The Methodology of Real Estate Appraisal: Land-Residual or Building-Residual, and their Social Implications

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NYU Real Estate Institute’s Round Table Discussion of Land- and Building-Price Indices

A meeting was held at New York University’s Real Estate Institute on October 25 to discuss the virtues and pitfalls of constructing a land-price index to distinguish between land and building values. The Institute’s Associate Dean Ken Patton had invited Michael Hudson and the Robert Schalkenbach Foundation to assemble an economic team to discuss the pros and cons of the Georgist position regarding land-values with the Institute’s faculty and real estate industry representatives.

The discussion was moderated by Schalkenbach’s Executive Director, Christopher Williams. Prior to the meeting, Dr. Hudson, President of the Institute for the Study of Long-term Economic Trends (ISLET) had circulated a discussion paper spelling out the statistical problems of constructing real estate value indices at the macroeconomic level. Ted Gwartney, city assessor for Bridgeport Connecticut, discussed appraisal problems at the local level. Prof. Lowell Harriss of Columbia University presented arguments for shifting the real estate tax off buildings and related manmade capital onto the land. The central thrust of these three discussants was that real estate values were best determined by valuing the overall property parcel by parcel, and then valuing the land, leaving the residual value (positive or even negative) to be assigned to the buildings on it.

The Real Estate Institute’s faculty was represented by Profs. Herve Kevenides, Gerald Levy, David Scribner, Rosemary Scanlon, and the Institute’s Director, Michael Waters. Industry representatives in attendance included John Bringleman and Marie-Danielle Faucher of Landauer. Their view that a property’s value should start by estimating the replacement cost of the buildings and other capital improvements (taking into account their estimated depreciation), along with a return to entrepreneurship. In this approach whatever was left over would be assigned to land. This “land residual approach” is usually followed in official statistics such as the Federal Reserve’s annual Balance Sheets of the U.S. Economy. Under this approach, land may be left with only a negligible value. The discussion therefore focused on how realistic this approach was. The two-hour discussion dealt with the statistical problems inherent in the two respective approaches.

Dr. Hudson said that his objective was to use statistics to quantify the reasons why real estate prices rise and fall, above all to trace how credit bubbles became real estate bubbles. Most of the variation, he believed, occurred in land values. But the Federal Reserve’s land-residual methodology that formed the basis of its national balance-sheet statistics attributed nearly all the increase in property values to rising construction costs. These costs typically rise at about 3 percent per year. However, when property values fall, the decline is attributed entirely to the land. This creates an asymmetry. Does it make sense, or should the rise in real estate values be attributed to enhanced site values?

The ensuing discussion made it clear that a number of different measures were required to reflect the various dimensions and objectives at play. Some of the measures were market oriented, some were tax oriented, credit oriented or otherwise policy-oriented. The imputation of value to buildings or land depended on what the purpose of the questioning was.

Prof. Patton pointed out that the Institute was in mid-town rather than downtown at the School of Arts and Sciences in Washington Square because it dealt with the real world rather than with general philosophy such as characterized most academic economics. Economists, he said, dealt with broad aggregates or abstractions, whereas real estate development was essentially a local market phenomenon. Dr. Hudson said that if they were going to introduce reality, then they were indeed leaving the realm of economics. He believed that the formal categories used by economic theory reflected essences that were important for analyzing the economic and financial dynamics at work. Market prices were immediate and often ephemeral, as they reflected the interplay of many different trends. In this respect Prof. Patton and Dr. Hudson agreed that in the subsequent discussion they were each referring to different planes of reference.

Dr. Hudson believed that there was a need to create a real estate index segregating land from buildings because what real estate owners sought primarily were capital gains, which he believed should be attributed to the appreciation of land sites. He based this view on the statistics of cash flow taken from the National Income and Product Accounts (NIPA). These statistics showed that most of the rental cash flow consisted of interest paid to mortgage financiers, as developers sought to use other peoples’ money to as large an extent as possible. After deducting local property taxes and depreciation allowances, the commercial real estate industry rarely showed any profit. In fact, it tended to generate tax deductions for its owners. The only explanation for why real estate owners would operate without showing an income was to take their return in the form of capital gains. Homeowners also found the value of their residences rising over time, at a rate that has more than covered their rising mortgage debt in recent years.

Prof. Patton believed that the motivations of real estate developers and the large real estate families, or REITS were better explained by recognizing that the major real estate magnates did not want to sell their properties at all, but to bequeath them to their heirs. Rather than developers and also REITS pledging the rental cash flow for interest payments to the bankers, hoping to sell the property in the end for a capital gain, they sought to extend their holdings by refinancing their property at lower interest rates and, where possible, higher values. The tax code let them do pass on their estates at relative low book values rather than reflecting current market value. (There was no discussion of the details of estate-tax valuation for real estate.)

It was agreed that statistically, REITs constitute only a small part of the real estate sector, and the net income they generate gets swamped by the magnitude of the nationwide NIPA statistics. REITs are largely a creature of the finance industry. Their role was essentially to securitize property values. The ability to turn real estate properties into stock market values gave them a higher price/earnings ratio, partly because securitizing real estate made its ownership claims more liquid.

Dr. Hudson thought that this case illustrated the extent to which the legal system determined the land and values, along with the tax treatment of property. Much of the ensuing discussion concerned the extent to which property values depend on use rather than on the land site as such.

Prof. Patton believed that attempts to distinguish between the “building” and “land” elements of real estate enterprise was of more interest to economists than to real estate investors themselves or to their bankers. Basically at issue was what the overall enterprise yielded. (The discussion focused on commercial investment, not the single-family market.)

Prof. Kevenides pointed out that entrepreneurs added value to real estate developments as a whole, beyond either the land costs or the building costs. Prof. Patton noted that Donald Trump was able to add 20 percent to the value of a building by putting his name on it. And Rudin Management had a loyal following ensured that its buildings were fully rented, giving them a premium value because of the tenants they were able to attract. Their management would add value to property, but it was not land value as such, nor was it reflected in the building’s replacement cost or original construction cost.

Dr. Hudson suggested that whatever does not appear statistically as a building cost must be attributed to the land, ipso facto. It followed that an entrepreneur’s reputation basically gives greater value to the site. But Profs. Patton and Kevenides thought that the value added by entrepreneurship should be imputed to both land and buildings together, that is, to the overall real estate enterprise, as neither the developers nor the renters or buyers separated one from the other in practice. Perhaps it should be pro-rated as an “entrepreneurial premium.” The distinction between land and buildings seemed to be an arbitrary, philosophical and “economic” one rather than one that real estate investors and developers bothered much about.

This threw the issue back to what the pro rata ratios should be. What ratio rightly reflected the land, and what ratio the buildings? Prof. Patton believed that the “equilibrium value” was best reflected in the replacement value of buildings, for this was the price at which builders would not build any more if they could not make an economic return.

Explaining that he himself came from the financial sector and viewed real estate from the perspective of an industry that absorbed 70 percent of the private sector’s credit, Dr. Hudson said that credit analysts and policy makers faced a problem of just how to quantify real estate’s dynamics. Although economics has become more and more about quantification, the empirical statistical foundation with regard to real estate is worse than that of any other sector, despite real estate’s dominant role in the economy.

Suppose one is trying to decide whether the real estate, stock or bond markets are overvalued. On an economy-wide basis, one would need to have an index of real estate values. And to see the dynamics at work, one needs an index that distinguishes how much real estate value belongs to the land and how much to buildings. The problem is not really one of equilibrium. At any given point market prices seem to be justified, and can be represented as being in equilibrium. A person falling on his face is in equilibrium. But the equilibrium may be out of balance. In a real estate bubble, prices rise beyond the level that reasonably can be justified. Banks for their part (and indeed, bank regulators and the Federal Reserve) need to decide at what point to cut back their mortgage lending so as not to fuel an overpriced market and have to deal with debt defaults.

For the stock market a convenient indicator of market overheating is the “Q Ratio” – the ratio of stock market prices to the book value of companies, their capitalization value or replacement value. This kind of index can be compiled from SEC figures based on corporate annual reports as compared to the market value of shares that trade daily. But no such index is available for real estate, at least on a national level. One reason is that there is no ongoing market value for each parcel. For as Prof. Patton pointed out, each development was different and had its own use and its owners had distinct economic objectives. The upshot is that there is no economy-wide index number reflecting when real estate is overvalued or the rate at which its prices are rising.

The discussion brought out the fact that much property changes hands only rarely, and each property has its distinct features. Real estate prices are “site-specific.” There are many local indexes, each comprising various categories of property whose use tends to shift over time. But it would be difficult to aggregate these into a single homogeneous real estate trend. Too many local trends and shifting categories are at work to produce a single “market capitalization” such as can be done for the stock market. Book values for buildings vary widely from one location to another, as do assessed values. They depend largely on such accidental variables as the last time a property was sold, and often its use.

Prof. Patton pointed out that a high-rise building might seem at first glance to have a higher land value, but at least in New York City it usually requires a tax subsidy to be built so high. This meant that the land itself had a negative value, for that balancing residual was the only way to balance the building’s construction cost with its market value. On this basis, much of the city’s most highly built-up land would have a negative value, including the World Trade Center even before its Sept. 11 destruction.

Suppose there were only a parking lot there, Dr. Hudson replied. Wouldn’t that “pure land” have a high value? Suppose there were a two-story “taxpayer” used as a restaurant. Wouldn’t that have a high value? Suppose there was a site-story or even 20-story office building. Wouldn’t that have a prime site value? And wouldn’t this value be given largely by the high-rise prestige real estate around it? Obviously, location was a vital element in determining the context in which land-holders bargained for building subsidies.

Prof. Patton agreed that low-rise uses would have a higher value. Indeed, the higher a building was constructed, the more of a subsidy it needed, given the economics of space involved (for elevators, surrounding air space and so forth). In that respect the value of land depends on the purpose for which property was used. The higher a building, the lower the land value had to be. While a low-rise building might be built on the World Trade Center site without subsidy, a skyscraper would need a subsidy, implying a negative land value.

Building prices are common throughout New York City, Prof. Patton continued, but midtown land sells for $80 a square foot while downtown land brings only about $50. For real estate investors, land is their equity. The Federal Reserve treats it as a non-performing asset. This means that to the extent that banks lend against land, over and above the building’s assessed value, they need to keep reserves as high as those for which they are obliged to hold for non-performing assets. The objective of this ruling is to prevent banks from lending against land. This is why they typically lend only for buildings. A property’s bankable value therefore consists of the building, and usually reflects its replacement cost.

The discussion showed that buyers of single-family residences were expected to put up only about 20 percent of the purchase price, yet land typically reflected more than this. Thus, part of the bank loan tended to be for the land, especially in rising property markets. Still, Prof. Patton concluded, most investment bankers and other financiers have little use for economy-wide indices, while commercial investors and their creditors are concerned mainly with arbitrage margins, that is, whether they can buy a property at one price, and sell it at another.

The general discussion produced agreement that an immediate problem in creating economy-wide indices lies in the fact that federal statistics are prepared mainly from Census surveys and tax returns. As the tax code has became more convoluted, the categories have had less and less to do with purely economic categories, but are distorted by the “small print” in which special interests won tax concessions. Accountants prepare tax filings not in accordance with the categories used by economists, but those designed to minimize the tax liability. For this reason one would expect federal statistics to show a different picture than would a real estate survey based on the industry’s own view and what its actual economic objectives were.

Prof. Patton emphasized that the industry’s Washington lobby, the Real Estate Round Table, had opposed the 1981 tax rules on the ground that their accelerated depreciation rates were excessively short, and contributed to overbuilding. It was Congress that tried to spur this building, and the financial industry that jumped on the bandwagon to spur a thriving mortgage credit market.

Prof. Patton elaborated his point that while America had a building-cost inflation and a real estate tax problem, Japan indeed had gone through a land-price inflation and subsequent collapse. He showed a chart showing Tokyo’s A-shaped sharp rise in land prices up to 1990, and their subsequent decline back almost to their pre-bubble levels in the mid-1980s.

Dr. Hudson said he had prepared similar charts for Japan, and in fact here was an example of the helpfulness of disaggregating statistics that Prof. Patton was talking about. Japanese authorities produced detailed land-value statistics for each category of land. The A-shaped graph was steepest of all for the nation’s most expensive land, that which surrounded the Tokyo palace in the Ginza district. And as Prof. Patton had noted, the land for wooden single-story residential housing had risen and fallen least steeply. Such cases in which one category of land rises much more rapidly than others provide a clear sign of land-price inflation, which usually in turn reflects a financial inflation. Japan’s high rates of saving were recycled to a remarkable extent within its own domestic economy, mainly into construction and real estate acquisition, which bid up land prices. In the United States, real estate prices were soaring primarily in about six major centers of e-commerce – Silicon Valley, Austin, Boston, downtown New York, and a few other such areas. Unlike Japan, however, the United States did not produce land-price statistics.

Prof. Patton said that the U.S. state of affairs reflected reality, as it was not very relevant to the real estate developer what part of his project reflected land and what part reflected buildings. Developers were concerned with the overall project costs, and their bankers were interested in what margin they could make by exchanging real estate packages for Treasury bonds. It was the yield spread that was most important to them.

Prof. Kevenides said that he found the most reasonable basis for valuing real estate to be cash flow, that is, how much rental cash flow a property generates. Dr. Hudson replied that this is only part of the equation when it comes to valuing properties (or stocks and bonds, for that matter), because the market discounts cash flow at the going rate of interest. When interest rates fall, developers are able to use the rental flow to borrow more money, and the value of the property rises accordingly. This is the equivalent of a rising price/earnings ratio for stocks.

To what should this rise be attributed? The building itself does not grow in value, but the forces of supply and demand bid up property prices. For the stock market, one can attribute rising price/earnings multiples to asset-price inflation. But for real estate, whatever is not attributable to buildings should be attributed to the land, in the sense that it is economy-wide. Today, an asset-price inflation is occurring independently of cost inflation.

Prof. Kevenides replied that land value is a derived value – that is, derived from its use. Different uses of a property would have different values. Much of this depends upon zoning and other regulations. Dr. Hudson agreed that land values were a product of zoning and other laws. As Thorstein Veblen had described in Absentee Ownership, most small towns in America around the turn of the twentieth century were best understood as real estate promotion projects. Real estate developers became civic boosters to increase the value of their properties, and were politically active in local politics to gain rezoning for their land. Jim Brown of the Lincoln Institute has written a book on how real estate gains come from rezoning agricultural or suburban land for residential use, and within residential areas how much value is added by permitting high-rise buildings to be constructed. In such cases, site values are the product of laws, above and beyond market supply and demand conditions.

Prof. Patton disagreed, and said that property values were a product of the market. Dr. Hudson pointed out that this left out a considerable portion of the nation’s real estate, starting with property in the hands of federal, state and local government. This property does not come onto the market. That is the stated reason given by the Federal Reserve Board for discontinuing its time series on U.S. real estate values – and without these values, the Fed no longer could compile estimates for the national balance sheet. “How do you measure the value of the Grand Canyon,” the Fed economists asked. When they were unable to answer this, they dropped their statistical series.

Prof. Patton said that he thought that government land should be assigned a negative value, because it has a negative cash flow: it cost more money to maintain than it generated. This operating deficit can be capitalized into a value that would produce the flow of income necessary to defray its carrying costs.

The point was raised that the government leases out various concessions in its national parks and other properties. Furthermore, public lands give value to adjoining properties in private hands. But on a cash-flow basis, Prof. Patton said, if the receipts are less than the maintenance costs, then public lands and other real estate should be assigned a negative value to reflect their ongoing subsidy. Just as municipal tax breaks and related subsidies to builders connote a negative land value to offset the building costs, so the operation of public lands at a deficit implies negative land values.

Underlying this view, Prof. Harriss pointed out, is the fact that many benefits provided by publicly owned lands are not marketed. But does this mean that they have no value? He said that the choice of what value to take depended on whether the purpose was to estimate use value or (potential or actual) market value.

Ted Gwartney described the process of residual analysis as subtracting from a property’s total value the portion that was easiest to estimate. This left the more difficult-to-measure value as a residual. For real estate, land is easier to estimate than building values. All appraisals start by determining the highest and best use for a property, which requires the estimation of land value. At the local level land values are well known by appraisers, real estate agents, bankers and the general public. Building values may be easy to estimate at the time they are constructed, but it is more difficult to determine their physical, functional and economic depreciation. No discussant supported the building-residual method as providing a superior basis for estimating value.

Prof. Gwartney pointed out that explained that land values rose even when properties such as parking lots or one- or two-story “taxpayers” were not improved, if the general district’s or neighborhood’s site values rose. This price gain was in the nature of a free lunch. The city of Bridgeport, Conn., for instance, had just completed its first citywide appraisal in twenty years. The results showed that while building values had risen by only 30 percent, land values had risen more than three times. When Assessment Commissioner in British Columbia, he witnessed land values increasing by ten times in just ten years in Vancouver due to the high demand for reinvesting capital from Hong Kong residents.

Prof. Patton pointed out that parking lot owners were not simply land speculators looking to sell out at a capital gain. Parking lots tended to be owned by developers themselves. They didn’t simply sell their property; they contributed it as their equity to a large development project, after waiting until a suitable development project was proposed. This is the positive role of speculators in waiting for the best – that is, the most economic – time to build up a property.

Prof. Levy said that he had read Henry George, and just recently had read Barker’s biography of George and found that the idea of “unearned increment” played little role in George’s philosophy. He asked whether once a smooth land-value map was made, the land value remained fixed or not.

Dr. Hudson explained that the shape of the land value map usually remained similar, but the level of land prices rose – and sometimes fell. He returned to the example of Japanese land that Prof. Patton had cited. The Bubble years (1985-90) were marked by soaring values for the most prestigious land near the imperial palace. A land-value map placing the highest values at the center and the lowest values in the outlying areas would tend to reflect a land-price bubble when price ratios steepened. On the other hand, a fairly level set of land values between the central city and its outskirts would indicate relatively less rent of location, and hence less land-value disparities. Using this analogy to examine New York City’s midtown area, he concluded that the steep land-value curve was fed by credit as affluent buyers sought the most prestigious locations. Land sites became the receptacle of the economy’s surplus savings.

Prof. Harriss explained that while he did not believe that there was enough rent to finance the Single Tax that the followers of Henry George advocated, he thought there was a good logic in levying real estate taxes on land rather than on buildings. A land tax would encourage the building up of parking lots and other under-utilized properties to their maximum potential.

Prof. Patton disagreed. For one thing, new buildings in New York City did not have to pay real estate taxes at all. All a builder had to do was go down to City Hall and say he wanted to erect a building, and he was given a tax exemption for 25 years or so. Furthermore, New York City was granting companies tax holidays to companies willing to locate here, or simply to stay. So the building that a land tax would supposedly encourage already were tax exempt. In general, if the aim of the kind of tax that Prof. Harriss suggested was to encourage construction, this was the way to do it. Otherwise, un-taxing buildings would give exemption to structures already built, providing a windfall to their owners without encouraging new construction.

Prof. Harriss pointed out that one of the classics of property valuation, by James Bonbright made the point that any calculation of value depended on the purpose for which the figure is desired. Was current or potential use value and market value the objective? Another discussant elaborated this point by saying out that buildings might have a negative value, in the sense that property often would be more valuable without these buildings on them, or delivered vacant. In such cases did this mean that the building had a negative value? Or was it the existing zoning rules and land-use that imposed this negative value?

Dr. Hudson said that this was precisely the point: In many central city areas, industrial properties have become gentrified and their prices have risen substantially. The land-residual technique attributes this rise in value to the rising reproduction cost of these buildings. But nobody would rebuild them as commercial properties. It is simply that they are there, as in Soho and Tribeca in New York. They would be worth more torn down, so that a new building might be constructed specifically aimed at luxury residential use.

Prof. Levy asked whether there were not some mixed methodology that could be used. Dr. Hudson said that the result would be like mixing apples and oranges, for precisely the reasons that Prof. Patton had pointed out. However, it could be argued that a set of different types of index could be used and compared, reflecting the different aims of the index makers – private real estate investors, developers, government policy makers, the financial sector and its regulators seeking to decide just when the real estate market was becoming overheated. When these indices diverged from one another, it would show how the economy’s shape was being warped or otherwise changed.

Prof. Patton said that one of the key indices would be the yield spread between the price that real estate investors had to pay for credit, and the rate available on Treasury bills or longer-term government bonds. A high yield spread indicated a rising degree of risk, and acted as a corrective to overheating of the real estate sector. The important point, he concluded was the “swap” value of real estate. Investment bankers were always trying to arrange swaps, and the actual values as such were of less and less concern to them.

The discussion concluded that different indices are necessary to show different aspects of the economy. Dr. Hudson’s objective was to show when a land-price bubble forming and to measure its magnitude. Japanese land-value indices enabled one to follow this, but no comparable index existed in the United States. Prof. Harriss was skeptical that a single land-price index could be created, as different types of land were valued differently – farmland, residential land, commercial and industrial land. The land market was heterogeneous, and all that investors knew was the property’s overall market value.

Prof. Patton agreed in taking an overall market-oriented approach. He pointed out that Japan had published detailed land-price indices by category, and that as recently as 1991 it looked like Japan was thinking long-term and the United States short-term when it came to real estate. But now Japan was mired on a long-term problem, while the United States had recovered to go on living in a way that reflected market conditions.

Summary Remarks

The analytic categories that economists use are not symmetrical with the statistical categories that are published, or for that matter with those of everyday speech. Most problematic of all is the concept of rent. To the man in the street and to the real estate investor alike, the word refers either to the gross rental income charged for a property or the net return remaining after meeting current expenses – what financial analysts call cash flow. In the National Income and Product Accounts, “rent” appears on only one line, where it refers to the benefit owner-occupants receive from their own residences, as if they paid rent to themselves. To academics, economic rent is defined as the excess return over and above “profit.” But this latter term also is problematic. It usually is defined after payment of interest charges, but also may be calculated prior to such charges. The upshot is that both for statistical practice and academic theory it is almost impossible to obtain general agreement on what “economic rent” is, in the classical Ricardian sense of the term.

Ricardo linked the analysis of rent to soil productivity. Some lands were more fertile than others, thanks to “the original and indestructible powers of the soil,” including its fertility differentials relative to other soils. Low-cost producers operated under a price umbrella that set food prices at the high-cost margin of cultivation. Their more plots provided an “economic rent” over and above the normal rate of profit earned on manmade capital investment.

A generation after Ricardo the German economist von Thünen refined the idea of the “rent of location.” Some properties were better situated than others, enabling them to charge a rental premium. Whereas von Thünen emphasized the transport-cost differentials enjoyed by good locations, Henry George and Thorstein Veblen applied this principle to urban real estate. Their idea was that properties near the economic center of towns have a premium rental value, which increases as economies grow denser and more prosperous. Economic surpluses have tended to be channeled into real estate ownership ever since antiquity.

For hundreds of years property’s value has been calculated by discounting its flow of rental income at the going rate of interest. The lower the interest rate, the higher the price a given rental stream will justify – or as property owners express it, the more years’ rent the property will bring. But land values are rising today for reasons independent of their earnings stream, above all prospects for future capital gains.

This became a common denominator of the discussion. Dr. Hudson believed that the objective of real estate investors was to obtain capital gains upon resale, but Prof. Patton explained that the aim often was to continue re-financing the property at rising values. This strategy raises equity funds to use as the basis for borrowing more mortgage credit to acquire yet more property. Existing loans are increased as property prices rise. As in Dr. Hudson’s example, the objective is to build up the value of one’s holdings, but this is done in a way that involves debt financing to leverage one’s own equity. In both cases rising property values – that is, capital gains – are used as the basis for further acquisitions.

A common thread of the meeting’s analysis was that real estate operates in different ways from that depicted by the usual academic analysis of investment in manufacturing. The ultimate aim of real estate investors is not so much to seek income – most of which is pledged to their bankers as interest payments on the property they acquire – but for property gains. These gains may come either from selling the property or from borrowing more money against it. But the essential phenomenon is one of growth in asset values. For if this were not the case, the real estate investor might as well simply put his money in the bank and earn interest on it, or in the stock market and earn dividends plus capital gains. Investors are in real estate because of the sector’s unique economic characteristics.

It is hard to follow all this from the profile of real estate one gets from the NIPA and its statistical categories. At issue, for instance, is the source of the capital gains that forms an important part of the total returns (net revenue plus capital gains) that accrue to real estate investors. Also important is the fact that their property may not actually be sold, but may be carried on the books at original cost price (“book value”) that does not reflect current market values.

One reason why it is so important to describe real estate behavior in terms of economic theory is that a rising proportion of the economy’s industrial investors are behaving more like real estate investors than like the textbook models based on manufacturing. Much of the mergers and acquisitions movement and its strategy underlying corporate takeovers has followed the pattern developed by real estate investors over the past half century.

It remains true that economic returns create capital asset values. But these returns in turn often are increased by legal changes in zoning, to the extent that this enables sites to be economically upgraded. In New York City in the 1980s, for instance, the right to use commercial loft spaces for residential purposes had the effect of multiplying asset values five or tenfold. Real estate values increased from three or five years’ purchase to ten or even twenty years as property values were capitalized at much higher rates.

This capital-gains dimension needs to be incorporated into the rental revenue statistics to measure real estate’s total returns. On an economy-wide level this would explain that while ostensible U.S. savings rates have plunged below the zero mark, Americans have been able to build up their bankable asset values and net worth rather than depleting their capital. But these rising asset values do not show up in national income and product statistics.