Development Option Theory

The real option theory of land development was a hot topic in the mid 2000′s, as the volatility of the real estate market peaked. Now that we have a break from the U.S. housing bubble and financial crisis, it’s worth talking about how we might decrease the volatility of the development market over time.

Urbanism by right is achieved with tools such as form-based codes, which allow walkable, compact, mixed-use, sustainable development, at the scale of the lot, block, neighbourhood, and region. Changing the law to allow urbanism by right makes walkable communities go “in the money” for several reasons, including decreased uncertainty, shortened planning and approval processes, increased flexibility, and increased long term asset value.

Snow falls on The Waters, a traditional neighborhood development in
Montgomery, Alabama, governed by the form-based SmartCode.

One of the best ways to decrease volatility is to decrease uncertainty. You change what developments pencil when you decrease the uncertainty of what is developable. Uncertainty is “beta” from the option theory perspective. As beta decreases, the required rate of return also decreases, because people don’t need to be paid so handsomely if they aren’t taking as much risk when they “buy” their option to develop.

The time value of money is less of a factor when the playing field is levelled to allow urbanism by right, because the development process is drastically shortened. If the developer isn’t owning a call option on a property as long, her interest fees decrease. The reason that form-based codes shorten the timeline is because a prerequisite is consensus on the community vision. By agreeing in advance about the sort of development that locals want, developers have both shorter plan approval times, and increased certainty about what their options are. Less emphasis is put on individual mojo and political connections that allow discretionary power over development decisions. Community NIMBYs have already spoken to what is and isn’t allowed in their back yards.

As flexibility increases, the option value increases. Form-based codes are inherently flexible, and nimble in their responsiveness to adapt to changing conditions. The mixture of compatible uses allows one building or block to respond to market demands, changing from a townhouse, to a live-work, to a storefront, and back again, all as a matter of right. Higher densities encourage more compact development patterns, allowing narrow lots that can provide a range of price points. Blocks within form-based codes are easily re-platted to move up or down the Transect, because the basics of the urban form and street grid are honoured. Conversely, in suburban bedroom communities, along strip retail, or within other auto-centric patterns, sprawl repair is expensive and time consuming. Once a developer commits to one of these uses, they’re locked in.

Increased long term asset value is enjoyed by walkable neighbourhoods, which are healthier for the economy, society, and environment. This is from myriad reasons, including increased walkscore, decreased vehicle miles traveled, increased housing value, decreased carbon emissions, decreased auto costs, increased personal fitness, decreased infrastructure cost, increased hours available, real community, and the list goes on.

All of this is captured in the intrinsic and extrinsic value of the development option. Intrinsic just marks the asset to market once the land is developed, while extrinsic is the value of the volatility around which a developer can bet or trade. Too much of the latter builds your house of cards, and bubble bursts. The extrinsic value decreases and intrinsic value increases when physical and policy planning reforms are undertaken.

A recent NY Times article discusses several market factors of the development landscape over the next two years, as we recover from recession. These include the current scarcity of construction financing, the lowering price points of residential demand along with increasing housing types to include condos, town homes, and flats, and that in many places, conversion is less expensive than new construction. All these items, with the exception of financing, find solutions within the flexibility, certainty, and timeliness of form-based codes. In fact, in places that have adopted optional form-based codes, locals indicate that most of the recessionary development is occurring under these optional form-based codes instead of under the auto-centric laws.

“One of the economic conundrums of the past year has been the great divergence in the Canadian and U.S. housing markets. While American home prices swooned in 2009, the Canadian market only stumbled before resuming its inexorable climb upward,” according to the Globe & Mail last week. Some economists say this is the result of Canada’s fiscally sound banking practices, while others argue that the Canadian housing market is 15 to 35% overvalued. If the latter is true, a careful look at the predominance of Euclidean bylaws in Canada that increase market volatility via destabilizing uncertainty is worth consideration. Indeed, western provinces are leading with bylaw reform, with 12 out of the current 14 Canadian form-based bylaw initiatives being based in the west.

–Hazel Borys

Atlanta, AARP, DPZ Attack Challenges of Aging in Place

The New Urbanist mantra for neighborhood planning is to go for compact, connected, and complete. Well, one critical component of completeness, that of making communities comfortable – and practical – for residents of all ages, has been sort of assumed by NU planners. Yet it’s taken an effort by the nation’s primary advocacy group for seniors, AARP, to make the idea of “Livable Communities” for aging in place a planning priority.

Can community design impact one's ability to age in place? The ARC is examining how.

Can community design impact one's ability to age in place? The ARC is examining how.

Integrating that priority into master planning for real places is getting its first major test with a Lifelong Communities Charrette in Atlanta, Feb. 9-17. The Atlanta Regional Commission (ARC), which coordinates planning for the 10-county metro region, is behind the project, with AARP as one of its partners. Duany Plater-Zyberk & Co. (DPZ), led by Andres Duany, will provide the design and planning expertise. Together they hope to make solid headway on an issue that will only loom larger moving forward.

The charrette targets five sites in the region, selected for their potential to represent typical challenges to aging in place and for communities’ willingness to embrace walkable, mixed-use, mixed-generational solutions to those challenges. How DPZ approaches the project and the plans that emerge from it are likely to provide models for similar efforts in other places. Lots of other places. Here’s why:

In 2008, the oldest members of the Baby Boom Generation became eligible for Social Security. The whole generation, 76 million strong, will have turned 70 by 2034. And if we’re not able to reverse the dominant trend of suburban sprawl and its near exclusive reliance on automobiles for mobility, we will make aging gracefully at home in America difficult for even well-off seniors and all but impossible for the majority of older people.

Flunking the aging-in-place test not only means an increased burden for family care-givers and public programs (and therefore tax-payers); it also means the loss of good neighbors and productive citizens who could live independently longer in their own homes and neighborhoods if their communities planned for walkability, diverse housing choices, and mixed-use.

In addition to AARP, healthcare and public safety experts have been connecting the housing issue with aging in place challenges for most of the last decade. You can read working papers from Harvard’s Joint Center for Housing Studies here. Included among those papers is one on “Aging in Place: Coordinating Housing and Health Care Provision for America’s Growing Elderly Population” by Kathryn Lawler, who’s one of the planners of the Atlanta Regional Commission project.

We’ll follow the ARC/DPZ charrette in blog posts to follow. In the meantime, care to shake this story up a little?  Then share your comments below.

- Ben Brown

Gluttony and Glut: Finding the New Normal

An evening cross section of Atlanta's Atlantic Station.

An evening cross section of Atlanta's Atlantic Station.

How serious is the implosion of the once-booming urban condo market? And what does the downturn say about the prospects for housing in urban centers?

A piece in the business section of the Atlanta Journal-Constitution seems to say it all. Desperate to unload some units in “a stagnant market,” says the sub-headline, an Atlantic Station  developer will auction off some 40 units, with bids starting at 56 percent off list price. A similar story about the stalled condo market in Chicago appeared in a Feb. 3 New York Times story.

Well, welcome to the New, New Normal. Just don’t read too much into implications for the future of multi-family housing in these places.

To be sure, fire sales aren’t great news for developers caught in the current pinch, or for investors, including condo owners who bought into a project at the old list price. But it seems to us that the only environment in which this sort of mark down is seen as a disaster is one in which folks deny the realities of the real estate marketplace. It’s not a marketplace unless prices go up and down depending upon what buyers are willing to pay, right?

For what we now recognize as an unsustainable period of speculator insanity, prices of detached single-family homes and condos soared, particularly in desirable cities and desirable climates. The period lasted long enough for a lot of folks – buyers, builders, developers, and real estate brokers, to name just a few – to believe the aberration was the New Normal. For a look at how a misguided sense of entitlement played out in the lives of real people on Florida’s southwest coast, check out George Packer’s story in the Feb. 9/16 New Yorker – it’s called “Ponzi State,” and for good reason – and then take a look at his video. And for a west coast take, watch this video from the Associated Press.

The remnants of that sense of entitlement persist in many of the conversations about “stabilizing” home values by artificially propping up prices in a market still seeking a bottom. New Urbanist developer Vince Graham explained how it’s time for a get-real approach to home values in one of our previous posts.

But it’s just as dangerous to assume an opposite marketplace trend, that advocates for downtown mixed-use development got it all wrong.  The current shakeout is not about whether or not there’s a market for condos and rental apartment options in downtowns; it’s about the nature of that market, particularly about how diverse the housing choices have to be and how well integrated is the planning for truly mixed use opportunities.

One of the best overviews of demographic and marketplace trends is the 2008 report from Harvard’s Joint Center for Housing Studies. And for a glimpse at how Americans rank places they’d like to move to – including places like Atlanta and Tampa that have experienced the greatest housing market downturns – see this recent survey from Pew Research. 

- Ben Brown