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The Economics Behind Measure 37 EM 8925 February 2007 W.K. Jaeger and A.J Plantinga Do you want to print a copy? We recommend downloading the print version (280 KB). First download the free Adobe Reader, if you don't already have it. Contents Two approaches to Measure 37 claims How might land use regulations affect the market value of land? What might happen if a single property were exempt from regulations? Why are standard appraisal methods inadequate for evaluating Measure 37 claims? What other factors need to be considered? The Portland Example The Tax Exemption Example The OPEC Example Conclusion Oregon’s Measure 37 asks whether a land use regulation has caused a reduction in value for a parcel of land. Different people interpret “reduction in value” in very different ways, and these differences are central to the controversies surrounding Measure 37. Measure 37 states: “If a public entity enacts or enforces a … land use regulation … that has the effect of reducing the fair market value of the property, or any interest therein, then the owner of the property shall be paid just compensation.” Alternatively, a waiver to the land use regulation may be granted. Measure 37 suggests a “before-and-after” or “with-and-without” comparison. Following enactment or enforcement of a land use regulation, was the market value of a piece of land reduced? If so, was the reduction caused by the land use regulation? A crucial point to remember is that “enactment or enforcement of a land use regulation” involves many parcels of land, not just the one making a Measure 37 claim. top Two approaches to Measure 37 claims Two very different approaches have been taken to evaluate whether compensation is due under Measure 37. One approach applies the “before-and-after” or “with-and-without” concept to all relevant properties; the other asks what would happen if a single property were granted a waiver to a regulation. The first approach has been used by Portland’s Metro Council. In evaluating Measure 37 claims, they ask whether the market value “after” is lower than the market value “before” (after adjusting for inflation). Using this approach, the Metro Council has evaluated seven Measure 37 claims to date, and in each case has found that the “after” value was at least as high as the “before” value. They thus concluded there was no evidence of a reduction in value and denied the claims.1 The second approach, which has been used by other local governments, asks, “If the land use regulation were removed from this one property, would its value increase?” This may seem like a similar question to the “with-and-without” question, but it is not. This approach involves a “single exemption” to the land use regulation, not removal of the regulation from all affected properties. It doesn’t consider what would have been different if the land use regulation had never existed. This “single exemption” approach nearly always leads to the conclusion that there has been a reduction in property value, even when the value of the property increased following introduction of the land use regulation. In fact, in cases where land use regulations have actually caused property values to rise, this approach is likely to indicate that a waiver would increase the value of the property even more. How can these two approaches lead to such different results? The with-and-without approach takes account of market effects. It recognizes that land use regulations can affect land markets directly and indirectly by shifting supply, demand, and prices. The single exemption approach assumes market changes would have happened anyway. It assumes that everything would be the same today even if land use regulations had not been introduced in the past. The single exemption approach looks only at the claimants’ opportunities for increased land values if they alone were granted a waiver to the land use regulation. This approach often identifies potentially lucrative opportunities, but in many cases these opportunities were created by the land use regulations’ effects on land markets. top How might land use regulations affect the market value of land? Land use regulations shift supply, demand, and prices for lands being put to different uses. First, there are changes in supply. Suppose a regulation prevents some lands from being put to use “A.” By restricting the supply of A-eligible land, the regulation may raise the price of the remaining A-eligible land. If the regulation later is removed, and the supply of A-eligible land is unlimited, the price of A-eligible land will fall and might be no higher than that of currently restricted lands. Thus, while the regulation “temporarily” raised the value of A-eligible lands, it may not have reduced the value of restricted lands. The Portland Example shows how misleading the “single exemption” approach can be if we interpret it as if it reflected the “with-and-without” approach. Second, when regulations limit development, they may preserve scenic values, open space, groundwater resources, and other amenities that would be valuable attributes for the first parcels of land developed (in the midst of lands that are restricted from development). Once again, this added value is due to the regulation that prevents other landowners from developing their land, or from using their land in ways that would detract from existing amenities, such as junk yards, gravel pits, or incinerators. (Consider “the Tax Exemption Example”.) Finally, one of the effects of Oregon’s land use laws is that it forces development of “compact” communities rather than sprawling ones. Sprawl leads to increased costs for public services, specifically roads, sewer and water lines, etc. Thus, land use regulations can increase the value of all properties by lowering the cost of public services. top What might happen if a single property were exempt from regulations? We have seen that market changes caused by land use regulations have, in some cases, created the opportunities that claimants now want to enjoy. An individual waiver is like a monopoly on those opportunities. A waiver may be valuable, but its value may be due to the fact that other landowners are denied the same exemption. If a regulation has increased the value of developable land, granting only Landowner “X” an exemption will allow him to benefit from the higher value created by the land use regulation. This outcome is quite different from what would happen if all landowners were granted waivers (or if the regulation didn’t exist). If the regulation were removed for all landowners, and land prices fell, Landowner X might no longer see opportunities to develop his parcel at the higher price. This is analogous to “the OPEC Example”. top Why are standard appraisal methods inadequate for evaluating Measure 37 claims? Standard appraisal methods estimate only what one individual property would be worth if that property alone had a land use regulation waived. They do not consider how adding land use regulations might raise prices on lands, nor do they consider how removing regulations might lower land prices. Thus, they ignore the effects that land use regulations have on land markets. top What other factors need to be considered? Other government actions (for example, services such as police and fire protection, schools, and investments in roads, sewers, parks, or other infrastructure) can increase potential land values. If these public actions occur after a land use regulation goes into effect, they may increase the “potential value” of a parcel (if it could be developed). However, this “increase in potential value” caused by unrelated public actions is quite different from a “reduction in value” caused by a land use regulation. The “single exemption” approach also creates its own “backlash” fairness issue. For example, if all of the Measure 37 waivers surrounding Portland were granted, how would that affect the value of other lands, such as the vacant lands inside the UGB (see the Portland Example)? Landowners who paid a premium for lands inside the UGB would see that value diminish if many waivers were granted to landowners outside the UGB. top Conclusion Some kinds of land use regulations may reduce the value of some parcels of land. However, in order to evaluate the Measure 37 question about “reduction in value” in a credible, accurate, and fair way, we must use something other than standard appraisal methods. These methods rely on a “single exemption” approach and sometimes lead to the conclusion that a Measure 37 claim is valid when, in fact, no reduction in property value has occurred. Since Measure 37 is intended to measure the effect of land use regulations (when enacted or enforced on all subject properties), a “before-and-after” or “with-and-without” approach is more appropriate.2 top The Portland Example Does the Single Exemption Approach Make Sense? The Measure 37 claims surrounding Portland’s urban growth boundary (UGB) as of November 2006 are shown in dark red-orange on the map below. Nearly all of these claims are based on development potential, with average land values estimated at $40,000/acre if the land could be developed (the average price in the claims). Do these estimates reflect “reductions in value” caused by the land use regulations? If we assume they do, we must conclude that in the absence of land use regulations surrounding Portland, the entire area within which Measure 37 claims have been filed (shaded in light red-orange) would have been bought by developers at $40,000/acre and developed. In this scenario realistic? It would result in 650,000 acres of developed land being added to the Portland area, making the developed area 3.6 times its current size. The value of the newly developed land would rise by $26 billion. Note, however, that there are about 28,000 acres of vacant land inside Portland’s UGB. With 28,000 acres vacant inside the UGB, is it likely that there is $26 billion worth of pent-up demand for 650,000 acres of developable land outside the UGB? No, it is not. Why not? Because this scenario is based on interpreting a “single exemption” approach as if it had estimated the correct “with-and-without” values. Obviously, a scenario suggesting a city 3.6 times its current size and a huge jump in total land value is unrealistic, but the way most Measure 37 claims are being evaluated implies believing this scenario to be true. By contrast, a valid “with-and-without” approach would recognize that eliminating land use regulations would increase supply and lower prices, and that only a fraction of the newly eligible lands would be developed. Figure 1. Portland-area Measure 37 claims, urban growth boundaries, and vacant UGB lands. Source: Measure 37 claims data are from Portland State University’s Measure 37 Database Project (as of November 2006). top The Tax Exemption Example When Regulations Add Value Suppose a landowner claimed that the requirement to pay property taxes was like a land use regulation. An appraiser could estimate the value of the landowner’s property, assuming that he alone were exempt from paying property taxes. Undoubtedly, the value of the property would increase by an amount equal to the avoided current and future taxes. Viewed narrowly, this suggests that the requirement to pay property taxes reduced the property’s value. Of course, property taxes make possible government services and infrastructure that raise and maintain high property values. Without police or fire protection, public schools, or road maintenance, property values would plummet. Thus, the requirement to pay property taxes actually increases property values because it affects the property’s “amenities,” which in turn affect demand and market price positively. In this example, using standard appraisal methods to evaluate a “reduction in value” would clearly miss the connection between the regulation (property tax payments) and the amenities (public services) that raise property values. top The OPEC Example When One Party Seeks a Waiver Member countries of OPEC (the Organization of Petroleum Exporting Countries) agree to restrict their oil exports. These quotas (a kind of regulation) drive up the world price of oil, which in turn increases per-barrel oil profits. OPEC member Country “A” might claim, however, that these quotas reduce its profits. After all, if Country A alone could export more oil at the current high price, it could earn even more profits. In fact, however, if the quotas were removed for all countries (or if they had never existed), oil prices would fall and the additional profits would not exist. Thus, the quotas have increased, not reduced, Country A’s profits. 1In some cases, the value of a property might increase in the presence of a land use regulation, but it might have increased even more in the absence of the regulation. To make this determination, one would need to analyze the various positive and negative factors that affected market-wide changes in supply, demand, and price. 2An alternative method for measuring reductions in value caused by land use regulations is proposed in: A. Plantinga, “Measuring Compensation Under Measure 37: An Economist’s Perspective,” December 2004 (http://arec.oregonstate.edu/faculty2/measure37.pdf). A detailed discussion of the concepts presented here is found in: W. Jaeger, “The Effects of Land Use Regulations on Property Values,” Environmental Law, Vol. 26, Spring 2006 (http://www.lclark.edu/org/envtl/objects/36-1_jaeger.pdf). Prepared by William K. Jaeger, associate professor of agricultural and resource economics and Extension policy specialist, and Andrew J. Plantinga, associate professor of agricultural and resource economics, both of Oregon State University. Published February 2007.

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