Location, location, location. Johan von Thunen did not coin that adage on what determines real estate values. But von Thunen’s explanations of the relationships between location, transport costs and product prices remain relevant 180 years after he wrote them.
They help explain, for example, why development reportedly is stalling in some distant Twin Cities suburbs while home values in some St. Paul and Minneapolis neighborhoods are holding steady. Not bad for an old German farmer.
In 1826, von Thunen, an estate manager from Mecklenburg, northern Germany, pioneered land economics, managerial economics and theories of marginal analysis and general equilibrium. For land, he recognized that transport costs coupled with product prices determine which farm products are produced where. But his ideas have far broader applications.
He observed that fruits, vegetables, eggs and fresh dairy products have high value and are difficult to transport without damage. They are grown in a ring close to the city. Forests for lumber and fuel come next. These products are not very high in value and are cumbersome to transport.
Grains and other nonperishable agricultural commodities are grown in a third ring. They are less heavy or bulky, relative to value, than timber. Transporting them, again relative to value, costs less.
The outermost ring is devoted to pasture for beef and sheep. These have even higher value per pound than grains, but are relatively cheap to transport since they can be driven to market when fat.
Von Thunen not only explained the spatial organization of production activities, but how land values varied with location. Independently of his better-known contemporary, British economist David Ricardo, von Thunen explained how the value of land depends on the value of what it produces. He related this not only to the land’s intrinsic productivity but also to its location and to transport costs.
One illustration involved farm workers transporting rye to market in a horse-drawn wagon. If close to town, all they need take along are some sandwiches and perhaps jackets in case of rain. The rest of the wagon is filled with grain.
But if they cannot make the round trip in one day, they need to pack blankets, food, a cooking pot plus fodder for the horses.
The longer the trip, the more the space in the wagon is devoted to trip supplies and the less available for the product being sold. The cost of transport increases compared to the value of the rye. Therefore, net profits from growing rye on distant farms, even with equal crop yields, are less than for close farms. Land prices have to be lower.
The same logic applies to modern metro-area commuters. If you work in the city and live in the suburbs you are in the same boat – or, perhaps, wagon – as von Thunen’s farmers. Cheaper transport raises distant property values. Expensive transport lowers them.
Buy a home 25 miles from your job instead of 15 and you drive 20 more miles per day, 5,000 more per year. At 40 miles per hour, 25 miles to the gallon and $2 gas, you spend an extra 125 hours and $400 in gas on your commute compared with a commuter from an inner-ring suburb.
The house has to be cheaper to make it worthwhile. If the gas price goes to $3, you pay that on every mile you drive, not just the 10 incremental ones. You spend $500 more per year. Getting a condo in a converted warehouse five blocks from work looks better and better each month.
That is what apparently is happening right now. Persistent high gasoline prices are lowering housing prices in some distant suburbs, while some central city properties – especially those located where people can walk or take convenient public transport to work – are maintaining or increasing their value.
Von Thunen also examined how a cheap transportation corridor affects property values. Suppose there is a canal or placid stream. One can load tons of rye onto a barge and move it to market much cheaper than with a wagon. Land prices are higher along the watercourse than elsewhere because produce transport costs are lower.
Ditto for the Twin Cities right now. Property prices have increased along the Hiawatha light rail line. More people want to live where getting to work is relatively cheap and convenient. In response to rising rental demand along the line, developers build apartments and condos. Neighborhood retail businesses spring up to serve the new residents.
The Central Corridor light-rail line is seeing similar activity, even though construction has not yet started. Developers are turning old commercial buildings into condos even though the buyers will have to depend on the No. 16 bus instead of snazzy light rail trains for years yet.
And yes, the same is true for communities along the planned Northstar commuter rail line. There is increased interest in buying property near planned stations.
Von Thunen predicted it all. The only difference is that commuters have replaced rye and the real estate is houses and apartments rather than sandy north German fields, woodlots and pastures.
© 2008 Edward Lotterman
Chanarambie Consulting, Inc.