Forum Journal & Forum Focus

Property Rights/Property Values: The Economic Misunderstandings of the Property-Rights Movement 

12-09-2015 17:35

By almost any definition, community implies the existence of a place--a physical place made up of land, buildings, and public spaces. In most American communities the vast majority of the place is in the ownership of individuals--and thus constitutes private property.


Since virtually the beginnings of the rights of private ownership of land there has been some restriction on the use of that property. Historically, restrictions have been enacted in order to protect the interests of the community from the potential adverse impacts that a private property might generate. But a fundamental challenge to the concept of public restrictions on private land is being issued.

The burgeoning private property-rights movement is launching a three-pronged attack on land-use regulation throughout the United States. The first assault is being waged by lawyers and developers who are contending that the regulation of private property has become a "taking" entitling the owner to "just compensation" for loss of property value. This prong of the attack is wending its way through the courts--both state and federal--and no doubt will continue to do so for years to come.

The second wave of the attack is being fought on the political front. If the first part of the argument could be rephrased as "the government does not have the right to pass such regulations," the second rephrasing might be "even if the government has the authority to enact such regulations, it should not exercise that right." This political issue will ultimately be decided by state legislatures and city councils.

The third prong of the property-rights advocates` attack is the economic argument. In simplified terms the argument is as follows: This land-use regulation diminishes the economic value of my asset. I am entitled to use (develop) my asset to its highest and best use. It is wrong for the government to deprive me of that opportunity.

The legal prong of the property-rights argument will be decided--and then probably redecided--in the courtroom. The political prong will be decided at the ballot box. But the economic prong is being used--and abused--with increasing frequency by the property-rights proponents, and it is this prong to which advocates of land-use regulations have inadequately responded.

It is stating the obvious to say that landuse regulations apply to land. But an acknowledgement of that fact is critical to an understanding of the source, justification, and economic impact of these regulations. Land is an asset like no other. (The terms "land," "real estate," and "property" are used interchangeably throughout this article.) Among the singular attributes of real estate are that every parcel is unique, fixed in place, finite in quantity, will last longer than any of its possessors, and is necessary for virtually every human activity. Contrast these traits with those of other types of investments--stocks, bonds, gold, insurance policies, commodities futures, oil, fine art treasury bills, certificates of deposit. None of these possesses all of real estate`s at tributes; most possess none at all.

In part because of its peculiar attributes real estate has always been treated differently from any other asset in law, taxation lending, political perspective, and philosophy. But real estate has been treated differently for two fundamental economic reasons as well: the impact of land use on surrounding property values, and the primary source of value of real estate being largely external to the property boundaries.

Imagine two next-door neighbors each owning a series of assets. One owns IBM stock, government bonds, gold coins, and antique watches; the other owns GM stock, corporate bonds, gold ingots, and baseball cards. The investment decisions of one have absolutely no measurable effect on the value of the assets of the other. One neighbor probably neither knows nor cares about the investment portfolio of the other. There is no need for one neighbor to urge the enactment of public restrictions on the use to which gold ingots can be put since the neighbor`s decisions will not affect his/her own asset value.

Now suppose that in addition to the assets above, each neighbor owns a parcel of real estate abutting the parcel of the other. Every decision one owner makes has an immediate impact on the economic value of the asset of the other. To the extent possible, one owner will try to limit the potential adverse effect the neighbor`s land-use decisions might have on his/her own property value.

Historically, the initial purpose of landuse regulation was public health and safety. Although it is conveniently forgotten by the proponents of the economic prong of the private property-rights argument, the mitigation of adverse economic impacts caused by proximate land use is also at the core of land-use limitations. There is an old principle of private rights that holds that my right to swing my fist ends where your nose begins. Certainly the same principle applies to the regulation of land use.

The sheer complexity of trying to establish individual agreements with every property owner whose decisions might affect the value of one`s real estate asset quickly reaches the point of mathematical absurdity. The common-sense approach to real estate investment protection, therefore, has been land-use regulations instituted by the public to protect the composite economic value of private land and to mitigate the risk of substantial value decline caused by actions on nearby properties.

Those who loudly proclaim, "It`s my land and you can`t tell me what to do with it," are quick to appear before the city council when a homeless shelter is moving in next door or a hazardous-waste disposal site is proposed next to their summer cottage. And their argument won`t be, "I`m against the homeless" or "Hazardous waste shouldn`t be disposed of," but rather, "That action will have an adverse effect on my property value and you, city council members, need to prevent that."

Land-use regulations protect property values. But where does real estate value originate? Some landowners would have you believe that the value of their assets somehow emerges from within the boundaries of their sites, and that since that value was created within their lot lines, they are entitled to the highest returns available. Nothing, in fact, could be further from the truth. Consider two five-acre parcels of desert land--one in the middle of the Sahara and the other in the middle of Las Vegas. Within the lot lines both have the same physical characteristics: flat, dry, and, in their natural state, incapable of supporting human habitation. Do they have the same economic value? Obviously not. But the differences between the two lie entirely outside of the boundaries of the property. Everyone has heard the old adage that the three most important characteristics of real estate are location, location, location. The truth of that maxim is well-illustrated by the two desert parcels.

It is not the land but the activity surrounding the land that gives considerable value to one parcel and next to none to the other. In other words, the millions of dollars the Las Vegas site is worth stems not from the investment of the deed holder of the site but almost entirely from the investment of others--the City of Las Vegas, employers, owners of other properties, residents of Las Vegas. The creation of value in real estate is to a large extent external to the property itself.

The scenario may be altered somewhat by constructing a forty-story hotel on each site. Certainly, the Las Vegas property is now worth millions more than the bare land prior to the construction of the hotel. But what is the value of the land and hotel in the middle of the Sahara? Next to nothing--irrespective of the cost of construction. The economic value of the property was created not from within the property lines but from without.

Restrictions on the use of land represent an appropriate dividend on the investment others have made that has generated the economic value of an individual parcel. Students of real estate economics have identified the forces of value that push the economic value of a single parcel up or down. These forces are social, economic, physical, and political. Land-use regulations reflect the political and, to a lesser extent, the social forces of value. Does the enactment of a land-use regulation affect value? Absolutely. In both directions. The rezoning of a parcel of land from general agricultural to light industrial will change the economic value of the property; in all likelihood the value will increase. That land-use decision increased the value of the site. Note that the land itself did not change. The permitted use changed, and, therefore, the econonmic value of the property changed. When was the last time you heard a property owner say, "Because of rezoning, my land went from being worth $10,000 to being worth $100,000, but since it was the action of the planning commission and not some investment I made that increased the value, I`m writing a check to the city for $90,000"?

The political force of value is one of the riskes inherent in the ownership of real estate and it has upside as well as downside potential. To suggest that a decline in value resulting from the enactment of a public land-use limitation entitles a property owner just compensation is to ask for a floor under the risk of real estate ownership. Where, then, is the offsetting ceiling limiting the enhanced value generated from the same source? No property-rights pamphlet has advocated that exquitable exchange.

Does the enactment of a historic preservation statute, a wetlands protection law, or a downsizing ordinance ever reduce the value of an individual parcel of real estate? Certainly. But every day hundreds of government decisions affect individual investments of all kinds, and often adversely. What happens to the value of Lockheed Corporation bonds when McDonnell Douglas is chosen instead to build a new bomber? It goes down. What happens to the value of the local Ford dealer`s franchise when the city decides to buy Chevrolets? It goes down. What happens to the value of the utility-company stock when the state utilities commission refuses to grant a rate increase? It goes down. In every instance, a political decision by a public body acting in what in deemed the public interest exerted an effect on someone`s assets. Real estate owners have no inherent right not to be adversely affected by political decisions.

To return to the forces of value, the social, political, and economic contexts within which a property exists give it value. Of the four forces only the physical is contained primarily within the property lines. To claim that the adverse impact of public decisions (the political force of value) is somehow unwarranted, unfair, or undemocratic is to fail to understand (by accident or by design) the fundamental nature of real estate economics. The potential adverse impact of political decision is simply one of the risks inherent in the ownership of real estate.

This does not mean that a land-use decision that is fundamentally unfair is imposssible. Of course that can happen, and when it does it is incumbent upon the property owner to demonstrate to the decision-making body that what he/she loses as a result of those restrictions is much greater than what the public (for whom the public body is acting) has to gain. No one should dispute an individual landowner`s right to testify against his/her property being subject to a particular land-use constraint. But to object solely because of a claim of potential loss of value demonstrates a basic misunderstanding of the nature of real estate.

Those seeking to rezone their property (or oppose historic districting, environmenal restrictions, etc.) oftern proclaim some divine right to use their property to its highest and best use. Based on their orations, one could quickly reach the conclusion that highest and best use means the greatest return imaginable. That simply is not so. Highest and best use is a real estate appraisal term that has a very specific definition: Highest and best use is the use that, at the time of the appraisal, is the most profitable likely use to which the property may be placed. The word "likely" is key here. The first constraint on likelihood is what is legally permitted--i.e., what is allowed under land-use limitations. It would be a fundamental violation of appraisal practice to estimate the value of the property assuming a use not presently permitted unless it were probable that the landuse restriction would be changed. Just the possibility of current regulation being changed is not sufficient; the appraiser would have to demonstrate the probability of change. In other words, for the owner of an undeveloped forty acres currently zoned general agricultural to argue that the highest and best use of his/her property is as a suburban office park when that use is neither permitted by current restrictions--nor is it probable that those restrictions will be changed--is very simply misusing and misrepresenting the vocabulary of real estate. Highest and best use is not the maximum value imaginable; it is the most profitable use for which there is market demand and legal authority. If the maximum imaginable value were the standard, we would have adult bookstores, hazardous-waste disposal sites, steel mills, and sewage-disposal plants in every residential neighborhood in America.

Furthermore, highest and best use often includes noneconomic factors.

The most profitable likely use cannot always be interpreted strictly in terms of money. Return sometimes takes the form of amenities. A wooded urban site, for example, may have its highest and best use as a public park; or the amenities of living in a private dwelling may represent to its owner satisfaction that outweighs a monetary net rental yield available from rental to a typical tenant. In this time of increasing concern over the environmental effects of land use, environmental acceptability is becoming an addition to the highest and best use concept.1

But the concept of highest and best use is but one of the principles of value misrepresented by the property-rights advocates. There doesn`t seem to have been much attempt to understand either the theory or the practice of real estate valuation. There are, for example, two principles of real estate appraisal that are particularly germane to this discussion: the principle of balance and the principle of conformity. The principle of balance establishes that land value is created and maintained when there is an appropriate balance among types and uses of land in the affected area. Comprehensive plans and zoning laws are important elements in sustaining that balance.

The principle of conformity affirms that areawide values are greatest when there is a reasonable degree of land-use compatibility and architectural homogeneity. Conformity in use establishes and sustains the composite value of the neighborhood and the individual affected parcels within.

Property-rights advocates usually frame the debate in terms of property owners versus the government. Defining the dispute in that context conjures up visions of faceless bureaucrats in Washington dictating how far a garage has to be set back from Elm Street and deciding what color one`s house can be painted. An eighty-year-old homeowner can be forgiven for having that misunderstanding when that`s what he/she has been told. But the leaders of the property-rights movement know full well that is a bogus argument. Virtually all land-use land-use controls are enacted and implemented at the local level. It is not Washington bureaucrats but citizens from the town or the county who pass zoning laws, subdivision ordinances, and historic-district provisions. Even the National Register of Historic Places places no restriction whatsoever on what a property owner may do with his/her property. The owner, in fact, is free to demolish the historic structure.

But this property-owners-versus-the-government argument is a blatant misrepresentation of the issue in another sense. It is not for the sake of local government that land-use restrictions are put into place but rather, to protect the value of the investment of one property owner from the adverse economic impact of the actions of another. Well-drawn land-use controls may very well reduce the maximum potential value of a single parcel, but the composite value of the same of the affected properties will be enhanced. Property-rights advocates often call land use restrictions a "fairness" issue. In that they are certainly right. But it is not the fairness of local government potentially reducing the uppermost value of a single parcel; it is the fairness of allowing a single property owner to receive a windfall at the expense of his/her neighbors. Local government is unaffected by how far I swing my fist; but my neighbor is not.

In virtually every objective evaluation of the economic impact of land-use controls- and particularly of historic districts- the composite value of the affected properties was protected at worst and significantly enhanced at best. It is the difference between individual value maximization for a few property owners and value optimization for all of the owners.

But even if land use were viewed as the rights of the public versus the rights of the private property owner, that public is entitled to a return on the value that public expenditures largely created. It is the streets, sewers, water lines, sidewalks, curbs, streetlights, and parking lots that were, in the main, paid for with tax dollars that have created much of the value of any given property. The contribution of public expenditures to the value of private property was well recognized by the father of laissezfaire economics, Adam Smith, who wrote:

Good roads, canals, and navigable rivers, by diminishing the expense of carriage, put the remote parts of the country more nearly upon a level with those in the neighborhood of the town. They are upon that account the greatest of all improvements.2

Yet today roads, canals, and their contemporary infrastructure counterparts remain the greatest of all improvements for which the regulation of land use is an appropriate recompense.

There is another fact of economic life in which the economic interests of the individual and the economic interests of the individual and the economic interests of the public at large coincide. In economics it is the differentiated product that commands a monetary premium. Any good advertising agency, manufacturer, retailer, or service vendor will tell you the economic value of their product is enhanced by identifying and capitalizing on the differences between their product and the competitors`. Much land-use legislation, particularly that pertaining to historic preservation districts, has at its heart the identification and maintenance of the differences between that community and any other. It is that product differentiation that has created an economic premium--from which both the public and private sector benefit--from Charleston, South Carolina, to Guthrie Oklahoma, from Seattle, Washington, to Fredericksburg, Virginia.

It is easy rhetoric to proclaim that this country was built on the unencumbered rights of private landowners, that it is un-American to limit what an individual may or may not do with the land he or she owns, and that we need to return to the frontier days of the homesteaders who developed their land without the interference of Big Brother in their decisions.

In fact, certainly the most severe and limiting land-use restrictions ever enacted by the federal government were those placed on the homesteaders of the western frontier. To be able to lay claim to their 160 acres, the men and women of the western expansion had to clear, cultivate, and live on their land for five years. No current land-use control is that demanding. It wasn`t for financial gain that the Homestead Act legislated those restrictions. The federal government paid less than three cents an acre for each of those 160-acre parcels--an amount most homesteaders could have afforded to pay. A homesteader was not permitted the option of paying $4.50 instead of abiding by the land-use controls. The actions were required because of the recognition of the interrelationship of properties and the desire to meet the social, political, and economic needs of the sum of the landowners (and the nation as a whole) even if it meant restricting the freedom of the individual landholder.

The property-rights debate is about fairness, about equity. It is about the fairness of allowing a single property owner to adversely affect the values of a multitude of owners. It is about the fairness of one owner`s windfall against a group of owners` maintenance of value. It is about the fairness of a single individual destroying the differentiations within a community differentiations built up over generations--in order to create a copy of somewhere else. It is about the fairness of the owner of real estate demanding compensation if his/her asset declines in value because of a public policy decision when the holder of the Lockheed bond, the Ford dealer, and the owner of utility-company stock have no such protection.

In fact, land-use controls are mechanisms by which to optimize the property values of the majority of real estate owners; they are not instruments devised to deprive individuals of some imaginary property rights.

Adam Smith perceptively observed that "as soon as the land of any country has all become private property, the landlords, like all other men, love to reap where they never sowed." That doesn`t mean we are depriving them of rights when we tell them no.

Notes

  1. The Appraisal of Real Estate, The American Institute of Real Estate Appraisers, 7th Edition, Chicago, 1978.
  2. Adam Smith, The Wealth of Nations, Penguin, Harmondsworth, 1970.



Publication Date: July/August 1993



#Legal #ForumJournal
#Economics

Author(s):Donovan D. Rypkema
Volume:7
Issue:4