Sunday, July 20, 2014

The premium from zoning regulations

Real estate ownership is no less important to the inequality debate today than it was in the 17th-19th centuries when landed gentry held sway. However, unlike then, the significance lies not so much in the extent of land ownership as its location. Today's aristocrats own real estate, in square yards and not acres, in areas where it commands a massive "location premium".

There is now strong evidence to suggest that restrictive zoning regulations are an important contributor to the "location premium". Such restrictions, mainly in the form of height and setbacks, limit the built-up area, and thereby the number of housing units, that can be constructed in the limited land available in such "desirable" neighborhoods. The scarcity so created raises property valuations and landowner wealth. Property prices in parts of London have risen sharply on the back of purchases by global business oligarchs as investments and not for residential purposes, so much so that it has forced the government to consider imposing higher property taxes on vacant properties.

An excellent recent FT oped, which described the premium as a "ransom" taken from renters and transferred to homeowners, writes,
About 40 per cent of the stated wealth of the UK – more than £3tn – does not exist. It is a terrible illusion. For the US the figure is about 12.5 per cent of total wealth, or $10tn, and growing fast. The “assets” in question are what planning or zoning restrictions have added to house prices. They are the ransom that renters and recent buyers must pay to existing homeowners – whose homes the rules protect – for use of an artificially limited stock of housing. So severe have those restrictions become that the value of the ransom runs into the trillions.
These valuations come from a landmark study by Edward Glaeser and Joseph Gyourko of whether the rise in urban housing prices come from scarcity or restrictions. They compared the prices of the marginal square feet of backyard land attached to a house with the average price of a square feet of land underneath the building. They found a large difference between the two, with the latter being many times the former, reflecting the restrictions on building on the backyard land. Their finding,
In the cities of coastal California, the average price of urban land is 10 times the price of land in a back yard because zoning laws make it impossible to turn one into the other. In Los Angeles, the price of the extra square foot on the garden was $2.60 while the average price of urban land was $30.44. In San Francisco, the back yard land was worth $7.84 per square foot, versus $63.72 on average for the same lot. The ratio of these two figures – as much as 10 to 1 – suggests only 10 per cent of the value of land in expensive cities is due to its natural scarcity. The rest is planning restrictions.
The scarcity in real estate markets induced by zoning regulations bear similarity with the privileged and unfettered access of vehicle owners to public roads at the cost of public transit users. Irrespective of private property rights, both real estate and roads are scarce and have critical public policy implications. Accordingly, many cities have policies that force vehicle owners to internalize the cost of road usage (congestion pricing, tolls, license plate fees etc), thereby also increasing the carriageway supply available for transit users.  

Urban planners need to do something similar with real estate. Like with road carriageway, the total supply of land available in cities is fixed, whereas the demand has been growing unabated. Zoning restrictions mean that the only way to accommodate the influx is to grow outward, resulting in the inefficient sprawl. The efficient alternative is to radically liberalize the zoning regulations and promote densified vertical growth. Lower building fees and property taxes higher up you go coupled with much higher property tax rates on newer large individual houses could incentivize more efficient use of limited land resources. 

No comments: