Richard Green, an urban economist who specializes in real estate economics, makes an interesting estimation:

Over the past six years, the price of gasoline has risen about $2 per gallon. What does this mean for relative urban land prices? Let's say the average household makes five one-way trips per day--for work, shopping, entertainment, etc. Let's also say that the average car gets 20 mpg in city driving. Each mile of distance to work, shopping, etc. is therefore now 50 cents per day per household more expensive than before. A household living immediately adjascent to work and shopping should then be willing to pay $5 per day more in rent than a household 10 miles away compared with six years ago, all else being equal. This becomes $150 per month, or $1800 per year. Assuming a five percent cap rate for owner occupied housing, this translates to $36,000 in relative change in value. Given that the median house price in the US is about $220k, this is kind of a big deal.
Professor Green acknowledges that his assumptions are "pretty crude," but his assumptions seem pretty reasonable to me at first glance. And given the magnitude of his estimation ($36,000), even significantly more dynamic assumptions would produce startlingly high results.

9 comments:

Tim Worstall said...

And of course over time we would expect land values to reflect that and thus purchasing patterns to change.
Which is why the long term elasticity of the demand for oil is different from the short term.
Prices stay high enough for long enough the US will start to look positively European in its urban layouts.

Zach said...

Where does the author assume the working/shopping/entertainment is located? Is it in urban or non-urban areas? If those are all located in urban areas and the typical family lives in the suburbs, then the urban land should INCREASE in value. It seems as though he's assuming the the household lives in the city and does everything else in the suburbs. I don't see that as representative.

In fact, I would argue that the typical family lives outside urban areas, commute to urbans areas for work, but shop and entertain themselves in non-urban areas. So, of those 5 one-way trips, only a couple of them are more expensive.

Can someone please clarify the assumptions?

Craig said...

I should think that lower suburban land values would only encourage more industry and retail to locate out there. In the end, isn't that the reason that cities in Europe are looking positively American in their urban layouts?

Economics of Contempt said...

Zach: Green was using "urban land" to refer to land in metropolitan areas generally (i.e., both suburban land and land in the central city). You're right that the typical family lives in the suburbs and commutes to the central city for work, entertainment, etc. Suburban land values will fall, as families try to move closer to the central city to cut down on transportation costs. Central city land values will rise, but probably not enough to offset the fall in suburban land values. Not only is the amount of land in central cities fixed, but a lot less of that land is residential (a lot of it is commercial, industrial, etc.). Suburban families looking to move to the central city will bid up the price of the residential central city land, but only to a point: they won't pay a premium that's higher than the increased transportation costs they're trying to offset.

Craig: The problem is, suburban communities have historically blocked a lot of industrial and commercial development. Suburban homeowners don't want to lose the "small-town feel" of their communities, and really don't want the increased congestion that commercial development would bring (i.e., non-resident shoppers). Maybe high gas prices will force them to rethink their NIMBYism -- it's certainly in their interest to have the jobs/entertainment come to them instead of commuting to the central city for it. I don't have very much confidence in suburban policymaking, though. Rationality is the exception rather than the rule in suburban land use policy.

Zach said...

EoC:

Thanks for the clarification.

So, the argument is that urban (defined collectively as both central city and subruban) land values will fall because the fall in suburban values will dominate the rise in urban areas. I'm not sure if this is the case.

Since suburban and central city land are imperfect substitutes, I think we all agree that a negative demand shock in the suburban land market (caused by high gas prices) will decrease suburban prices and increase central city prices as people move inward. So far, so good.

However, if we assume that central city land is fixed in supply while suburban land is not, then we might expect the net land values in the metro area to increase - opposite Green's conclusion. As people move in from the suburbs, the fall in prices is cushioned by the reduction in the quantity of land suburban land supplied (i.e. a standard, upward-sloping supply curve). Those same movers are bidding up a fixed amount of central city land. This upward pressure on city prices is not able to be cushioned by increases in the quantity of land supplied. Prices increase by the full amount of the demand increase. Thus, the higher city prices dominate the lower suburban prices.

This theoretical result holds even if central city supply is not perfectly elastic. All that requires is that central city supply is relatively more inelastic than suburban land supply.

I question Green's conclusions. I'd really like to hear what others have to say about my analysis. Am I missing something?

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