Pricing upzoning: The great debate

Upzoning privatises public space and governments should not give it away for free

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Airspace can be valuable real estate - don’t give it away for free!

Recent insider dealings of politically connected property owners nearly got them an $8 billion windfall when their land in the greenbelt around Toronto, Canada, was announced to be upzoned. The political storm that ensued after the details emerged led to a rapid backtrack.

These types of decisions were no surprise to me. I have studied this exact issue before. Here’s a taste.

Using micro-level relationship data from multiple sources, we compare the relationship-network characteristics of landowners of comparable sites inside and outside the ULDA areas, finding that ‘connected’ landowners owned 75% of land inside the rezoned areas, and only 12% outside, capturing $410 million in land value gains out of the total $710 million from rezoning. We also find that engaging a professional lobbyist is a substitute for having one’s own connections.

Pricing upzoning to avoid these gains to corruption and political influence has become very relevant in Australia. The final report of Victoria’s Independent Broad-based Anti-corruption Commission’s (IBAC) Operation Sandon investigation into corruption in the planning system was recently released.

Section 4.3 of that report noted the corruption incentive from the high value of gains to private property owners from upzoning decisions. The report quotes a guy who wrote a book about grey corruption saying that pricing these gains

…decreases the incentive for corruption […] because it greatly reduces the payoff from it. Even if the planning system is manipulated in favour of a landowner, their payoff is only marginally increased.

Corruption risk is only part of the picture, however.

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In a new Forum article in Housing Policy Debate, Josh Gordon and I argue that the market value of property rights granted by upzoning has been overlooked in current housing policy debates and that this is a major problem

Our paper is Land as airspace: How rezoning privatizes public space (and why governments should not give it away for free). A free pre-print version is here.

Upzoning is often thought to have no budgetary cost and hence is an attractive housing policy. Whether or not it actually makes housing cheaper, the policy is not costless. Upzoning involves the de facto privatisation of public space, as property owners are able to build into what is either public, or quasi-public, airspace. These rights created by upzoning can be priced, and the budgetary cost is therefore exactly the market value of those property rights.

As we explain:

This view shows that rezoning to provide rights to airspace for existing landowners is not costless. It involves transferring valuable property rights from the public to existing private landowners for free, creating a more unequal distribution of property rights ownership without necessarily generating faster housing development.

The four discussion articles in response to our article are:

1. Airspace Rights and Affordable Housing Supply, by Casey J. Dawkins.

2. The Case of Mass Upzoning, by Minjee Kim.

3. An Unpersuasive Argument for Selling Development Rights, by Paavo Monkkonen.

4. Response: It’s Always About the Context, by Harley Etienne

Our response to these discussion articles is Pricing Upzoning: A Reply to Critics. A free pre-print version is here.

Please enjoy them all.

To summarise, our main arguments are as follows.

• Upzoning provides additional property rights to current property owners, akin to providing them with “airspace” rights.

• These rights have a market value that could be priced.

• Unpriced upzoning has a budgetary cost due to this foregone revenue.

• The initial allocation of residential property rights in most countries is highly unequal, and thus unpriced upzoning will accrue to current property owners, exacerbating inequality.

• The alleged housing benefits from upzoning rely primarily on the idea that it will significantly increase the rate of supply, and thereby lower house prices and rents for non-owners. However, this claim is questionable, and existing evidence suggests it will not occur.

• There are many effective policies to price upzoning or otherwise achieve public benefit from upzoning, and these should be undertaken.

The main response in the discussion articles was to argue that we have the evidence wrong on the effect of upzoning on housing supply and prices.

Sure, some studies find small local effects on prices or rents when new buildings are completed. We argue, however, that the total supply across all potential locations in an urban region may not change, even if upzoning shapes which locations get into the supply pipeline sooner, since the rate of supply in an urban region is primarily determined by the absorption rate.

A simplistic view, that the only thing holding back property owners from flooding the market with new homes is restrictive zoning, is not supported by the evidence, nor is it consistent profit-maximising for property owners. Property owners have strong incentives to delay housing development, even in the absence of zoning, since housing development is irreversible and homes sold today cannot be sold tomorrow.

Auckland’s city-wide upzoning was cited as evidence that we got this wrong, but this case study is something I’ve looked at in detail and even after some back and forth, find much of the analysis uncompelling given the methodological issues.

Another response was the idea that single-family (detached housing) zoning is somehow “racist”. There is no doubt that racial politics historically influenced planning regulation in the United States, as it did many regulations. But we allocate homes by price, not by race, and in most Anglo-Saxon countries single-family zoning proliferated initially in racially homogeneous contexts – its spread and popularity are due it the desirability of that housing form (among racial minorities too), not racial animus.

We also note in our reply that because new housing generated through upzoning is likely to be relatively expensive in local contexts

to the extent that race and class correlate, as they do in the United States, this is unlikely to generate much new racial integration, certainly not in the short-term.

Another criticism was that rights to airspace, or rights to additional development, are not fundamentally owned by the public and able to be priced, since they are actually private rights that were first ‘taken’ by the public through planning systems. As Casey Dawkins wrote in his response article:

Murray and Gordon’s critique of the privatization of airspace rights implicitly assumes that land use rights are public rights that are given away, rather than private rights that were originally taken by the public.

Yet the very fact that systems for capturing the value of upzoning already exist in some form, such as inclusionary zoning or airspace rights, suggests this is not a legal or real barrier to pricing development rights from upzoning. Moreover, as we explain in the Forum article, property rights are socially negotiated and limited by existing law, or as we say, “zoning does not impinge on a landowner’s property rights; rather, zoning defines property rights.”

In addition to these arguments, there are two big ideas that came up in the response articles that I want to expand on further here.

1. Bribing existing owners with upzoning is apparently a good thing

2. Pricing property rights from upzoning slows down supply

Bribing existing property owners is good, actually

Minjee Kim suggested that mass upzoning “can be seen as the public sector using air space as currency to buy out private homeowners who have been the fervent gatekeepers of their neighborhoods.”

This is exactly why unpriced upzoning is so perverse as a policy agenda, especially for those on the left of politics.

Somehow, in the context of rising housing unaffordability, where many property owners have become very wealthy as prices have risen, the ostensible solution is to grant these property owners further economic windfalls, exacerbating the wealth divide.

Amazing.

We noted the politics of pricing upzoning development rights is not easy.

There are powerful vested interests who lobby continuously for unpriced upzonings and who would fight vigorously against any attempt to curtail that arrangement (see e.g., Archer, 1976). In fact, it was precisely the point of our article to make this dynamic clearer to the public and to researchers, and to alert them to the large public financial costs implied by granting airspace rights cheaply or free. As we noted, based on the figures from policies that price upzoning in the Australian Capital Territory (ACT), around AUD$19 billion could be collected annually in Australia were such policies adopted across the country (Murray & Frijters, 2022). These are not small sums and indicate what might be possible in other countries.

We also noted that these financial interests are partly why confusion persists.

It is arguably because of these large financial stakes that we see so much confusion on this topic. Indeed, in some places, a central purpose of so-called YIMBY groups has been to argue for more favorable upzonings for developers, especially in the context of local council meetings, and to obfuscate the public costs involved with rhetoric such as “legalizing housing.”

This is but one element of the politics involved in these debates, and undoubtedly the politics are highly complex and vary by context. However, our basic point remains this: many leftist politicians and researchers in countries with politically charged housing debates have recently adopted a perspective and policy agenda that would grant highly valuable property rights to existing landowners at no cost, despite the clear upwards redistribution involved, when there are established policy alternatives available that could capture significant public benefits or revenues.

For a better sense of the policy alternatives that could capture for the public the value of property rights granted by upzoning, rather than fuelling wealth inequality, please refer to our paper.

Now, what about that incentive to slow housing construction?

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Does pricing upzoning slow housing supply?

In Paavo Monkkonen’s discussion article, he quotes Michael Manville explaining that pricing upzoning will "tacitly punish landowners who share land value, and tacitly reward owners who withhold it.”

Casey Dawkins wrote in his discussion article that charging for property rights “increases development costs and likely dampens the incentive to add affordable housing supply at higher densities.”

We chose not to elaborate in detail in our brief response article, so I want to now explain why this is not the case.

Pricing upzoning does not create an incentive to delay housing development. If anything, it punishes delaying development.

Upzoning creates value immediately even though its cash flow benefit is in the future. Pricing that benefit also has an immediate financial effect. But because the value payable for market-priced new development rights will rise and fall with market values, waiting to develop new housing in the future when prices are higher comes at a higher cost than developing now.

Consider a simple example.

The current market value of a property is $1,000,000 as a detached home, assuming there are no other allowable uses (no development rights). With upzoning, the right to a new use, say apartments, is granted to the property owners. The property rights are now worth $2,000,000 if sold today.

Why did the market price rise? Because the market value of developed apartments is $5,000,000, and the development cost to build them, including a margin for risk, is $3,000,000, leaving a $2,000,000 residual value.

If apartment prices rise between the upzoning and when this property owner decides to develop, they get those gains. In the year after upzoning, if apartment prices rise 10% while the development cost rises only 5%, then the property value of the undeveloped site increases to $2,350,000 (revenue is $5.5 million, the development cost is $3.15 million, and the residual land value is $2.35 million).

This is a 17.5% increase in the property value from waiting for a year to develop.

Now compare this scenario to one where new property rights are priced at, say, 50% of the market value, and payable when the option to develop is taken up. Will this punish development and encourage withholding land from development?

In this scenario, immediately after upzoning the property is worth $1,500,000. This is because the residual value from development is still $2,000,000, but 50% of the extra million in value is payable for the right to develop, leaving $1,500,000 for the property owner.

If apartment prices rise by 10%, and development costs by 5%, then the residual value is still $2,350,000. But now 50% of the $1,350,000 in extra value is payable for the right to develop, or $675,000, leaving the property owner with a market value of $1,725,000.

This is a 15% increase in the property value from waiting for a year to develop.

These two scenarios are summarised in the below table.

Without pricing the rights to develop, the benefit of waiting is higher than when the upzoned property rights are priced, both in absolute terms and as a rate of return on the value of the property asset.

If there is any incentive effect from pricing upzoning, it is to reduce delays, not increase them, as doing so reduces the benefits of delaying development.

In sum, if upzoning is going to be enacted, whether because it is desirable from an urban design perspective or is thought to reduce the rent and price of homes, there is no clear economic case against pricing those property rights.