An introduction to economics - Lesson 3: Building Value and Land Value

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Building Value and Land Value

When a house is first built it is likely that it’s building costs represent a significant fraction of its purchase price. If with the passage of time land values increase at a rate faster than do building costs this fraction will diminish. Since house builders will, in general, only adopt advances in building technology if they have the effect of reducing their house building costs we may see that any increase in the purchase price of housing is likely to be due to a rise in land values or costs of raw materials rather than an increase in actual building costs. It may be shown further, that an increase in the price of raw materials may frequently be linked to a rise in the value of the land from which those raw materials have been drawn.


The price of houses (and flats) vary enormously with location. A house in one location (say in the North East of England may be purchased for a fraction of the price needed to purchase an identical house in London or the South East of England. The price difference represents the difference in value that people are willing and able to place upon living in one location compared with the other. We need to note also, how, the activities of wealthy purchasers, who may be buying retirement or second homes with the cash or equity value they have acquired from the sale or possession of other valuable property or, as in recent cases, from windfall city bonuses, in some areas, affects the price of housing. Here we may note the inflationary effect on house prices where both individuals and corporations treat both houses and their sites as items for speculation and investment.

The Parallel of Water Rationing Through Price

We see in the case of housing, where some people may price owner-occupiers out of the market, a phenomenon that is also evident with other natural necessities such as water. People in many developing world cities desperately need water for life and public health, but people also use water for trivial, amenity and luxury purposes.

Conventional free market economics would suggest that the market would ensure that if the price were right, water would be used most economically. However, experience shows that the effect of indiscriminate metered charging for clean water frequently leads to a situation where the rich are able to purchase all the clean water that is available within the city, leaving the poor with an unsafe and inadequate supply for their basic needs. If we wish to maximise the economic benefit to the community as a whole it is clear that everybody needs access to a basic water supply before anybody is able to avail themselves of this vital element for luxury purposes. The market price cannot achieve this but physical control could do so.

Planning Constraints

We often hear the problem of ‘affordable housing’ described as ‘a supply problem’ related to restrictions imposed by planning constraints on new build housing. However, new build housing represents a minute fraction of the housing market. The enormous number of unoccupied and under occupied dwellings throughout the country, together with the abundance of vacant sites with planning permission, including in those areas where demand (as indicated by high prices) is greatest, indicates that this is not the main issue.

Every existing house has planning permission and could be rebuilt or modified to suit changing housing needs if the owners of those houses really wished to do so, or they could release them to builders who would. There is a stock of housing that is substandard from both an environmental and amenity perspective in virtually every city, town and village in the UK. The scope for conversion and/or rebuild is vast and the need is pressing. The barrier to progress in this area is not fundamentally any of the planning constraints but the basic economic arrangements we have in place. It is these economic arrangements that cause many existing house owners to feel a need to hang on to more than they now need out of fear for their financial security, whilst others are encouraged to hoard by the prospect of an unearned financial gain.

The economic arrangements referred to here include not only those that relate to housing but to how people earn their living and government raises revenue to pay for public services. At its heart are fundamental questions relating to the origins of public and private property. The next step is to consider the means by which people earn their living.

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