Economic rent, the basis of value. - Urban economic rent the residuum after payment of all charges and interest on buildings. - Intrinsic vs. exchange value. - Utility precedes value in city land. Ground rents based on social service of locations. Structure of cities controlled by definite laws Cities originate at point of contact with outer world, and grow in line of least resistance or greatest attraction or their result-ant Central or axial Growth.Influence of buildings. - Final , basis, psychological.
THE basis of agricultural land values has been established since the time of Ricardo, and throws light on the fundamentals of our problem. Value in urban land, as in agricultural land, is the resultant of economic or ground rent capitalized. As first laid down, the theory of agricultural ground rents emphasized fertility as a source of rent. Later, when it was noted that it was not the most fertile lands that were first occupied but rather those nearest new settlements, accessibility or proximity to cities was recognized as an important factor in creating agricultural ground rent. In cities, economic rent is based on superiority of location only, the sole function of city land being to furnish area on which to erect buildings.
Urban economic rent is ascertained by deducting from the gross rent of land and building, first, all charges for services, such as heat, light, elevators, janitors, agents' commission for collecting rents, etc.; second, taxes, insurance, and repairs, and, finally, interest on the capital invested in the building. This interest on the cost of the building must exceed the average interest rate by an amount equal to the annual depreciation of the building, thus providing a sinking fund sufficient to replace the building at the end of its life. To make a correct showing the building must be suited to the location and managed with ordinary ability, or the apparent economic rent will have little or no bearing on the value of the land.
The rate of capitalization, turning income into value, is based on the average interest rates of all investments and fluctuates with them, although within closer limits and more slowly. Wide differences occur in the rates of capitalization of rents from land of different uses in the same city, and smaller differences from land having the same use in different cities. Where a locality is advancing in value, capitalization rates are low, where stationary they are normal, and where declining they run very high. After the vital factor of prospective increase or decrease of value, the lesser factors are stability of rents, ease of convertibility, - in part by mortgaging or in whole by selling, - and character of utilization, as involving the rates of depreciation of different classes of buildings. In general, the larger the city and the higher the class of property, the greater the stability of rents, and ease of convertibility and the lower the rate of capitalization. Differences in rent are plainly apparent, but differences in rates of capitalization are frequently overlooked, although a very large proportion of value in urban land comes from a low rate of capitalization. To illustrate, of two pieces of land yielding an economic rent of $10,000 annually, one well located and improved with office building or retail shop might sell, excluding the building, on a 4 per cent. basis, or for $250,000; while the other, covered with cheap tenements, might sell, excluding the buildings, on a 10 per cent. basis, or for $100,000. The rate of capitalization is ascertained by figuring backwards, i. e., dividing average prices paid for similar land by the net income, which shows the interest rate which the community is satisfied to receive on such investments.
While intrinsic value is correctly derived by capitalizing ground rent, exchange value may differ widely from it. As ordinarily expressed, "value" means exchange value, average sales being considered the best test of value, and since all ownership lies subsequent to the date of purchase, the estimated future prospects form the mastering factor of all exchange values. Although speculation in the sense of assuming large risk for the chance of large gain, is normally confined to limited sections of cities where marked changes of utility are taking place, speculation in the sense of an attempt to make money from an increase in the value of property apart from its earnings, is a fac-. tor in all real estate transfers. We may note that real estate speculation is always for the rise, speculation for the fall or "short" sales being impossible, owing to the non-representative quality of land.