UEMC2513 Building Economics and Finance Introduction To Urban Land Economics

© Chia Fah Choy 2005 Learning Objectives After studying this topic you will: be able to explain the concept of ‘economic rent’ Show how a demand curve of land can be determined Explain and illustrate how the interaction of demand and supply will lead to an equilibrium market price or rent Explain the economic rationale for intensity of site use Explain how the timing of redevelopment is an economic decision

© Chia Fah Choy 2005 Land Undeveloped land, or ‘pure’ land, refers solely to natural resources and space. Land as a whole i.e. the earth’s land surface – can be regarded as being fixed in supply. Increasing such land by reclamation from the sea shall be view as an additional to capital goods rather than to land.

© Chia Fah Choy 2005 ECONOMIC RENT O Price Quantity of ‘Pure’ Land Demanded and Supplied D P1P1 P Economic rent N L D1D1 S M

© Chia Fah Choy 2005 Price perform the vital function of rationing scarce supply among competing uses. Supply of land can never be regarded as fixed from the viewpoint of any one use. The productivity of land can usually be increased in response to additional demand by using it more intensively by the addition of capital. Land as whole are entirely demand- determined – a tax on pure land has no disincentive effect on the supply of land The Pricing of Land

© Chia Fah Choy 2005 The Pricing of Land Unless all forms of land use are taxed equally, the pattern of land use will be distorted Whether such distortion is on balance good or bad can only be decided by: –A comparison with the inevitable distortions produced by alternative taxes –Its connection with spillover benefits and costs –One’s political views Cost of production include normal profit – what is necessary to keep the entrepreneur in the current line of production

© Chia Fah Choy 2005 Commercial rent is simply a periodic payment for the hire of land. Normally, there is competition for land between the different potential users. The rent of land, therefore, is determined in the absence of any government interference, by the interaction of demand and supply. The Commercial Rent of Land

© Chia Fah Choy 2005 The Demand of Land Assumptions: The land under discussion is homogenous Buyers are only interested in maximising private utility or money returns Conditions of demand and supply do not change A long-period situation prevails The output at which profits are maximised is known

© Chia Fah Choy 2005 The Demand of Land The demand for land as a factor of production is a derived demand It has to be combined with other factors, labor and capital, to produce the goods that are wanted The quantity of land which a firm demands depends upon: –its productivity –the price relative to other factors –the price of the final product

© Chia Fah Choy 2005 The Demand of Land Thee main problems have to be answered: How does a change in the price of land relative to other factors affect the demand for land? How will a change in the productivity of land in a particular use affect demand? How will a change in the price of the product affect the demand for land in that use?

© Chia Fah Choy 2005 L C EP 20 Land (units) Capital (units) M A The Optimum Combination of Factors of Production O P

© Chia Fah Choy 2005 Capital (units) EP 20 M A The Optimum Combination of Factors of Production L O C P Price of land rise EP 10 B N Q E More capital is now combined with less land Level of output has been reduced from 20 units to 10 units Land (units)

© Chia Fah Choy 2005 Capital (units) EP 20 M A The Optimum Combination of Factors of Production L O C P Increase in productivity EP’ 20 K R S The same output can be produced for a smaller outlay Land (units)

© Chia Fah Choy 2005 Capital (units) EP 20 M A The Optimum Combination of Factors of Production L O C P Price of land increase Quantity of land remained EP 10 E Land has to be employed extensively EP 10 Land (units) H F

© Chia Fah Choy 2005 Capital (units) EP 20 M A The Optimum Combination of Factors of Production L O C P Increase in demand More capital and more land would be demanded EP 30 F R Land (units)

© Chia Fah Choy 2005 The Demand of Land A fall in the price of a factor will lead to an extension of demand (the demand curves slopes downwards) An increase in productivity or an increase in the price of the product will lead to an increase in demand for the factor (the demand curve moves to the right)

© Chia Fah Choy 2005 Quantity demanded and supplied (units) SmSm D P O D1D1 P1P1 SmSm P2P2 P3P3 SlSl Supply, price and the time period Price (RM)

© Chia Fah Choy 2005 The dominance of stock of real property on its price Demand for houses (determined by income, tastes, etc) Existing stock of accommodation Net annual new construction Prices of houses determines amount of new houses it is profitable to construct Determines the demand for, and prices offered for, building sites. Competition among developers ensures that any supernormal development profit tends to accrue to sellers of building sites in the form of higher land prices

© Chia Fah Choy 2005 O Unit of capital RM M Perfectly competitive factor market MRP A C Total cost of Capital Economic Rent (surplus) B MC

© Chia Fah Choy 2005 O Unit of capital RM M Perfectly competitive factor market MRP A C Total cost of Capital Value of Site B MC

© Chia Fah Choy 2005 O Unit of capital RM Effect of changes in the productivity C M B A’ MRP’ M’ MRP A C’ the price bid will be for the best use of the site. The alternative use with greater productivity would shown by the higher MRP’ curve Competition will ensures that the site is developed upwards to the point where MR=MC where A’BC’ is maximum A higher building and a higher site price will result from a rise in the MRP of capital The higher the land price, the more intensive use of the land is required. High land prices have caused high buildings

© Chia Fah Choy 2005 Effect of changes in the rate of interest O Unit of capital RM C M i M’ MRP A i’ C’ A fall in the interest would lower the cost of each capital unit. The price of site will rise from AiC to Ai’C’

© Chia Fah Choy 2005 Effect of changes in the productivity or in the rate of interest O Unit of capital RM C M i A’ MRP’ M’ MRP A i’ C’ C” Where demand is high the use of the capacity of land is high A highly intensive use of land is profitable Because high building is profitable, land values are likely to be high Where demand is high the use of the capacity of land is high A highly intensive use of land is profitable Because high building is profitable, land values are likely to be high

© Chia Fah Choy 2005 O Years Expected gross annual return and operating cost (£) Gross annual returns and operating costs over time N Z Expected gross annual returns Operating Costs Expected net annual return for any given year

© Chia Fah Choy 2005 O Years Present value (capitalised future NARs) in existing use P (£) Present value of building in its existing use The present value of a land resource over time Z

© Chia Fah Choy 2005 O Years PV of current highest and best use, costs of clearing site and of rebuilding The value of cleared site R Cost of rebuilding Deduct cost of clearing site PV of current highest and best use Value of cleared site - B A

© Chia Fah Choy 2005 O Years PV of existing use + value of cleared site PV of existing use The timing of Redevelopment T Retains land and building in existing use Secures land and building in existing use Redevelopment Value of cleared site - Z R

© Chia Fah Choy 2005 Factors influencing Land Value Supply and demand The permitted use Location Physical characteristics Availability of public services Form of title General nature of the surrounding

© Chia Fah Choy 2005 Site Characteristics Soil conditions Groundwater Contours Contamination Obstructions Services Access Aspect Site boundaries Area of site

© Chia Fah Choy 2005