Week 8: Public Goods, Externalities, Development and regulations.House Prices and Park Access: greater distance = less benefit or more sharing?Additional examples of public goods/externalitiesSolutions to Public Good/Externality Problems.Solutions to Public Good/Externality Problems.Are there “externalities” in commercial Real Estate?Multiple equilibrium solutions to a city in which one use dislikes being near to the other. History matters! Which patterns maBidding for Uses: Coase Theorem RevisitedImpacts of regional open space policy: Always raises house prices and land values. How much is from constricting supply as oppDitto California Coastal Commission Zoning [see French and Lafferty]Travel Congestion: MagnitudesMIT OpenCourseWare http://ocw.mit.edu 11.433J / 15.021J Real Estate EconomicsFall 2008 For information about citing these materials or our Terms of Use, visit: http://ocw.mit.edu/terms.MIT Center for Real EstateWeek 8: Public Goods, Externalities, Development and regulations.• Public goods (e.g. open space) and “free riding”. • Externalities across properties: Nash versus cooperative solutions. • The impact of historical development in “locking in” current land use patterns. • Regional open space/land constraint impacts.• Congestion and development decisions.MIT Center for Real Estate1). A number (n) of neighbors contemplate purchasing a vacant lot in their midst.MV = valuation of the lot by each (as a piece of adjoining open space).p = price of lotMV >p/n , but MV<pFree riding with open space as a pure public good. Sharing? Exclusion? Voting?MIT Center for Real EstateHouse Prices and Park Access: greater distance = less benefit or more sharing?25%20%15%10%5%0%100 300 500 700 900 1,100 1,300 1,500 1,700 1,900 2,100 2,300 2,500Travel distance to park, in feetImpact of Proximity to ParkPercent premiumFigure by MIT OpenCourseWare.MIT Center for Real Estate2). Suppose park benefits depend on the number using it (n)?MV(n) = valuation of the park by each (as a function of how many are sharing it) If the park is not excludable how many will use it:MV(n0) = 0 so n0= ∞ (possibly) [examples: Fishing, grazing]3). Total value of usage to group: nMV(n)How many should use to maximize total usage value: MV(n*) + n∂MV/∂n*= 0MIT Center for Real EstateMV(n*) = - n∂MV/∂n*>0, hence n*< n04). n0-n*= degree of “over grazing, fishing…”If the park is excludable it can be “privatized”. Owner winds up setting an entrance fee as above = [- n∂MV/∂n*].Public Goods –vs- ExternalitiesExternalities: impact of what happens on one parcel to adjoining ones.Public good: a collective impact on many parcels whose origination is not one specific other parcel.MIT Center for Real Estate5). P = α - βF - γfF = FAR of subject’s lotf = FAR of neighbors [an externality]β = marginal impact of own FAR on price γ = marginal impact of neighbor FARα = all other location factors6). C = μ + τF [construction costs:as before]MIT Center for Real Estate7). p = [(α-μ) – (τ + β)F - γf]F8). Nash [“a beautiful mind”] solution:Fm= [(α-μ) – γf] / 2(τ + β)Fm= f , implies:Fm= (α-μ) / [2(τ + β) + γ]pm= (α-μ)2 (τ + β) /[2(τ + β) + γ]2MIT Center for Real Estate9). Cooperative solution that maximizes all property recognizing that f=F from the beginning:p = (α-μ)F – (τ + β)F2- γF2Solution is:F*= (α-μ) / 2(τ + β + γ) , F*< Fmp*= (α-μ)2/ 4(τ + β + γ) , p*> pmWhat if γ<0 and greater neighborhood FAR increases home values?MIT Center for Real EstateAdditional examples of public goods/externalities• Infrastructure: sidewalks, roads, waterways, lagoons..in addition to open space.• Historic Districts. Designation provides insurance and control against adverse design/use (a public good). Downside is loss of individual development options. Net is positive (Coulson)? Empirical issue: suppose “better” properties are chosen for historic designation? • Comprehensive Development Design. Is the “style” of your property an externality to others? Yes in Europe, no in the US.MIT Center for Real EstateSolutions to Public Good/Externality Problems.• Scale:single (collective) ownership of a large parcel of land insures few negative and many positive externalities at development stage (Thorsnes shows development scale matters – lots are worth more in big developments) • Single owner maximizes the total value of development –sacrificing value at one location if such a sacrifice creates more value at other locations. • If development ownership is fragmented – each fragment considers only what best for his portion.• Is the “whole” always worth more than the sum of the parts? [Liquidity – versus – externalities]. Does the price of an acre decrease/increase with the size of purchase?MIT Center for Real EstateSolutions to Public Good/Externality Problems.• With large scale Private development, what happens later on – maintaining the original concept and adapting to change.– Are covenants and restrictions enough?– Lessons from Houston, Hilton Head• Public Regulation/Planning. Alternatively, careful public regulations and master-planning could achieve such harmony. (If you trust planners or politicians to maximize aggregate land value). How to insure this – give them a stake?• “Town Architects” in Europe. What if there is little consensus on what good design is?MIT Center for Real EstateAre there “externalities” in commercial Real Estate?• Office Building height: views versus view blockage, the market for air rights.• “Good” office architecture. Where is the externality, tenants or neighbors?• Adjacent retail stores: auto strips (multiple dealerships), shopping centers.• Hospitals, medical “zones”.MIT Center for Real Estate10). Industry (I)-Household (H) Externalities can operate at a metropolitan scale.rI(d) = rI-kIdrH(d) = rH-kHd + |m-d| γkI,kH= marginal values for commuting to the center: kI< kHγ = marginal valuation of distance from industries by households: assume γ “large”[note works in both directions with the absolute value function |--|. ]Region Wide ExternalitiesMIT Center for Real EstateMultiple equilibrium solutions to a city in which one use dislikes being near to the other. History matters!Which patterns maximizes regional land value?m bm brI-kIdrH–kH+ γ[m-d]IndustriesHouseholdsLand