Swings in Commercial and Residential Land Prices in the United States

August 16, 2012

All types of economic activity require land.  This requirement is obvious in industries such as farming and construction, but all other forms of commerce ultimately need land as well because workers, equipment and buildings must be located somewhere. Consequently, the price of land is a crucial economic consideration, especially in a country with a ravaged housing market, say Joseph B. Nichols of the Federal Reserve Board, Stephen D. Oliner of the American Enterprise Institute, and Michael R. Mulhall of J.P. Morgan Chase.

In studying this crucial resource, researchers Bostic, Longhofer and Redfearn established in 2007 the land leverage hypothesis, which holds that home prices and commercial property prices will be more volatile, all else equal, in areas where land represents a relatively large share of real estate value. That is to say, land prices are more volatile than the prices for the structures that reside on the land.

Exploring this hypothesis, Nichols, Oliner and Mulhall studied a dataset consisting of 180,000 land transactions in 23 metropolitan areas (MSAs) from the mid- or late 1990s through mid-2011.

  • They find that land prices trended up at a moderate pace from 1995 until about 2002 and then accelerated sharply.
  • From the second half of 2002 to the second half of 2006, their composite index of residential and commercial land prices for the 23 MSAs as a group jumped nearly 135 percent, with even larger increases in the MSAs along the East Coast and in the far West.
  • However, prices tumbled over the next few years: as of mid-2011, the composite index had fallen more than 50 percent from its peak.

The ups and downs in the aggregate land price indexes since 2002 outstrip those for well-known national indexes of home prices and commercial real estate prices.  Because those indexes price a bundle of land and structures, this comparison implies that land prices have been more volatile than structure prices over this period.

The results in this paper imply that residential land prices have been more variable than the prices of housing structures, supporting the aforementioned hypothesis.  The same pattern holds qualitatively for the commercial sector, where land prices rose and then fell roughly one and half times as much as measures of property prices.

Source: Joseph B. Nichols, Stephen D. Oliner and Michael R. Mulhall, "Swings in Commercial and Residential Land Prices in the United States," American Enterprise Institute, June 2012.

 

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