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Submission to the All Party Oireachtas Committee on the Constitution - page 2

by Tom Dunne

4 The property market is a market for property rights

The constitutional protection for landed property can be considered in the light of an understanding of what is traded in the property market and has economic value. The property market rather than being a market for land and buildings is in fact a market in the rights to land and buildings. This is a very important characteristic to understand when considering the question of windfall profits from development land rezoning.

There can be no such thing as absolute ownership of land and buildings. The state provides a system of categorising the types of ownership of landed property by law and a structure defining the rights to property interests.

Also, it is axiomatic that ownership of property rights is constrained by the rights of other property owners. Moreover, other people may have property rights affecting any piece of landed property; e.g. rights of way or of support to adjoining buildings. In short, ownership of property entails responsibility to the community generally and other property owners.

The largest collection, or bundle, of rights to land and buildings that a person can own is a freehold interest and these rights can be unbundled and disposed of separately. The state often has to alter or limit the rights comprising property interests by legislation in the interests of the common good or to regulate social and economic activities. Put another way the state can by law circumscribe or remove particular parts of the bundle of rights that comprise particular landed property interests and has done so in the past. Examples of this include the granting of security of tenure to tenants, control of the airspace over property by the air navigation acts or control of use and development under the planning acts.

What is traded in a property market is therefore rights to use land and buildings coupled with responsibilities to the state and others. These are not immutable and are subject to law and obligations to others. Development rights, which are regulated through the planning process, are just one of the rights involved. Since the introduction of the 1963 Planning Act these are no longer inherent in property interests. Indeed the planning system is constructed on the principle that the state has the right and the need to alter the bundle of rights that comprise legal property interests.

All property owners benefit from the planning system in that at the very least it protects individual properties from inappropriate development on neighbouring property. More widely, complex modern urban environments require a formal statutory planning system to work effectively and secure the interests of all property owners and the integrity of the property they hold. To have such a system it is necessary to give the state or a local authority control over development. This requires the removal of the right to develop without permission from the bundle of legal rights which a person holds to a piece of property.

However, development rights have economic value and the consequences of having removed these rights is that property values are affected. The grant of permission to develop, therefore, confers an economic value to a property owner. Where a property is developed and permission is being granted for further development, such development rights already exist.

Through planning development rights are granted to some landed property owners but not to others and decisions are made on the basis of development plans adopted democratically by planning authorities. These plans are devised and implemented in the interests of the common good. It would seem logical that the community who, through a planning authority, made the development plan and provided the infrastructure and services required for development should get the value of the development rights thereby created. It does not seem to be logical to argue that the constitution would require that a right with economic value created by one body should be transferred as a gift to another who does nothing to create this value.

Consequences of the Economic Characteristics of Landed Property

Where knowledge of market conditions is defective price signals work less efficiently and adjustments to supply and demand are slow. This is the case in the property market. Relatively high transaction costs, incurred either in obtaining market knowledge or in the administrative procedures involved, restrict the extent to which market signals can motivate a response to increased demand.

Eventually the market will respond to signals indicating increased demand and additional buildings will be provided but this will take time, perhaps years. In the meantime limitations on the market, through inadequate or poor planning or other restrictions make it easy for imperfect competition to exist in the short run. In contrast, for people seeking accommodation the near future will be a crucial factor in making decisions about accommodation. They will have to bid against competitors for accommodation available on the market. Hence the effect of restrictions is to drive up prices in the short term.

The consequences of the above and other characteristics of landed property are that the market will respond slowly to increases in demand for accommodation in the economy. Thus, it is in the natural order of the market that periodic shortages occur and these will be associated with high prices. The corollary is also true. When demand falls off the supply of property available in the economy will remain and prices will contract. Consequently the market is volatile and prone to booms and busts when prices overshoot both on the way up and on the way down.

This points to the need for the government to be careful about policies that affect landed property particularly in the area of taxation. Pro cyclical taxation and grant aid policies will amplify booms and busts in the property market. The same can be said of the lending policies of financial institutions.

All in all these characteristics make property markets difficult to regulate and manage from a policy perspective. Understanding them will help to analyse problems associated with high house prices and the price of development land.

One important consequences of the economic characteristic of landed property is that the increase in value created by granting permission to develop agricultural land is not inherent in the land. Development rights, which are denied to some property owners, are concentrated and increased by the local authority through the planning system and infrastructure provision and transferred to land zoned for development. The economic value that flows from denying development rights to others and from the provision of infrastructure, should not be given by way of gift to the owners of zoned development land. Instead the value of development rights should be kept by the planning authority. The question at issue is just how should this be done and this is discussed later in this paper.

House Prices and Development Land

As we have seen land by itself has little or no intrinsic value above its agricultural value. Clearly if you cannot use land it will have no economic value. The value of land suitable for development is directly related to the value of the buildings that may be erected on it. The value of those buildings will be determined by supply and demand.

The value of landed property is not determined in the same way in the short term as the value of other commodities but is influenced to a substantial degree by the stock of existing buildings which have been constructed in a given location over past years.

Increased economic activity and population growth will give rise to increased demand for accommodation. At first this demand will be met by occupying vacant accommodation from the existing stock. Those requiring accommodation will bid against each other for the available supply and prices will go up. At first this will encourage the more efficient use of existing buildings. It will also act as a signal to developers to provide more accommodation. But in any given period the new addition to the existing stock will be only a very small proportion of that stock. Therefore the market is dominated by the existing stock of buildings. Prices will be set primarily by demand for the existing stock and not by the flow of new buildings coming onto the market in any given period.

The decision to develop or not takes as a given the price that can be achieved for the finished product of buildings available for occupation or use. Thus, for example, in the housing market builders are price takers and will sell their product at a price determined by the market and not by the value of land and the cost of construction.

The inputs needed to provide buildings comprise the site or development land, to which is added construction material, labour and professional expertise, finance and the enterprise of the developer. All but the first will be in relatively unlimited supply compared to the supply of land. Consequently most of the increase in the value of property resources will descend to the site or development land. In this way the value of development land and sites as a factor of production is what is called a derived demand. Put another way the value of development land is the residual after all other costs involved in the construction process have been taken into account.

When analysing problems in housing markets or in other property markets, urban economic theory points to two important principles that should be understood by those framing urban and regional policies. First, the price of landed property, including housing, is not determined by the cost of production. Second, the value of development land is the result of high property prices not the cause. These are important insights from urban economic theory, which allow a better understanding of the problems of urban development.

The perspective of developers

On first consideration these principles might appear to contradict common experience and not appear in accordance with a general understanding of how the market for land and buildings works. This is understandable.

From the perspective of a particular developer or house builder it can appear that high land or site costs drive up the price at which they will offer their product to the market. Indeed, once development land or a site has been acquired it becomes a fixed cost to developers and builders. If there are complaints about the high price of property they will argue that the high cost of land forces them to sell at high prices. If prices stumble but demand remains, developers and builders will argue that the high price of land is causing the affordability problem. They will suggest that for developers to be able to supply houses and other buildings profitably, government must subsidise developers or purchasers by tax breaks or grants or some combination of both.

This may appear to be the case from the particular perspective of a developer. But urban economic theory demonstrates it is wrong to conclude that particular examples based on the experience of the individual builder or developer will point to a general truth. In simple terms, in the case of development land it is not correct to argue from the particular to the general. The general case is that high house prices cause high land prices and not the reverse. This is so even if there are many examples of individual developers who all share the same experience.

It follows that while it can be prudent at times to provide tax or other subsidies for specific locations or for periods of recession, in times of economic growth they will usually have the effect of increasing the value of development land and sites and drive the prices of houses and building land higher in boom times.

It may be concluded from this discussion that tax and other financial inducements intended to subsidise developers or to assist purchasers with the acquisition of property, including houses, find their way into higher development land values. This is even more the case when there is excess demand for the available stock of accommodation and prices are high. Attempts to deal with say, high house prices, by providing subsidies ultimately have increased the value of development land. Hence, high development land values are an unintended result of government action in housing and other markets. Many government interventions in the market provide a good example of this theory in action.

The Introduction of Planning to Ireland

High development land values are a common characteristic of countries experiencing rapid economic growth. The reverse is also true. Economic recession or stagnation results in relatively low values for development land. Indeed they may not be significantly higher than underlying agricultural values. In the absence of land zoning confining property development to a restricted part of the lands surrounding an urban area, development land values would eventually decline to agricultural land values the further out from the centre of urbanisation one moved.

In the conditions that existed in Ireland in the late 1950s the economy was stagnant and land values on the periphery of urban areas would not have been particularly high. The main concern of a developer contemplating a housing development would have been the ability to connect to sewers and a water supply. There was no need to seek approval for the development. It should also be noted that at that time capital was scarce and difficult to access by way of a mortgage, and rates were payable on residential property. These factors and others would have kept ambient house prices down and hence development land values were not high.

A person wishing to provide themselves with a house or other property would have had the choice of buying, buying a property built by a developer or buying a site at a price not significantly above agricultural land values and building themselves. During the period of economic prosperity in the early 1960s land values would have increased but in the absence of zoning, which came with the development plans published in the late 1960s, development land values would not have been dramatic. This was the background against which the Planning act of 1963 was devised and passed.

In the circumstances that applied in Ireland in the late fifties and early sixties it is perhaps not surprising that the consequences of introducing a planning system with development plans and zoning were not given sufficient attention when enacting the '63 Planning Act. The consequences for the value of development land of introducing the planning system, and particularly development plans which allowed land zoning, were not properly addressed in the 1963 Act.

It says something that now we can hardly imagine a situation where such a process did not exist. But it is worth recalling the fact that what the '63 Planning Act did was to remove from property owners the right to develop their property and provide a procedure where if they wanted to do so they needed the permission of the planning authority.

In a sense this was a modern version of surrender and re-grant. On introduction the '63 Act removed development rights from all property owners. It also instituted a process whereby the right to develop was granted by a planning authority following an application for permission to develop. All landowners whose land was suitable for development lost some value in 1964. However, as we see from the earlier part of this discussion, because of the economic conditions at the time this would not have been as great as might be thought if one considered the levels of development land values that now prevail. In any event doing this was necessary to bring into operation the development plans devised under the Act.

The planning process confined development to those lands the planning authority thought it appropriate to develop. By doing so they automatically restricted the amount of development land available. The demand was concentrated on land which had been designated in the development plan as being suitable for development. This has the effect of increasing the value of the zoned land and reducing the value of land not zoned to agricultural land values, plus perhaps some element of value attributable to the hope that it would be zoned in the future.

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