The fixed location of land creates varying degrees of monopoly power in land ownership. In turn, this gives rise to the need for expropriation and justifies certain land use planning policies because of externalities. It also creates value differentials between parcels of land resulting in the need for location adjustments in appraising properties. Finally, the fixed nature of land creates bilateral monopoly markets, a source of considerable difficulty for appraisers.

By David Enns

Introduction Monopoly power Every time we write an appraisal report, Monopoly power, on the other hand, Most markets are not considered to we define market value for our client comes from there being a lack of competi- be monopolized because there are usu- as being “the most probable price that a tion in a market, i.e., from having a prod- ally a reasonable number of close substi- property should bring in a competitive and uct (or service) that that does not have a tutes. In all property markets, however, open market under all conditions requi- very good substitute. In the extreme case, any substitute properties are close but site to a fair sale, the buyer and seller when there is only one seller facing are never perfect substitutes. There is a each acting prudently and knowledge- many buyers, no close substitute and singular important reason for this and ably, and assuming the price is not blocked entry of new firms (additional that is because the location of all prop- affected by undue stimulus.” 1 [emphasis producers/sellers), we have what is erty is fixed in space. Thus, each prop- added] known as a monopoly. Bell Telephone, of erty is unique, at least in respect to its These are conditions that economists course, was a monopoly before the new location relative to all other properties. would deem to be part of a competitive technology of wireless cell phones and Although there is said to be slightly over market. In the extreme case, a perfectly the deregulation of the telephone indus- 32 billion acres of land in the world competitive market is one where there try. Monopolies can set their price or their (excluding Antarctica), no acre has the are a large number of buyers and sellers level of output but they cannot do both at same location as any other. such that none, acting alone, can influence the same time. Further, because of the fixed location price. Each market participant is too small of land, no arbitrage can take place in to affect any change on price and it Fixed location and monopoly power property markets. Arbitrage is the pro- assumes that there is no price fixing or In property markets, there is often a sig- cess of buying and selling assets between collusion on the part of sellers. As well, it nificant amount of monopoly power on two markets, separated by space, in assumes that the product is identical from the part of property owners. This is a order to make a profit from any price one seller to another such that a buyer can feature of property markets that is often differential between markets. Arbitrage find a perfect substitute from any one of a ignored by professional economists who reduces price differentials between mar- number of alternative sellers. While there tend to concentrate on macroeconomics.2 kets because the process itself raises are other conditions that are also assumed However, even land economists have supply in one market and demand in to exist in such competitive markets, these been known to ignore monopoly ele- the other.4 It is practiced in commodity, are the critical ones. ments in land markets.3 currency and stock markets and is the

20 The Canadian Appraiser • Spring • 2002 • Printemps • L’Évaluateur Canadien reason, for example, why there is only Monopoly power and expropriation In appraising the value of a property, one world price for gold. Because of the fixed location of land, while we recognize the location of a prop- This unique fixed location character- monopoly power on the part of certain erty as an important attribute in many istic of land creates at least some ele- property owners is quite significant in instances, we do not dwell on this differ- ment of monopoly power for each and some situations. For example, it creates ence. Further, we usually assume that the every landowner. In many instances, a the rational for the expropriation of land comparable properties have all sold in a variation in location from one property by a government for the public good. reasonably competitive market. to another has no real significance and Alternative sites, due to land being fixed any difference in location is trivial. in space, are not acceptable for a new Bilateral monopoly For example, two identical residences highway that is designated to go through However, not all property sales occur in located on the same street (both interior a particular corridor. Should a highway such a competitive market. A bilateral lots) would each have a unique position need widening, only those sites beside market is a market structure that is far in space, but would probably have no the existing roadway are needed, no other removed from a competitive market of difference in value due to their different sites will suffice. Accordingly, because of many buyers and many sellers.5 A bilat- locations. their monopoly position, property owners eral market is a market structure that has could prevent the construction of such only one seller and only one buyer. Two Fixed location and externalities public infrastructure by refusing to sell situations are of interest to appraisers in Before we turn to the issue of monopoly their property. This gives rise to the this regard. One deals with water lots power in property markets, it is note- power of eminent domain on the part of and the other deals with what some worthy to mention one other aspect of governments. If land was moveable, the refer to as non-viable properties, how- the fixed location factor of land. Exter- required property could simply be pur- ever, both are an example of a bilateral nalities are often significant in property chased elsewhere. market. markets because of this fixed location This same element of monopoly power factor. Smoke and noise pollution are may prevent private redevelopment Water lots two examples of external costs that schemes from moving forward. With Water lots are defined as “an area of are imposed on adjacent properties by checkerboard ownership of land, partic- land either contiguous or attached to dry nearby activities. These are costs that, ularly in central urban areas, one land- land, or may be entirely separated from in most circumstances, do not fall on owner can easily stop land assembly for dry land; usually covered with water, the activities giving rise to them. If the urban renewal projects from taking place but not necessarily at low tide. It may effects are negative, economists refer to by asking an above-market value for be filled or partially filled.” 6 Water lots them as negative externalities (if they their property and expropriation cannot almost always sell (or get leased) to are good they are positive externalities). be used to facilitate private projects, as it the adjacent (or upland) property owner. These are very common and give justifi- can for public projects. That adjacent landowner, whose prop- cation to land use planning in the form erty is bounded by a natural body of of zoning regulations. Zoning attempts Location, location and location water, under the common-law riparian to group together similar land uses All of us have heard the expression that doctrine, has the right to use those that are complementary to one another what lies behind a property’s value is waters to which they are riparian (relat- (they generate positive externalities) location, location, location, and, indeed, ing to a riverbank) for navigating and and separate obnoxious land uses (that location is much more important for some recreation purposes. 7 generate negative externalities). The property types than for others. Commer- If we are to estimate the market value fixed location of land and the close cial properties, of course, rely on their of a water lot, we will look to the sales proximity of urban activities dramati- exposure, accessibility and complemen- of other water lots in order to see if there cally compounds the problem of nega- tary aspects (all attributes of location) for are some benchmarks that we can utilize. tive externalities. Contrast one factory much of their market appeal. This trans- However, these sales occur in a bilateral polluting one adjacent residence with lates into a higher order use (and hence monopoly market and virtually all water four polluting factories adjacent to four higher land value) for some properties lots are sold in this type of market. As residences. The fourfold increase in than for others. So, if a property has a a result, appraising in this market struc- activity (from one to four factories) superior location than its comparables, ture is quite difficult. results in 16 times the amount of pollu- appraisers deal with that feature, if it is Imagine a residential water front tion as each factory now pollutes, not warranted, by making an adjustment in property (owner X) along the shore of a one, but four residences. the appraisal process for location. river or lake as shown in Figure 1, and

The Canadian Appraiser • Spring • 2002 • Printemps • L’Évaluateur Canadien 21 a water lot (owner Y) in front of that argument and purchase the water lot for Non-viable properties property. Owner X may wish to purchase a nominal amount. In light of all the hag- For another group of somewhat unique the water lot. The water lot may even gling, a policy might be decided on by properties, such as water lots, there have been partly filled over time by pre- the crown to sell the water lot for perhaps may also be only one potential buyer. vious landowners. From the perspective 50% or 100% of upland value. Maybe this Consider a parcel of land that might be of the seller (usually the crown), there particular property owner will buy at this left over from an earlier expropriation is only one potential purchaser for the price level, while another owner, if in this for a highway. Ownership may resemble subject property and that is the owner of same situation, would not. something like the situation shown in the adjacent property (owner X). From the Although this water lot may eventu- Figure 2. 10 In this case, property Y can perspective of the purchaser (owner X), ally sell, it does so under these bilateral only sell to owner X as a lot addition, there is only one seller (the crown), since monopoly conditions and the outcome is since only X has road access. If land in the alternative water lots in other locations not what appraisers would consider to area is selling for $10,000/acre, it might would not be useable and would not be ‘normal market conditions’ as stated be argued that the parcel owned by Y also accommodate the needs of the purchaser. in our definition of market value. For has a market value of $10,000/acre. But Under such circumstances, a seller will this reason (although often ignored does it? If X is the only potential buyer press for the highest price possible, while by appraisers), the direct comparison for the property, as with the described the purchaser will press for the lowest approach, without some modification, water lot, the actual price negotiated in price possible. cannot be used as a predictor of market this market will again depend on the This bilateral monopoly has no single value for the subject property because bargaining ability and the bargaining predictable outcome as to market price. almost all of these water lots that we strength of each party. Here, each property owner has a signifi- want to use as comparables, sell under cant degree of monopoly power. Unlike these bilateral market conditions. other property markets, if either owner A review of the literature on the val- refuses to sell or buy, this will stop the uation of water lots suggests that an process and no trade will take place since uplands approach might be used. With there are no substitutes for either party. this approach, if upland sells for a certain In competitive markets, substitutes exist price per unit of area, a water lot would such that this type of monopoly power is be worth a percentage of that rate. In one eliminated. appraisal article, the percentage seems to range from 5% to 100% of upland value depending on the use made of the water lot area (some are used for industrial pur- poses). In another article, an appraiser suggested that, under the percentage method, a percentage of upland value As with the water lot, the maximum between 10% and 25% can be used. 9 This of the value range comes from the fact very wide variation (from 5% to 100%) the potential purchaser of the property in suggested percentages of upland value, (who knows the market value of the in actual fact, reflects the very real prob- combined property X + Y) would be lematic nature of the market structure rational to offer up to some maximum referred to as a bilateral monopoly and, for the additional land. To pay any more indeed, it tends to mirror market theory than this maximum would mean that the that indicates there is no single predict- adjacent owner was paying more than The actual price negotiated in this able market value outcome. market value for the combined property. bilateral monopoly market will depend Notwithstanding the above, this In a competitive market, there is no on both the bargaining ability and bar- upland approach appears to be the cur- reason to pay more than the market gaining strength of each party. The adja- rent policy of at least one government value of the combined property and, of cent property owner may take the atti- ministry in Ontario and has been referred course the combined property is in a tude that he or she has riparian rights to as the utility approach. A serious prob- competitive market and not in a bilateral anyway so will offer the crown $1 for lem with any upland approach is the market. Naturally, the adjacent property the water lot. The crown may argue that lack of market derived data. The sale of owner X might well offer much less the water lot is worth whatever upland is upland property is obviously not the sale knowing that there is no other buyer for selling for (on a sq. ft. basis). The property of a water lot and so it is difficult to refer the property. Indeed, if owner Y were to owner may respond to the crown’s posi- to upland as a comparable property. have an open tender for this property tion by arguing that the addition of the As noted above, market theory indi- without a reserve bid, this conclusion water lot will add to the property’s depth cates that there can only be a range of would be confirmed. In a real life but not to its frontage.8 Accordingly, if value estimates in such a market. The low bargaining process, as noted in the case water front property sells on a per front end will be a nominal amount, while the of the water lot, the actual market foot basis and not on a unit of depth basis, upper end will be set by the market value outcome would depend on the one side may persuade the other with this of X and Y together. bargaining strength of the two

22 The Canadian Appraiser • Spring • 2002 • Printemps • L’Évaluateur Canadien participants and not on a particular pled with concentrated land ownership, total) in subdivisions across the city policy. Obviously, if the crown is the can create a bilateral market. A bilateral showed no difference in selling price owner of Y, the bargaining strength of property market is a unique property for lots that were deeper by about 13% the crown will be greater than that of market and requires additional analysis to 60% of lot depth. This conclusion most potential purchasers. The crown and effort on the part of appraisers. should not be surprising as it reflects has a much longer time horizon than Sometimes, appraisal policies have been the law of diminishing marginal util- most property owners and a greater developed to deal with this market situa- ity. Of course, the findings might be ability to postpone the sale of a property. tion without being explicit about the true quite different for another type of land One approach that has been used to nature of a bilateral market. If a client’s use such as industrial property that is deal with this unique market structure is policy happens to be a ‘value in contribu- area sensitive. to estimate the value in contribution of tion approach’ or an ‘upland approach’ in 9. M. R. Grover, AACI, Submerged Land, the non-viable property to the adjacent a bilateral market, and it is used to set a Appraisal Institute Magazine, (August property.11 selling price or compensation level, it is 1980): p 11., and S. G. Foster, AACI, This is done by estimating the market important to be clear on two things: The Appraisal Process in the Valuation value of property X, then estimating In order not to mislead, appraisers of Water Lots, Appraisal Institute Maga- the market value of the two properties need to point out to anyone relying on zine, (November 1983): p 23. (X plus Y) combined. The difference the appraisal report 1) that this market 10. Property Y could be surrounded by between the two is the value in is non-competitive (it does not reflect our more that just one landowner. There contribution of Y and, hence, it is definition of market value) and 2) that the might be two or three landowners and argued, this difference is the value of market outcome can only be estimated as this may change the market outcome Y. In this scenario, this approach would a range of values and not as a single value but only if adjacent owners had some imply that Parcel Y has a value of estimate. u degree of interest in the property and $10,000/acre, or $10,000 if Y was one there may be several reasons why acre in size. But this is the maximum End notes: they may have no interest in acquiring value of Y and not the value of Y. 1. Practice Notes – lines 6142 to 6147, The additional land. As described above, a value in Standards 2002 Edition, Appraisal Insti- 11. This is the approach taken by the contribution approach will always result tute of Canada, p 47. Ontario Ministry of Transportation. in an outcome that will be at the upper 2. Milton and Rose Friedman, Free to Consultant Appraiser’s Handbook, end of the value range. However, a Choose, Avon, 1979. Even Milton Fried- Queen’s Printer for Ontario, 1997, true market based outcome would not man, winner of the Nobel prize for p E 1. necessarily be at this upper level. As Economics, in this widely read book, pointed out, this property’s market largely ignores the importance of David Enns, B. Sc. Agr., M. B. A., AACI is value could be anywhere between $1 natural monopolies and concentrates the founder and president of Enns, MacEach- and $10,000 for the acre. If owner Y on contrived (government created) ern, Pace, Maloney & Associates Inc. a full really wanted to sell, and owner X monopolies. service real estate appraisal firm servicing was only moderately interested in Y, 3. Raleigh Barlowe, Land Resource Eco- Eastern Ontario. He specializes in the the property might sell for very little. nomics, 4th Edition, Prentice Hall Inc., appraisal of all types of agricultural properties Conversely, if owner X really wanted 1986. In this widely used textbook, and special use properties and has been recog- the parcel, and owner Y was somewhat Barlowe does not even mention nized in court as an expert witness. He can be indifferent (the crown), it would sell at monopoly power in his index, p 553. reached on the world wide web @ empm.ca. the upper end of the value range. 4. Through this process, the arbitrageur will add to demand in the low-price Conclusions market and add to supply in the high- The fixed location factor of land gives price market and so eliminate the price rise to a variety of issues in property mar- disparity, except for transaction costs, kets. between the two markets. While arbi- It creates an element of monopoly trage deals with markets separated by power that could delay or prevent land space, speculation – a similar process – use change and provides a justification deals with markets separated by time. for expropriation for the public good. 5. Micheal Parkin and Robin Wade, The fixed location factor magnifies the Microeconomics: Canada in the Global problems associated with negative exter- Environment, 2nd Edition, Addison- nalities and provides a justification for Welsley, 1994, p 419. various land use planning policies. It also 6. The Appraisal Journal, Vol. 45, prevents arbitrage from taking place in No. 1., p 70. property markets and thus gives rise to 7. Raleigh Barlowe, p 414. price differentials for variations in prop- 8. A recent appraisal assignment for a erty locations that require location adjust- client that showed no premium was ments by real estate appraisers. paid for deeper residential building Finally, the fixed location factor, cou- lots. Eight paired sales (16 sales in

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