Vous êtes sur la page 1sur 18

© The College of Estate Management 2007

Paper 0334V3-0

The real property market


1. The nature of real property

2. The functions of the real property market

Activities 1

3. Efficiency in the market economy

4. Reasons for government intervention in the market economy

5. Efficiency in the real property market

5.1 Technical characteristics
5.2 Economic characteristics
Activities 2

6. The pricing of land and land resources

6.1 Land as a whole
6.2 Commercial rent
6.3 Non-homogeneous land and economic rent

7. The dominance of stocks over flows

7.1 The relative size of stocks and flows
7.2 Corollaries of the above analysis

8. Conclusion
Activities 3
The real property market Paper 0334 Page 3

1 The nature of real property

Real property refers to a particular type of good – land or resources embodied in land.
The point is that neither is physically movable. This characteristic distinguishes it
from labour, capital and goods in general.

Although the resources embodied in land are not movable, they are a form of property
which can be owned by some person or institution. What are actually owned are
‘property rights’, often referred to as ‘interests’. To emphasise such ‘rights’, there is
usually a written definition of the rights owned. Thus the real property market is
simply the arrangement by which buyers and sellers of virgin land, agricultural
estates, industrial buildings, offices, shops and houses are brought together to
determine a price at which the particular property rights owned can be exchanged.

Sometimes the market is formal (the London Auction Market), sometimes informal
(introductions by estate agents, deals between principals). Indeed, it is not possible to
distinguish the means by which people are informed from ‘the market’. Much real
property, as with consumer goods and labour, is advertised in journals (the Estates
Gazette and Daltons Weekly) and newspapers, all of which can therefore be said to be
part of the market. Thus ‘the real property market’ is simply an omnibus term
covering all transactions in real property, but with submarkets distinguishable
according to special characteristics – City of London office blocks, prime shop
properties, houses in a given locality – with each fulfilling, albeit perhaps
imperfectly, the basic functions of a market.

Certain aspects of ‘property rights’ should be noted:

1. Rights can be separated or unified through the market mechanism.

2. Rights can be finely adjusted according to individual preferences, e.g. through

restrictive covenants.

3. Rights only have market value when others can be excluded from enjoying
them. Being therefore a legal concept, they have to be clearly defined.

4. Because real property is durable, rights existing in real property have a long
timescale. Moreover, no problem of storing such rights exists, though there
may be management costs. Real property rights, like stocks and shares, are
therefore demanded as investment assets. Indeed, the real property market can
now be regarded as a part of the wider investment asset market, its significance
in this respect having increased in recent years.
The real property market Paper 0334 Page 4

2 The functions of the real property market

In the market economy, exchanges take place on the basis of prices determined in the
market by the interaction of demand and supply. Because the formation of price is
central to the functions of the market, we can define a market as any arrangement by
which the buyers and sellers are brought together to fix a price at which goods can be

Allocating land resources and real property through the price mechanism, therefore,
immediately poses three questions:

1. In what sense is there a ‘real property market’: i.e. what are its functions?
2. How efficient is the market in registering changes in demand and supply for
the same kind of property by means of changes in a common price?
3. How does the market function through price changes to bring demand and
supply into equilibrium (a) in the short run, (b) in the long run?

We shall consider each question in turn.

In any market, a price of a good is established which reflects current conditions of

demand and supply. But the market does more than indicate. Because buyers and
sellers respond to these price signals, it also motivates. In short, the price system
functions through the market.

Thus we can break down the function of the real property market as follows:

1. To allocate existing real property resources and interests. Because land

resources are scarce (that is, not unlimited in supply) they have to be allocated
between the various uses and people wanting them, including both occupiers
and investors. This is achieved by arriving at the equilibrium market price –
the price which equates the resources (or interests) being offered for sale with
what people wish to buy. Thus the market reflects preferences and allocates
available supply accordingly.

2. To indicate changes in demand for land resources and interests. If, for
instance, house occupiers switch their demand from rented to owner-occupied
houses, this will be shown, other things being equal, by a relative rise in the
price of houses for owner-occupation compared with houses for renting.

3. To induce supply to adjust to changes in demand. Changes in supply take

time, and it is usual to distinguish between the short and the long periods.
Since these periods are discussed later, we shall ignore them for the time

Of course, such changes are subject to the imperfections of the real property
market. Moreover, efficient adjustment to changes in demand and supply
assumes that all interests are divisible and that there is a perfect capital market.
Neither assumption is true. Office blocks come in large ‘lumps’ (though the
emergence of property bonds and property unit trusts has helped to overcome
this difficulty). Imperfections of the capital market may prevent a full response
to preferences regarding interests. Thus a building society may not give a
mortgage on a long-lease flat in the centre of a town, the would-be purchaser
thereby being forced to go to a modern semi-detached freehold house in the
suburbs. Or a speculative builder may be short of capital, thereby forcing him
to lease the land instead of buying outright.
The real property market Paper 0334 Page 5

4. To indicate changes in the conditions upon which land resources can be

supplied. Improved techniques in constructing high-rise buildings, for
example, may make flats cheaper compared with low-rise houses and flats.

5. To induce demand to respond to changes in the conditions of supply.

6. To ‘reward’ the owners of land resources. Rewarding the owners of land

resources is a by-product of the market. Such rewards are of two main kinds.

First there is the return on capital invested. When a person looks for certain
return without risk, e.g. freehold ground rents (FGRs), then the return
corresponds closely with the opportunity cost, what that capital could have
earned in the best alternative use, such as government stock. There is,
therefore, little ‘profit’ element in such return.

Second there is the return for risk. The yield from a land resource usually
extends far into the future. Being a fixed factor, the reward on it will depend
upon demand. Thus the return is largely in the nature of ‘economic rent’. It can
be high, for example to people who own ‘land banks’ before an increase in
demand, or it may be negative, for example to builders who have bought ‘land
banks’ before a slump. In short, the return, ‘supernormal profit’, arises because
of the risk attached to any fixed factor.

To conclude, the function of the real property market is to establish a pattern of prices
so that, given sufficient time (the long period), land resources are allocated according
to their most profitable (‘highest and best’) use relative to other land resources. This
occurs because competition in the market induces owners to switch resources to the
use which yields the highest net return. Should, however, any of the conditions of the
perfect market (see below) not hold, the allocative efficiency of the market will be


1. Review your understanding of basic market theory by reference to study paper


2. It is often claimed that when you buy property, you are buying a ‘bundle of rights’.
For any property with which you are familar (your house, your office space, etc.)
briefly list what rights are to be found in that bundle.

3. A similar claim is that property is a ‘bundle of characteristics’. Again list what

these might include for your given property. This time, try to put a monetary value
on each one!

4. Draw demand and supply diagrams to show how the market:

a. allocates owner-occupied houses;

b. indicates a change in demand towards owner-occupied houses and away
from rented accommodation;
c. causes supply to respond to (b);
d. would indicate improved techniques in house building;
e. causes demand to respond to (d).
The real property market Paper 0334 Page 6

3 Efficiency in the market economy

In the mixed economy of the UK, land resources are still allocated mainly through the
market mechanism, with the government intervening where this mechanism could be
defective. The conditions of perfect competition would be required to achieve a
Pareto-efficient allocation of resources. The exact requirements may now be spelt out
in more detail and contrasted with the actual conditions that prevail in the real
property market.

Perfect market competition involves:

z Atomistic market structure. There are many buyers and sellers, each too
small to individually influence the prevailing price in the market.

z Homogeneous product. All sellers are providing goods that are identical
(perfect substitutes) in the eyes of the buyers.

z Perfect information. Sellers are aware of the availability and prices of all
factors of production and the profit opportunities within the economy, and
buyers are aware of the availability and prices of all finished goods.

z Free entry of new firms. When profit beckons, new firms are able to enter the
market without restriction and without incurring any costs that established
firms avoid.

z Profit maximisation. It is assumed that sellers are motivated by the self-

interested pursuit of as much profit as possible.

z No government intervention. The government at local or national level is

assumed not to modify or supplement market forces in any way.

z Excludability applies. Goods are marketable in the sense that the benefits may
be enjoyed by those willing to pay while those not willing to pay are excluded
in a practical way from enjoying those benefits.

z No externalities. All costs and benefits of production and consumption fall

upon buyers or sellers and do not spill over to third parties.

z Perfect factor mobility. All factor inputs are available to all sellers at perfect
market prices, irrespective of location.

It does not take much imagination to appreciate that the real property market differs
in virtually every respect from this description of the perfect market. In addition,
these conditions would only lead to one of many potentially efficient outcomes. The
precise result will depend upon the initial distribution of resources in the economy.
The pursuit of market efficiency may conflict with the distributional goals of society.
The real property market Paper 0334 Page 7

4 Reasons for government intervention in the

market economy
The statement of the above conditions suggests that intervention by the government in
the allocation of resources by the market occurs where the following considerations

1. It has superior knowledge to private individuals. Thus a large-scale,

comprehensive, controlled and well-planned approach to economic decision
making may produce less uncertainty about the future and fewer piecemeal
solutions than the independent decisions of individuals.

2. There is imperfect competition due to a limited number of sellers or a

differentiated product. Government intervention can overcome imperfections,
rid the market of supernormal profits and contribute to the attaining of a more
efficient allocation of resources.

3. The mobility of factors of production can be improved. Mobilities can be

increased by regional policy, by policies which remove barriers hindering
urban renewal, by compensation to tenant farmers for improvements they have
carried out, etc. Paradoxically, other government policies, particularly rent
control, may hinder factor mobility.

4. Social costs and benefits diverge from private costs and benefits.

5. Certain satisfactions cannot be adequately priced in a market, the government

having to provide the facility itself, such as defence, street lighting, where non-
excludability applies.

6. Output of the good or service can only be pushed to where marginal benefit
equals marginal cost if the full or extra cost is covered by taxation, for example
bridges, parks, drainage, fire services.

7. There is an unacceptable degree of inequality in the distribution of income.

Greater equality in the distribution of income is secured by the system of
taxation. Income tax is progressive (the higher the income, the higher the rate
of tax), thus redistributing income from the richer to the poorer: capital gains
tax, inheritance tax, etc. have a similar effect.

8. Intervention to achieve greater equity (7 above) may itself create allocative

inefficiency which may warrant secondary intervention. Thus private rent
control combined with state provision of housing was probably less inefficient
than private rent control on its own.
The real property market Paper 0334 Page 8

5 Efficiency in the real property market

Since the market is essential to the functioning of the price system, a defective market
mechanism will impair the efficiency with which resources are allocated through the
price system. We therefore have to ask: how efficient is the real property market in
registering the effect on price of changes in demand and supply?

The efficiency of a market depends on both technical and economic characteristics.

5.1 Technical characteristics

Physical conditions should be such that price differences for the same commodity in
different parts of the market are eliminated easily and quickly. This comes about by
buyers moving to cheaper parts of the market and sellers moving to the dearer. For
this to happen, however, both buyers and sellers must have up-to-date knowledge of
the prices ruling in different parts of the market and base their actions solely on these
prices. Moreover, dealing costs should be small relative to the value of the

Now when we look at the real property market, we find factors which not only make
it difficult to obtain up-to-date knowledge but also lead to dealing costs being
relatively high. As regards the first, knowledge tends to be obtained infrequently and
limited geographically.

Nor do we overcome the difficulty of lack of knowledge simply by saying that it can
be overcome by paying for advice. Because of differences of site, construction and
age, most units of real property have special characteristics, making ‘grading’, the
most efficient form of description, difficult.

Nor, owing to their great heterogeneity, can a professional valuer fully assess their
respective merits. To some degree, therefore, his valuation is subjective. Thus, unlike
transport costs, costs of obtaining knowledge are not absolutely certain, and a
purchaser would normally go to the trouble of making a personal inspection and
discussing with his professional adviser the weight to be given to special

Except for the difficulty regarding the uncertainty of information costs, the cost of
obtaining knowledge, estate agents’ fees and legal costs involved in the actual
transfer are, in principle, no different from the costs usually incurred in transporting
goods within the market. Thus they have the same effect as transport costs: if they are
high relative to the value of the commodity dealt in, they tend to separate markets
geographically or, at least, to reduce their sensitivity to small changes in demand and

In practice, therefore, the real property market is not one market but is divided into a
number of separate markets. Moreover, while some markets are quite distinct (e.g.
urban housing and Scottish grouse moors), others are intimately related and
overlapping (e.g. houses and shops can be sold for both occupation and investment).
Some, where institutional investment demand dominates, are national (even
international) in coverage (offices and prime shop property). Others, where demand is
local, tend to be divided geographically into submarkets (owner-occupied houses and
seaside hotels). Moreover, even within these markets or submarkets, differences in
rent persist, changes in demand not being fully effective until leases have expired.
The real property market Paper 0334 Page 9

5.2 Economic characteristics

In addition to its physical features, we must examine the market’s economic
characteristics particularly as regards the extent to which competition prevails. We
have to ask: is there freedom of entry into the market? Does the market consist of
many buyers and sellers, each so small that no one can exert monopsony (buyer) or
monopoly (seller) powers?

Generally speaking, there is freedom of entry into real property markets, resulting in
many buyers and many sellers. But we must also recognise that certain conditions
make it easy for an owner to gain some monopolistic control. Such conditions are:

1. The geographical divisions of the market lead to imperfect competition

through local markets.

2. The imperfection of the capital market may prevent would-be buyers from
borrowing the large sums required for certain purchases, such as multi-storey
office blocks.

3. The spatial fixity of real property puts certain site-owners in a strong position
relative to a buyer.

To summarise, therefore, prices are the signals which indicate changes in the
conditions of demand and supply. Where markets are defective, the price signals
work at less than full efficiency, and adjustments in supply and demand are sluggish.
Relatively high costs of dealing, incurred either in obtaining knowledge or in the
necessary legal procedures, restrict the extent to which small signals can motivate
response. Furthermore, any limitation of the market localises demand and supply,
making it easier for imperfect competition to exist.

Nevertheless, by and large, prices do respond, albeit somewhat sluggishly, to changes

in market conditions; given sufficient time, the necessary adjustments to supply and
demand do take place. How these adjustments come about through the mechanism of
the market will now be examined.


1. Review your understanding of economic efficiency with reference to study paper


2. Government intervention takes the form of:

a. physical controls
b. taxation and subsidies
c. government production.

Give examples under each heading from land resource use.

3. This study paper states that a site-owner may enjoy monopoly strength. Explain
briefly how this can occur in a comprehensive development. How might a
government react?

4. Use the analysis of the nature of the real property market to suggest ways in which
it can be made more efficient in allocating land resources.
The real property market Paper 0334 Page 10

6 The pricing of land and land resources

6.1 Land as a whole
Undeveloped land, or ‘pure’ land, refers solely to natural resources and space. Thus
land as a whole, that is the earth’s land surface, can be regarded as being fixed in
supply. Since the total supply of land is the same whatever its earnings, its
opportunity cost is zero. Earnings represent economic rent.

Certain points should be noted as regards this general statement:

1. To say that the earnings of land are a surplus over opportunity cost does not
mean that payments do not have to be made for land. Price still performs the
vital function of rationing scarce supply among competing uses. This is
necessary to ensure that, in each location, land is put to its highest and best use
according to the preferences of consumers and society.

2. It follows from 1 that the supply of land can never be regarded as fixed from
the viewpoint of any one use (unless it can only be used in one way).
Additional supplies can always be bid from other uses if the proposed new use
has a higher value than the existing use.

3. Except in the purely technical sense of space, additional supplies of land can
always be created in response to additional demand by a more intensive use of
existing land.

4. The fact that the earnings of land as a whole are entirely demand-determined is
important from the point of view of land taxation – the land will still be there
no matter how high the tax. In other words, a tax on pure land has no
disincentive effect on the supply of land. Economic rent can be taxed away
entirely. This is the basis of taxes on land, for example petroleum revenue tax,
development land tax.

But two further points should be noted:

5. Unless all forms of land used are taxed equally, the pattern of land use will be
distorted. Whether such distortion is good or bad on balance can only be
decided by:
a. a comparison with the inevitable distortions produced by different taxes;
b. spillover benefits and costs;
c. one’s political views.

6. Costs of production include normal profit, that is, what is necessary to keep the
entrepreneur in the current line of production. But the size of normal profit
may be uncertain, and taxes may overlap supernormal profit and fall on normal
The real property market Paper 0334 Page 11

6.2 Commercial rent

Commercial rent is simply a periodic payment for the hire of land. Normally, there is
competition for land between the different potential users. The rent of land, therefore,
as with rewards to other factors of production, is determined, in the absence of any
government interference with free market forces, by the interaction of demand and

The demand for land as a factor of production is a derived demand – it is wanted for
the contribution it can make to a final product. Moreover, it has to be combined with
other factors, labour and capital, to produce the goods that are wanted. Thus the
quantity of land a firm demands depends upon:

1. its productivity;
2. its price relative to other factors;
3. the price of the final product.

The sum of the demands for land by the individual firms will give the industry’s
demand for land.

As regards supply, as the rent of land in a particular use rises, it will be surrendered
by less profitable uses. In short, more will usually be supplied the higher the rent.
Therefore, although the total supply of the land is fixed, the supply curve of land with
respect to specific uses will be upward sloping.

The interaction of demand and supply will give an equilibrium market rent for this
type of land. Competition will have ensured that at this rent it goes to the highest and
best use.

Up to this point we have talked as if all land is of equal quality, i.e. as if land is
homogenous. Obviously this is not the case and so now we relax this assumption.

6.3 Non-homogeneous land and economic rent

In practice, land varies in quality. Thus agricultural land differs in fertility, climate,
altitude, topography and accessibility to the market.

Consider a piece of land which produces 2½ tonnes of wheat per acre. There will be
less fertile land but, we will assume, such land will still be used for growing wheat
provided it yields 1½ tonnes per acre. This latter land just earns its transfer cost, the
minimum it has to earn to be kept in its present use; it is said to be marginal as
regards wheat-growing. In contrast, the 2½-tonne land yields 1 tonne per acre above
the marginal land; this 1 tonne is an economic rent resulting from its greater fertility.

The same argument applies to urban land. Different characteristics, such as

accessibility, the physical condition of the site and institutional restrictions
(development plans and covenants), give rise to differential rents. Shops in Oxford
Street and offices in the City of London all earn a high economic rent as a result of
the high commercial rents which they command.

Whereas land refers to natural resources, land resources have been defined as ‘the
total natural and man-made resources over which possession of the earth’s surface
gives control’. That is, land resources are equal to the natural content of land plus any
improvements attaching to or incorporated in the land. Indeed, when we talk about a
transaction in land, we are usually referring to land resources. In agriculture, for
instance, land would include the farmhouse and buildings, the fences and water
supply, while a freehold residence is the land plus all the fixtures on the land – the
house, conservatory, fishponds, swimming pool, fences, and so on.
The real property market Paper 0334 Page 12

Price in the market is determined by demand and supply. In economic analysis it is

usual to allow for the fact that changes in supply take time by dividing time into three
main periods (Figure 1).

If demand increases from D to D1 in the ‘momentary period’, no adjustment of supply

is possible (Sm); in the ‘short period’, supply can be altered by engaging more
variable factors (Ss). Eventually, however, in the ‘long period’ supply can be
increased by adding to fixed capital, thus combining the factors of production in their
best proportions (SL). The price of the product changes from OP to OP1, OP2 or OP3
according to the time period.

FIGURE 1 The effect of time on the conditions of supply

The real property market Paper 0334 Page 13

7 The dominance of stocks over flows

7.1 The relative size of stocks and flows
While not incorrect, the general analysis of the formation of price over time suffers
from two main weaknesses when applied to individual goods:

1 The time taken to achieve the long period situation varies considerably
The full response of supply to a rise in the price of buildings usually takes a very long
time. The various interests in a site required for redevelopment have to be
amalgamated (usually by acquiring leases), planning permission has to be obtained
and any compulsory purchase orders subjected to time-consuming procedures. This
means that, when applying the usual time period analysis to land resources, we have
to recognise that for a considerable period of time we are virtually dealing with a
fixed stock. Thus changes in demand will tend to be more significant than changes in
supply in determining market price.

2 No allowance is made for the size of stocks of existing goods relative to

flows of new goods coming on to the market
With most goods we do not have to pay much attention to this. Because their life is
relatively short, existing goods (the stock) have to be frequently replaced by new
supplies (the flow over a period).

Take cars, for example. Other things being equal, any increase in the demand for cars
will, in a free market, push up the price. Extra imports may help to meet this
additional demand. But if manufacturers consider that the higher price is likely to be
permanent, they will eventually add to plant so that the supply of cars coming on to
the market increases. This flow of new supplies will be significant relative to the
supply coming on to the market from existing stocks, and will thus be a main
determinant, with demand, of price.

But the position is somewhat different with certain goods, such as ships, aircraft, and
land resources. Because such goods are so durable, stocks of them accumulate over
time. As a result, new flows on to the market (additions, say, per annum) are small or
insignificant in comparison with the supply to the market coming from existing
stocks. As a result, new supply has relatively little influence on price: for all practical
purposes, supply from old stock dominates the market.

Two qualifications, however, should be made. First, it is the turnover of old stock
which is really significant. Second, over the years, accumulated flows affect the size
of stocks, and have their effect in this way. But the possibility of this is very limited
in developed city centres.

Price, therefore, is largely determined by demand; new supplies largely follow this
price, rather than having much influence in determining it. The position is
summarised in Figure 2.
The real property market Paper 0334 Page 14

FIGURE 2 The dominance of the stock of real property over its price

An illustration from housing

When the stock of owner-occupied housing units in the United Kingdom was
approximately 15.6 million, the turnover of this stock each year, about 5% or
780,000, was large relative to the flow of additional units being produced each year,
on average 180,000 for the period 1987–91. Indeed, in areas, like Greater London,
which are surrounded by a green belt, practically every house coming on to the
market is from the existing, and almost fixed, stock of houses.

In such a situation, demand determines the price of houses. For example, let us
assume an increase in the demand for living accommodation. In the short run,
existing dwellings are used more intensively, perhaps by a decrease in or
disappearance of the number of vacant dwellings, an increase in subtenancies, a
doubling up of families, an increase in the number of persons per room. Eventually,
the prices of existing accommodation units will rise (Figure 3).

But since the flow of new houses on to the market is insufficient to affect the supply
significantly, the higher price of existing houses will represent the price of all houses
in the market. Any newly built house which comes on to the market will be sold at the
higher price, P1. In other words, the price of new houses is determined by the price at
which existing houses sell.

The price paid for land for new housing is thus the residual between what the new
house will sell at (determined by the demand for old houses) and what it costs to
build, including normal profit. Take, for instance, a builder bidding for an odd site in
London on which to erect a house. Suppose similar old houses are selling for
£120,000, and that he estimates that it will cost him £80,000 (including his normal
profit) to build. He can therefore afford to bid £40,000 for the land, and indeed will
have to if he is to secure it in competition with other builders.
The real property market Paper 0334 Page 15

FIGURE 3 The effect of an increase in the demand for accommodation on

the price of dwellings

Because houses take time to build, this explanation of price determination applies in
all localities in the short period. Where building land is available, however, the high
price offered for existing and, therefore, new houses will encourage builders to erect
new houses so long as the production cost of new houses is less than the price of old

Over time the flow of these new houses on to the market will be sufficient to
influence the stock of houses, and the price of old houses will tend to fall. This
process is most noticeable in districts where the supply of building plots is plentiful,
for example new towns, overflow towns (Swindon, Ashford, etc.) and on the fringe
land of certain towns where planning permissions have been freely given to permit

In the long period, therefore, these new flows affect the price of old houses and, when
the prices of old and new houses coincide, the cost of building new houses does affect
the price. In other words, the long-period supply curve of houses is now likely to be
more gently upward sloping – but it may take a very long time before this happens
and, where cities are surrounded by green belts which cannot be built on, the price of
houses will tend to be dominated by demand.

7.2 Corollaries of the above analysis

1 Current construction costs are not relevant in determining prices and rents
of real property
Such costs include the price of land, building material and labour costs, and the cost
of builders’ borrowing, for example on overdrafts.

As regards the price of land, it is sometimes stated, for example, that the high cost of
land is responsible for high house prices, thus limiting homeownership. Our analysis
gives scant support to this view. An increase in demand for houses causes the price of
old houses to rise. This enables builders to bid more for land – up to the difference
between what they can sell a new house for (the price of similar existing houses) and
the cost of building (including normal profit). Thus, in our example, if the price of
houses rose to £200,000 and building costs remained unchanged, £120,000 could now
be paid for the land.
The real property market Paper 0334 Page 16

Of course, to the individual builder, the price of land is a cost; as with building
components, he has to pay the going competitive market rate to obtain it. But the
‘individual’ view that land prices should be controlled because they are too high puts
the cart before the horse. What we have done is to examine the underlying factors –
the demand for houses – which determine the price of land from the point of view of
builders as a whole. Land prices are determined by house prices rather than the other
way round.

Three other points should be noted:

a. It is what would be the builder’s abnormal profit which represents the

maximum he can bid for land. Unless this is sufficient to attract land from its
next best use, for instance agriculture, he cannot build.

b. Since the price of land is determined by the demand for housing, controlling
the price artificially would not result in house prices falling. Instead the surplus
return would simply go to somebody other than the landowner, e.g. the first
purchaser, or local authorities who acquire land compulsorily at existing use
values. Furthermore, controls would upset the allocative function, ensuring that
scarce land is used for its highest and best use, performed by market prices.
Artificially low prices, maintained by some form of price control, would lead
to a ‘wasteful’ demand for land in less profitable uses.

c. As the price of houses rises, land costs form a greater proportion of that price.
Thus, in our earlier example, when the house sold for £120,000, the land cost
formed one third of that price; when the house rose to £200,000 through
increased demand, the land cost rose to three fifths.

Similarly, we have to ask whether a rise in the cost of building materials and labour
will put up the price of houses in the short period. The answer is that, where building
land is earning an economic rent (that is, its price is above its ‘transfer’ or next-best-
use price), a rise in building costs has no effect on the current price of houses. Since
the supply of houses comes mainly from existing stock, their price in the market is
determined by demand. A rise in building costs, therefore, simply means that the
builder has a smaller margin to bid for the land. Thus, in our original example, had
building costs risen by £8,000, his maximum bid for land would have been only

The effect of a rise in the rate of interest must be considered from the viewpoint of
both the builder and house purchaser. On the supply side, the builder has to pay more
for his overdraft but this will affect only what he can bid for the land, not the house
price. It is on the demand side that the rise in the rate of interest has the major effect –
the higher cost of borrowing on mortgages leads to a decrease in demand, and thus
the price of houses will tend to fall!
The real property market Paper 0334 Page 17

2 A tax may be imposed on the economic rent of land resources

Since the short period in practice tends to be very long, the government can impose a
tax on land resources up to the level of economic rent they earn, since this will make
no difference to their supply. It should be noted, however, that land resources include
capital. If the tax should be so large as to overlap on the transfer earnings of capital or
on normal profit, further building will not take place.

3 Developers can be required to cover some of the social costs of projects

A different type of ‘tax’ may be imposed. So long as it does not cut into normal
profit, a local authority can, as a condition of planning permission, require developers
to include in their schemes either houses (although these are less profitable than
offices) or improvements to the infrastructure, e.g. sewers. The first condition is
largely based on political-social grounds; the second can be regarded as covering
some of the social costs of the scheme. Such a tax is known as ‘planning gain’.

4 An increase in transport costs will increase economic rents at the city centre
Increased transport costs will make houses on the periphery of a city a poorer
substitute for houses at the centre. This will diminish the extent to which the increase
in new flows of houses can be significant compared with the existing stock. Thus the
difference in economic rent between the centre and the periphery will increase as
house and therefore land prices rise at the centre, and will tend to persist.

8 Conclusion
The real property market differs substantially from the benchmark of the perfect
market. This suggests that inefficient allocations of society’s scarce resources occur
in the property sector, providing a justification for limited state intervention.
However, market forces do shape the allocation of property resources through the
price mechanism.

A striking feature of the property market is how the stock of property is usually so
large that its turnover dominates the flow of new build coming on to the market.
The real property market Paper 0334 Page 18


1. Review your understanding of price elasticity of supply with reference to study

paper P3449.

2. Review your understanding of economic rent with reference to study papers P3723
and P0018.

3. Reflect on the relationship between price elasticity of supply and economic rent.

Average price of
Average price private sector housing
Year construction
of new dwellings land at constant
average density
1 100 100 100
2 109 102 104
3 119 107 118

Comment briefly on the above index figures.

5. What do houses and government stock have in common in the determination of

their prices?