Residential land prices prior to development

Journal of Real Estate Research, The, 1997 by Karl L Guntermann

Capozza and Helsley (1989) state that in a growing area, the growth premium could represent 50% of land value. The regression results presented in Exhibit 4 (equation 1) can be used to calculate the growth premium reflected in Phoenix land values. Exhibit 7 contains calculated real prices per acre over the entire period of the data (1983-91) and for the peak year (1985) and trough of the cycle (1991). It can be seen that long-term growth as measured by net in-migration, represented 57% of land prices over this time period and accounted for over 70% of value at the peak in 1985.'o The changed perception of Phoenix's growth potential is reflected in the 1991 figure (38%). It would appear that not only are growth rates capitalized into land values but that the degree of capitalization fluctuates throughout the real estate cycle.

The relationship between long-term growth rates and land values in contrast to shorter-term development expectations can be inferred from these empirical results. Estimated land value would be $16,232 per acre in the absence of growth expectations compared to $37,742 based on historical growth rates (Exhibit 7). When the same equation is recalculated for zero active subdivisions within three miles of a parcel, estimated value declines to $8,232 per acre. This suggests that micro or localized development expectations, as distinct from local growth rates, can cause land values to roughly double as development becomes imminent. The $8,232 per acre could be compared to remote, desert land with very limited urban use potential in the 1980s, which was selling in the range of $2,000 to $5,000 per acre.ll

Conclusions

This study presents the results of tests of hypotheses related to the market for land prior to development. Considerable evidence is found to support the contention by Capozza and Helsley (1989) that a significant portion of the land in rapidly growing areas, such as Phoenix, Arizona, reflects a growth premium. While the growth premium reflects longterm historical rates, it increases as a percent of land value during boom times and accounts for less than 50% of value during down times. Net in-migration appears to be the best measure of growth, while other population and employment did not produce results that were as strong.

Separate from the Capozza-Helsley growth hypothesis were tests of development expectations conducted for relatively small geographic areas within the metropolitan area. Evidence was found that employment or population forecasts for small planning areas influence land values in the near term (one to five years). An alternative measure of development expectations was based on subdivision activity around individual parcels. Land values are sensitive to the level of residential activity occurring within two to three miles of a parcel but not to activity that is only within one mile of a parcel.

This research suggests an interesting and potentially valuable follow-up study. Over 50% of the transactions used in this study resulted in residential development, usually shortly after the sale. However, development did not occur on the remaining parcels for at least three years after the observed transactions. From both a private and public perspective, it would be desirable to have a more complete understanding of why certain parcels underwent development but others that are similarly situated did not. Local governments and private utilities monitor new development and activity in the land market because of the lead times required to build the necessary infrastructure to accommodate growth. Much of the activity in the Phoenix land market in the 1980s sent false signals to both governments and utility companies about the likelihood that development would occur in specific areas. In some cases, investments in infrastructure were not justified by subsequent development in an area, while at other locations development proceeded much faster than anticipated. A better understanding of those factors associated with the conversion of land to a residential use would be beneficial to both the private and public sectors.