Real Estate Economics 156

Urban planning and real estate

The word “plan” stems from the French term meaning foundation,

derived in turn from the Latin word planus, meaning “the sole of the foot,”

the bottom on which the body stands.

A plan is a design in the form of a model,

which serves as the blueprint or foundation for a construction or action.

A town or urban plan is a design for the physical elements of a city

(the streets, blocks, land usage, and transit)

and the operational elements (the governance and financing).

Regional planning is applied to a wider area, with less detail.

There have been cities such as Washington DC which were physically designed from the beginning, but also many urban comprehensive or master plans for the further development of the city as well as the preservation of status-quo land uses.

There have also been many communities planned from the beginning by private developers, operating in the market.

Their plans have included not only the physical elements but also the post-construction administration of the community, such as with homeowner associations.

Hardware implies software, and the design of the hardware - buildings and streets -

implies their subsequent software - administration and its financing

Private organizations necessarily include administration, decision making, rules, financing,

thus governance.

Homeowner associations elect a board of directors whose function is analogous to a city council. Hence, the deeper contrast is between imposed government, and voluntary governance.

The streets, transit, parks, and other elements of a private plan complement the financial side.

Since locational benefits become capitalized into higher site values,

the optimal plan maximizes the land rental of the community,

and the optimal amount of particular features such as parks and recreation is

the amount at which the marginal benefit equals the marginal cost,

i.e. the extra rent generated by that feature equals the cost of providing more,

assuming the marginal cost is increasing.

In proprietary communities such as shopping centers and large hotels,

the developer plans for complementary tenants who will maximize the expected rentals.

This includes, in a shopping center, an anchor store which attracts customers.

The plan also provides services, parking, waste collection, restrooms, traffic controls, and security. In residential developments, the design for planned unit developments often uses clustered houses, with smaller side and back yards, but more forests and lakes and other open space.

Historically, cities have grown rapidly and in an orderly manner

without any visible hand to control the development.

Great Britain became the world's first urbanized population by 1851,

with an unprecedented growth of its cities,

without any centralized urban planning or land-use controls

until the Housing and Town Planning Act of 1909.

The urban growth was "directed by property rights and private contracts,

and shaped and determined by market forces.

There were no housing shortages, and the poor were provided with affordable housing. Infrastructure was provided by the landlord or the developer.

Covenants were used to coordinate and allocate land-use rights, preventing offensive uses.

Prescriptive covenants specified the types of materials used and the heights of the buildings.

The absence of governmental planning was therefore not a chaos of disorder,

but a decentralized profit-incentivized contract-based order

that was simultaneously spontaneous and organizational.

The key role of the government was to enforce the contracts.

Governmental zoning

We can contrast zoning and other imposed controls with market-based planning structures.

First comprehensive zoning, 1916, New York City.

Court cases have upheld as within the police powers of governments,

the authority to control land use.

Most city governments impose zoning,

the division of a community into districts that prohibit or require some set of activities.

Prescriptive zoning, the most common form, prescribes the permitted uses of each plot of land. Cumulative zoning sets a hierarchy of uses,

and all uses below the maximum are permitted.

For example, single house would be permitted in an area zoned for apartments.

"Inclusionary zoning” requires developers to include low-income housing, shifting the cost to the other units, and inducing development to shift to other locations.

The U.S. Supreme Court upheld the authority of the city government of Euclid, Ohio,

to impose zoning in 1926 (Euclid v. Ambler Realty),

and so "traditional zoning" is also referred to as "Euclidian zoning,"

referring to that case and not to the ancient Greek geometer,

although the city was named after him.

While zoning has been mostly a local mater, several states have set state-wide zoning requirements. The U.S. federal government promoted more intrusive city planning with the Housing Act of 1954, which financed urban renewal with the requirement to encompass a comprehensive city plan.

Zoning and other elements of a comprehensive governmental plan implies

that the city council and planning commission have set objectives and goals,

such as the extent and direction of economic development.

But such goals at best reflect the values of a portion of the community,

since it is well established by the Condorcet Voting Paradox

that the outcomes of voting are not necessarily consistent,

and the "impossibility theorem" of Kenneth Arrow

concludes that no voting system can unambiguously reflect a general will of the public.

The word "smart" is often used to make a policy sound scientific and beneficial,

thus the term "smart growth," implying that spontaneous growth is stupid.

The term came to be used around 1996 to designate the goal of making cities more compact,

using urban-growth boundaries and replacing much of automobile use with public transit,

especially light rail.

Smart growth takes zoning to a greater level of planning,

to implement a centrally planned vision of the future.

The results, according to Randal O'Toole

have been greater congestion, higher real estate prices, higher taxes,

and little reduction in the use of cars.

Urban growth boundaries shift rather than prevent development,

as developers leapfrog over the green zone

and end up extending the sprawl.

Like other attempts at central planning, smart-growth zoning fails

because it is impossible to know and control all the changing dynamic variables of urban evolution.

All central planning, of whatever scale, has been subject to the problem of dispersed knowledge.

Zoning is an intervention into the land-use decisions

that property owners would otherwise wish to make.

One rationale of zoning is the reduction in negative externalities

such as noise, excessive traffic, crowding, and visual blight.

But the attempt to treat an externality

that accompanies higher density can itself create other externalities,

such as higher housing costs and costly urban sprawl.

As we have read, the negative effects

of zoning and other restrictions on real estate development

can be seen starkly in California, and in the Bay Area,

where residential real estate prices have soared to several times

that of locations with similar density but less restrictive regulations.

As we read, the regulations of cities in the Silicon Valley

have included urban growth boundaries, building codes, zoning, redevelopment agencies,

affordable housing requirements, development fees, and environmental impact reports. 

Jane Jacobs’s 1961 classic, The Death and Life of Great American Cities,

a critique of modernist planning and "urban renewal,"

identified four conditions need for thriving, diverse cities:

(1) relatively high densities of population and activities;

(2) diversity in primary uses;

(3) small-scale, pedestrian-friendly blocks and streets; and

(4) old buildings coexisting with new ones.

These principles conflict with the Euclidean zoning restrictions

that mandate maximum density, separate the primary uses,

favor street designs based on traffic demands,

and do not attempt to preserve older buildings.

Urban renewal replaced coherent neighborhoods

with higher-income dwellings

which shifted the poor to massive housing projects

that became infested with crime and blight.

This modernist era is said to have ended in the 1970s,

when tower-block construction fell into disfavor;

we are now said to be in the "post-modernist" planning era,

which the ideas of Jacobs have influenced.

Nevertheless, Euclidian zoning is still the rule.

Houston is now the only large American city without zoning.

The city has held three elections in which the voters could choose to switch to zoning,

and in each case the voters chose to avoid zoning.

Judging by property values,

the absence of zoning has not reduced the quality of life in Houston;

two independent cities within Houston have zoning,

and their land values rose more slowly than in Houston.

There is greater flexibility with "performance zoning,"

also called "impact zoning,"

which sets some outcome such as density,

but leaves the means to individual property owners,

providing them with greater property rights than with more rigid zoning.

Within the zone there can be private exchanges

and agreements such as easements subject to meeting the performance goals.

Zoning has been construed as a collective property right.

The collective presumably consists of a majority of the current real estate owners.

With zoning they restrict the property rights of those within the community

who prefer other land uses

as well as those outside the community

who wish to enter and develop sites differently.

In practice, the "collective" which pushes for and benefits from zoning

can be a special interest that gains at the expense of the majority.

Governmental planning decisions are made by city councils and legislatures,

who may well pay attention to professional planners,

but also cater to those helping them get elected.

Once government has the power to control rights,

then groups with concentrated potential benefits

will use the political market for legislation to transfer wealth and privileges to themselves.

In effect, zoning creates a territorial cartel.

Among other pathologies,

Zoning was a powerful instrument of income and class segregation.

In a pure free market, there is no natural collective property right

to the density or a particular land use in a neighborhood.

In market-based planning and dynamic evolution,

unfavorable changes can be prevented with covenants and easements.

An easement gives particular persons property rights in real estate owned by others.

Easements, along with covenants and deed restrictions,

can take the place of zoning and other governmental land-use controls.

An “easement appurtenant” runs with the land, being transferred to new owners.

Since the same ends could be accomplished with such private rules,

 in effect zoning confers a subsidy to the beneficiaries.

Instead of buying an easement,

the city benefits a landowner by restricting the property use of others.

By saving the cost of buying an easement or deed restriction,

the beneficiary is subsidized.

Developments such as shopping centers or greater density

are often restricted to prevent congestion.

But a congested street or highway implies mispricing.

There are too many cars because the monetary cost of driving is subsidized.

Each extra car in a crowded road or a congested parking place

makes it more crowded for the others, imposing a negative externality.

The congestion can be eliminated by a toll or meter

just high enough to eliminate the traffic congestion

or to usually provide a parking area within a block.

Crowding does not by itself warrant restrictions on development;

to be fully warranted, one must show why

the alternative of congestion pricing or increasing the traffic capacity

is not a more effective remedy.

That there are beneficiaries does not warrant a policy such as zoning,

since one must analyze the totality of the effects to judge the social costs and benefits.

Zoning that prohibits greater density, for example,

benefits the current residents

at the expense of those who wish to move in,

and raises rental costs and land prices for tenants and new buyers.

By reducing the efficiency of land use,

zoning that prevents higher density can have a net social cost.

Urban sprawl

"Urban sprawl" can be defined as a greater use of land than would occur in a pure free market. There are several reasons why a free market

could result in a more compact use of urban land

than that of the typical American city today.

First, zoning that sets a maximum density

forces development to move to the fringes.

Secondly, current property taxes penalize vertical construction

and reward horizontal development.

In almost all states,

the real property tax is based on the current or historical value

of both the land and the buildings.

If the lot is rebuilt or greatly improved,

the structure gets taxed,

adding to the total cost of the improvement.

In the older sections of a city, especially the aging center,

renovations incur a property tax penalty,

and so at the margin, will not be done, creating blight.

Although developers are now paying impact fees

to finance some of the infrastructure of new developments,

still, the on-going costs of maintenance,

along with operating costs of services such as police and schools,

provide a net benefit to landowners,

especially so at the fringes where government accommodates growth

with more freeways and other services.

The real property tax,

making improvements more costly while subsidizing landownership,

induces less infilling and the extension of the urban edge, i.e. urban sprawl.

When people prefer to live in suburbs today,

this is not entirely a free-market choice.

Their incentives have been skewed

from what they would be in a pure free market

by price and profit distortions.

Developers and residents

are responding to restrictions on development that shift it elsewhere,

to tax-reduced wages and profits,

and public-works-inflated locational values.

One cannot therefore logically conclude

from current land-use patterns

that this is simply what people “choose.”

As Mason Gaffney versed it:

            O, Thou, who didst with windfall and with waste

            Beset the streets where buildings may be placed

            Thou wilt not with predetermined choice propel

            Me outwards, then impute my sprawl to "Taste"!

Building codes

Governmental planning also includes specifications for construction and maintenance.

Building codes can help assure safety,

but they can also subsidize status-quo interests and pressure groups

such as labor unions engaged in construction.

Such restrictions can stifle innovative construction methods.

Building codes are thus an intervention into contracts between builders and their customers.

Of course it is legitimate to protect a buyer from faulty wiring and leaky roofs.

The primary method of consumer protection in a market is a proper contract.

The law has long recognized that a legitimate contract

involves parties who understand what is being obtained.

When the seller has greater knowledge about the product,

then the rule, caveat venditor (let the seller beware) should apply.

The typical buyer who seeks a safe house

will sign a contract requiring a level of safety.

If a city provides a recommended minimum standard for construction and repairs,

that could facilitate safety, as it could well be voluntarily adopted.

The builder could then be sued if the housing is below the standard set by the contract.

A secondary method of assuring safety would be in the CC&Rs of the civic association,

which could have standards for keeping buildings in good condition,

to avoid negative external effects.

Third, insurance companies have an interest in minimizing losses,

and can require that the property insured be safe,

such as being retrofitted to better withstand an earthquake,

just as in areas with high amounts of crime,

insurance companies will not protect homeowners

against theft unless they have a strong fence and an alarm connected to a security service.

Insurance firms as well as financial firms that provide mortgage loans

would have a greater role in assuring safety if not pre-empted by government’s building codes.

Quasi-governmental planning

Planning by government edict and planning by voluntary market dynamics

are not disjoint, but a continuum.

For example, in Hong Kong, the government sells leaseholds of government-owned land,

with conditions set in the contract.

Since nobody is forced to buy a leasehold, is this a voluntary "planning by contract"?

There is a market element in the competition for the leaseholds by auction and tender.

Excessively restrictive contract terms result in lower leasehold bids.

In Hong Kong, the leasehold contracts

permit housing development and commercial uses in many zones.

But that can also be accomplished by a more permissive zoning system.

The effect of the land use rules set by the contract

is the same as that set by governmental zoning of fee-simple land titles.

In a pure free market, the government could indeed lease land for revenue,

but not condition the leaseholds with covenants.

The covenants of private owners are paid for by the owners,

reflecting their individual subjective values,

as they seek to maximize rents and other gains.

Private covenants engage local knowledge

and can be altered without bureaucratic permissions.

Contracts set by the government in effect implement central planning.

Business improvement districts are another mix of government and market.

While they may be established by a vote of the commercial property owners,

once established, membership in these districts is mandatory

for the real estate within the boundaries.

They often do provide beneficial services

such as enhanced security and trash removal,

and they are often privately directed by councils

elected by the district enterprise or real estate owners,

but the mission is based on city planning,

and the district rules are imposed on all,

thus making such districts a level of government beneath the city.

Moreover, business improvement districts have tended to become permanent.

Similar services could be provided by voluntary districts.

Those who do not join it would be denied its package of services,

or the city government could have a joint venture

with the voluntary district

to which the holdouts would contribute via assessments to the city.

In a pure market setting,

there would be a package of services

such as security with benefits largely internal to the club,

and nonmembers would have to provide them on their own.

Another type of hybrid planning

is where the initial plan is set by a developer,

but then the town incorporates,

and the city government adopts the existing plan in its own zoning,

as happened in the case of Foster City in the Bay Area.

Where government can succeed

Government policy can succeed where it does not seek to plan

but rather motives and incites private planning and construction.

In physics, energy can be kinetic or potential,

the former being energy in motion,

the latter being the capacity to become kinetic.

Likewise in public finance,

taxation can be on kinetic or potential action.

Income and sales are kinetic activities,

and taxing these add friction, slowing them down.

But if instead the levy is on the potential action,

that motivates people to act.

A payment based on the potential rent of land has that effect.

A levy based on the value of land in its highest and best use,

even if it currently is not so used,

will spur the user to develop a site to its full potential.

The great San Francisco earthquake of 1906

provided a case study of this effect.

San Francisco had only the local property tax,

and much of this tax base was burned to the ground.

The answer is that it taxed the ground itself,

raising money while also kindling a new kind of fire

under landowners to get on with it or get out of the way...

It was a jolt to replace the lost part of the tax base

by taxing land value more, but small enough to be doable.

This firm tax base also sustained the city's credit,

allowing it to finance the great burst of civic works that was to follow.

A similar effect can be had in a market setting

with civic associations' assessments based on the site values.

After a disaster, they could, by their bylaws,

continue collecting assessments,

which would spur the members to quickly rebuild,

utilizing insurance funds, loans,

as well as perhaps financing from the association.