Recent media coverage has focused on how the housing crisis could be solved if only land values could be reduced. Lowering land values would mean the price of new homes would fall, making housing more affordable.
As attractive as that may sound, it gets the problem backwards – high house prices are the cause of high land values, not the result of them.
The relationship between house prices and land values
When developers are bidding to buy a piece of land, they calculate what they can afford to pay using what is known as the residual appraisal method.
In simple terms, they estimate what price they are likely to sell the homes for, and then take off the cost of build and their required profit level. What is left, the residual, is the price they are able to pay for the land.
Build costs are, broadly, fixed. The cost of building the house plus any site-specific costs (usually relating to things like drainage, remediation and foundation designs) will be basically the same regardless of the selling price of the homes.
So, the more those homes are sold for, the bigger the residual land value will be.
House builders don’t operate in a vacuum; new build sales account for just 12% of transactions every year. If a developer attempts to sell a home for too much, potentially interested buyers will simply buy something that represents better value in the re-sale market instead.
House builders are price takers, not price setters.
The logic of high land values causing high house prices assumes exactly the opposite – that in order to pay the top price for a site, developers will attempt to sell their homes for ever increasing prices. They simply can’t – they don’t control the market to that extent.
Land value capture as a solution to the housing crisis
Understanding the relationship between land values and house prices makes it obvious that land value capture isn’t an answer to the problem of high house prices. There are certainly potential benefits to land value capture as a concept. By taxing the uplift in land value when planning permission is granted, it can help deliver more money to spend on roads, schools and affordable housing, for example.
What it won’t do is reduce house prices.
The 88% of the housing market which is made up of re-sales will still set the level of that market in the same way it does now. While land value capture will increase the costs of development and push land values down, it won’t impact on eventual sales prices. The only way for house prices to become more affordable is for enough homes to be built to meet demand.
Which is why the planning system is key.
The role for the planning system
Land value capture might free up funds for the public sector to contribute by building new homes themselves, but the sites where those homes are to be built on will still need planning permission.
The planning system, therefore, is still the gatekeeper to allowing those homes to be built.
Countless studies across the globe have shown that the more restrictive planning systems become, the higher house prices rise. A study by academics at the London School of Economics found that 35% of the average house in England price can be attributed to the planning system, for example.
The government’s proposed standard approach for calculating housing need shows that many councils, particularly (but not exclusively) in the South, are simply planning to build an inadequate number of homes. That is nothing to do with high land values and everything to do with the availability of land for development – something that land value capture simply won’t address.
If we want to solve the housing crisis, we need to build more homes – to do that, we need to look at the planning system.
The Strategic Land Group are a specialist land promoter. We work with owners to deliver planning permission on their sites at our cost and risk. Our return is a share of the value once the site is sold – so if we don’t succeed, it doesn’t cost you a thing.
If you own or know of a site that could benefit from our approach, get in touch today.