Real property market


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Real property market

  1. 1. © The College of Estate Management 2006 Paper 0334V2-0 The real property marketContents 1. The nature of real property 2. The functions of the real property market 3. Efficiency in the market economy 4. Reasons for government intervention in the market economy 5. Efficiency in the real property market 5.1 Technical characteristics 5.2 Economic characteristics 6. The pricing of land and land resources 6.1 Land as a whole 6.2 Commercial rent 6.3 Non-homogeneous land and economic rent 7. The dominance of stocks over flows 7.1 The relative size of stocks and flows 7.2 Corollaries of the above analysis 8. Conclusion
  2. 2. The real property market Paper 0334 Page 3 1 The nature of real propertyReal property refers to a particular type of good – land or resources embodied in land.The point is that neither is physically movable. This characteristic distinguishes itfrom labour, capital and goods in general.Although the resources embodied in land are not movable, they are a form of propertywhich can be owned by some person or institution. What are actually owned are‘property rights’, often referred to as ‘interests’. To emphasise such ‘rights’, there isusually a written definition of the rights owned. Thus the real property market issimply the arrangement by which buyers and sellers of virgin land, agriculturalestates, industrial buildings, offices, shops and houses are brought together todetermine a price at which the particular property rights owned can be exchanged.Sometimes the market is formal (the London Auction Market), sometimes informal(introductions by estate agents, deals between principals). Indeed, it is not possible todistinguish the means by which people are informed from ‘the market’. Much realproperty, as with consumer goods and labour, is advertised in journals (the EstatesGazette and Daltons Weekly) and newspapers, all of which can therefore be said to bepart of the market. Thus ‘the real property market’ is simply an omnibus termcovering all transactions in real property, but with submarkets distinguishableaccording to special characteristics – City of London office blocks, prime shopproperties, houses in a given locality – with each fulfilling, albeit perhapsimperfectly, the basic functions of a market.Certain aspects of ‘property rights’ should be noted: 1. Rights can be separated or unified through the market mechanism. 2. Rights can be finely adjusted according to individual preferences, eg through restrictive covenants. 3. Rights only have market value when others can be excluded from enjoying them. Being therefore a legal concept, they have to be clearly defined. 4. Because real property is durable, rights existing in real property have a long timescale. Moreover, no problem of storing such rights exists, though there may be management costs. Real property rights, like stocks and shares, are therefore demanded as investment assets. Indeed, the real property market can now be regarded as a part of the wider investment asset market, its significance in this respect having increased in recent years.
  3. 3. The real property market Paper 0334 Page 4 2 The functions of the real property marketIn the market economy, exchanges take place on the basis of prices determined in themarket by the interaction of demand and supply. Because the formation of price iscentral to the functions of the market, we can define a market as any arrangement bywhich the buyers and sellers are brought together to fix a price at which goods can beexchanged.Allocating land resources and real property through the price mechanism, therefore,immediately poses three questions: 1. In what sense is there a ‘real property market’: ie what are its functions? 2. How efficient is the market in registering changes in demand and supply for the same kind of property by means of changes in a common price? 3. How does the market function through price changes to bring demand and supply into equilibrium (a) in the short run, (b) in the long run?We shall consider each question in turn.In any market, a price of a good is established which reflects current conditions ofdemand and supply. But the market does more than indicate. Because buyers andsellers respond to these price signals, it also motivates. In short, the price systemfunctions through the market.Thus we can break down the function of the real property market as follows: 1. To allocate existing real property resources and interests. Because land resources are scarce (that is, not unlimited in supply) they have to be allocated between the various uses and people wanting them, including both occupiers and investors. This is achieved by arriving at the equilibrium market price – the price which equates the resources (or interests) being offered for sale with what people wish to buy. Thus the market reflects preferences and allocates available supply accordingly. 2. To indicate changes in demand for land resources and interests. If, for instance, house occupiers switch their demand from rented to owner-occupied houses, this will be shown, other things being equal, by a relative rise in the price of houses for owner-occupation compared with houses for renting. 3. To induce supply to adjust to changes in demand. Changes in supply take time, and it is usual to distinguish between the short and the long periods. Since these periods are discussed later, we shall ignore them for the time being. Of course, such changes are subject to the imperfections of the real property market. Moreover, efficient adjustment to changes in demand and supply assumes that all interests are divisible and that there is a perfect capital market. Neither assumption is true. Office blocks come in large ‘lumps’ (though the emergence of property bonds and property unit trusts has helped to overcome this difficulty). Imperfections of the capital market may prevent a full response to preferences regarding interests. Thus a building society may not give a mortgage on a long-lease flat in the centre of a town, the would-be purchaser thereby being forced to go to a modern semi-detached freehold house in the suburbs. Or a speculative builder may be short of capital, thereby forcing him to lease the land instead of buying outright.
  4. 4. The real property market Paper 0334 Page 5 4. To indicate changes in the conditions upon which land resources can be supplied. Improved techniques in constructing high-rise buildings, for example, may make flats cheaper compared with low-rise houses and flats. 5. To induce demand to respond to changes in the conditions of supply. 6. To ‘reward’ the owners of land resources. Rewarding the owners of land resources is a by-product of the market. Such rewards are of two main kinds. First there is the return on capital invested. When a person looks for certain return without risk, eg freehold ground rents (FGRs), then the return corresponds closely with the opportunity cost, what that capital could have earned in the best alternative use, such as government stock. There is, therefore, little ‘profit’ element in such return. Second there is the return for risk. The yield from a land resource usually extends far into the future. Being a fixed factor, the reward on it will depend upon demand. Thus the return is largely in the nature of ‘economic rent’. It can be high, for example to people who own ‘land banks’ before an increase in demand, or it may be negative, for example to builders who have bought ‘land banks’ before a slump. In short, the return, ‘supernormal profit’, arises because of the risk attached to any fixed factor.To conclude, the function of the real property market is to establish a pattern of pricesso that, given sufficient time (the long period), land resources are allocated accordingto their most profitable (‘highest and best’) use relative to other land resources. Thisoccurs because competition in the market induces owners to switch resources to theuse which yields the highest net return. Should, however, any of the conditions of theperfect market (see below) not hold, the allocative efficiency of the market will beimpaired.
  5. 5. The real property market Paper 0334 Page 6 3 Efficiency in the market economyIn the mixed economy of the UK, land resources are still allocated mainly through themarket mechanism, with the government intervening where this mechanism could bedefective. The conditions of perfect competition would be required to achieve aPareto-efficient allocation of resources. The exact requirements may now be spelt outin more detail and contrasted with the actual conditions that prevail in the realproperty market.Perfect market competition involves: Atomistic market structure. There are many buyers and sellers, each too small to individually influence the prevailing price in the market. Homogeneous product. All sellers are providing goods that are identical (perfect substitutes) in the eyes of the buyers. Perfect information. Sellers are aware of the availability and prices of all factors of production and the profit opportunities within the economy, and buyers are aware of the availability and prices of all finished goods. Free entry of new firms. When profit beckons, new firms are able to enter the market without restriction and without incurring any costs that established firms avoid. Profit maximisation. It is assumed that sellers are motivated by the self- interested pursuit of as much profit as possible. No government intervention. The government at local or national level is assumed not to modify or supplement market forces in any way. Excludability applies. Goods are marketable in the sense that the benefits may be enjoyed by those willing to pay while those not willing to pay are excluded in a practical way from enjoying those benefits. No externalities. All costs and benefits of production and consumption fall upon buyers or sellers and do not spill over to third parties. Perfect factor mobility. All factor inputs are available to all sellers at perfect market prices, irrespective of location.It does not take much imagination to appreciate that the real property market differsin virtually every respect from this description of the perfect market. In addition,these conditions would only lead to one of many potentially efficient outcomes. Theprecise result will depend upon the initial distribution of resources in the economy.The pursuit of market efficiency may conflict with the distributional goals of society.
  6. 6. The real property market Paper 0334 Page 7 4 Reasons for government intervention in the market economyThe statement of the above conditions suggests that intervention by the government inthe allocation of resources by the market occurs where the following considerationsapply: 1. It has superior knowledge to private individuals. Thus a large-scale, comprehensive, controlled and well-planned approach to economic decision making may produce less uncertainty about the future and fewer piecemeal solutions than the independent decisions of individuals. 2. There is imperfect competition due to a limited number of sellers or a differentiated product. Government intervention can overcome imperfections, rid the market of supernormal profits and contribute to the attaining of a more efficient allocation of resources. 3. The mobility of factors of production can be improved. Mobilities can be increased by regional policy, by policies which remove barriers hindering urban renewal, by compensation to tenant farmers for improvements they have carried out, etc. Paradoxically, other government policies, particularly rent control, may hinder factor mobility. 4. Social costs and benefits diverge from private costs and benefits. 5. Certain satisfactions cannot be adequately priced in a market, the government having to provide the facility itself, such as defence, streetlighting, where non- excludability applies. 6. Output of the good or service can only be pushed to where marginal benefit equals marginal cost if the full or extra cost is covered by taxation, for example bridges, parks, drainage, fire services. 7. There is an unacceptable degree of inequality in the distribution of income. Greater equality in the distribution of income is secured by the system of taxation. Income tax is progressive (the higher the income, the higher the rate of tax), thus redistributing income from the richer to the poorer: capital gains tax, inheritance tax, etc have a similar effect. 8. Intervention to achieve greater equity (7 above) may itself create allocative inefficiency which may warrant secondary intervention. Thus private rent control combined with state provision of housing was probably less inefficient than private rent control on its own.
  7. 7. The real property market Paper 0334 Page 8 5 Efficiency in the real property marketSince the market is essential to the functioning of the price system, a defective marketmechanism will impair the efficiency with which resources are allocated through theprice system. We therefore have to ask: how efficient is the real property market inregistering the effect on price of changes in demand and supply?The efficiency of a market depends on both technical and economic characteristics.5.1 Technical characteristicsPhysical conditions should be such that price differences for the same commodity indifferent parts of the market are eliminated easily and quickly. This comes about bybuyers moving to cheaper parts of the market and sellers moving to the dearer. Forthis to happen, however, both buyers and sellers must have up-to-date knowledge ofthe prices ruling in different parts of the market and base their actions solely on theseprices. Moreover, dealing costs should be small relative to the value of thetransaction.Now when we look at the real property market, we find factors which not only makeit difficult to obtain up-to-date knowledge but also lead to dealing costs beingrelatively high. As regards the first, knowledge tends to be obtained infrequently andlimited geographically.Nor do we overcome the difficulty of lack of knowledge simply by saying that it canbe overcome by paying for advice. Because of differences of site, construction andage, most units of real property have special characteristics, making ‘grading’, themost efficient form of description, difficult.Nor, owing to their great heterogeneity, can a professional valuer fully assess theirrespective merits. To some degree, therefore, his valuation is subjective. Thus, unliketransport costs, costs of obtaining knowledge are not absolutely certain, and apurchaser would normally go to the trouble of making a personal inspection anddiscussing with his professional adviser the weight to be given to specialcharacteristics.Except for the difficulty regarding the uncertainty of information costs, the cost ofobtaining knowledge, estate agents’ fees and legal costs involved in the actualtransfer are, in principle, no different from the costs usually incurred in transportinggoods within the market. Thus they have the same effect as transport costs: if they arehigh relative to the value of the commodity dealt in, they tend to separate marketsgeographically or, at least, to reduce their sensitivity to small changes in demand andsupply.In practice, therefore, the real property market is not one market but is divided into anumber of separate markets. Moreover, while some markets are quite distinct (egurban housing and Scottish grouse moors), others are intimately related andoverlapping (eg houses and shops can be sold for both occupation and investment).Some, where institutional investment demand dominates, are national (eveninternational) in coverage (offices and prime shop property). Others, where demand islocal, tend to be divided geographically into submarkets (owner-occupied houses andseaside hotels). Moreover, even within these markets or submarkets, differences inrent persist, changes in demand not being fully effective until leases have expired.
  8. 8. The real property market Paper 0334 Page 95.2 Economic characteristicsIn addition to its physical features, we must examine the market’s economiccharacteristics particularly as regards the extent to which competition prevails. Wehave to ask: is there freedom of entry into the market? Does the market consist ofmany buyers and sellers, each so small that no one can exert monopsony (buyer) ormonopoly (seller) powers?Generally speaking, there is freedom of entry into real property markets, resulting inmany buyers and many sellers. But we must also recognise that certain conditionsmake it easy for an owner to gain some monopolistic control. Such conditions are: 1. The geographical divisions of the market lead to imperfect competition through local markets. 2. The imperfection of the capital market may prevent would-be buyers from borrowing the large sums required for certain purchases, such as multi-storey office blocks. 3. The spatial fixity of real property puts certain site-owners in a strong position relative to a buyer.To summarise, therefore, prices are the signals which indicate changes in theconditions of demand and supply. Where markets are defective, the price signalswork at less than full efficiency, and adjustments in supply and demand are sluggish.Relatively high costs of dealing, incurred either in obtaining knowledge or in thenecessary legal procedures, restrict the extent to which small signals can motivateresponse. Furthermore, any limitation of the market localises demand and supply,making it easier for imperfect competition to exist.Nevertheless, by and large, prices do respond, albeit somewhat sluggishly, to changesin market conditions; given sufficient time, the necessary adjustments to supply anddemand do take place. How these adjustments come about through the mechanism ofthe market will now be examined.
  9. 9. The real property market Paper 0334 Page 10 6 The pricing of land and land resources6.1 Land as a wholeUndeveloped land, or ‘pure’ land, refers solely to natural resources and space. Thusland as a whole, that is the earth’s land surface, can be regarded as being fixed insupply. Since the total supply of land is the same whatever its earnings, itsopportunity cost is zero. Earnings represent economic rent.Certain points should be noted as regards this general statement: 1. To say that the earnings of land are a surplus over opportunity cost does not mean that payments do not have to be made for land. Price still performs the vital function of rationing scarce supply among competing uses. This is necessary to ensure that, in each location, land is put to its highest and best use according to the preferences of consumers and society. 2. It follows from 1 that the supply of land can never be regarded as fixed from the viewpoint of any one use (unless it can only be used in one way). Additional supplies can always be bid from other uses if the proposed new use has a higher value than the existing use. 3. Except in the purely technical sense of space, additional supplies of land can always be created in response to additional demand by a more intensive use of existing land. 4. The fact that the earnings of land as a whole are entirely demand-determined is important from the point of view of land taxation – the land will still be there no matter how high the tax. In other words, a tax on pure land has no disincentive effect on the supply of land. Economic rent can be taxed away entirely. This is the basis of taxes on land, for example petroleum revenue tax, development land tax. But two further points should be noted: 5. Unless all forms of land used are taxed equally, the pattern of land use will be distorted. Whether such distortion is good or bad on balance can only be decided by: a. a comparison with the inevitable distortions produced by different taxes; b. spillover benefits and costs; c. one’s political views. 6. Costs of production include normal profit, that is, what is necessary to keep the entrepreneur in the current line of production. But the size of normal profit may be uncertain, and taxes may overlap supernormal profit and fall on normal profit.
  10. 10. The real property market Paper 0334 Page 116.2 Commercial rentCommercial rent is simply a periodic payment for the hire of land. Normally, there iscompetition for land between the different potential users. The rent of land, therefore,as with rewards to other factors of production, is determined, in the absence of anygovernment interference with free market forces, by the interaction of demand andsupply.The demand for land as a factor of production is a derived demand – it is wanted forthe contribution it can make to a final product. Moreover, it has to be combined withother factors, labour and capital, to produce the goods that are wanted. Thus thequantity of land a firm demands depends upon: 1. its productivity; 2. its price relative to other factors; 3. the price of the final product.The sum of the demands for land by the individual firms will give the industry’sdemand for land.As regards supply, as the rent of land in a particular use rises, it will be surrenderedby less profitable uses. In short, more will usually be supplied the higher the rent.Therefore, although the total supply of the land is fixed, the supply curve of land withrespect to specific uses will be upward sloping.The interaction of demand and supply will give an equilibrium market rent for thistype of land. Competition will have ensured that at this rent it goes to the highest andbest use.Up to this point we have talked as if all land is of equal quality, ie as if land ishomogenous. Obviously this is not the case and so now we relax this assumption.6.3 Non-homogeneous land and economic rentIn practice, land varies in quality. Thus agricultural land differs in fertility, climate,altitude, topography and accessibility to the market.Consider a piece of land which produces 2½ tonnes of wheat per acre. There will beless fertile land but, we will assume, such land will still be used for growing wheatprovided it yields 1½ tonnes per acre. This latter land just earns its transfer cost, theminimum it has to earn to be kept in its present use; it is said to be marginal asregards wheat-growing. In contrast, the 2½-tonne land yields 1 tonne per acre abovethe marginal land; this 1 tonne is an economic rent resulting from its greater fertility.The same argument applies to urban land. Different characteristics, such asaccessibility, the physical condition of the site and institutional restrictions(development plans and covenants), give rise to differential rents. Shops in OxfordStreet and offices in the City of London all earn a high economic rent as a result ofthe high commercial rents which they command.Whereas land refers to natural resources, land resources have been defined as ‘thetotal natural and man-made resources over which possession of the earth’s surfacegives control’. That is, land resources are equal to the natural content of land plus anyimprovements attaching to or incorporated in the land. Indeed, when we talk about atransaction in land, we are usually referring to land resources. In agriculture, forinstance, land would include the farmhouse and buildings, the fences and watersupply, while a freehold residence is the land plus all the fixtures on the land – thehouse, conservatory, fishponds, swimming pool, fences, and so on.
  11. 11. The real property market Paper 0334 Page 12Price in the market is determined by demand and supply. In economic analysis it isusual to allow for the fact that changes in supply take time by dividing time into threemain periods (Figure 1).If demand increases from D to D1 in the ‘momentary period’, no adjustment of supplyis possible (Sm); in the ‘short period’, supply can be altered by engaging morevariable factors (Ss). Eventually, however, in the ‘long period’ supply can beincreased by adding to fixed capital, thus combining the factors of production in theirbest proportions (SL). The price of the product changes from OP to OP1, OP2 or OP3according to the time period. FIGURE 1 The effect of time on the conditions of supply
  12. 12. The real property market Paper 0334 Page 13 7 The dominance of stocks over flows7.1 The relative size of stocks and flowsWhile not incorrect, the general analysis of the formation of price over time suffersfrom two main weaknesses when applied to individual goods:1 The time taken to achieve the long period situation varies considerablyThe full response of supply to a rise in the price of buildings usually takes a very longtime. The various interests in a site required for redevelopment have to beamalgamated (usually by acquiring leases), planning permission has to be obtainedand any compulsory purchase orders subjected to time-consuming procedures. Thismeans that, when applying the usual time period analysis to land resources, we haveto recognise that for a considerable period of time we are virtually dealing with afixed stock. Thus changes in demand will tend to be more significant than changes insupply in determining market price.2 No allowance is made for the size of stocks of existing goods relative toflows of new goods coming on to the marketWith most goods we do not have to pay much attention to this. Because their life isrelatively short, existing goods (the stock) have to be frequently replaced by newsupplies (the flow over a period).Take cars, for example. Other things being equal, any increase in the demand for carswill, in a free market, push up the price. Extra imports may help to meet thisadditional demand. But if manufacturers consider that the higher price is likely to bepermanent, they will eventually add to plant so that the supply of cars coming on tothe market increases. This flow of new supplies will be significant relative to thesupply coming on to the market from existing stocks, and will thus be a maindeterminant, with demand, of price.But the position is somewhat different with certain goods, such as ships, aircraft, andland resources. Because such goods are so durable, stocks of them accumulate overtime. As a result, new flows on to the market (additions, say, per annum) are small orinsignificant in comparison with the supply to the market coming from existingstocks. As a result, new supply has relatively little influence on price: for all practicalpurposes, supply from old stock dominates the market.Two qualifications, however, should be made. First, it is the turnover of old stockwhich is really significant. Second, over the years, accumulated flows affect the sizeof stocks, and have their effect in this way. But the possibility of this is very limitedin developed city centres.Price, therefore, is largely determined by demand; new supplies largely follow thisprice, rather than having much influence in determining it. The position issummarised in Figure 2.
  13. 13. The real property market Paper 0334 Page 14 FIGURE 2 The dominance of the stock of real property over its priceAn illustration from housingWhen the stock of owner-occupied housing units in the United Kingdom wasapproximately 15.6 million, the turnover of this stock each year, about 5% or780,000, was large relative to the flow of additional units being produced each year,on average 180,000 for the period 1987–1991. Indeed, in areas, like Greater London,which are surrounded by a green belt, practically every house coming on to themarket is from the existing, and almost fixed, stock of houses.In such a situation, demand determines the price of houses. For example, let usassume an increase in the demand for living accommodation. In the short run,existing dwellings are used more intensively, perhaps by a decrease in ordisappearance of the number of vacant dwellings, an increase in subtenancies, adoubling up of families, an increase in the number of persons per room. Eventually,the prices of existing accommodation units will rise (Figure 3).But since the flow of new houses on to the market is insufficient to affect the supplysignificantly, the higher price of existing houses will represent the price of all housesin the market. Any newly built house which comes on to the market will be sold at thehigher price, P1. In other words, the price of new houses is determined by the price atwhich existing houses sell.The price paid for land for new housing is thus the residual between what the newhouse will sell at (determined by the demand for old houses) and what it costs tobuild, including normal profit. Take, for instance, a builder bidding for an odd site inLondon on which to erect a house. Suppose similar old houses are selling for£120,000, and that he estimates that it will cost him £80,000 (including his normalprofit) to build. He can therefore afford to bid £40,000 for the land, and indeed willhave to if he is to secure it in competition with other builders.
  14. 14. The real property market Paper 0334 Page 15 FIGURE 3 The effect of an increase in the demand for accommodation on the price of dwellingsBecause houses take time to build, this explanation of price determination applies inall localities in the short period. Where building land is available, however, the highprice offered for existing and, therefore, new houses, will encourage builders to erectnew houses so long as the production cost of new houses is less than the price of oldhouses.Over time the flow of these new houses on to the market will be sufficient toinfluence the stock of houses, and the price of old houses will tend to fall. Thisprocess is most noticeable in districts where the supply of building plots is plentiful,for example new towns, overflow towns (Swindon, Ashford, etc) and on the fringeland of certain towns where planning permissions have been freely given to permitexpansion.In the long period, therefore, these new flows affect the price of old houses and, whenthe prices of old and new houses coincide, the cost of building new houses does affectthe price. In other words, the long-period supply curve of houses is now likely to bemore gently upward sloping – but it may take a very long time before this happensand, where cities are surrounded by green belts which cannot be built on, the price ofhouses will tend to be dominated by demand.7.2 Corollaries of the above analysis1 Current construction costs are not relevant in determining prices and rentsof real propertySuch costs include the price of land, building material and labour costs, and the costof builders’ borrowing, for example on overdrafts.As regards the price of land, it is sometimes stated, for example, that the high cost ofland is responsible for high house prices, thus limiting homeownership. Our analysisgives scant support to this view. An increase in demand for houses causes the price ofold houses to rise. This enables builders to bid more for land – up to the differencebetween what they can sell a new house for (the price of similar existing houses) andthe cost of building (including normal profit). Thus, in our example, if the price ofhouses rose to £200,000 and building costs remained unchanged, £120,000 could nowbe paid for the land.
  15. 15. The real property market Paper 0334 Page 16Of course, to the individual builder, the price of land is a cost; as with buildingcomponents, he has to pay the going competitive market rate to obtain it. But the‘individual’ view that land prices should be controlled because they are too high putsthe cart before the horse. What we have done is to examine the underlying factors –the demand for houses – which determine the price of land from the point of view ofbuilders as a whole.Evidence in support of the above analysis is contained in the Housing andConstruction Statistics 1981–1991. In 1989 the average price paid for housing land inEngland and Wales was £435,629 a hectare. In the first half of 1991 it had fallen to£308,774 and builders who had acquired land banks at 1989 prices were showing aloss. The reasons for the fall in land prices were the fall in house prices and the rise incosts; current conditions make it clear that ‘land prices are determined by houseprices rather than the other way round’. This is an example of the inductive method ofestablishing hypotheses as opposed to our deductive method.Three other points should be noted: a. It is what would be the builder’s abnormal profit which represents the maximum he can bid for land. Unless this is sufficient to attract land from its next best use, for instance agriculture, he cannot build. b. Since the price of land is determined by the demand for housing, controlling the price artificially would not result in house prices falling. Instead the surplus return would simply go to somebody other than the landowner, eg the first purchaser, or local authorities who acquire land compulsorily at existing use values. Furthermore, controls would upset the allocative function, ensuring that scarce land is used for its highest and best use, performed by market prices. Artificially low prices, maintained by some form of price control, would lead to a ‘wasteful’ demand for land in less profitable uses. c. As the price of houses rises, land costs form a greater proportion of that price. Thus, in our earlier example, when the house sold for £120,000, the land cost formed one third of that price; when the house rose to £200,000 through increased demand, the land cost rose to three fifths.Similarly, we have to ask whether a rise in the cost of building materials and labourwill put up the price of houses in the short period. The answer is that, where buildingland is earning an economic rent (that is, its price is above its ‘transfer’ or next-best-use price), a rise in building costs has no effect on the current price of houses. Sincethe supply of houses comes mainly from existing stock, their price in the market isdetermined by demand. A rise in building costs, therefore, simply means that thebuilder has a smaller margin to bid for the land. Thus, in our original example, hadbuilding costs risen by £8000, his maximum bid for land would have been only£32,000.Price changes in 1982–3 support this argument. Whereas average construction costsrose by approximately 7%, the price of new dwellings rose by only 1% and the priceof housing land by 13%. On the other hand, in 1988, the price of new dwellings roseby 12% and construction costs by 11%, but the price of housing land rose by 47%.The effect of a rise in the rate of interest must be considered from the viewpoint ofboth the builder and house purchaser. On the supply side, the builder has to pay morefor his overdraft but this will affect only what he can bid for the land, not the houseprice. It is on the demand side that the rise in the rate of interest has the major effect –the higher cost of borrowing on mortgages leads to a decrease in demand, and thusthe price of houses will tend to fall!
  16. 16. The real property market Paper 0334 Page 172 A tax may be imposed on the economic rent of land resourcesSince the short period in practice tends to be very long, the government can impose atax on land resources up to the level of economic rent they earn, since this will makeno difference to their supply. It should be noted, however, that land resources includecapital. If the tax should be so large as to overlap on the transfer earnings of capital oron normal profit, further building will not take place.3 Developers can be required to cover some of the social costs of projectsA different type of ‘tax’ may be imposed. So long as it does not cut into normalprofit, a local authority can, as a condition of planning permission, require developersto include in their schemes either houses (although these are less profitable thanoffices) or improvements to the infrastructure, eg sewers. The first condition islargely based on political–social grounds; the second can be regarded as coveringsome of the social costs of the scheme. Such a tax is known as ‘planning gain’.4 An increase in transport costs will increase economic rents at the city centreIncreased transport costs will make houses on the periphery of a city a poorersubstitute for houses at the centre. This will diminish the extent to which the increasein new flows of houses can be significant compared with the existing stock. Thus thedifference in economic rent between the centre and the periphery will increase ashouse and therefore land prices rise at the centre, and will tend to persist. 8 ConclusionThe real property market differs substantially from the benchmark of the perfectmarket. This suggests that inefficient allocations of society’s scarce resources occurin the property sector, providing a justification for limited State intervention.However, market forces do shape the allocation of property resources through theprice mechanism.A striking feature of the property market is how the stock of property is usually solarge that its turnover dominates the flow of new build coming on to the market.
  17. 17. The real property market Paper 0334 Page 18SELF-ASSESSMENT QUESTIONS 1. Draw demand and supply diagrams to show how the market: a. allocates owner-occupied houses; b. indicates a change in demand towards owner-occupied houses and away from rented accommodation; c. causes supply to respond to (b); d. would indicate improved techniques in housebuilding; e. causes demand to respond to (d). 2. Government intervention takes the form of: a. physical controls; b. taxation and subsidies; c. government production. Give examples under each heading from land resource use. 3. The study paper states that a site-owner may enjoy monopoly strength. Explain briefly how this can occur in a comprehensive development. How might a government react? 4. Use the analysis of the nature of the real property market to suggest ways in which it can be made more efficient in allocating land resources. 5. Average price of Average Average price private sector housing Year construction of new dwellings land at constant costs average density 1 100 100 100 2 109 102 104 3 119 107 118 Comment briefly on the above index figures. 6. What do houses and government stock have in common in the determination of their prices?