Inefficiencies in Land Markets

February 22, 2006

Benefits = $1400/yr

Cost = $600/yr

Net benefits = $800/yr

000,16$05.

800$

r

aV

Little House on the Prairie

Flood Zone

10% chance of storm that will cause flood

RIVER

A River Runs Through It

No storm 90% Storm 10%

Benefits $1400 0

Costs $600 $600

Net Benefits $800 -$600

Expected value of net benefits = .9(800) +.1(-600) = 660

200,13$05.

660$

r

aV

Benefits $1400

Costs $740

Net Benefits $660

Standard reaction to risk: purchase flood insurance

Cost of premium: $140/year [based on 10% probability of having to make a $1400 payout in any given year]

200,13$05.

660$

r

aV

Ex. 1 – Land values may be artificially high and send the wrong signal to buyers and sellers

Subsidized flood insurance Bail-outs

Does the land market function properly and result in the efficient uses of land?

Benefits $1400

Costs $635

Net Benefits $765

Subsidized flood insurance $35/year (instead of $140)

300,15$05.

765$

r

aV

Benefits $1400

Costs $600

Net Benefits $800

Bail-outs

000,16$05.

800$

r

aV

Ex. 2 – Costs of land ownership may be artificially low and send the wrong signal to buyers, e.g. Subsidizing Sprawl

Sprawl – defined as low-density, auto-dependent residential and commercial development

Subsidies– Provision of utilities– Mortgage interest deductions– Transportation development

Residential lot size

$S or MSC

qe

pe

D or MB

q*

P*

MC with mortgage interest deductions (MPC)

Growth Management Direct

– Urban growth boundaries– Urban service area boundaries– Zoning

Indirect– Impact fees– Transfer taxes– State investments

Ex. 3 – Externalities in the land market may result in inefficient uses of land

External benefits from using land for agriculture– Ecological benefits– Aesthetic benefits

External costs of developed uses– Water runoff from impervious surfaces– Air pollution from automobile exhaust

Acres of farmland

$

D=MPB only

S

qm

pm

q*

P*

D=MSB

Acres of land developed

$

D

S=MPC only

qm

pm

S=MSC

q*

P*

Farmland Preservation

Property rights tools – zoning Taxes – differential assessment Market

– purchase in fee or purchase development rights– create development rights market

Zoning

Exclusive– Concern about windfall/wipeout syndrome

Non-exclusive– Large minimum lot size– Cluster zoning

Conservation design

Conservation Design/Zoning

Taxes Differential assessment

– Preferential assessment: agricultural land is assessed for property tax purposes at a lower rate than is other land

– Deferred taxation: agricultural land is taxed at a lower rate but some or all of the taxes are captured at time of development

– Restrictive agreements: contractual arrangements that give agricultural land owners lower property taxes in exchange for agreement not to develop

Deferred taxation (penalty) When land is converted, owner must repay a

specified amount of the tax benefits realized (10 years of benefits is common).– Owner of land enters into differential assessment

program.– Property taxes assessed at $66.66, rather than

$142.88– When land is developed, owner must repay

$76.22 for each year of preferential assessment up to 10 years (maximum penalty is $762.20)

Market

Purchase in fee Purchase development

rights (PDR) Lease development

rights (this is essentially the Michigan model)

Create market for transfer of development rights (TDR)

Purchase of Development Rights

Fair market value is $7144 (can develop) Agricultural use value is $3333 (cannot

develop) Development value is

$7144 - $3333 = $3811 Public or private entity pays landowner

$3811; removes development rights stick from the bundle

Lease of Development Rights

Landowner receives regular (e.g. annual) payment in exchange for keeping land in agricultural use.

Michigan – Circuit breaker program (PA 116)– Farmers sign development rights agreements

(leases) and receive income tax credits for the duration of the agreement

– Income tax credits depend upon level of property taxes and agricultural income

Farmland owner enters PA 116 agreement.

Farm income is $200 rent plus $50 salary per year.

Property tax is $66.66.

3.5% of income is $8.75.

In Michigan:

Income tax credit is $66.66 - $8.75 = $57.91

Transferable Development Rights

2.5 units/acre 8 units/acre

.1 units/acre 10 units/acre

Sending Zone – area to protect

Receiving Zone – deemed suitable for development