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Land Appreciates, Buildings Depreciate

land appreciates — capital rusts!

Few media stories about the real estate market or the "housing bubble" — and probably few economists— recognize the reality that while land appreciates, buildings depreciate.  Commercial investors claim depreciation on their income tax filings — in fact, the same building may be depreciated over and over again by a series of owners, each time probably from a higher starting point!  But few will acknowledge that what has actually occurred is a decline in the value of the building. 

Electrical, plumbing, HVAC, roof, windows and other systems deteriorate even when well maintained.  Equally important, features once considered state-of-the-art become obsolete as technology moves forward.  Finally, a building that was highly suitable for a Central Business District site at midcentury is likely to be an underuse of the same site at the turn of the century, if the local area is healthy. 

And in the same period of time, the Central Business District is likely to have expanded, changing the definition of "highest and best use" of sites in the newer zone from residential to commercial, or single-family residential to multi-family. Even a well-maintained and updated mansion in the business district may no longer be a good use of that site.

It appears that when a new house is built, the cost of the land represents 20% to 25% of the selling price.  In the first years, the house's depreciation may be slow, because systems are new and the owners may be adding amenities that the builder didn't provide (a deck, closet and other fittings, landscaping, etc).  But within a few years, all the improvements other than perhaps well-maintained landscaping start to depreciate a bit.  Meanwhile, if the location is good, the site will appreciate.  If it is close to established amenities of the central business district, that will tend to be fairly steady.  If it is in a fringe area, with new schools, new firehouse, slowly developing shopping and services, as those services start to be developed, the site value will begin to rise.  Depending on the site's proximity to secure and high-paying jobs, appreciation may be rapid.  Within a few years, land's share of the total property value will pass 50% and then 75%.  When it gets as high as 85%, there may begin to be a trend toward teardowns. (Think of the northern suburbs of Chicago.) In some areas, sites get recycled rather frequently.  (Think of Hollywood.)

A May, 2006, Federal Reserve Board study confirmed that single family houses depreciate at 1.5% per year. Can commercial buildings be much different? Certainly machinery will tend to depreciate, no matter how well it is maintained. That same study said that, in the top 46 metro markets, land averaged about 51% of the total value of single family housing in 2004, with a range from about 20% in Oklahoma City to over 88% in San Francisco. (Interestingly, the average value of the housing stock varied far less than the land values per house!)

Henry George: The Condition of Labor — An Open Letter to Pope Leo XIII in response to Rerum Novarum (1891)

God’s laws do not change. Though their applications may alter with altering conditions, the same principles of right and wrong that hold when men are few and industry is rude also hold amid teeming populations and complex industries. In our cities of millions and our states of scores of millions, in a civilization where the division of labor has gone so far that large numbers are hardly conscious that they are land-users, it still remains true that we are all land animals and can live only on land, and that land is God’s bounty to all, of which no one can be deprived without being murdered, and for which no one can be compelled to pay another without being robbed. But even in a state of society where the elaboration of industry and the increase of permanent improvements have made the need for private possession of land wide-spread, there is no difficulty in conforming individual possession with the equal right to land. For as soon as any piece of land will yield to the possessor a larger return than is had by similar labor on other land a value attaches to it which is shown when it is sold or rented. Thus, the value of the land itself, irrespective of the value of any improvements in or on it, always indicates the precise value of the benefit to which all are entitled in its use, as distinguished from the value which, as producer or successor of a producer, belongs to the possessor in individual right.

To combine the advantages of private possession with the justice of common ownership it is only necessary therefore to take for common uses what value attaches to land irrespective of any exertion of labor on it. The principle is the same as in the case referred to, where a human father leaves equally to his children things not susceptible of specific division or common use. In that case such things would be sold or rented and the value equally applied.

It is on this common-sense principle that we, who term ourselves single-tax men, would have the community act.

We do not propose to assert equal rights to land by keeping land common, letting any one use any part of it at any time. We do not propose the task, impossible in the present state of society, of dividing land in equal shares; still less the yet more impossible task of keeping it so divided.

We propose — leaving land in the private possession of individuals, with full liberty on their part to give, sell or bequeath it — simply to levy on it for public uses a tax that shall equal the annual value of the land itself, irrespective of the use made of it or the improvements on it. And since this would provide amply for the need of public revenues, we would accompany this tax on land values with the repeal of all taxes now levied on the products and processes of industry — which taxes, since they take from the earnings of labor, we hold to be infringements of the right of property.

This we propose, not as a cunning device of human ingenuity, but as a conforming of human regulations to the will of God.

God cannot contradict himself nor impose on his creatures laws that clash.

If it be God’s command to men that they should not steal — that is to say, that they should respect the right of property which each one has in the fruits of his labor;

And if he be also the Father of all men, who in his common bounty has intended all to have equal opportunities for sharing;

Then, in any possible stage of civilization, however elaborate, there must be some way in which the exclusive right to the products of industry may be reconciled with the equal right to land.

If the Almighty be consistent with himself, it cannot be, as say those socialists referred to by you, that in order to secure the equal participation of men in the opportunities of life and labor we must ignore the right of private property. Nor yet can it be, as you yourself in the Encyclical seem to argue, that to secure the right of private property we must ignore the equality of right in the opportunities of life and labor. To say the one thing or the other is equally to deny the harmony of God’s laws.

But, the private possession of land, subject to the payment to the community of the value of any special advantage thus given to the individual, satisfies both laws, securing to all equal participation in the bounty of the Creator and to each the full ownership of the products of his labor. ...

Nor do we hesitate to say that this way of securing the equal right to the bounty of the Creator and the exclusive right to the products of labor is the way intended by God for raising public revenues. For we are not atheists, who deny God; nor semi-atheists, who deny that he has any concern in politics and legislation.

It is true as you say — a salutary truth too often forgotten — that “man is older than the state, and he holds the right of providing for the life of his body prior to the formation of any state.” Yet, as you too perceive, it is also true that the state is in the divinely appointed order. For He who foresaw all things and provided for all things, foresaw and provided that with the increase of population and the development of industry the organization of human society into states or governments would become both expedient and necessary.

No sooner does the state arise than, as we all know, it needs revenues. This need for revenues is small at first, while population is sparse, industry rude and the functions of the state few and simple. But with growth of population and advance of civilization the functions of the state increase and larger and larger revenues are needed.

Now, He that made the world and placed man in it, He that pre-ordained civilization as the means whereby man might rise to higher powers and become more and more conscious of the works of his Creator, must have foreseen this increasing need for state revenues and have made provision for it. That is to say: The increasing need for public revenues with social advance, being a natural, God-ordained need, there must be a right way of raising them — some way that we can truly say is the way intended by God. It is clear that this right way of raising public revenues must accord with the moral law.

Hence:

  • It must not take from individuals what rightfully belongs to individuals.
  • It must not give some an advantage over others, as by increasing the prices of what some have to sell and others must buy.
  • It must not lead men into temptation, by requiring trivial oaths, by making it profitable to lie, to swear falsely, to bribe or to take bribes.
  • It must not confuse the distinctions of right and wrong, and weaken the sanctions of religion and the state by creating crimes that are not sins, and punishing men for doing what in itself they have an undoubted right to do.
  • It must not repress industry. It must not check commerce. It must not punish thrift. It must offer no impediment to the largest production and the fairest division of wealth.

Let me ask your Holiness to consider the taxes on the processes and products of industry by which through the civilized world public revenues are collected —

  • the octroi duties that surround Italian cities with barriers;
  • the monstrous customs duties that hamper intercourse between so-called Christian states;
  • the taxes on occupations, on earnings, on investments, on the building of houses, on the cultivation of fields, on industry and thrift in all forms.
    Can these be the ways God has intended that governments should raise the means they need? Have any of them the characteristics indispensable in any plan we can deem a right one?

All these taxes violate the moral law. They take by force what belongs to the individual alone; they give to the unscrupulous an advantage over the scrupulous; they have the effect, nay are largely intended, to increase the price of what some have to sell and others must buy; they corrupt government; they make oaths a mockery; they shackle commerce; they fine industry and thrift; they lessen the wealth that men might enjoy, and enrich some by impoverishing others.

Yet what most strikingly shows how opposed to Christianity is this system of raising public revenues is its influence on thought.

Christianity teaches us that all men are brethren; that their true interests are harmonious, not antagonistic. It gives us, as the golden rule of life, that we should do to others as we would have others do to us. But out of the system of taxing the products and processes of labor, and out of its effects in increasing the price of what some have to sell and others must buy, has grown the theory of “protection,” which denies this gospel, which holds Christ ignorant of political economy and proclaims laws of national well-being utterly at variance with his teaching. This theory sanctifies national hatreds; it inculcates a universal war of hostile tariffs; it teaches peoples that their prosperity lies in imposing on the productions of other peoples restrictions they do not wish imposed on their own; and instead of the Christian doctrine of man’s brotherhood it makes injury of foreigners a civic virtue.

“By their fruits ye shall know them.” Can anything more clearly show that to tax the products and processes of industry is not the way God intended public revenues to be raised?

But to consider what we propose — the raising of public revenues by a single tax on the value of land irrespective of improvements — is to see that in all respects this does conform to the moral law.

Let me ask your Holiness to keep in mind that the value we propose to tax, the value of land irrespective of improvements, does not come from any exertion of labor or investment of capital on or in it — the values produced in this way being values of improvement which we would exempt. The value of land irrespective of improvement is the value that attaches to land by reason of increasing population and social progress. This is a value that always goes to the owner as owner, and never does and never can go to the user; for if the user be a different person from the owner he must always pay the owner for it in rent or in purchase-money; while if the user be also the owner, it is as owner, not as user, that he receives it, and by selling or renting the land he can, as owner, continue to receive it after he ceases to be a user.

Thus, taxes on land irrespective of improvement cannot lessen the rewards of industry, nor add to prices,* nor in any way take from the individual what belongs to the individual. They can take only the value that attaches to land by the growth of the community, and which therefore belongs to the community as a whole.

* As to this point it may be well to add that all economists are agreed that taxes on land values irrespective of improvement or use — or what in the terminology of political economy is styled rent, a term distinguished from the ordinary use of the word rent by being applied solely to payments for the use of land itself — must be paid by the owner and cannot be shifted by him on the user. To explain in another way the reason given in the text: Price is not determined by the will of the seller or the will of the buyer, but by the equation of demand and supply, and therefore as to things constantly demanded and constantly produced rests at a point determined by the cost of production — whatever tends to increase the cost of bringing fresh quantities of such articles to the consumer increasing price by checking supply, and whatever tends to reduce such cost decreasing price by increasing supply. Thus taxes on wheat or tobacco or cloth add to the price that the consumer must pay, and thus the cheapening in the cost of producing steel which improved processes have made in recent years has greatly reduced the price of steel. But land has no cost of production, since it is created by God, not produced by man. Its price therefore is fixed —

1 (monopoly rent), where land is held in close monopoly, by what the owners can extract from the users under penalty of deprivation and consequently of starvation, and amounts to all that common labor can earn on it beyond what is necessary to life;
2 (economic rent proper), where there is no special monopoly, by what the particular land will yield to common labor over and above what may be had by like expenditure and exertion on land having no special advantage and for which no rent is paid; and,
3 (speculative rent, which is a species of monopoly rent, telling particularly in selling price), by the expectation of future increase of value from social growth and improvement, which expectation causing landowners to withhold land at present prices has the same effect as combination.

Taxes on land values or economic rent can therefore never be shifted by the landowner to the land-user, since they in no wise increase the demand for land or enable landowners to check supply by withholding land from use. Where rent depends on mere monopolization, a case I mention because rent may in this way be demanded for the use of land even before economic or natural rent arises, the taking by taxation of what the landowners were able to extort from labor could not enable them to extort any more, since laborers, if not left enough to live on, will die. So, in the case of economic rent proper, to take from the landowners the premiums they receive, would in no way increase the superiority of their land and the demand for it. While, so far as price is affected by speculative rent, to compel the landowners to pay taxes on the value of land whether they were getting any income from it or not, would make it more difficult for them to withhold land from use; and to tax the full value would not merely destroy the power but the desire to do so.

To take land values for the state, abolishing all taxes on the products of labor, would therefore leave to the laborer the full produce of labor; to the individual all that rightfully belongs to the individual. It would impose no burden on industry, no check on commerce, no punishment on thrift; it would secure the largest production and the fairest distribution of wealth, by leaving men free to produce and to exchange as they please, without any artificial enhancement of prices; and by taking for public purposes a value that cannot be carried off, that cannot be hidden, that of all values is most easily ascertained and most certainly and cheaply collected, it would enormously lessen the number of officials, dispense with oaths, do away with temptations to bribery and evasion, and abolish man-made crimes in themselves innocent.

But, further: That God has intended the state to obtain the revenues it needs by the taxation of land values is shown by the same order and degree of evidence that shows that God has intended the milk of the mother for the nourishment of the babe.

See how close is the analogy. In that primitive condition ere the need for the state arises there are no land values. The products of labor have value, but in the sparsity of population no value as yet attaches to land itself. But as increasing density of population and increasing elaboration of industry necessitate the organization of the state, with its need for revenues, value begins to attach to land. As population still increases and industry grows more elaborate, so the needs for public revenues increase. And at the same time and from the same causes land values increase. The connection is invariable. The value of things produced by labor tends to decline with social development, since the larger scale of production and the improvement of processes tend steadily to reduce their cost. But the value of land on which population centers goes up and up. Take Rome or Paris or London or New York or Melbourne. Consider the enormous value of land in such cities as compared with the value of land in sparsely settled parts of the same countries. To what is this due? Is it not due to the density and activity of the populations of those cities — to the very causes that require great public expenditure for streets, drains, public buildings, and all the many things needed for the health, convenience and safety of such great cities? See how with the growth of such cities the one thing that steadily increases in value is land; how the opening of roads, the building of railways, the making of any public improvement, adds to the value of land. Is it not clear that here is a natural law — that is to say a tendency willed by the Creator? Can it mean anything else than that He who ordained the state with its needs has in the values which attach to land provided the means to meet those needs?

That it does mean this and nothing else is confirmed if we look deeper still, and inquire not merely as to the intent, but as to the purpose of the intent. If we do so we may see in this natural law by which land values increase with the growth of society not only such a perfectly adapted provision for the needs of society as gratifies our intellectual perceptions by showing us the wisdom of the Creator, but a purpose with regard to the individual that gratifies our moral perceptions by opening to us a glimpse of his beneficence.

Consider: Here is a natural law by which as society advances the one thing that increases in value is land — a natural law by virtue of which all growth of population, all advance of the arts, all general improvements of whatever kind, add to a fund that both the commands of justice and the dictates of expediency prompt us to take for the common uses of society. Now, since increase in the fund available for the common uses of society is increase in the gain that goes equally to each member of society, is it not clear that the law by which land values increase with social advance while the value of the products of labor does not increase, tends with the advance of civilization to make the share that goes equally to each member of society more and more important as compared with what goes to him from his individual earnings, and thus to make the advance of civilization lessen relatively the differences that in a ruder social state must exist between the strong and the weak, the fortunate and the unfortunate? Does it not show the purpose of the Creator to be that the advance of man in civilization should be an advance not merely to larger powers but to a greater and greater equality, instead of what we, by our ignoring of his intent, are making it, an advance toward a more and more monstrous inequality? ... read the whole letter

Henry George:  The Land Question (1881)

When a man makes a fortune by the rise of real estate, as in New York and elsewhere many men have done within the past few months, what does it mean? It means that he may have fine clothes, costly food, a grand house luxuriously furnished, etc. Now, these things are not the spontaneous fruits of the soil; neither do they fall from heaven, nor are they cast up by the sea. They are products of labor – can be produced only by labor. And hence, if men who do no labor get them, it must necessarily be at the expense of those who do labor.

Louis Post: Outlines of Louis F. Post's Lectures, with Illustrative Notes and Charts (1894) — Appendix: FAQ

Q21. Do not the benefits of good government increase the value of houses as well as of land?
A. No. Houses are never worth any more than it costs to reproduce them. Good government tends to diminish the cost of house building; how, then, can good government increase the value of houses? You are confused by the fact that houses, being attached to land, seem to increase in value, when it is the land and not the house that really increases. It is the same mistake that a somewhat noted economic teacher, who advocates protection as his specialty, made when he tried to show that there is an "unearned increment" to houses as well as to lands. He did so by instancing a lot of vacant land which had risen in value from $5000 to $10,000, and comparing it with a house on a neighboring lot which, as he said, had also increased in value from $5000 to $10,000. At the moment when he wrote, the house to which he referred could have been reproduced for $5000; and had he been capable of thinking out a proposition he must have discovered that it was the lot on which the house stood, and not the house itself, which had increased in value. ... read the book

Charles B. Fillebrown: A Catechism of Natural Taxation, from Principles of Natural Taxation (1917)

Q61. Do you think there would be any injustice in taking by taxation the future increment in the value of land?
A. Fifteen professors of political economy have answered "Yes." Ninety-four have answered "No."

Q62. Would it be wise to take gradually in taxation, say, 1/4, one half, or 3/4 of the future increase in economic rent?
A. One hundred and one professors of political economy have answered "Yes." Twenty-nine have answered "No." ... read the whole article

Jeff Smith: What To Do About the Real Estate Bubble

What’s bubbling, and until when?

Sellers are happy. So are developers and speculators. Real estate has gone all bubbly, and that bubble has gone ballistic. What goes up, however, must soon do something else. ...

Actually, it’s not housing whose price has entered the stratosphere. Buildings age – get older, more worn out. What’s getting more valuable is the land, the location – whether it has a building on it or not. Buildings you can make more of, but land you can not, especially locations along the coasts or on the good side of town. None of that would matter if you could ever get buildings to hover around in the air. Meanwhile however, speculators are happy.  Read the whole article

Michael Hudson and Kris Feder: Real Estate and the Capital Gains Debate
... the Fed statistics37 understate land values for methodological reasons. Starting with estimates for overall real estate market prices, Fed statisticians subtract estimated replacement prices for existing buildings and capital improvements to derive land values as a residual. These replacement prices are based on the Commerce Department’s index of construction costs. Thus, building values are estimated to increase steadily over time, on the implicit assumption that all such property is worth reproducing at today’s rising costs.
37 Balance Sheets for the U.S. Economy, 1945-94, Tables B. 11, B. 12 and R 11.

However, the value of any building tends eventually to decline, until finally it is scrapped and replaced. It is the value of land which tends to rise as population and income grow (over the long run, with cyclical swings), precisely because no more land can be produced. Thus, capital gains in real estate result mainly from land appreciation.

Building values fall because of physical deterioration, but also because buildings undergo locational obsolescence as neighborhood land uses change over time, so market prices tend to fall below replacement costs. It would not be economical to rebuild many types of structures on the same site if they were suddenly destroyed.38 In particular, where land use is intensifying over the long run, rising land values effectively drain the capital value out of old buildings. This is because the salvage value of land (its worth upon renewal) tends to rise, while the scrap or salvage value of most immovable improvements is negligible. Where land has alternative uses, rent is not its current net income but its opportunity cost -- the minimum yield required by the market to warrant keeping the land in its present use instead of converting it to the best alternative use. As the land value rises, a rising share of the property income must be imputed to the land and a falling share remains to be imputed to the improvements. Read the whole article
Herbert J. G. Bab:  Property Tax -- Cause of Unemployment  (circa 1964)
... A defect of our property tax system that is seldom mentioned is that it puts a premium on obsolescence and penalizes new housing. This is so because property taxes are ad valorem taxes. Every piece of real estate except land is subject to depreciation. Thus the owners of old and obsolete real estate will pay little in taxes, while newly constructed buildings will bear the brunt of the tax.

This characteristic of the property tax is obscured by the rising trends of land values, which in many cases offset the loss in value of the improvement. Increases in tax rates and differences in assessment procedures and practices further hide the fact that ad valorem taxes favor obsolete real property. ...

Homeowners who bought their homes some time in the past can reap large profits when selling them. Old homes should sell at a lower price, because of the depreciation of the building, but in most cases the depreciation of the building is more than offset by the increased value of the lot. This increased value forces buyers to increase their down payments or to increase their loan are higher, many families are priced out of the market. ...

The administration of the property tax leaves very much to be desired. Assessment procedures and practices are in many cases erroneous, arbitrary and widely variant. So is the ratio of assessed value to full market or cash value. In many states no public records are available indicating assessed values and the taxpayer has no of knowing what his tax bill will be.

The most serious defect in the administration of property taxation is the continuous, widespread and enormous underassessment of land. A survey made recently found that in 9 California counties, vacant lots and acreage were assessed at only 5.3% of the cash value, while residential property was assessed at 19.3% of its value. The illegal underassessment of land deprives local governments of millions of dollars of revenues. Moreover, it further aggravates the serious defects of property taxation.

We have analyzed the effects of property taxation on improvements as distinguished from those caused by the incidence of these taxes on land.
  • We have found that a high and burdensome tax rate on improvements will discourage residential construction, create unemployment, penalize home-ownership, aggravate the housing shortage and force up rents.
  • Yet a low tax rate on land will have similar if not identical effects: it will lead to a rise in urban land values, which in turn will discourage residential construction, create unemployment, penalize home-ownership, aggravate the housing shortage and force up rents.
... The paradox of property taxation consists in the fact that lower rates on improvements produce the same results as higher rates on land and conversely higher rates on improvements produce the same results as lower rates on land. Read the whole article

Charles T. Root — Not a Single Tax! (1925)

Now imagine for a moment the effect upon the appearance of a city and upon the comfort of its population which would result from the change of fiscal policy which this article proposes. At present, a tempting premium is placed upon keeping land unimproved or inadequately improved, while a heavy penalty is imposed upon improvement. Most land appreciates constantly. All buildings depreciate from the moment of completion. Yet the building is taxed equally with the land.

What incentive does such a system offer the speculative landowner to put up a commodious, well-lighted modern structure in place of the old ruin which now pays him so well? The old one cannot depreciate much more, and while paying a trifling tax because of its physical worthlessness, he is thereby enabled to collect and pocket the economic rent of the ground, which the community is continually rendering more valuable. The new building would absorb a large amount of capital, would begin to run down even before it could be occupied, and would be taxed to the limit. Why then is not the landlord justified in letting well enough alone, enjoying the growing economic rent, and waiting till he can get a fancy price for the right to collect it?

But reverse the conditions. Reclaim for the community its natural income, making it expensive either to keep needed land vacant or to withhold it from the ready and willing to improve it to the full extent of its possibilities.

Does it require severe intellectual effort to foresee the results? Better and better houses, apartments, tenements, offices and stores, more employment for labor in all enterprises now held back by the shadow of the tax-gatherer, an end of all tax-lying, tax-evasion and tax-injustice, and withal, a public revenue adequate to all real public needs.

What a contrast to the existing plan of pouring public money into the laps of individual landowners ... read the whole article

Bill Batt: Comment on Parts of the NYS Legislative Tax Study Commission's 1985 study “Who Pays New York Taxes?”

Except in the implicit recognition involved in their analysis of shifting, the distinction between land and improvements was opaque. This is a remarkable oversight, because improvements typically depreciate at the rate of 0.5 to 1.5 percent annually; only land values appreciate.9 And in view of the fact that assessments in New York localities have historically been very infrequent, one can understand how the land values are in reality a far higher proportion of parcel value than assessments would suggest.10 This means that in a period of seven years, for example, a property parcel could easily increase in price by 50 percent, far more if recent real estate market history is to be illustrative. Moreover real estate prices varied greatly in their rates of change during this time span; upstate New York was largely stable, but downstate localities experienced huge booms and busts.

Recognition of this would tend to favor what is known as the “new view” of property tax incidence, an acceptance of the idea that ”the burden of the tax on improvements remains with the owners of capital in the form of a lower net return instead of being shifted to users of property in the form of higher rents or prices.”11 Proponents point out that “the tax on improvements is essentially a nationwide tax on capital . . . [and therefore] its incidence will depend on the characteristics of supply and demand for capital nationally rather than on a single market.”12 The effect of this is to make the tax ”highly progressive.”13 Nonetheless, in a small footnote, Messrs. Pomp and Phares elected to go with the “old view” in stating that, “it seems most appropriate to assume that the new view does not apply to the analysis of tax burdens within one specific state (underlining in original). Thus, the old or traditional view was adhered to in the analysis. . ; that is, the excise effect of the tax was considered dominant.”14 The ubiquity of New York's property tax, and that it has over 1,300 local assessment and tax districts, may well have escaped their notice. ... read the whole commentary


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