Value Drivers: Land Use, Economic Principles & Ownership

Chapter: Value Drivers: land❓ Use, Economic Principles & Ownership

This chapter explores the fundamental value drivers in real estate, focusing on land use, economic principles, and ownership structure❓s. Understanding these drivers is crucial for accurate real estate appraisal and decision-making.

1. Land Use and its Impact on Value

Land, as a finite resource, is subject to competing demands and societal needs. Its utilization significantly impacts property values, influenced by market forces, regulations, and social considerations.

• 1.1 Scarcity and Intensification: The supply of land is inherently fixed. Increased demand leads to more intensive land use, impacting density and development patterns. This is a basic principle of supply and demand. As demand (D) increases with a fixed supply (S), the equilibrium price (P) increases. This can be illustrated graphically with a supply and demand curve.

  D↑, S = Constant => P↑

• 1.2 Conflicting Land Use Perspectives: Differing viewpoints on land use create conflicts.

  • Land as a Shared Resource: Some advocate for land as a resource benefiting all, emphasizing equitable access and environmental preservation.
  • Land as a Marketable Commodity: Others view land as primarily a commodity, prioritizing private ownership and unrestricted development to stimulate economic growth.
  • These viewpoints can lead to conflict, especially when considering externalities. A positive externality is a benefit conveyed to a third party from the use of a property (e.g. a community garden that also provides aesthetic value). A negative externality occurs when the use of a property negatively impacts a third party (e.g. a factory that generates pollution).

• 1.3 Land Use Controls and Regulations: Governments implement land use controls to regulate development and protect public interests.

  • Zoning Ordinances: These specify permitted land uses (residential, commercial, industrial) and development standards (density, setbacks, height restrictions).
  • Building Codes: These establish minimum construction standards to ensure safety and structural integrity.
  • Environmental Regulations: These address pollution, wetlands protection, and endangered species habitats, influencing development feasibility and costs.
  • Subdivision Regulations: These control the division of land into smaller parcels, ensuring proper infrastructure and planning.

• 1.4 Public vs. Private Ownership: Real property ownership can be categorized as public or private.

  • Public Ownership: Governmental bodies own properties for public benefit, such as roads, schools, parks, and utility systems. Publicly owned property is often not subject to real estate taxation. Land is often acquired through eminent domain.
  • Private Ownership: Individuals, businesses, or other entities hold title to properties, entitling them to certain rights and responsibilities.
  • The valuation of public property is often based on its use to the public rather than market value.

2. Economic Principles Governing Real Estate Value

Several economic principles underpin real estate value, influencing market dynamics and investment decisions.

• 2.1 Supply and Demand: As previously mentioned, this fundamental principle dictates that price is determined by the interaction of supply and demand. In real estate, factors like population growth, economic activity, and interest rates affect demand, while construction costs, land availability, and regulations influence supply.

  • Experiment: Track the change in average house price in an area when a major employer moves into the area and creates more job opportunities. You will likely see an increase in housing prices due to increased demand.
  • Formulas:
    • Price Elasticity of Demand (PED) = % Change in Quantity Demanded / % Change in Price
    • Price Elasticity of Supply (PES) = % Change in Quantity Supplied / % Change in Price

• 2.2 Utility: The usefulness or satisfaction derived from a property. A property’s utility is closely tied to its location, size, amenities, and condition. A property lacking utility will have little to no market value.

• 2.3 Scarcity: The limited availability of land, particularly in desirable locations, drives up property values. The scarcity of a property’s amenities will also drive up value.

• 2.4 Transferability: The ability to easily transfer ownership rights. Clear title, efficient legal processes, and low transaction costs enhance transferability and contribute to value.

• 2.5 Anticipation: The expectation of future benefits or detriments associated with a property. Investors often base their decisions on anticipated income, appreciation, or changes in zoning regulations.

  • Example: Anticipation of a new subway station being built nearby can increase property values in the surrounding area, even before construction begins.

• 2.6 Substitution: The principle that a buyer will pay no more for a property than the cost of acquiring an equally desirable substitute. This forms the basis for the sales comparison approach to appraisal.

• 2.7 Contribution: The value of a component part of a property is measured by its contribution to the overall value, not its individual cost. This explains why expensive upgrades may not always translate into a proportional increase in property value.

  • Formula: Δ Value of Property ≈ Δ Value of Component

• 2.8 Highest and Best Use: The most probable use of a property that is legally permissible, physically possible, financially feasible, and results in the highest value. This is a critical concept in appraisal, as it determines the basis for valuation.

  • Experiment: Identify a vacant lot in an area and analyze the legality, physical possibility, financial feasibility and the resulting value for various potential uses of that lot (e.g., a parking lot, a coffee shop, a small apartment building). Determine the highest and best use of the lot.

• 2.9 Agents of Production: The production of goods, services, and income depends on the combined effects of four essential economic ingredients:

  • Land
  • Labor
  • Capital
  • Entrepreneurial coordination

  A well-supported opinion of value can be derived through systematic analysis of each of these components, their interrelationships, and their relationship to the property as a whole.

3. Ownership Structures and Their Influence on Value

The way property is owned impacts rights, responsibilities, and ultimately, value.

• 3.1 Fee Simple: The most complete form of ownership, granting the owner unrestricted rights to possess, use, and dispose of the property.

• 3.2 Leasehold Estate: Ownership rights are separated through a lease agreement. The Lessor retains the fee simple interest in the property, while the Lessee has the right of use and possession for a defined period.

  • The value of a leasehold estate is dependent upon the lease terms and the prevailing market rents.
  • Formula:
    • Leasehold Value = Present Value of (Market Rent - Contract Rent)

• 3.3 Concurrent Ownership: Multiple parties own the property simultaneously.

  • Joint Tenancy: Features right of survivorship, where a deceased owner’s interest automatically transfers to the surviving owner(s).
  • Tenancy in Common: Each owner holds a separate, undivided interest in the property, which can be transferred independently.
  • Tenancy by the Entirety: A form of joint tenancy specific to married couples in some states, offering creditor protection.

• 3.4 Trusts: A legal arrangement where a trustee holds property for the benefit of a beneficiary. Trusts can be used for estate planning, asset protection, and privacy.

• 3.5 Business Entities: Properties can be owned by corporations, partnerships, or limited liability companies (LLCs). The choice of entity impacts liability, taxation, and management.

  • Example: A chain of fast-food restaurants may be held as a beneficial interest in a land trust or a limited liability corporation.

• 3.6 Impact of Ownership on Value: The chosen ownership structure affects value through factors like:

  • Transferability: Ease of transferring ownership interests.
  • Liability: Extent of personal liability for property-related issues.
  • Taxation: Tax implications associated with ownership and disposition.
  • Management: Complexity of managing the property and related decisions.

4. Value Theory

• 4.1 Classical School: Attributed value to the cost of production. Adam Smith suggested that capital, in addition to land and labor, constituted a primary agent of production. Value was created when the agents of production were brought together to produce a useful item.
• 4.2 Marginal Utility School: Links value to the utility of and demand for the marginal, or additional, unit of an item. Value is regarded as a function of demand, with utility as its fundamental precept. Marginal utility is the theoretical basis for the concept of contribution.
• 4.3 Neoclassical Synthesis: Successfully merged the supply-cost considerations of the classicists with the demand-price theory of marginal utility. Alfred Marshall compared supply and demand to the blades of a pair of scissors because neither concept could ever be separated from the determination of value. Market forces tend toward an equilibrium where prices and production costs meet.

Conclusion

Understanding the interplay of land use regulations, economic principles, and ownership structures is paramount for real estate appraisers and professionals. These factors drive property values, shape market dynamics, and influence investment decisions. By mastering these concepts, appraisers can provide accurate and reliable valuations, contributing to sound real estate practices.