Mar142017

Residual land value and the politics of theft

Politicians and special interest groups utilize increasingly sophisticated ways of confiscating the wealth of private landowners.

The resale value of a house in California is only loosely tethered to construction costs. While homebuilders won’t construct a house if they can’t sell it for enough to recoup their costs, once house prices rise above construction costs, the key variable that fluctuates most radically is the residual land value.

Land value is a residual calculation, meaning it’s calculated by determining the market sales price and subtracting off all the costs of production. Since land residual is determined by whatever is left over, rising market prices fall entirely to the bottom line, and any increases in costs come directly out of the bottom line.

Residual land values can be negative because prices can fall so low that the cost of construction exceeds the value of the house, which happened across much of California during the housing bust. Residual values can be very high, like they are on the Irvine Ranch where most of the cost of a house is actually the purchase price paid for the land.

This “left over” nature of land residual is a key concept to understand. Anything that increases construction costs reduces land residuals, and if these increased costs drive the residual negative, landowners won’t develop their land, and homebuilders won’t build anything.

It’s very tempting for politicians to view land residuals as a piggy bank they can raid at will. Much of politics is a zero-sum game where opposing forces compete to see who can get a bigger piece of the pie. The old Republican-Capital, Democrat-Labor political battles of years past determined whether the rich or the middle classes prospered more. These were zero-sum fights where one party won and the other lost in direct proportion.

The current zero-sum game being fought in California is over residual land value. Since nimbys resist providing enough housing to accommodate our growing population and increasing job base, workers must compete with each other for the available housing stock, and prices get bid up very high. Since increasing home prices directly increases land residuals, owners of developable land sit on enormous piles of untapped funds — money politicians want to seize in order to fund our government.

One area where local governments work to extract land residual is with new home impact fees. The concept of impact fees is a good one: new residents should pay their proportional impact on schools, fire protection, road improvements, and so on. However, while nexus studies are supposed to determine how large this impact is, as one might imagine, politicians lobby to maximize impact fees in order to generate tax revenue — even to the point of absurdity.

The zero-sum game for land residual starts with impact fees.

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A CASE FOR ITEMIZING IMPACT FEES IN NEW-HOME PRICES

Perhaps if home buyers saw what they were paying to the government, they might seek to oust the politicos responsible.

By Adam Deermount, March 6, 2017

The first step in solving a problem is admitting there is a problem to begin with. … the extent of most people’s knowledge about home prices in the Golden State is that housing supply is scarce in California, not much gets built in desirable areas due to land use restrictions, the weather is really nice here and the economy is good, therefore it’s expensive.

In my opinion, one of the first steps to generating real, meaningful push-back against excessive impact fees is to educate the general public on just how high fees are. …

When you purchase a new home today, the builder will typically break out the base price and any available options and upgrades minus any discounts in its marketing material. … builders could itemize pricing … [and] add in the impact fees as a separate line item just like they would an upgrade. The total advertised price of the home doesn’t change at all but the buyer is now aware that he or she is paying $40k-$80k in impact fees that are substantially impacting their purchase price. This should sound familiar if you’ve ever purchased a car since it’s similar to the way that auto dealers represent pricing on their lots.

The actual impacts of new homes are far, far less than the impact fees charged. Local governments funded their operations long before impact fees were charged, and they functioned well when impact fees were much smaller. The size of impact fees today doesn’t reflect the impact, these fees reflect the incentives to maximize impact fees. Politicians love a tax they can charge where nobody realizes they pay it.

… I believe that many California home buyers are in the dark about where all that money that they are spending for a new home is actually going. I would wager that they wouldn’t be too happy about it once they found out. Consumer advocacy groups should be in support of such a proposal since it increases transparency when it comes to the largest economic decision that most people make in their lifetimes. …

This would be relatively easy for builders to do because they know exactly what their fees are. Would it make a difference?

This same argument also applies to Mello Roos taxes. Developers created Community Facilities Districts in order to pass development impact fees and other costs back to the consumer. Most people assume when they buy their house that the developer paid for the roads and infrastructure required to build their neighborhood. They are often quite surprised to see these costs and fees are passed on to them in a CFD through Mello Roos taxes.

The nexus studies that support development impact fees are always exaggerated. Politicians don’t want to charge too little and end up with a bill at the end. Plus, when a politicians coffers are full, it’s easier to say yes to spending that will help them get reelected.

Of course, this also opens politicians to the potential corruption of strong lobbying groups like firefighters, police, and other public service unions who invariably petition for increases in pay or benefits when money is available — or even when it’s not. Indirectly, these unions lobby for their piece of the land residual pie.

Usually, union lobbying for land residual is indirect, but the construction unions in California ordered one of the California legislators they bought to introduce legislation that would require union labor rates to be paid on all public and private construction in California. Since any increase in construction costs would deplete land residuals, this is a direct attempt by unions to raid this piggy bank. If passed, this would be a wealth transfer from landowners to union laborers.

PROTECT HOUSING AFFORDABILITY

STOP THE NEW PREVAILING WAGE MANDATE

PREVAILING WAGE COULD DRIVE UP THE COST OF HOUSING

California already has a shortage of at least 2 million housing units and an annual housing deficit of over 100,000 units. (Source: California Department of Housing and Community Development). We can’t afford up to a 46% increase in the total costs of new residential construction in California.

This would crush land residuals in the state and make many feasible projects not feasible. It’s a crazy idea during a time of extreme shortage of available housing.

PREVAILING WAGE COULD RESULT IN LOST JOBS AND REDUCED ECONOMIC GROWTH

AB 199 could result in tens of thousands of jobs killed. California’s housing shortage costs the state more than $140 billion per year in lost economic input, including lost construction investment as well as foregone consumption of goods and services because Californians spend so much of their income on housing.

The assumption by labor unions is that homebuilders would respond by employing the same amount of labor at a much higher cost. In the short term, that would probably be true, but if this law were passed, it would spawn a revolution in how houses are built in the state.

Instead of building on-site where union labor is required, homebuilders would turn to pre-fab construction off-site at a non-union factory. Most roof trusses are already pre-fabbed, and if labor costs were higher, all framing would be pre-fabbed along with many other features. Homebuilders would still employ a few on-site master craftsmen to assemble the parts, but the era of large labor crews pounding nails on houses across California would come to an end.

PREVAILING WAGE COULD REDUCE STATE AND LOCAL TAX REVENUE

AB 199 could result in the state and local governments losing millions of dollars in permit fees and property tax revenue. The loss of tax revenue could mean less money for vital services like public safety, education, and infrastructure. Less tax revenue could force state and local governments to raise taxes.

I doubt this is true over the long term, but it certainly would be in the short term.

The ongoing war over land residual is likely to intensify because California is doing nothing to alleviate the problem of building too few homes. Expect to see more ingenious ways politicians can rob landowners through political zero-sum games.