The Economic Analysis of Land Use Planning

Paul Cheshireemail p.cheshire@lse.ac.uk

December 2007

The Economics of Land Use Regulation: Housing Prices, Urban Sprawl & CorruptionXREAP Network Workshop: Barcelona 17th December 2007

• Land is an environmental resource, a factor of production and – as space – a good giving direct welfare

• In general land use regulation only treats land as an ‘environmental resource’

• Land use planning a system of regulation via direct intervention

• Land a scarce resource but allocation only partially via markets - or not at all

• Think about some of the economic implications of this; estimate some of the effects in UK residential markets– serves as dreadful warning!

• Look also at gross costs in commercial markets• And - can we use price information to improve economic

efficiency of planning?

Land Market Regulation:‘Planning’, ‘Zoning’, ‘Growth Boundaries’….

• Clear problems of market failure• Each plot of land specific location: lumpy and illiquid• Value – welfare/productivity – of all plots influenced by

uses on neighbouring plots: lead smelting, bull breeding, agricultural chemicals, gardens….• So an intrinsic problem of externalities from

interdependencies between neighbouring plots• ‘Public Goods’ –open space, rare habitats,

beautiful scenery, mountains, sea shore etc • Coasian solutions impractical – transactions costs• Internalisation via Pigovian taxes?

• ‘Solutions’ have come from design, architecture & civil engineering traditions – ‘planning’ ‘zoning’

• Era of utopian visions, belief in central planning• (in UK part of post WWII socialist reconstruction – land

use and economic planning)

Why Regulate Land Markets?

So - lots of good reasons for land use regulation - only interest if regulation restricts supply relative to demand – of…

1. Space – land by locations & use category (e.g. – residential or retail); building heights

2. Land+building bundles (often in US system)3. Development - by imposing costs e.g. delays,

compliance, rent-seeking

• And demand for space as consumption good largely driven by real incomes – not household numbers

• Also demand for space as factor of production – so output & incomes?

Planning Restricts the Supply of What?Legal, institutional context critical

• A proclamation of 1580 commanded the subjects of Queen Elizabeth I to:

• “desist and forebeare from any new buildings of any house or tenement within three miles of any of the gates” of the City of London “where no house hath been known”

• 3 mile Tudor Green Belt later extended to 7 miles but never fully enforced. State connived at avoidance of the law - increasingly preferred fines to knocking down all buildings

• In effect became transmuted into a green field development tax and another source of state revenue

• Then as now – stop hovels encroaching on royal palaces & burghers’ villas [suburbs-subhuman]

• Only repealed with London’s rebuilding post-1666 ‘Great Fire’• Rational economic analysis and political economy….

May think Growth Boundaries Newbut in UK a very long history…

• Planning creates amenities - local public goods• Retains type 1) open space within cities (parks etc): this is

valued: open space with public access• Type 2) open space beyond growth boundary – ‘urban

containment’ – Greenbelts: Open space but no public access• Separates industrial, commercial residential uses: less

industrial space within residential areas is valued• But - constrains land as ‘pure-space-with-accessibility’ –

‘land’ in strict sense of classical urban economics• Does not constrain supply of housing directly: indirectly via

land availability• Evaluation of net welfare effects of, say, relaxation requires:• Valuing of loss of Type 1) & 2) open space• Valuing lower land and house prices (& bigger houses &

gardens). New German houses 44% bigger than British: Dutch 45% cheaper per m2

The Costs & Benefits of British-style Supply Restriction

• Residential is main consumer of ‘urban’ land• Price of ‘pure land’ increased => costs of housing

higher: consumers’ choices constrained; land substituted out of consumption - so higher densities.• Welfare gross cost is loss of income/other goods and

sub optimal attribute bundle consumed• Net cost allows for loss of open space +other amenities

created by planning consequent on relaxation of restriction

• So to estimate need to know prices and structure of demand – contribution of attributes to welfare and rate of substitution between attributes

Welfare Costs of Containment?

1. Estimate the structure of hedonic prices for land and other attributes;2. Using prices + household incomes - estimate demand system including

land and planning produced amenities;3. Use demand system to determine a utility level for each household in

status quo;4. Use utility level + observed incomes + household numbers + value of land

at periphery to estimate share of land made available for residential consumption (equilibrium =>land supplied consumed);

5. To estimate gross benefits:For amenities i) use demand system to estimate (reservation) price that if no planning system; ii) for each household calculate income compensation needed to maintain observed utility when amenity price raised to reservation price – so household demand for amenity is zero

6. To estimate net benefits:i) Estimate change in land available for consumption associated with planning; ii) for given relaxation in land supply/reduction in amenities estimate new household utility levels & increase in land consumption iii) for each household calculate implied variation in income equivalent to new utility level.

A Method for Estimation Net Welfare Impacts (Cheshire & Sheppard, 2002)

Net costs of Land Use Planning: Reading 1984

Modest Relaxation

Significant Relaxation

Average net cost of land use planning per household - £ p.a.

210.94 407.44

S.D. across households 376.68 335.40

Net cost as per cent of income 2.01 3.89

Capitalised land value at urban periphery 30 000 25 000

Per cent increase in urbanised area 46.9 70.7

Welfare Costs of Containment

The Distribution of Planning Benefits relative to Incomes

• Costs are in terms of ‘income’ flows• But amenities capitalised into house prices• Houses including land are part of asset portfolio• As real and relative house prices rise over time with

rising incomes and constrained land supply asset values become relatively more important

• The longer growth is constrained the more difficult it is to relax constraints?

• But the longer growth is constrained the more serious economic impacts become – including macroeconomic management & monetary policy

• Fischel W. (2001): Barker, 2003; Barker II July 2006

Costs? Or Asset Values?

• Housing – many characteristics• Physical + locational (including very important local

amenities, public good & neighbourhood characteristics)• Hedonic models => price of a ‘house’ – aggregate of

each of its characteristics• So need to think of supply, demand & price of individual

characteristics• Some attributes ‘industrially’ supplied e.g. central heat• Space – both internal & in gardens (& as public open

space) – a characteristic for which there is an identifiable demand …& supply via planning

• But – empirically – locational attributes dominate value of ‘land-as-pure-space-with-accessibility’ (concept implicit in monocentric trade-off model)

How Have Net Welfare Costs Changed Over Time?

• Exceedingly resource intensive to estimate net welfare costs

• Can we get relatively clear evidence from more modest research effort?

• If planning generates amenities and also restricts supply of space:

• First question: What has happened to price of individual characteristics over time?

• Have planning produced amenities or private space become relatively more valued?

Getting a fix…

1984 1993 % Change Income (pre-tax)

from sample £13,694 £28,969 111.5

Price Level (1987=100) 91.0 141.9 55.9 Sample mean house price £51,066 £94,990 86.0

Reproducible attributes Central heating £4,954 £5,997 21.1 Bedrooms £2,599 £2,801 7.8 Bathrooms + WC £4,687 £6,229 32.9

Planning amenities Less industrial land £74 £224 202.7 More open accessible land £51 £227 345.1 More closed unbuilt land1 £102 £60 - 41.2

Space (price per m2) Garden Space : at centre

£49.5

£152.3

207.9

at periphery £4.5 £22.9 404.9 median distance £12.8 £32.1 151.5 Internal floorspace £171 £425 148.5

Changes in Prices: Selected Attributes Reading Housing Market, 1984-93

In Britain policy constrains the supply of space – not the supply of buildings+land

1) Demand for space driven very much more by real incomes than household numbers…& this feeds through to house price changes (income elasticity of demand for space both in houses & gardens at sample mean, above 1.5 Cheshire & Sheppard, 1998); &

2) Since housing attributes can be substituted for each other (e.g. floors, terraced/detached, space, public open space, room size/design) – expect land prices to have risen more than

house prices

So Real Price of Space Rises and...

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100

150

200

250

300

350

400

Land Price Index House Price Index Note: House and Land data for w ar years are interpolated.

Land Price Index

Housing land prices are from 3 sources: Vallis (1972) Estates Gazette – 1892 to 1969 England: Housing & Construction Statistics – 1963 to 1987 England & Wales; and Property Market Report, Valuation Office – 1983 to 2002 House Prices: ODPM: Table 502 Housing Market: House Prices from 1930. Table 502 Housing market: house prices from 1930, annual house price inflation, United Kingdom, from 1970 Table 502 Housing market: house prices from 1930, annual house price inflation, United K ingdom, from 1970

Long Run Real Land & House Price Indices(1975=100) from Cheshire & Sheppard 2004

• We observe price discontinuities at zone boundaries• Supply of land for each urban use determined by fiat

independently of price but sold on market• Agricultural land in wider London region

• Maybe £10 000 per ha….• Housing land

• Now more than £4 million per ha• Price of housing land twice that of industrial• But highest for offices & retail• => What about impacts of regulation on commercial

real estate?

…and since Supply of Land Determined for Each Use…

CBD Office use price gradient

Residential use price gradient

Industrial use price gradient

Recreational & agricultural use price gradient

£

£

Distance to Centre

Distance to Centre

Designated Areas in 1947

Inflexible Zones

Price Discontinuities

Cost of infrastructure to convert agricultural land

Markets Get their Revenge

Figure 1b: After Change in Demand

British Office Costs – take Birmingham(Cheshire & Hilber, 2006)

• Take Birmingham – medium sized city (2.5m), declining industrial economy, situated on flat plain

• Construction costs for offices about 50% of costs in Manhattan – no surprise

• What fundamentals determine costs of space? City size, income level, construction costs, growth, transport systems….

• In Birmingham office space costs 44% more than Manhattan (2004)

• That is some surprise: something must be going on• Land use planning constraints seem plausible candidate• Work on UK residential sector suggests land supply

restrictions impose about 4% income equivalent net welfare loss

‘Regulatory Tax’ measure (Glaeser et al 2005)no restrictions; high demand (L), low demand (B) cities

hB

PB AVCB=AVCL

ACL

PL

ACB

MCB=MCL

building height

price per m2

Land Rent (L)

Land Rent (B)

hL

Competitive development industry so in equilibrium P=AC=MC

A Developer’s Cost Curves with Height

Restrictions – The ‘Regulatory Tax’

PL

LP

noLMC

height restriction

AVCL

ACL MCL

building height

price per m2

RT

Abstracts from land costs but a ‘black box’? But if no height restriction?? Regulation via compliance costs??

Estimating the Regulatory Tax (RT) • For 14 UK office locations: marginal costs of

construction per m2 in hypothetical additional floor – estimated by Davis Langdon back to 1960 from actual projects: common spec (+ not used yet – standard office park boxes – investigate endogeneity issue).

• For Continental locations (+ Manhattan) Gardiner & Theobald Average Cost data, converted to ‘MC’ using ratio to Davis Langdon for common locations

• UK prices via CBRE: m2 prime rentals + yields from 1973 (1960) converted to capital values using ‘Equivalent Yield Model’ allowing for voids, rent frees etc (see paper); + CBRE data on total Occupation Costs (2004 & 2005 only)

• For Continental prices - JLL rental & yield data from 1990: used common locations to cross check

Summary Statistics: Regulatory Tax – sensitivity to assumptions

Variable: Ratio: Regulatory Tax / MCC Obs Mean Std. Dev.

Min Max

Specification:

Based on prime rent (no adjustment) 480 3.70 2.92 0.13 22.06

Prime rent partially adjusted for rent-free periods 480 3.03 2.66 -0.05 19.81

Prime rent fully adjusted for rent-free periods and vacancy rates (central estimate)

480 2.64 2.37 -0.14 17.55

Upper bound: Assume 10% premium for top floor plus 50% of fully adjusted total occupation cost markup

480 3.88 3.10 0.15 23.95

Based on fully adjusted prime rent plus 10% premium for top floor

480 3.01 2.60 -0.05 19.41

Lower bound: As central estimate but assume 0.5 percentage point higher yield

480 2.37 2.15 -0.18 15.78

Data Sources: CBRE (prime rent, yield and total occupation cost information), Davis Langdon (marginal construction cost information), IPD (national void rate index) and ODPM (regional vacancy rates).

Regulatory Tax: Mean values

Regulatory tax Office Market Years with Available

Data Mean 1973-2005*

or available 2005

City of London ’61-’05 7.54* 3.34 London West End ’61-’05 6.80* 8.89 Canary Wharf ’98-’05 3.29 2.77 London Hammersmith ’91-’05 2.28 1.82 Manchester ’73-’05 1.58* 2.50 Newcastle upon Tyne ’65-’05 0.72* 1.19 Croydon ’65-’05 1.29* 0.98 Edinburgh) ’65-’05 2.18* 2.62 Glasgow ’65-’05 1.69* 2.05 Maidenhead ’84-’05 2.81 2.27 Reading ’65-’05 2.73* 1.61 Bristol ’73-’05 1.46* 1.96 Birmingham ’65-’05 1.86* 2.68 Leeds ’73-’05 1.71* 2.17

Figure 1: Regulatory Tax(Central Estimate)London Office Markets

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18.00

1960 1965 1970 1975 1980 1985 1990 1995 2000 2005

Year

Reg

ula

tory

Tax

City of London London WE Docklands Hammersmith Croyden

Comparisons with Continental European Locations

City Estimated Regulatory Tax

1999 2005 Average

London West End 7.62 8.37 8.00*

London City 4.68 4.31 4.49*

Frankfurt 5.44 3.31 4.37

Stockholm 4.28 3.30 3.79

Milan 2.07 4.11 3.09

Paris: City 2.35 3.75 3.05

Barcelona 2.23 3.16 2.69

Amsterdam 2.12 1.92 2.02

Paris: La Defense 1.41 1.93 1.67

Brussels 0.52 0.84 0.68

Data from JonesLangLasalle and Gardiner Theobald adjusted to CBRE & Davis Langdon norms *9.0 and 4.9 respectively using Davis Langdon & CBRE data

Explaining the Regulatory Tax• Very high costs of land use planning in UK• Planning policies controlled by residents - Homevoter

hypothesis + benefits widespread & costs of development very local

• Except – helpfully in City of London + Docklands• Planning authorities small (Districts, Boroughs)• Strong negative fiscal incentive to allow any commercial

development: reinforced post 1989 – Uniform Business Rate

• Except – helpfully – City of London: retained 15%• For resident controlled only incentive - fear of

unemployment?• But RT cyclical: supply or demand? Include a ‘pure’

demand measure – local employment in office sectors

Explaining the Regulatory Tax: Hypotheses/questions

1. As unemployment rises, planning becomes less restrictive => i.e. supply side determine

2. Potential problem of identification hence direct demand measure

2. Elasticity of response to unemployment much stronger in Business compared to Resident-controlled LPAs – if found => then most convincing evidence

3. City of London becomes less restrictive relative to all other locations following Uniform Business Rate (UBR) - 1990

4. UBR to prevent leftist local governments damaging business with punitive property taxes to redistribute: but what impact on business costs indirectly via increased fiscal disincentive to permit development?

Results• Gross costs of regulation for office space in UK seriously high

cf US or most of Continental Europe• High ‘generalised’ costs in London (location fixed effects)• Sharp distinction business and resident controlled authorities in

responsiveness to local economic conditions (unemployment)• Including a direct measure of demand confirms results• Strong impact of changing business property tax to national tax

(UBR post 1989) outside City of London• Done to mitigate taxes on business from leftist local

governments• But impact for medium sized firm - 200 employees in 1500m2?• Total Business rates £47,819: estimated change in space costs

£67 312 if mean: or £84 010 if West End! =>Market Revenge!• More generally – reinforces view that RT is a useful measure of

gross costs of regulation: ‘It works’

Land Use £ 000’s acre @ 1984

£ 000’s acre @ 2002

Office use Zone 1 7 964-13 2411 15 748-26 183 Zone 2 3 806-8 3701 7 526-16 551 Zone 3 2 621-5 1031 Zone 4 602-1 3081 1 190-2 586

Retail Zone 1a 28 779-34 1512 56908-67 531 Zone 1b 24 467-27 8182 48 382-55 008

Zone 2 12 807-15 7942 25 325-31 231 Zone 3 9 786-12 4582 19 351-24 635 Zone 4 8 941 17 680 Zone 5 3 020-3 9272 5 972-7 765 Zone 6 2 876 5 688 Zone 7 2 539 5 021

Industrial Zone 1 400* 791 Zone 2 500* 989 Zone 3 450* 890

Residential Edge of urban area 120-205 237-405

Source: Cheshire, P. and S. Sheppard The Economic Consequences of the British Land Use Planning System: a Pilot Study, Final Report to ESRC 1986 *Estimated variance 5% 1 Range of observations 2 Range of estimates varying with exact location and floor plan size/access/permitted structure type

Using Price Discontinuities: Reading - Prices 1984

• Price premia for developable land vary between uses, locations & over time indicating relative supply constraint

• Introduce as ‘material consideration’ into planning decision-making

• If the price premium in any location for any use over the adjoining use(s) exceeds some ‘threshold’

• =>Presumption that planning permission will be granted

• Unless ‘amenities’ generated by the land in current use exceed the value of the premium

• Would release large areas of intensive, low amenity agricultural land…but – another paper

These Price Premia Provide Market Signals

• Distortions and perverse incentives that arise variable – but endemic

• Scope for & how to introduce price information varies with systems of land use regulation

• In UK introduction of price information could generate a flexible signal & systematically reduce supply constraints

• Without action price distortions get worse: but politically easier to start restricting than to stop

• Rising incomes more than population growth given evidence on income elasticity of demand for space in space constrained UK

• Very high recent rate of build & land conversion in Spain: + (maybe) lack of safeguard for high amenity areas

• BUT simple restriction + containment not the answer.• The UK a warning for Spain….?

Conclusions

Barker, K. (2003) Review of Housing Supply: Securing our Future Housing Needs: Interim Report – Analysis, London: HMSO.

Barker, K. (2004) Review of Housing Supply: Final Report - Recommendations, London: HMSO.

Barker, K. (2006a) Barker Review of Land Use Planning; Interim Report - Analysis, London: HMSO.

Barker, K. (2006b) Barker Review of Land Use Planning; Final Report - Recommendations, London: HMSO.

Cheshire, P.C. and C. Hilber, (2006) 'Office Space Supply Restrictions in Britain: the political economy of market revenge’, Research Papers in Environmental and Spatial Analysis, No 117, Department of Geography and Environment, London School of Economics, 2006, 46 pages.

Cheshire, P.C. and S. Sheppard (1998) Estimating the demand for housing, land and neighbourhood characteristics, Oxford Bulletin of Economics and Statistics, 60, 3, 357-82.

Cheshire, P.C., and S. Sheppard (2002) 'Welfare Economics of Land Use Regulation', Journal of Urban Economics, 52, 242-69.

Cheshire, P.C. and S. Sheppard, (2004) ‘Land Markets and Land Market Regulation: progress towards understanding’, Regional Science and Urban Economics, 34, 6, 619-637.

Cheshire, P.C. and S. Sheppard (2005) ‘The Introduction of Price Signals into Land Use Planning Decision-making: a proposal’, Urban Studies, 42 (4), 647-663.

Glaeser, E.L., J. Gyourko and R.E. Saks (2005) ‘Why is Manhattan so Expensive? Regulation and the Rise in Housing Prices’, Journal of Law and Economics, 48 (2), 331-369.

Fischel, W. A. (2001) The Home Voter Hypothesis: How Home Values Influence Local Government Taxation, School Finance, and Land-Use Policies, Cambs, Mass: Harvard University Press.

References

Residential Land Prices: An indicator of Foregone Agglomeration Economies