This week we have looked at incremental development and how continual redevelopment – neighborhoods growing incrementally on a continuum of improvement – is essential to building wealth and making our communities financially strong. We’ve examined the Improvement Value to Land Value Ratio (I/L Ratio) as an indicator of redevelopment potential. And we’ve noted that, when neighborhoods are not incrementally growing and reinventing themselves – when they aren’t building wealth – there are only two other options: stagnation and decline. This is the outcome of all properties in the Suburban Experiment.

There are many of you who live in stagnating areas who have remarked about how insightful this conversation has been, how it explains a lot of what you experience, particularly why more growth doesn’t solve anything because it doesn’t do anything to address the decline of existing housing stock. There are others in the audience – people who have largely self-identified as being from one of the coasts – who have reacted quite differently.

Chuck, old neighborhoods here are really expensive, not falling in value as you suggest. My experience is that prices just keep going up everywhere. Sure, we don’t allow incremental growth and we don’t see much redevelopment, but I don’t get why that’s important when property is already so expensive.

It’s important to understand that declining neighborhoods can still be expensive. It’s also important to understand that rising prices often don’t reflect rising value, especially in markets as manipulated as ours. And finally, it’s important to understand that Ponzi scheme economics – where we are really good at experiencing the illusion of wealth but not so good at actually accumulating wealth – can make things look better than they are, at least for a while.

Let me provide a concrete example (and there are more to come) of how the I/L ratio reveals decline and stagnation even in places where we’ve been able to macro-engineer our way to an illusion of wealth, at least for now. As usual, I’ll start with neighborhoods I know best here where I live in Central Minnesota.

The first neighborhood, Cherrywood, is one I worked on towards the end of my engineering days. These houses were developed during the bubble years 2001 to 2008. The homes are new, spacious and have all the modern luxuries a sophisticated homeowner would look for. The median property in this neighborhood is currently assessed at $251,000. You could expect it to sell for around $315,000.

The second neighborhood, Wedgewood, is one my wife and I looked at buying into back when we got married two decades ago. We opted not to because the houses were just too expensive for us starting out. These homes were mostly developed before and during the bubble between the years 1994 and 2000. At the time they were built, the homes were new, spacious and had all the modern luxuries a sophisticated homeowner would look for. The median property in this neighborhood is currently assessed at $236,000. You could expect it to sell for around $295,000.

The third neighborhood, Southdale, is one I grew up playing in. As a young boy, all my friends were from this neighborhood. The homes here were developed during the 1970’s and early 1980’s. At the time they were built, the homes were new, spacious and had all the modern luxuries a sophisticated homeowner would look for. The median property in this neighborhood is currently assessed at $159,000. You could expect it to sell for around $198,000.

Three neighborhoods of different age. The newer the neighborhood, the more the property is worth in total. It’s important to understand that, when these properties were built, the I/L ratio for all of them was around 9:1. Those basic relationships don’t change because most rational people are not going to buy a cheap lot and put something really expensive on it nor will they buy an expensive lot and put something really cheap on it. Whatever the lot is worth, it’s going to be about 10% of the finished construction cost because that is what it takes to develop a property. Thus an improvement value to land value ratio of 9:1.

Here are the median I/L ratios of these three neighborhoods:

The two newer neighborhoods are already experiencing decline. This is simply because things age. That is natural and normal. The siding is older, the carpet is older, the shingles are older, the appliances are older, etc... Their I/L ratios are well below 9 but are still in the stable zone. If these were pre-Depression neighborhoods, we would not expect to see a lot of redevelopment of these properties. They just aren’t ready.

The neighborhood that is 45 years old, however, is a different case. The median I/L is below the redevelopment threshold of 3; it’s just 2.7. We would expect there to be some redevelopment pressure here – people purchasing these homes with an eye towards intensifying them, perhaps from a single family to a duplex – because, in relation to the improvements on them, the land value is relatively high. But there is no redevelopment pressure. Zero. The very notion of redevelopment would be laughed at by everyone, yet there is a clear economic case that the improvements on these properties far underperform the value of the land they occupy.

The answer lies in the value of the land. Look closer at the land values. They are essentially the same, regardless of age. A platted lot of similar acreage with sewer, water and a street is worth the same pretty much everywhere in this community.

Cherrywood: $39,600

Wedgewood: $41,600

Southdale: $42,900

So, relative to other properties in the city, while the improvements in Southdale have declined, the land value has not appreciated. And it’s not going to appreciate. There’s no improvement here that can be anticipated in this neighborhood. There is no new amenity or increased quality of life anticipated there. There are no new homes going to come in that would create an upward trend. All the lots are built and this neighborhood is complete. There is nothing more. Ever. It's done.

Sure, city leaders are proud that there is going to be a PetSmart and a Panera Bread opening soon a couple miles away along the highway strip, and they have made some investments to make sure there are nice parks that people can drive to, but those amenities, to the extent they make the land in this city more valuable, make all of it equally more valuable. There is no competitive advantage to being in Southdale. The transportation investments have flattened and stagnated land values, a key post War strategy.

And thus, while the improvements decline, land values don’t appreciate. Therefore, nothing (short of heroic government intervention) is going to prompt redevelopment. And if it did, the zoning code now wouldn’t allow it anyway. The neighborhood can stagnate for a while, but it will eventually decline because that is the only remaining option. Just like every other neighborhood in the city. And just like pretty much every neighborhood in America of the Suburban Experiment.

We’ve created what we at Strong Towns call a bad party. Tomorrow I’m going to revisit the party analogy.