The Land Price-Density Spiral

The housing discourse in the United States and around the world has taken many turns over the years as house prices have skyrocketed in many countries. In many places, especially the United States, the so-called YIMBY movement has called for up-zoning many neighborhoods to allow for greater density. The idea is that a greater supply of housing units will put downward pressure on rents and prices. Ceteris paribus, this would certainly be the case. In this short piece we will examine a potential counter-veiling economic force, which occurred to me in a flash of insight, that could at least somewhat attenuate the rent reductions which density can achieve. I call this mechanism the land price-density spiral.

Urban Land

In the past 200 years, urban land has been the best performing asset class, crushing stocks. Financial gurus frequently claim that real estate prices go up much slower than stock prices, but those figures include ALL real estate, not just urban land in particular. Land in New York City or Los Angeles has absolutely thumped stocks over the past 200 years in terms of total returns.

This fact owes itself to the broader trend of urbanization and migration from rural to urban areas. Every year a greater percentage of the population in virtually every country on Earth lives in urban areas. The result has been ever increasing housing costs in most cities around the world.

A Competition for Space

Fundamentally, we have a rivalrous competition for space. Land is a rivalrous good. If one agent owns or occupies land another cannot. Land is also in fixed supply. As more people bid for the fixed supply of urban land, either as owners or rents, prices rise.

YIMBY policies which allow the construction of denser housing allow more people to occupy the same amount of land. In essence, either as renters or condo-owners, densification allows the many to pool their resources to bid on expensive urban land. But this presents a different issue. As groups of condo or apartment dwellers pool their resources to bid on urban land, it paradoxically creates even more buying power for land and drives land prices even higher. This pushes up housing costs more. The YIMBY solution is then even more densification, but this just bundles up even more buying power in the market for urban land/space, which pushes up prices, and so and forth. The cycle keeps repeating and housing costs never actually fall, at least on a square footage basis. Hence, the Land Price-Density spriral.

Lastly, this cycle is even further accelerated by financialization, which multiplies buying power five-fold or more.

Quick Predictions

The Land Price-Density Spiral makes some predictions about the housing make that the data seems to bear out, but of course rigorous empirical work is needed to on this topic. Let’s examine them in turn

1. Densification may lead to rent/price declines per unit of housing, but not per square foot

   This is easily demonstrated by the fact that each marginal bedroom added to a condo/apartament increases its price/rent less and less. In fact, the declining marginal value of square footage results in a chronic under-development of apartments for families because 1-bedrooms and studios are more profitable.

2. Densification increases land prices

   Trivially true. Land values are equal to the discounted future revenue of a given parcel of lands highest best use. If land is allowed to be used for projects which produce more revenue, its value must increase. In fact, many YIMBYs want to tax windfall profits from upzonings. (Which would ironically defeat their own agenda, but that’s for another time)

3. Dense areas have higher prices per square foot, ceteris paribus, than less dense areas

   I believe this is true, but it is very hard to test given income differences.

Testing these predictions more rigorously could shed light on the potential validity of the land price-density spiral, which of course is still a hypothetical idea.

Conclusion

The Land Price-Density Spiral is a potential counter weight against the promise of densification and its ability to reduce housing costs. More research is of course required. One potential concern is that if higher density actually increases costs per square foot by pulling in even more buying power, the welfare effects are unclear. In a nutshell, agents get to consume much less housing, at a higher price per square foot, but in perhaps a more desirable location. In any event, this potential mechanism points to the need to move beyond the basic frame work of exogenously set supply and demand curves for housing put forth by many YIMBY activists.