Friday, September 23, 2011

The Zoning Paradox

At the new website The Atlantic Cities, Ryan Avent has published an adapted portion of his new book in which he makes a common sense, but infrequently raised, observation about the economic effects of zoning laws:
"People tend to have a proprietary feeling about their neighborhoods, particularly when they have large sums of money on the line thanks to their investment in their home. This feeling leaves urban property rights in a gray area. Residents are remarkably willing to dictate to private property owners what can and can't be done with their land. They're willing to approve restrictive zoning rules and lobby against permitting in ways that dramatically reduce potential land value, without ever dreaming of compensating owners and would-be developers."
If zoning reduces land values, however, how is it that zoning has been convincingly shown, by Ed Glaeser among others, that zoning contributes to inflated housing costs?  The answer, what I'm referring to as the zoning paradox, is simply stated: zoning increases the per unit cost of housing, while decreasing underlying land values.*  I've alluded to this before in an earlier post, but let me illustrate with a real life example to demonstrate this seemingly counterintuitive point.  You may be able to find an example in your own town or city that will work out in similar fashion.

Here's an image from near my old neighborhood in Nashville, the Music Row area, where what had long been a single-family residential area was rezoned decades ago for a mix of office, residential and commercial space in the area to the west of  the alley running between the two streets shown (this was in reaction to the arrival of the city's famous music recording industry into the area).  Given its mix of uses, the rezoned area does not enjoy the typical "protections" of Euclidean zoning, while the single family area is strictly limited to single-family and duplex residential.  Since protection from the externalities generated by incompatible uses is commonly mentioned as an economic benefit of zoning, this factor should, in theory, weight the scales on the side of the single-family area.

If we look at the appraised value of one of the houses on the rezoned side -- a house of similar characteristics to those in the single family area, having been built for that purpose in the 1920s -- we find a per acre land value of $1,786,000.  On the opposite side of the block, where duplex residential zoning applies, land values are only $294,000 per acre!  In fact we can go further and note that the combined value of the single family home and the land on the residential side is only half the value of the land alone on the rezoned side of the block.  The net effect, therefore, is to lower overall property values.  The property tax benefits to the city of more permissive zoning seem clear. 

It's worth noting that these values are derived from an allowance of as much as 80 units per acre on the mixed-use side (a genuinely urban density), while the duplex zoning on the residential side permits slightly less than 12 units per acre.  Yet with this greater intensity of development, per unit costs fall considerably for new construction (although the price per square foot may actually rise**).  By contrast, on the residential side, even though land values are low by comparison, a developer purchasing an existing home must build a very large and expensive house to justify a tear-down.  Since the market for very large homes is saturated by the imposition of minimum lot sizes and other low-density regulations throughout the city, however, this means that little redevelopment will occur, even though this neighborhood is only a mile and a half from the downtown.  Existing houses stagger on, while development is displaced elsewhere.

Overall, the effect of these density and use-limiting restrictions seems to be to concentrate financial benefits in the hands of incumbent homeowners (by inflating the values of homes), while impoverishing the city as a whole (by substantially devaluing the property tax base while increasing the cost of both rentals and new home purchases). 

One last point: simply because permissive zoning increases land values, does it necessarily follow that eliminating some or all density-related restrictions -- minimum lot sizes, height limits, etc. -- will provide a net economic benefit to the city?   I'd suggest Michael Lewyn's work as a good starting point on that issue, but in a follow-up post I'll venture a couple more thoughts on the topic.

Related posts: Did Zoning Ever Conserve Property Values?

*See On the effects of minimum-lot-size zoning, S. Bucovetsky.  This paper deals with minimum lot sizes only, but logically the same analysis should apply to other restrictions, such as FAR ratios and other density and use limitations.
**The higher per square foot prices paid in certain instances that I was able to identify suggest that buyers, at least in this market, are willing to give up large amounts of square footage in exchange for a reasonable price -- to the extent of taking a apartment 60% smaller than a new duplex home for a price only 30% less.  This could indicate an undersupply of mid- and small-sized apartments in this area (almost certainly true) or that the marginal value of each additional square foot above, say, 1200 sq. ft. is quite low for the type of buyers who are looking in the area.


  1. I wonder if the higher property values on the relaxed zoning side of the block reflect city wide restrictions on offices and other commercial. So if you relaxed zoning in a few select areas you'll see this kind of rise in property values, but if you relaxed zoning everywhere, you'd find more of a market equilibrium.

    Then that makes you wonder: home owners are worried about commercial and industrial uses moving in next door, but would that happen if zoning restrictions were relaxed everywhere? I'd be pretty mad if the lot next door to my house were rezoned to heavy industry, but if zoning laws were relaxed *everywhere* I bet the lot next door to me would remain residential.

  2. Vince -- that is possible, but the fact that residential is being built in significant quantities on the mixed-use side suggests that the key factor here is density rather than use.

    As for zoning -- the neighborhoods I've shown were actually laid out some decades before Nashville adopted a zoning code. Industry "moving in next door" was simply not a realistic possibility for many reasons. The factories of the day needed large land areas convenient to rail transport. Even if they could have outbid the residential buyers (not likely), assembling a sufficient number of parcels would have been almost impossible, and there still would have been no rail access.

    Without zoning, things actually worked out quite well. Industry located in land it valued highly but which was shunned by residential (along train tracks and at city fringes where land was cheap). Commercial located in space that was valuable for its purposes (first floors, for visibility and accessibility) while residential took the above floors (for privacy and security). No one was consciously trying to make things "mixed-use." The idea that chaos would ensue if zoning were abolished flourishes in the absence of critical thinking about urban economics and urban history. (I'd also add that there's no logical reason that zoning has to cover everything. It's not all or nothing. If there is lingering concern about industry, why not just create one area for industry and leave the rest alone? That is what Paris seems to do, based on the essay I posed a couple weeks back.)

  3. Overall, the effect of these density and use-limiting restrictions seems to be to concentrate financial benefits in the hands of incumbent homeowners, while impoverishing the city as a whole
    So very true, except not much can be done about it, because they're the ones who can vote, as opposed to all the people priced out of the city, who, since they are not living in the city (and adding value to it), can't vote against the NIMBYs. I'm not sure how to get around this, if it's even possible at all.

  4. You should think of it as the equivalent of OPEC. By slightly restricting the supply of oil, OPEC countries can cause large increases in the cost of a barrel, earning more export income than they would if they'd sold more oil.

    The same is true of restrictive zoning (and parking minimums, and so on), with the added complication that sometimes keeping out the poor is worth extra. It makes the area more desirable to snobs and racists and thus raises property values, and also adds to the satisfaction of snobbish or racist locals in addition to the economic benefit.

  5. Alon -- even though exclusionary zoning may be "worth extra" to quite a few people, the amount of that extra value, whatever it is, seems to be almost insignificant next to the increase that results from significant upzoning. I think that homeowners do actually perceive this, in a way, with the constant grumbling about "greedy developers" and the fear of "affordable housing," which I take as an implicit recognition that high-density development simultaneously increases developers' profits while decreasing housing costs.

  6. Alon has the better of this argument. Zoning is the only way to give land much of any value at all.

    If there were no zoning laws and you could build as much as you wanted on any piece of property, then nothing would really justify me paying any sort of a premium for land above what it could generate as farm land. If anyone tried to charge me extra, I'd just move on to the next property.

    In the days before automobiles, proximity to other built areas would have been enough to make land in highly developed areas highly valuable. But once cars and roads come into the picture, anyplace within about 20 miles of the developer's targeted area is as good as any other. A circle with a 20 mile radius contains about 1300 square miles, which means developer choices are limitless and land sellers have basically zero leverage.

    OK, ones in the very best parts of very developed places like Manhattan would have some leverage, but only a tiny number of them in the absolute prime spaces.

    To illustrate why, let's say that Manhattan abolishes its zoning and developers can go as dense as they want. If they consistently built as dense as the Equitable building, they could put all the commercial and housing space that now exists on Manhattan, plus another 50 percent of both, onto the portion of the island below Houston St. Of couse, people who owned land outside of the truly core areas, to avoid being totally irrelevant, would offer discounts and prices would spiral down everywhere, even in Manhattan below 110th Street.

    The only reason land has any value is because zoning creates artificial scarcity. Eliminate those barriers and you could put the entire population of the country in an area no larger than the northeastern quarter of New Jersey. Land, in other words, is not a scarce asset. It is a limitless one as far as human habitation needs are concerned.

  7. To illustrate why, let's say that Manhattan abolishes its zoning and developers can go as dense as they want. If they consistently built as dense as the Equitable building, they could put all the commercial and housing space that now exists on Manhattan, plus another 50 percent of both, onto the portion of the island below Houston St. Of couse, people who owned land outside of the truly core areas, to avoid being totally irrelevant, would offer discounts and prices would spiral down everywhere, even in Manhattan below 110th Street.

    Andrew: It's my understanding, based on reading Robert Fogelson's "Downtown," that the scenario you describe actually did take place in the unzoned American cities of the late 1800s and early 1900s, and it happens to this day in Houston. This issue only arose once skyscrapers became possible, and the preferred remedy (assuming one believed it to be a problem), was a height limit, not zoning by use.
    Another alternative would be an urban growth boundary.