot of development along a corridor, it doesn’t have the supporting network to attract DENSE development like Louisiana St. can downtown.

This is why highly connective networks (diffuse traffic, allow walking and transit) and market-priced parking (property owners decide how much they need and price it appropriately) are critical for the future of Houston.

When businesses are required to provide parking they’re literally being forced to give up land that might be used for something else. When a parking space sits empty that business owner is losing money: he has invested in the paving and the dirt beneath it and is getting no use from it.

Transit Matters for our Future

We now live in a very different time and place from America in 1900. We’re not an agricultural nation, we’re an urban industrial one. In order to secure a better future for ourselves and our cities, we need to increase the productivity of our urban centers by removing the artificial cap that auto-only transportation systems place on urban development. Transit gives people a different way to get from A to B, and it means that more growth can happen without more parking.

In our urban centers this means more vacant lots can develop, because they don’t have to build as much structured parking (which increases the rent they would have to charge). In corridors this creates the potential for new businesses to start on smaller, more affordable lots, where parking wouldn’t be available. This reduces the cost of entry into the market, and creates more opportunity. After all we’re proud of Houston being the Opportunity City, aren’t we? Transit, and a shift beyond the auto-dependent past is the paramount opportunity of the 21st century.

- – - – -

I hope you enjoyed this essay, please let me know what you think by leaving a comment. I’ll be following up soon with Part 2.

(Update 04/02/09: As I was writing the next piece I changed my mind on what it would be about… an installment about Places that Attract People will follow soon!)


Posted: Tuesday, March 31st, 2009 at 3:04 pm
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6 Comments

  1. Andrew, in what city was that photo at the top taken?

    • The photo is from Washington DC. It’s from the CNU image library, and if you click on the image it will take you to the source. Thanks for asking!

  2. That is the Columbia Heights area of Washington. If you examine the before and after shot, you will note that it used to be a pretty crummy area. Thankfully, they redeveloped the area up and down 14th Street and made it a nice place to live. I have a great friend who lives just north of Thomas Circle off 14th Street.

    Not to long ago, basically you didn’t go east of 14th Street. On 14th Street itself there was a lot of crime; an ex-girlfriend who was living in the area moved farther west when there was a murder on 14th Street in broad daylight. There were a lot of pawn shops, liquor stores, check-cashing places, etc. (all with bars on the windows). Now that whole area has been cleaned up. Neglected jewels east of 14th Street (like the beautiful Victorian townhomes around Logan Circle) are being renovated and reborn. They are building new mid-rize buildings in the area for new residents (like those in the picture). New business is opening up to cater to the new residents.

    And it didn’t take all that long for this to happen. In a matter of about two years, the area changed dramatically. But what it did take was a concerted effort on the part of the city, developers, police and the population at large. You need planning to accomplish something like this in any meaningful period of time. Otherwise, you end up with a haphazard series of pockets, surrounded by the abandoned buildings and fenced in lots (like Midtown in Houston). And I will remind everyone that Washington is a city with a pittance of resources when compared to places like Houston. But what Washington does have is the will to change, a system in place and the long-term planning and foresight to (for example) build the METRO in the 1970’s rather than ruining the city with a series of mega-highways like so many other cities were doing at that time.

  3. Well, it took 20 years to happen. THere were plans starting in the mid-1980s. The area had been once thriving but with suburban outmigration and then the 1968 riots, it declined (as did the rest of the city) precipitously.

    This particular piece of the plan took 10 years to come to fruition. While it was not the preferred course by the community, which preferred an alternative that came out of a charrette process (1997) that would have been better funded and likely built earlier, now that it is open it’s a good thing.

    And DC has existed more than just the last few year period and people have lived East of 14th Street throughout the period. In fact, except for all but three years, I have lived east of 14th Street for the 21 years I’ve lived in the city…

    Excellent post.

  4. The beautiful Victorian townhomes served well throughout the post-thriving period. When another unthinkable decline happens, do you think the buildings pictured above are going to serve well at all?

    One part of this post (well, two) doesn’t hold up to scrutiny very well. For one, the idea that the automobile appealed to a rural nation. In fact it was an urbanized phenomenon first of all. The kinds of things you see for tokens of long distance personal mobility all lay still in the future.
    Second is your point that expense wouldn’t be there (in highly planned areas) without there being desire for some valued quality that’s nurtured specially there. You could, I suppose, even have tied your vehemence explicitly back into the idea that the price reflects the property’s economic use. But the truth is that you neglect larger geography. If your whole life, family and friends are on the West Coast, but you’re sick of urban California’s mess or you’re priced out of it, then you could move to inland California, but then you’d be out of the reach of job markets too. Other than Tijuana, the Pacific Northwest is the only game in town. If you got in early, you may have gamed the real estate – and many Boomers did, so even a normal-sized cohort of other age demographic groups has to find a spot in the leftovers – but the macro Californian flow has equilibrated those two urban areas to California prices and its emigrants now head to the urbanized Intermountain West.
    Even the perceived economic value of being in any of these places will change as soon as the Boomers start not to be filling up most of the housing stock anymore. The point is that in the psychology of the demandors, any premium they’re willing to pay does not exist with reference to normal nationwide pricing options, but only the options of the social radius they need to stay within. Your own sense of certainty was in judging how the effect must have happened for people not to go elsewhere instead; I hope you have a finer sense now of how it stacks up. It would be interesting to hear of any pairs of expensive-highly-planning-taxed-cities and similar sized cities where this isolation effect does not obtain. Thanks for the posts.

    • Neil,
      Your observation on the appreciation in the Pacific Northwest is relevant, but ignores the entire reason the California economy exists in the first place.

      Lots and lots and lots of people really really really want to live there, and it’s been that way for a long, long time. Combine that with a heavy-handed state government and you’ve got a recipe for extreme prices.

      Certainly the remainder of the West Coast is disproportionately influenced by California’s economy, but this only proves my original point. If people can’t afford to be where they would most prefer (or to stay where they were) then they’ll compete for the next best thing.

3 Trackbacks

  1. [...] we took a look at the fundamental components of property values, at a macro level. In short, properties fall in two categories: resource-productive, and [...]

  2. [...] far this week I’ve laid out the basis of my theory that explains the roots of property value, and the various components that impact property values on a local level. For those who [...]

  3. Transportation Theory -- July 10, 2009 at 10:31 am

    [...] Property Value Theory, Part 1 [...]

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