The Differential Pricing of Cities

Aug 9 · 5 min read

by Philip Hayward -originally submitted as a response to Geometric considerations: Intensification vs extensification

Ludwig von Mises

There is interesting real life data showing that US cities with the most elastic housing supply, are supplying more houses by both means, intensification and sprawl, than the cities with supply elasticity problems.

It appears likely that the availability of the low-cost land ex-fringe disciplines the price expectations for all land within the existing city. This is sometimes called “differential” pricing. The land adjacent to the fringe is worth only a little bit more than rural land plus the cost of development and infrastructure. Then the land adjacent to that is worth a little bit more, and so on in a knock-on effect all the way to the city centre. This is demonstrable in real life, by the fact that the cities with freedom to develop that rural land, have CBD land prices as much as 80 percent to 95 percent lower than the cities that do not. Even in New York, where the fringe was dozens of miles from Manhattan, this knock-on effect has been very clear compared to a city like London. London has absolutely no location options priced equivalent to New Jersey, just across the river from Manhattan, let alone further into the hinterland.

The increasing size of city diameter does not of itself result in the potential land supply becoming inadequate to suppress prices. Otherwise there would be evidence of cities with no identifiable barriers to expansion, experiencing price inflation. “Splatter” growth patterns (a norm when not suppressed by regulations) mean that undeveloped fragmented land remains part of “supply”, it is not as clean-cut a question as “within-fringe versus greenfields beyond”. In fact as cities expand, the dispersion of employment and amenities tends to keep flattening the land price “curve”; it is not as if the location advantage that “capitalizes in” to distance from the ex-fringe rural land, needs to be dramatic. These things tend to find their own level, as clusters of certain types evolve faster on low-cost land, creating new employment nodes and rendering the old centre less important. Many cities have less than 10% of regional employment in their centres.

There is also data for Auckland, showing that after enacting a growth boundary, all the city land values exploded, from the boundary to the CBD. Then a wicked problem is created, whereby the value of sites becomes elastic to allowed density. Every time the planners upzone, the site values inflate so that the site seller captures all the potential value of the redevelopment. Redevelopment does not become a profitable incentive for the people who matter; the developers and builders. Their costs and risk are actually increased in comparison to cities where the site values are static thanks to the availability of low-cost ex-fringe land. This is why it is also observable in cities with these wicked affordability issues, developers are constantly going broke during a housing shortage and a price bubble. They are not making any more money on actually building or “developing” anything, and their cost of site acquisition and holding is several times as high relative to their actual chargeable “value added”.

The British Town Planning system has been experimenting with increasingly aggressive upzoning for decades, and all it does is worsen the problem via the mechanisms I describe. I am skeptical that some kind of wholesale abolition of restrictions on density would solve the problem by allegedly “swamping the market with redevelopment potential”. The upzonings done by British planners have been aggressive enough to create decades of potential new housing supply but all it does is inflate site values, it does not deflate them. It is all about the psychology of site vendor expectations; prices are “downwards sticky”.

I think that there is a decisive choke on the potential rate of intensification represented by the need to demolish existing structures, to retrofit expanded underground infrastructure in already built-out and congested locations, to deploy expensive and scarce capital equipment such as cranes and concrete placing equipment; that means that intensification can never match greenfields sprawl for elasticity of housing supply. But the good news is that if the greenfields are available, and suppress the value of urban land, the right incentives should be able to increase the fraction of housing supply that is done via intensification. Anthony Downs wryly compared prescriptive planning (about which many people seem to hold a fatal conceit) to simple fiscal nudges, by the illustration of a picture on a living-room wall; moving the picture is like using fiscal nudges; prescriptive planning is like trying to move the whole wall to make the picture look right.

Exceptions like Japanese cities, involve a mix of institutional arrangements that we should advocate copying if we want to achieve comparable outcomes. Crises of housing affordability and cyclical volatility really shouldn’t just wait for theory after theory to be tested; vested interests in sustaining the inflated prices make reform harder and harder as time goes on. I regard reform in Britain as an impossibility, and it will probably only take one single additional property cycle now (which would take us to about 2030) to make reform impossible (if experimental reform had not succeeded) in every other country that has got itself this crisis since “save the planet” urban planning became the orthodoxy in the 1990’s.

As Michael Reddell said about NZ’s housing bubble; “the sooner it is burst, the better”. That was three years ago now. At that time, things had become a lot more painful than they would have been had reform opportunity been seized a decade ago. It will take a whole property cycle to work out if “reform” that deliberately proscribes the use of ex-fringe land to suppress prices, will actually work; if it doesn’t, it will be too late. Of course economies entire monetary systems will collapse completely eventually as Von Mises predicted; the temporary (for a few decades) stabilization of the property cycle and hence the macro cycle, by automobile based sprawl, made Von Mises look mistaken for a while.

New Zealand needs an urbanisation project

A collection of essays about cities, housing, land, the built environment and transport which collectively make the case for New Zealand to implement a wide ranging urbanisation project

Brendon Harre

Written by

Trying to optimise amenity and affordability values for urban areas

New Zealand needs an urbanisation project

A collection of essays about cities, housing, land, the built environment and transport which collectively make the case for New Zealand to implement a wide ranging urbanisation project

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