Put simply, when one buys property they are actually purchasing a bundle of property rights associated with that land title. These rights are granted to the title holder by the State. This bundle of rights approach allows us to distinguish between, and appropriately value, different types of tenure, such as freehold and leasehold, and for differing levels of planning regulation, native title rights, and rights to minerals (which even freehold land owners does not have rights to).
When you value property, you value just those rights that are granted to the title holder by the State. A block of land where the title grants a pastoral lease with 10 years remaining will be valued differently if it was a freehold parcel. Changing the legal rights of the owner may vastly change the market value of the property because the property is different – it is a different set of rights, even though the physical land has not changed.
And so we move on to town planning. Local governments have the power to decide what rights, in terms of land use and scale of development (amongst other things) to grant to which parcels of land through their planning regulations.
When people argue that town planning restricts land market activity and leads to higher values, they are generally confusing basic economic theories of production with fundamental theories of valuation of property rights.
As the RBA's Anthony Richards proclaimed -
However, supply-side factors should have a much greater influence on prices towards the fringes of cities, where land is less scarce and accounts for a smaller proportion of the total dwelling price. In principle, the price of housing there should be close to its marginal cost, determined as the sum of the cost of new housing construction, land development costs, and the cost of raw land. And in the absence of any restrictions on supply, the price of raw land on the fringes should be tied reasonably closely to its value in alternative uses, such as agriculture. So unless there has been a marked increase in the value of this land when used for other purposes, the availability of additional land towards the edges of our cities should have limited increases in the cost of housing there.
Richards is essential arguing that prices for land are determined not by the highest and best use available under its own bundle of property rights, but by a second best alternative use. This is a logical absurdity which is easily demonstrated to be nonsense.
For starters, why isn’t the value of agricultural land itself tied to its next best alternative use... which would be... umm... some less productive form of agriculture. Which itself should be valued at close to its alternative use which is...umm... nothing?
And what of the value of land for high rise commercial buildings? Should it be reasonably tied to the value of land for multi-storey residential? Which is in turn tied to the value of single detached residential, and so on.
If this logic applied in reality, no land would have value because it is all costless to produce and there are always lower value uses. We would only value improvements to land.
What happens in reality is the exact opposite – all land has value because it has a bundle of rights which the owner can use to their own private advantage. Land values are the residual value of the location benefits of the highest and best allowable use of the land, less the capital costs required to establish that use.
It is pretty clear that "House prices determine land prices, not the reverse, because the builder's estimate of the selling price of the building will largely determine his bid for the piece of land”. Indeed, the house price itself should be determined by its rental value which arises from the actual interaction of supply and demand for housing in the market.
As I have said before, land goes to its highest value use not by competing with other uses, but by competing buyers who want to use it for the highest and best use. There doesn’t need to be a secondary alternative use to create value.
So if all land zoning is removed who are the most likely buyers going to be?
In some areas, perhaps commercial users would outbid residential users, driving up the value of land for residential use in that area. This often happens when zoning is changed. This clearly demonstrates that strict zoning laws can reduce the value of residential land if competing uses, which are not part of the bundle of rights, would outbid residential users for that land.
This type of ‘free zoning’ would see high value uses muscling in to inner city locations, and ‘pushing’ residential land uses into the fringes. These fringe residential uses will also push up prices for rural and agricultural uses.
Whether that results in cheaper average prices for homes I don’t know, but it would definitely result in inferior locations for the housing market as a whole, so any price declines must be seen in the context of quality declines.
Changes to land zoning are changes to the bundle of rights of property owners. As a general rule, increasing the rights increases the value of the land, while decreasing the rights (limiting the scale of allowable development) has the direct result of decreasing the value, since buyers are purchasing fewer rights.