Thursday, 10 June 2021

Land banking logic

Further to my post of two days ago...

Let's assume in their neo-lib fantasy world, we abandon planning restrictions and everything in a radius or two or three miles around each town is zoned for residential development.

For simplicity, let's assume that all land in this zone is owned by one feudal landowner, who hitherto has just been selling off the odd acre here and there to developers to expand the town. Which is exactly what Prince Charles and his ancestors have been doing for centuries. His ancestors were doing this long before they invented planning laws, and if he really wanted planning permission, does anybody think he wouldn't get it?

Why does he drip feed it? To maximise the total value that he and his heirs can wring out of it. He might sell off the most valuable fraction of a percent each year (the parts immediately adjacent to the towns) but his remaining land, in particular the bit that is now adjacent to the expanded towns, goes up in value by a larger percentage.

Does the fact that he could theoretically sell all his land to developers or anybody else tomorrow mean that he will do so, and that tens of thousands of homes would be built? No, why would he? Developers have a steep input cost curve, if they try and increase output, their input costs rise dramatically, which reduces their gross profit, which reduces the amount they are prepared to pay for land. And they don't want to depress selling prices short-term by flooding the market. So they are only prepared to pay full price for small amounts of land each year.
Does it make much difference, if any, if the land surrounding the town is divided into smaller and larger farms, each with a different owner? No, why would it? Collectively, their wealth-maximising strategy is to do the same as the monopolist, i.e. drip feed it, starting with the most valuable bits.

Let's look at three farmers who are thinking of offering some land to developers.

1. Farmer A owns land adjacent to the developed area. Homes in the area sell for £250,000, each home costs the developer £100,000 to build and he expects £50,000 profit per home. At ten homes per acre, he is prepared to pay max. £1 million per acre for the land.

2. Farmer B owns land a mile out of town, same numbers as above, but it will cost the developer an extra £40,000 per home to build/widen the narrow track out of town (or pay the council to do so under a s106 agreement) and connect it up to the normal utilities a mile away (water, sewage, utilities, internet etc), which will involve also sorts of hassle, costs, ransom and wayleave payments. So the developer is only prepared to pay £600,000 per acre for this land.

3. Farmer C owns land two miles out of town, it will cost £80,000 per home to hook it up to the town two miles away, developer is prepared to pay only £200,000 per acre.
Which Farmer is most likely to sell and/or which land is a developer most likely to buy and actually build houses on it?

1. Farmer A has an offer of £1 million on the table. That land has reached its maximum value - it's next to the developed area and can't get any closer - so future increases in value will be minimal (might even fall temporarily if a developer buys other favourably situated land and builds a new estate there). A developer who buys it will be able to get the houses up and sold, recoup his outlay, and bank his £50,000 per home profit fairly quickly. There are few uncertainties involved here.

2. Farmer B has an offer of £600,000, but if the town expands a mile towards him over the next decade it will be worth £1 million. So if he hangs on for a decade, his compound growth is 5% per annum. Maybe he wants to sell anyway, but whoever buys it (another farmer, a developer, a speculator) will probably decide to hang on and bank the 5% compound until the land has reached its maximum value. The large developers do this, and they explain in great detail in their published accounts how these carefully chosen marginal sites are steadily ticking up in value.

3. Farmer C has an offer of £200,000. If he is lucky and the town expands towards him, in thirty years it might be worth £1 million. So if he hangs on for thirty years, his compound growth is also 5%. Maybe he wants to sell anyway, makes no difference, same as 2.
So Farmer A is most likely to sell, and whoever buys it might as well get those new houses up and get his money back ASAP, there is no advantage to hanging on. This also happens to be the most efficient strategy in economic and environmental terms as well (lowest costs, least additional car use, least land being covered with roads etc).

While the developer is busy building and selling these homes, no developer is going to be particularly interested in buying land from Farmer 2 or Farmer 3 - they'd risk having to sell for lower prices and will face higher input costs (on top of the high connection costs).


Graeme said...

We both know this. It is clearly stated in the annual reports of every house builder and yet no one believes us.

Graeme said...

The cost of getting fibre broadband might skew this

Bayard said...

"and yet no one believes us."

No-one wants to believe us. The myth is more attractive than the truth. They want to believe, that, if only Someone did Something, they could return to the 80s and 90s and be able to buy a house that went up in value by more than ten times in as many years.

Mark Wadsworth said...

G, yup, their accounts tell the true story.

G, my costs estimates are purely illustrative, it's about the general principle.

B "the myth is more attractive than the truth" Very depressing but very true.

Mark said...

People don't live like this. They don't live forever and they have a need to spend now, so can't afford to put off things forever.

Farmer A dies, and his heirs sell in order to divide the property.

Farmer B gets sick, decides he'd rather be able to spend his money before he dies, and sells.

Farmer C has a nasty divorce and has to sell.

In your world no-one would ever sell a profitable expanding company or start-up. In the real world people do so all the time, because real people would often rather be rich at 40 and enjoy themselves than very rich at 70, when the extra money doesn't actually make any difference because they can't spend it anyway.

Also, they could sell and *invest* the money. Land banking is a hopelessly illiquid way to make money.

Bayard said...

"Farmer A dies, and his heirs sell in order to divide the property."

Which is bought by a developer who goes on to build as in the example above. If it was Farmers, B or C, the land will be bought by another farmer, or a speculator, who is content to wait.

"Farmer B gets sick, decides he'd rather be able to spend his money before he dies, and sells."

The land is bought by another farmer, or a speculator, who is content to wait.

"Farmer C has a nasty divorce and has to sell."


"Also, they could sell and *invest* the money. Land banking is a hopelessly illiquid way to make money."

Meanwhile, back in the real world, where interest rates are 0.1% if you are lucky, buying land which is increasing in value at 5% above inflation is an investment. Agricultural land is not illiquid. Perhaps you are confusing it with land that has someone's home sitting on it.

Mark Wadsworth said...

M, see Bayard's reply.

B, thanks!

Bayard said...

"Developers have a steep input cost curve, if they try and increase output, their input costs rise dramatically,"

This is another thing ignored by the "loosen planning constraints and thousands of houses will be built, bring the real cost down to levels not see since the 80s" brigade. A very small increase in demand for skilled labour pushes up the price skilled labour can charge dramatically, even semi-skilled. For example, a gardener I employed at £11.50 an hour earlier in the year is now working as a building labourer and getting £15.00/hr. No-one wants to be an unemployed brickie/plasterer/chippie so there tends to be only enough of them to meet the current demand. Now that we have left the EU, we cannot import hundreds of Poles to make up the difference. Keeping demand steady for housebuilding labour benefits both developers and tradesmen. OK, once demand has ramped up, more skilled workers will train, but that process takes years and no-one wants to be the dummy paying over the odds for labour on their development while this happens.

Mark Wadsworth said...

B,ta for back up.