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Land prices are not simply a matter of supply and demand

By Bryan Kavanagh - posted Thursday, 4 August 2016


So, why then is it always said that high or escalating land prices are simply a function of supply and demand? This may be so to a lesser extent, but the main determinant of the price of land is the quantum of its rent which has not been captured by government in real estate rates or taxes. If the government takes more of the site rent, the land price will be less and, in the case of a leasehold land system where virtually all the land rent is collected, the land price will be close to zero.

It is not well known that there is biblical injunction that land must be held on a leasehold basis:

“The profit of the earth is for all.” – Ecclesiastes 5:9

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“The land shall not be sold …” – Leviticus 25:23

But Jew and Christian alike prefer to ignore biblical economics, presumably in order to generate higher land prices, viz, the private capitalisation of uncaptured land rent. For whom is this land price, a pathology in biblical terms, the most profitable? Is it not banks who lend against the security of the combined twosome, namely, the price added by improvements together with the price of the site? It would not appear to benefit those who purchase homes, factories, shops or offices for private or commercial use that land prices are high, but it will certainly assist real estate investors who purchase with the intention of making a profit: “Buy land, they’re not making it any more”, said Mark Twain ironically.

Nor does it benefit other than ‘investors’ if land prices are permitted to escalate into unnatural bubbles by taxation privileges granted to investors by way of low municipal rates or land tax, taxation concessions on realised capital gains, or the ‘negative gearing’ of investment real estate, and so forth.

So, do we have a problem with the land price component in the valuation of real estate? We’ve learnt that it is not determined merely by supply and demand, but mainly by the extent to which its economic rent (unearned income) is captured for revenue by government. This appears to be novel and unknown to most economists.

Therefore, the price of land remains nebulous to those not skilled in land economics. If governments increase the property tax in the US, or rates and land tax in Australia, the land price actually decreases. Should a real estate valuer therefore qualify his/her report to this effect? What if taxation privileges make land an object of investment, rather than of productive use? Is land price indeed pathological? If land prices become inflated into a bubble, such as at present in Australia, surely a valuer must qualify his/her professional report to the effect that if the bubble were to burst, or if real estate taxation privileges were to be withdrawn on capital gains or negative gearing, then the valuation would need to be adjusted lower.

The replacement prices of buildings are known and their depreciation rates may easily be established to assess their added price, because they are of a capital/created wealth nature, but is the price of land–a value by obligation rather than of substantive wealth–a true market price within a real estate bubble?

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The valuer must resort to his/her catch-all disclaimer: the ‘valuation’ is the market price as at TODAY. It cannot be taken to hold true tomorrow, nor at any other time in the future, due to myriad affects on the price of the land component, much of which may disappear overnight.

What particularly is the threat to any assessment produced within a land price bubble? How will banks be affected when that bubble bursts? What is the bank’s liability for drawing up mortgages on the ‘security’ of valuations produced during a bubble, as at present in Australia? If fraud has not been involved in banking’s risk management in recent years, negligence most certainly appears to be. The only defence left to bankers is to deny the existence of bubbles – at least until they have burst. [!]

Whilst purchasers of real estate at inflated prices want to see their land prices remain inflated, their children, in their endeavours to buy a home for themselves will be less so-inclined. Although generational discord on the point has grown enormously, it will resolve itself in the eventual collapse of Australian land prices, as is being tentatively seen in all states and territories except New South Wales and Victoria. The media is unsure about land price, so this will be reported as a collapse in ‘house’ prices.

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About the Author

Bryan Kavanagh is a real estate valuer and associate of the Land Values Research Group.

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All articles by Bryan Kavanagh

Creative Commons LicenseThis work is licensed under a Creative Commons License.

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