A vacant lot next to a new planned trolley station at Clairemont Drive and Morena Boulevard has been home to years of development fights. / Photo by Jamie Scott Lytle

City officials would be wrong to think they are creating a windfall for landowners in their recent approval of the Moreno Community Plan. Moreover, this is exactly the wrong time to attempt to recapture some of that “profit” for public benefit.

The author of the op-ed “The Morena Plan Still Needs Work,” misunderstands the economics and feasibility of real estate development. His argument is that an increase in housing density along Morena Boulevard is going to create a windfall for nearby landowners through increased property values.

The argument that there is money to pay for additional public amenities and low-income housing is simply not supportable, at least at the present time. In fact, to even begin a conversation about recapturing profit through a tax or by requiring more affordable units for each project, the city would have to consider  further upzoning the area by increasing the height limit on those properties to two to three times the current density allowed.

The idea of a land value recapture tax would only work in cases where there is a significant amount of upzoning — think of a small house on a lot in East Village in which a high-rise project is now permitted through a zoning change. That is a true upzoning windfall for the landowner because the value of the house is far lower than that of a 50-plus unit development on the parcel.

Along the Morena Corridor, however, there are functioning businesses. These businesses pay rent. This rental income translates to real, existing value to landowners. To compel a landowner to sell their property to a housing developer, they need to be convinced that the land value exceeds the current value.

The simple act of upzoning properties to achieve values equal to the commercial value is not enough reason for landowners to sell. When a developer buys a property, typically there is a long escrow period while the project is designed and then works its way through the entitlement and approval process. Construction contracts and financing must be arranged as well.

There is also a very real risk that a developer will ultimately decide not to buy the property.

But if the landowner sold their property at a price that is based on current commercial income, the escrow period is typically compressed to a range of 30 to 60 days, dramatically reducing the uncertainty (and the risk) of closing the deal. Therefore, land values need to be substantially higher than existing values to compensate owners for the risk of having their property tied up for a longer period.

Call it a windfall or not. It’s economics. The landowner would rather sell to an investor who wants the existing commercial income from rents, rather than sell their property to a homebuilder as land.

Therefore, developers must determine if they can raise the land value high enough so that the landowner will sell the property to them. This “land residual” analysis is what developers undertake to determine the price that they can pay for a property. Built into that calculation is what is achievable in terms of density, costs and revenues.

But in today’s environment, high land values with windfalls are not being achieved. Construction costs are up 15 percent to 20 percent over the past three years. Conversely, rents have leveled off and generally have not kept pace with construction cost inflation. This has the effect of reducing the land value. To keep land values attractive to property owners, developers are forced to turn to less expensive construction methods and away from mid-rise and high-density projects. In many cases, developers are actually building under the density allowed by zoning. This is how development is playing out currently in Mission Valley. There, and in other neighborhoods, developers are leaving density on the table because they can’t afford to build bigger.

Or they are simply walking away from the deals.

While a land value capture tax is a compelling idea that might be considered for selective markets with substantial upzoning, it is almost certain to have a detrimental effect on development along Morena Boulevard. For such a tax to be appropriate, the city must grant double to triple the density. Next, developers have to bite; they have to make sure that they can pencil the deal to the higher density with higher costs and achieve a significantly higher value, or true windfall, for the landowner. Then there will be something to actually capture.

For now, it’s best that the city complete its $2 billion investment in the Mid-Coast Trolley extension to do its part to encourage new development. That is the requisite infrastructure that can create value in the neighborhood. It will also generate more housing that will result in more impact fees to afford the improvements.

This is not the time nor the cost environment to ignore economics and attempt to recapture density value. First things first: create more density, which will eventually raise land values, which then will increase transaction activity, and ultimately, result in more housing units.

Nathan Moeder is a principal at London Moeder Advisors, a real estate analysis and consulting firm. He is also adjunct professor at UCSD in the Urban Studies and Planning program.

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