Real Estate Development and Market Obstruction

The city of Lafayette Indiana has just made $161,000 investment in a local neighborhood .

It’s good to be a property owner, if you are on the correct side of the street.

Markets synthesize information about goods, services, locations, impediments and a multiplicity of other factors. The information is calculated and fed back in the form of a price. For example, consider how much information is conveyed in the price of one pound of coffee sold at your favorite coffeehouse.

First, you may ask, what type of coffee? Decaf? Whole bean? Organic? Fair trade (don’t take that misnomer literally). South American? Central American? You get the idea. All of this information and more (transportation, handling, roasting, marketing etc) is all incorporated into the price. With this information in hand, you the consumer can make decisions about what product to buy, where to buy it and when to buy it.

So what?

The same process is true for real estate. The market communicates information about a specific piece of property via price. A 1200 square foot home priced $120,000 and one priced at $240,000 tells the consumer that there exists a material difference between the two. That difference can be anything from property condition, to location, or maybe amenities that come along with it, or maybe the fact that George Washington once owned the home. Nonetheless, the market has taken into consideration these factors.

But what happens when an arbitrary line is drawn around a specific group of properties by local, state or federal authorities, and designated for improvement?

Hmm, I never thought about.

First, a study is commissioned, sometimes by elected officials, their appointees or “development corporations”, paid for by taxpayers, who feel the need to act for the good of the community. The study arbitrarily determines that a specific area should be targeted for redevelopment. Once the study is released to the public, the market begins to process the information. Because real estate is illiquid the process is slow. Announce that South American coffee beans will get special treatment and watch what happens to the price of coffee. The response is immediately seen on the futures market.

What is the new information? Market intervention communicates a willingness by the authorities to support activity that may not of occurred otherwise. It also expresses a willingness to further intervene to support the stated goals. As a consequence, the market becomes distorted. The new calculus of price now will incorporate another factor; signaling.

Two identical properties, selling for the same price, literally separated by a street now have two different values. Why? Because one property, on the south side, is included in the designated area for improvement and the other property on the north side of the street, is not.

If you were interested in either building or rehabbing a property, which would you pick? Either the property in the zone designated for improvement, or the property outside the zone? Fortunately, the market will work and reflect the information in terms of price. But therein lies the problem. Why should one property value benefit from the intervention and another value diminish based upon the arbitrary drawing of lines?

Another problem with such planning is the inoculation affect of the study. The plan will become de facto policy. Future rezoning requests, site plan submissions and the litany of other administrative matters associated with real estate development will be looked at through the prism of the study.

Kinda like a self-fulfilling prophecy. Got any proof?

As much as local officials would vigorously deny favoritism for plans that conform to their vision and indifference, or outright hostility, to plans that do not meet the study objectives, it is hard to believe otherwise. Especially after spending $161,000 for the study.

The case of Herman & Kittle Properties (HKP) illustrates the problem. HKP submitted plans for the development of a tract of land in Lafayette which is outside the designated zone. Although the public reveal of the study did not occur until after HKP began the process, local officials were well aware of the scope and designated area the study encompassed. Inoculation had taken affect.

The requirements for development of the HKP land had long been established prior to the submission and prior to the study. Based on fixed rules, HKP proceeded. The plans met all the zoning requirements, site plan requirements and use requirements (all three are distinct hurdles to overcome). What should have been pro forma approval became a nightmare for the petitioner.

What kind of nightmare?

The mayor of Lafayette, Tony Roswarski, was first to express displeasure by stating “It’s just not right – it’s not how we do things here”. Apparently following the rules, regulations and requirements promulgated by local authorities is not “how things get done”. Aside from submitting oneself to the arbitrary nature of an authority, what other way was HKP to proceed?

Next, the local state representative, Sally Siegrist, sought a way to “remedy” the situation by proposing legislation to give more authority to local governments to control land use; affectively changing the rules. Outside of complete arbitrary authority, what else could they want? Thankfully this misguided plan to expand control was stopped before it got started. Wiser minds prevailed.

After that failure, Todd Rokita, U.S. House Representative for the 4th district of Indiana, which includes the Lafayette area, brought his federal weight to the petition; sending a letter to the Indiana Housing and Development Board registering his displeasure with the project calling upon the state to stop the project. Thankfully his efforts failed and the rule of law prevailed. The project was approved.

What does this example have to do with the redevelopment study?

First, regardless of well established rules, as in the case with HKP, it shows how far authorities will go to thwart a plan that does not conform to their whimsical desires. As mayor Roswarki said, “I had met with potential developers early on, and they had described the project to me. I had told them at that time I was not interested”, as if the rules meant nothing. Later the Mayor would state that plan was not right for that area of Lafayette. Maybe the petitioner should have picked land within the study zone.

Likewise, the impetuous to support efforts within the designated zone will increase. It is reasonable to assume that the same elected officials will work as diligently to get a project approved as they did to deny HKP, simply because they want it. What if two competitive projects are introduced, which one gets approved? One conforms to the standards, but projects less tax revenue than an non-conforming project promising more tax revenue? My crystal ball is broken, but I would say the non-conforming project will manage to get approved.

Second, what is the purpose of these regulations if they are arbitrarily challenged or even changed with the latest political whim? Why would a private enterprise risk capital? Land use rules are established to bring about an expected outcome if they are followed; approval of the project. Consider the costs HKP incurred simply to ask permission to use the land. Lawyers, surveyors and site plan developers, soft costs, generally add 6% to 10% to the cost of the project. Without fixed rules, the process of securing administrative approval to developing land becomes increasingly impractical, resulting in higher costs and or housing shortages.

Third, how does a market account for arbitrary intervention? In regards to the study designating a redevelopment zone, the property within the designated zone now becomes more valuable. The study immediately conveys (signaling theory) to the market a specific intent of local authorities to support projects inside the zone. Which would you develop/redevelop? In the zone, or out of the zone property? You may pay more for a property in the zone because you have a reasonable expectation of governmental support, or you may pay less for a property outside the zone because there is a lack of support.

Which begs the question that free market advocates always wonder: Why should some benefit and others lose because of an arbitrary decision made by governing authorities? Whether it is real estate or coffee does not matter. Free markets and free people depend on the simple axiom of equal treatment before the law. In Lafayette, it is pretty evident that some are more equal than others and they will be treated as such. You just have to be on the correct side of the street.

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