An expensive improvement on a cheap piece of land is likely to raise the value of the land, not just on the site of the improvement but on neighboring properties. This is especially true if the improvement is built in such a way that it complements surrounding properties.
These two realities – rising land prices inducing redevelopment, redevelopment increasing land values – work together in an incremental framework of development to create a natural renewal mechanism within a neighborhood (Figure 2.3).
Low I/L Ratio: Redevelopment
High I/L Ratio: Land Price Appreciation
Figure 2.3 Improvement to Land (I/L) Ratio over Time
Consider the row of pop-up shacks described earlier, the starting point for every city built before modern times. When those shacks were originally constructed, the land was cheap. So were the shacks. No early speculator went into a frontier town like mine and, before anything else had been constructed, built a bank with granite columns and marble stairs. That would have been silly. The town could easily have become a ghost town and that massive investment would be lost.
The first iteration of every city was cheap buildings on cheap land. Little bets.
With every cheap building that went in, however, the value of the land increased. A row of shacks constitutes a place, somewhere people from the surrounding area could come to have a drink, purchase supplies, cable the outside world, meet other people, play billiards, and go to church. Each new building, each new enterprise, improved the value of the place.
This is especially true with the traditional design as it had evolved. These shacks were built in a tight cluster for a reason; their proximity to each other created value for all of them. This could be enhanced, even in really poor places, by the design. This first iteration of a city began the process of harmonizing multiple objectives, one of them being the urgent need to make the place valuable enough to endure.
Each individual property owner, acting in their own self- interest, would do what is best for themselves. Yet, even in an infant phase of development, this highly evolved human habitat would harmonize those selfish actions to the benefit of the other, nearby property owners.
If a property owner in this early phase of a town wanted to maximize their own position, they would build their building in line with the others on the street. They would have their entrance and windows facing the street. They would make the front of their building as ornate as resources and skill would allow. They would put the trash and latrine and other less-savory things in the rear of the building, away from potential patrons.
Each of these things, and more I’m certainly overlooking, would improve their own property’s value. It would also increase the value of adjacent properties. The traditional way of building – the way they would have all intuitively understood as the only proper way to do things – used individual action to maximize the collective value of the place. This is one of those spooky features of complex systems.
And it is a critical feature, because improving the collective value of the place is a requirement if the city is to become stronger and more prosperous. It is a prerequisite for the survival of the town. North America is full of failed settlements, most long forgotten, that didn’t successfully meet this viability threshold.
As the block of pop-up shacks is developed, as those small investments are growing into a place, the land underneath each of those shacks increases in value. Simultaneous with the rising land values, the shacks themselves are declining. The owners of these shacks, which were hastily constructed of rather marginal materials anyway, must put resources and energy into maintaining them if they want them to retain their value. If they don’t make those maintenance investments, their buildings will start to decline. This condition – rising land values and declining improvement values – accelerates redevelopment pressure.
At some point, someone will purchase that property, tear down the shack, and build something more substantive, something that better aligns with the underlying value of the land. So long as the underlying land continues to rise in value – so long as the place continues to get better – this redevelopment pressure will exist, transforming buildings that go into decline into investment opportunities.
This is how a street transforms from pop-up shack to two- and three-story wood structures. This is the mechanism used to nudge that second-generation street into one with buildings of brick and granite. And this is the way a well-situated little town grew from a tiny settlement into Manhattan: incrementally, on a continuum of improvement, with the resulting increase in land values creating a self-reinforcing renewal process.
The Stifling Nature of High Land Values
This renewal process might seem like a wonderful thing, particularly compared to the cycle of decline we experience in modern cities, so it’s important to reiterate that evolution is not a happy process. Adaptation happens in response to stress. Complex systems are relentless in forcing failure, as early and conclusively as possible. There are good reasons Americans abandoned this approach after World War II when they had the opportunity, turning their back in the process on millennia of accumulated wisdom in pursuit of something they felt to be better.
Auto-oriented, suburban development was an attempt to address many problems with the city. One of the most pernicious was the stifling nature of high land values, the inevitable result of a maturing city.
A key characteristic of traditional cities, especially those that reached a level of maturity, was stability. These were human habitats designed to endure, a refinement achieved through thousands of years of trial and error experimentation. In a coarse sense, a traditional city is valuable land surrounded by cheap land, wealthy people surrounded by poor people. The stability of the city was a function of this wealth.
For young cities, this relationship between the center and the edge was a feature. An upstart could acquire cheap land on the nearby edge of the city, make a nominal investment of largely sweat equity, and experience the increase in wealth of a rising tide. This allowed people to start with nothing and end up with something, to start small and share in the prosperity of the community as the human habitat matured.
The more mature the city, however, the more entrenched the wealth. This is great for the stability of the community as communal efforts, such as police protection or water distribution, require a stable base of wealth to draw from. It was less appreciated by those who had nothing, who found themselves living in places that had matured, where the opportunities incremental improvement provides had slowed.
Auto-oriented development changes this dynamic radically. When a connection is made between two places – by a river or a railroad or a highway – that connection creates value for each place. It builds wealth. The original vision for America’s highways was for them to function as connections between established places, to augment the wealth creation mechanism of rivers and railroads. Had that been done, it would have reinforced existing development patterns further entrenching the stifling nature of high land values.
Instead, all levels of American government coalesced around policies that destroyed the underlying land values of core cities. The mechanism is simple: Running a road through the center of an established neighborhood to the edge of town opens land up for development. With the automobile and the new road, comparatively massive amounts of raw land is now reachable. From a simple supply and demand standpoint, flooding the market with cheap land drives down the price of land.
Instead of connecting places, highways primarily became a mechanism for land development around our cities. Policies were established at the state and federal levels focusing on auto-commuting patterns. Highways were run, not around cities, but through the middle of established neighborhoods. Cities adopted regulations and practices – such as high design speeds on local streets, parking requirements for private property, and anti-walking campaigns – that privilege distant auto-commuters over local land owners. Over time, mitigating traffic congestion became a top pub
lic policy priority.
This is not great for those wealthy property owners who experienced the destruction of their property values in the core of the city, but it was great for people suffering under an approach that favors high land values, particularly middle-class families that couldn’t get into the prime real estate. Coming after the Great Depression and World War II, this flipping of the economic chessboard was exactly what Americans were looking for.
Even so, this shift was a disaster for the financial stability of the community, which depends on extracting wealth to provide for ongoing communal services. The next chapter will examine how local governments have responded by shifting from an approach centered around wealth creation to one dependent on increasing rates of growth.
Simultaneous with highway building and the government-led creation of auto-oriented suburbs came the destruction of property values in the core of every American city. Again, with supply and demand dynamics, a massive increase in developable land puts downward pressure on land prices. With underlying land values in mature neighborhoods not just stagnant but falling, the natural renewal mechanism that gave cities stability collapsed.
In the subsequent decades, buildings of astounding grandeur in our core cities were razed to make room for parking lots. It wasn’t because parking provides great value – it doesn’t – but merely that the cost of maintaining and repairing the structures could not be justified with collapsing land values. Americans spent an incredible amount of money to destroy generations of wealth, buildings of such magnificence that we could not recreate them today if we desired to.
Modern development is built all at once and to a finished state, a condition that does not naturally induce the rising land values necessary to drive redevelopment and renewal. We have defeated the stifling constraint of high land values, but in exchange we sacrificed the stability that has been the hallmark of cities throughout time.
Private and Public Investment
Consider the pop-up shacks of Brainerd once again, only this time ponder the public infrastructure serving them. In short, there was none. There were no sewer and water systems. No streets or sidewalks. No drainage system. Nothing. The first iteration of the city didn’t produce enough wealth to justify any of those things. The people who built that place had more urgent things to do with their resources.
The second generation of buildings was different. Along with those two- and three-story wood structures came a wooden sidewalk and a gravel street. The modest increase in wealth justified and supported the modest increase in collective commitment.
The third generation of brick and granite buildings had fully modern infrastructure systems. There were concrete sidewalks on the edges of an asphalt street. A storm drain is visible in the middle of the street, a way to shed rainwater into a pipe that would also transport sewage to the river. There is a fire hydrant on the corner indicating a water system. The increase in intensity of the street supported an increase in intensity of communal infrastructure.
That little collection of pop-up shacks did not produce enough wealth to maintain a paved street or a sewer and water system, even if they had somehow found the money to build it. The community that could afford to build brick and granite buildings could also afford to build and maintain all those infrastructure systems; there was enough wealth there to extract what was necessary to keep it all going.
There is no chicken and egg conundrum here; in traditional cities, private investment preceded public investment. The wealth of the private investment is necessary to justify, and ultimately sustain, the collective public investment. This is essential for community stability. Evolved systems punish failure; they use little bets to probe uncertainty, but never ongoing gambling as a pathway to prosperity.
For traditional cities, rising private wealth leads to increased public commitment. The city itself serves as the ultimate rentier, extracting ongoing income from the wealth of the community, for the benefit of the community. The stable relationship between private and public investment graphs as shown in Figure 2.4.
Figure 2.4 Private Investment Leading Public Investment
This is in stark contrast to everything we experience today regarding growth and development. Instead of private wealth leading, in today’s cities it is the collective public investment that leads. Governments frequently invest millions of dollars, or make long-term maintenance commitments worth millions, before any taxable private investment has been made.
In the best-case scenario for a local government, a developer will agree to put in all the required public infrastructure – all the roads, streets, curbs, sidewalks, pipes, pumps, valves, and meters – and do so completely at their own expense. The developer takes the first life-cycle risk, the chance that the development does not cash flow adequately enough to cover the up-front expense. What the city then assumes is the ongoing maintenance liability and the risk that the development will not grow to have, or retain over time, adequate tax base to fund ongoing maintenance costs. This is the best deal our cities ever experience today. Most cities do far worse.
For example, in addition to the long-term maintenance costs, some cities voluntarily incur financing risk during the development process. They serve as the bank for the developer by borrowing the money to build new infrastructure, using the good faith and credit of their taxpayers as security. The developer, in exchange, agrees to pay back the loan, with some interest, when the developed property sells, although sometimes that promise is transferred to the property owner at the time of purchase. Either way, the city is taking the additional risk that the development fails, in which case they are stuck with the debt, a nonperforming asset and the long-term maintenance liability.
Some cities will forego working with a private developer altogether and simply acquire and develop the property themselves. The concept of a shovel-ready site, owned by the city and ready for transfer, with all the public utilities preinstalled, has become commonplace. These deals are often sweetened with tax subsidies, waiving of fees, and expedited permitting.
While these approaches are commonplace today, it’s important to recognize the shift in phasing and risk that has occurred. Instead of private investment leading, the public sector now takes the risks by being out in front of the development process. The modern relationship between public and private investment is graphed as shown in Figure 2.5.
Figure 2.5 Public Investment Leading Private Investment
None of this is to suggest that, throughout human history prior to modern times, the public sector never took risk to spur development. They did; it was just the rare occasion and not the rule. Today, the public sector backstops almost all private land development, either by direct investments up front or by assuming the long-term maintenance obligations before the tax base has matured.
While this might seem like a subtle shift, the impacts are enormous. Once in place, public infrastructure investments become sunk costs. Cities have the capacity to borrow large sums of money, or shortchange other parts of their budget, to make debt payments. This blunts the intensely motivating incentive of financial failure and replaces it with the more abstract notion of political failure.
When the public sector leads, vacant space becomes an embarrassment instead of an immediate fiscal crisis. The human need to fill the space, at whatever cost, is not conducive to good decision-making. Worst of all, putting all the public improvements into a finished state before any private investment has occurred merely ensures that the city will become a bad party.
The Party Analogy
Consider a dinner party where each invited guest brings more food and beverage than they themselves consume. With each person that shows up, there is a wider selection of food and drink, the conversation grows, and the party simply gets better. The logical thing to do as host of this good party is to open the doors as wide as possible and invite more people in. The more the merrier!
What about a party where each invited guest consumes more food and beverage than they t
hemselves bring to the party? With each person that shows up, the supplies are dwindling. This is rapidly turning into a bad party. As host, the logical thing to do is to bar the door and not let anyone else in.
Traditional development patterns were a good party. While each neighborhood began modestly as a collection of small investments, each new arrival simply made things better. Not only did new construction improve underlying land values in a virtuous cycle of growth, stagnation, and renewal, but it improved the capacity of the neighborhood to take collective action.
Get enough people and you could start a bucket brigade. Add some more and you can afford to put in a water line. Even more and those gravel roads could be paved. Keep growing and you could staff a police department or a library. In a good party, private growth provides collective benefits.
Modern development, where the public sector leads and everything is built to a finished state, is a bad party. When someone buys that new house on the cul-de-sac, they don’t want more development around them. To the contrary; new development merely means more traffic, more people using the park, more taxes.
In our bad development party, there is no reason to expect new growth in a neighborhood to provide any real benefit to that neighborhood. There is already a paved street. The water and sewer system are already installed. The park is built, the fire station staffed, and the library is open. What benefit is there to me for adding a bunch of new people to my cul-de-sac? Little to none.
Strong Towns Page 4
