I've written about the flawed Kelo decision several times recently, but have been particularly concerned about the threat to property rights when I have done so. But I have also had another concern, one related to economics and the nature of the real estate market. Unfortunately, I feel I lack the expertise in the latter to do a good job discussing the former, and so I have held off doing so pending some research time. And then I woke up this morning and saw my very concern addressed in the Houston Chronicle by a local developer, Mark A. Anawaty. As he notes correctly, the Kelo decision effectively does away with the notion of "market value". Heck, it even raises the question of whether or not "just compensation" survives Kelo.

Maybe because I live in this world daily in my business of trying to acquire property for private development, I think the decision has a soft underbelly in another area that hasn't been much discussed. The decision may likely erode the distinction between two core concepts in real estate development — just compensation and true market value.

Eminent domain robs property owners of the premium we optimistic developers are often willing to pay in true arm's length negotiations. It exchanges this market test for the notion of just compensation which, if it were just, theoretically wouldn't be so regularly fought over in the courts. Why pay the market price when a politically connected developer can rely on eminent domain?

After all, if governemnt can step into the picture and end the notion that real estate is worth "market value" (what a willing buyer and willing seller agree to by mutual consent for their mutual benefit), instead substituting some nebulous concept of "just compensation", then real estate no longer has a real market value in the development market. And I will be very clear on this -- I'm willing to take significantly less for my house if it will become the home of a family with a couple of kids than I would ever consider taking from a developer who wants to tear down my home and build a grocery store, bank, or gas station -- or even one wanting to put up million-dollar McMansions. After all, the relative values to the buyer differ in each of those scenarios, and it is my right to take full advantage of such differences. That is, after all, the very essence of the market. But instead we now have a willing buyer and an unwilling seller who is forced to accept a price he does not want for property he does not wish to sell.

That leads us back to the question of "just compensation", which I've dealt with in elsewhere. Who decides what constitutes just compensation? Why, the government, which acts as the buyer in this transaction. Imagine the fun I could have had four years ago if I, as the willing buyer, had been able to select my house and set a more-or-less non-negotiable price for it, whether or not the owner had any interest at selling, regardless of price! I can think of a number of places in the area that I would have been glad to purchase instead of my current house (which suits my needs very well) -- an extra 1000 square feet, with a larger yard on the lake or the bay might have been a bit more desirable for my wife and I had we simply been able to walk in and giver the owner notice to vacate the property in return for the price we felt was just. While eminent domain actions do offer the option of challenging the level of comensation, the goal is often to get a low-ball figure accepted. After all, how many of us have the ability to pursue the matter in court against the relatively unlimited funds available to governmement can then add value to it by changing the zoning and re-selling it to the developer at a higher price -- therefore taking for itself profit that morally belongs to the owner to whom was paid "just compensation"!

And then there is the question of competition. When government subsidizes a project -- especially when it becomes a partner in the project -- it has the effect of squeezing out competitive ventures.

Hampered by low investment returns in the stock market and buoyed by rising real estate values across the nation, ambitious officials (some elected, some not) are eager to shape the world according to their vision by making what they view as fail-safe investments in real estate. The growth in the number of requests for proposals from municipalities and economic development groups across the country has been exponential in the past three years.

This is all coming at a time when many long-term real estate professionals believe many land uses are nearing the peaks of their cycles.

These well-intentioned groups have supported public-private partnerships without fully appreciating the potential conflicts and risks that encouraging public entities to cross the line into the private sector can bring — even in the most thoughtful, well-executed plans.

As a private developer I can't help wonder about a conflict such as the following hypothetical: Ambitious City X teams up with grateful Developer Y to design a mixed-use project for a blighted area. Of course, the plans take a while because the project must be fully vetted with numerous city departments. Market cycles get missed, or the end product is not what the market desires — the proverbial design by committee — and only a portion of the project attracts tenants.

Meanwhile, Private Developer Z has an anchor tenant and wants to start her more desirable building in the same market area.

Will the city feel compelled to allow a competitive product in the marketplace?

Will the city subsidize the rents in its project, thus usurping Developer Z's ability to lease the remainder of her project?

These public subsidies serve to make private development less appealing to those not working in partnership with governemnt. And why shouldn't this be the case? The government is taking money from the private developer in the form of taxes and giving it to the competition, in effect forcing the private developer to comete against himself while realizing none of the benefits of the subsidized development!

No, Kelo is a disaster for many reasons. We need to slay this beast on the state level, assuming there is not a national solution to it.

Posted by: Greg at 05:36 AM | Comments (2) | Add Comment
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