Forced Development and Urban Land Prices
BRENT W. AMBROSE
Gatton College of Business and Economics, University of Kentucky, Lexington, KY 40506-0034, USA
This paper examines the distortions in property markets resulting from government actions to alleviate
externalities associated with vacant lots. Using an equilibrium based real option model, the analysis indicates
that announcement of a program of forced development may actually delay market-based development. By
incorporating externalities associated with vacant lots into the model, the analysis indicates that owners of
neighboring developed property beneﬁt suggesting such programs will be politically popular.
Key Words: real options, development, government intervention
Economists have long considered the issues associated with urban land development and
the question of why valuable real properties in urban environments remain undeveloped.
For example, classical intertemporal land development models, such as those presented
by Shoup (1970), Anas (1978), Arnott (1980), Fujita (1976), Mills (1981), and Sinn
(1986), explain the presence of vacant land in urban settings. Furthermore, a related
literature examines the optimal timing of urban land development under certainty in
response to externalitites associated with government intervention. For example, Arnott
and Lewis (1979), Bentick (1979), Mills (1981), Anderson (1986), Turnbull (1989),
Anderson (1993), and McFarlane (1999) model the role of property taxation on optimal
development timing and density. In one of the ﬁrst formal analysis of vacant land
development, Arnott and Lewis (1979) develop a partial equilibrium model that
examines the timing and density of development that maximizes the net present value
of the land. They further extend the analysis to show that externalities arising from
government intervention in the form of differential property tax rates will impact the
timing of development. This paper builds on previous research to examine the impact of
a government policy designed to force development of vacant urban land. However,
rather than utilize a certainty based model, I examine government intervention using a
real option model that explicitly incorporates demand uncertainty.
In his path-breaking study, Titman (1985) developed a model of vacant urban land
prices that recognized the importance of uncertainty in the development process.
recognized that real estate development is inherently risky and that rational land owners
may often delay their investment decision. In Titman’s model, holding vacant land is
analogous to owning an option to purchase one of a number of different buildings at
The Journal of Real Estate Finance and Economics, 30:3, 245–265, 2005
2005 Springer Science + Business Media, Inc. Manufactured in The Netherlands.