Sunday, September 30, 2018

What is land? It is not a product, but an ownership share of three-dimensional space

Is land an object that can be produced? The answer to this important question provides the foundation for properly analysing land and housing markets.

And the answer is no.

Land is not a newly-produced good of the type considered by standard economic theory. Instead, land is a bundle of legal rights held by the owner of a land title. Each land title refers to a unique three-dimensional location on the earth as described on a register of maps known as a cadastre. Together, the land title system is best thought of as a legal and financial instrument that carves up ownership and control of a nation’s finite three-dimensional space into smaller territorial containers.

Land is not the plants, animals, or even the soil, which can be produced. We know this because you can buy such objects produced within someone’s land container without buying the actual legal container itself. What is a farm but a location that produces plants and animals within their container and sells them to others? You can even put a house on a truck and sell it independently of the land title.

The legal and financial instrument of the land title provides a bundle of rights to owners via combined national, state, and local laws and regulations. A core right is to allow the title owner exclusive use of the space and to claim an income in the form of rent from others accessing the space. These rights are guaranteed and enforced by the relevant levels of government.

Another property ownership system

The land titles system shares the legal and financial control over the three-dimensional space within the boundary of a county. Each share of the nation’s land is identified on the cadastre, and the legal owner is identified on the database of tradable land titles.

Company shares (stocks) are probably the most similar system we have to land. Share systems carve up legal and financial ownership of a company, with each owner having a claim on the income generated by the real production that occurs within the boundary of the company.

Despite the common institutional design, most economists discuss the share market and land market in totally different ways.

When the market price of company shares increases no one says crazy things like “the supply of shares is not responding to demand”. It doesn’t make sense. We know that shares are not part of the real production economy for new goods and services.

But when we talk about land we forget that we are talking about a system of ownership claims. People say crazy things all the time, like “land supply is not responding to demand.” Huh?

There are only trades of financial instruments

In share markets, the supply curve is the ask price schedule of sellers, while the demand curve is the bid price schedule of buyers. In land markets the same price-dynamics of trading and speculating apply. There is no new land produced. All rights to three-dimensional space are already allocated to someone and the price is set by traders swapping those financial instruments back and forth.

But when economists say that the price of land is due to supply and demand they mean something completely different.

Economists pretend that land is a new product coming off the production line rather than an existing financial instrument. They confuse the ownership claim, the land title, with the production of new goods and services, like housing construction or the service of home occupation. While new homes can be made, new land cannot.

No one confuses the supply of Apple shares and the supply of iPhones — but call Apple shares land, and iPhones houses, and chaos reigns.

The fact that homeownership requires first owning a location (a financial instrument) in order build a house (a produced object) means that the land market primary determines whether new buyers can afford homes. It is like having to own Apple shares in order to buy an iPhone.

If the price of the bundled Apple-share-plus-iPhone became more expensive, fewer people would buy iPhones, creating to an iPhone affordability crisis. But the crisis would have nothing to do with the supply of iPhones.

Myth: Build up and no land is required

Some people argue that building taller buildings requires no new land, and hence higher density is a low-cost solution to housing affordability.

The economist Edward Glaeser makes such claims, which have been echoed recently by Australia’s Reserve Bank.
Although land is required to build an apartment block, this is a fixed cost – there is no marginal land cost involved with building higher on a given block.
But remember, the rights to all three-dimensional space are already carved up in the land titles system. If a title owner does not have the right to build above a certain height, say ten metres, due to zoning controls, it means that the rights to the space above ten metres in that location are retained by the government.

To build higher density requires a financial trade of the rights to the airspace above ten metres from the government to the title owner below. These rights can be sold by the government to the owner of the title below them, as they are in some places, or they can be given for free, as they usually are. But they are not valueless, or costless, as Glaeser and the Reserve Bank believe.

Think about it this way. If the three-dimensional space needed to build an extra storey of an apartment building is costless, then this should be true whether the space is used by building vertically into it, or horizontally into it.

I could, for example, start constructing on site, and then once above the ground, cantilever my building to occupy the free, costless, three-dimensional space that sits above the site next door. But when we think about it this way it becomes obvious that the space is owned and has a positive value. If the rights to that space are owned by the neighbouring title owner, then they can be sold at a positive value to the apartment developer so that they own the full territorial container in which they are building.

So why do many high-profile economists assume that this space is free?

In sum

The biggest mistake made in property market analysis is to ignore the fact that land is a share of the ownership of the three-dimensional space assets of a country. Pretending it is a newly-produced good or service will lead you to make fundamental errors in your analysis of land and housing markets.


  1. But Apple's production of iPhones doesn't depend on SEC permits linked to the number of shares on issue!

    The "bundle of rights" over "land" can be changed to permit more or less production of useful buildings.

    Take Camberwell Station in Melbourne. Should they be able to roof over the tracks to add some new shops? Or should that airspace be left as is to create a heritage feel?

    What about my house in the inner city. Should I be permitted to add a third storey? And the apartment building up the road, should they be allowed a 25th storey?

    I see the fight as over the allocation of bundles of rights to useful buildings vs other uses. Perhaps people talking about land supply as though land *can* be produced have in mind examples where the current use of those rights is relatively low value? (Hello to most of Canberra's parkland!) Cases where we could reallocate it to useful buildings at low cost. I doubt they imagine a large apartment building cantilevered over their roof!

  2. It is nevertheless more efficient use of space to obtain permission to build up, but as you point out, it certainly isn't cost free.

  3. "But Apple's production of iPhones doesn't depend on SEC permits linked to the number of shares on issue!"

    Nor is the number of planning approvals for new dwellings linked to the number of shares of the three-dimensional space. Indeed, the very nature of planning is to ensure that if a new building (or use) is proposed that it falls within the bundle of rights of a landowner. That is all. It doesn't constrain anyone proposing new uses or building them.

    It equivalent to checking that when iPhones are made their production complies with the rights of patent holders. If you fall within the rights, there is no cap on the number of iPhones, nor is there a cap on the rate of new dwelling supply in any Australian planning scheme I am familiar with.

    None of these planning rules determine how many landowners can build new homes at the same time, or how fast a single landowner can sell off-the-plan and develop. In fact, many planning schemes allow certain uses with no planning application (they are 'self-assessed'). If you build a type and size of building that complies with the certain legal conditions of your land rights, then you just build it (e.g. granny flats, many small subdivisions, etc).

    I think you are also missing the point about transferring/trading land rights. Just because someone gets a new land right doesn't mean they will immediately use it. After all, if that was the case, there would be no development sites left in any city. The city would already be built to the allowable planning limit on every site!

    I wrote about that here.

    And here

    Probably the best parallel is if you have the right to only one iPhone with an Apple share, but you (the shareowner) get to decide when to exercise that right. Since iPhones are becoming more expensive, delaying that decision can pay off. Indeed, the option to get the iPhone embedded in that share also increases in value. It is no obvious how giving shares to different owners changes any incentives to immediately take up the option and get the one iPhone.

    Design decisions about how the city should look and feel are very much a separate issue. They involve a transfer of land rights which constrain the type of future development in different locations (but not the rate of new development) in order to change over time the urban structure of different areas.

    My view is that the land owned communally should not be given away. For example, if you want to add a third storey to your house, you should pay for the right to do so from the community that currently holds the right to that space.

    Lastly, I find the way you frame the 'fight' interesting because it is not quite right, though very appealing/intuitive:

    "the fight as over the allocation of bundles of rights to useful buildings vs other uses"

    But rights are to space, not buildings. You can get the rights to the space without building anything. If you want buildings, don't give people free rights to space. Make them buy the rights from the community. Or simply change financial incentives so that the option to delay building within the planning rules becomes more expensive.

  4. In order to maximise their returns, the incentives of a small plot owner are different to those of a large plot owner.

    For the former, they simply want to to consume as much of the shared environment as possible. This causes negativity externalities which can simply be though of as a tragedy of the commons. This is why we need planning regulations.

    However, for a large plot owner, those externalties don't exist. In order to maximise their returns, they must carefully balance the amount of development and the preservation/enhancement of the shared environment.

    In other words, in an economy where all resources are optimally allocated, land rental values in aggregated will be maximised.

    This is more or less the findings of Stiglitz/Arnott in their paper "Aggregate Land Rents, Expenditure on Public Goods, and Optimal City Size"

    A more general/simlified model here.