The High Cost of Commercial Land-Use Restrictions

Legal and policy debates about land-use restrictions tend to focus on exclusionary zoning that restricts housing construction. Such restrictions do indeed cause great harm, and also violate constitutional rights. But restrictions on commercial uses of property also have major negative effects. A recent National Bureau of Economic Research  (NBER) study by economists Fil Babalievsky, Kyle Herkenhoff, Lee Ohanian and Edward Prescott attempts to quantify the effect. Here is the abstract:

Commercial real estate accounts for roughly 20% of the U.S. fixed asset stock, and commercial land use is highly regulated. However, little is known about the quantitative impact of these regulations on economic activity or consumer welfare. This paper develops a spatial general equilibrium model of the U.S. economy that includes commercial real estate regulations and congestion effects, the latter of which provide a rationale for such regulations. The model is tailored to exploit the near-universe of CoreLogic’s commercial, parcel-level, property tax records to construct a quantitative index of commercial real estate regulations for nearly every commercial property. We use the model to evaluate the positive and normative impacts of commercial land use deregulations. Moderately relaxing commercial regulations across all U.S. cities yields large allocative efficiency effects, with output gains of about 3 percent to 6 percent and welfare gains of about 3 percent to 9 percent of lifetime consumption. We also find significant positive and normative gains from deregulation with 40 percent of the labor force working remotely.

Ohanian summarizes their findings in a bit more detail here:

The size of a building relative to the value of a parcel of land is influenced by the stringency of the land-use regulations governing the parcel. For example, the skyscrapers in midtown and downtown Manhattan that sit on extremely valuable land indicate that commercial land-use regulations are relatively small and thus allow for building larger structures. On the other hand, the very small buildings that are home to Silicon Valley venture capital firms on the extremely valuable land on Sand Hill Road indicate very stringent land-use regulations, which deny larger buildings.

My coauthors and I use this concept to quantify the stringency of these regulations by collecting tax assessment data from most commercial building parcels in the United States. Our approach requires only two numbers: the assessor’s total valuation of a parcel and the amount of that valuation accounted for by just the structure that sits on the land. On Sand Hill Road, much less of the total value of a commercial parcel is accounted for by the structure, while in midtown Manhattan, much more of the total value is accounted for by the structure.

Given this simple but powerful economic logic, our analysis develops an economic model comprising the more than two hundred metropolitan statistical areas (MSAs) of the United States. The model calculates the regulation stringency at the individual parcel level, aggregates the individual parcels to the MSA level, and then aggregates each of the MSAs to the national level. The analysis finds that the least-regulated MSA is Midland, Texas, known as the “Tall City” for its towering buildings. Los Angeles and San Jose are among the most-regulated MSAs, having smaller commercial buildings that account for less of the total value of commercial parcels than the average of all MSAs. The model accounts for the positive role of land-use regulations that limit the congestion arising from completely unfettered land use in a city. Thus, the model recognizes the potential benefits of some regulations.

The analysis conducts several policy experiments that assess how real US GDP, as well as consumer welfare and developer profits, would be affected if land-use regulations were changed. One experiment analyzes what would happen if all MSAs adopted the relatively low level of land use regulation found in Midland, Texas. With this policy reform, we find that real US GDP would increase by about 3 percent in perpetuity, or about $1 trillion per year. The amount of commercial square footage would increase by around 15 percent under this scenario. Consumers would benefit from this change, as a better allocation of land use would increase their incomes, boost their consumption, and allow them to work less. The results of this experiment indicate that our present land-use regulations are far too stringent.

This model is admittedly imperfect. There are likely factors other than regulatory stringency that account for the relative value of structures compared to that of the land they sit on. For example, in some areas, tall buildings may have little value, even if permitted, because the highest-value use of the land consists of shops or restaurants that can only operate effectively if customers don’t have to ascend to a high floor to reach them. The authors try to control for some of these factors. But I don’t think they fully succeed in this admittedly difficult task.

On the other hand, as the authors recognize, their model only captures restrictions on building size and floor space. It does not fully consider restrictions on types of uses (e.g.—the types of commercial enterprises allowed on the property). In that important respect, they actually underestimate the impact of commercial zoning restrictions. For example, their model does not capture restrictions like the one at issue in the recent Indiana case addressing whether tacos and burritos qualify as “sandwiches” (the answer determines whether a Mexican restaurant qualifies as one of the types of restaurants allowed to operate in the area, under the local zoning code).

Despite the debate it triggered in the media and in legal circles, the Indiana sandwich restriction is relatively trivial in its impact. But it’s the tip of a much larger iceberg of use-based (as opposed to height and floor spaced-based) commercial zoning restrictions, many of which are probably not captured by the NBER model.

Despite its limitations, the NBER study is likely right to conclude that legal restrictions on commercial land uses have large negative effects. Even if the effects are only a quarter or a third of what the authors estimate (about $250 billion or $333 billion per year in lost GDP, as opposed to $1 trillion), it’s still an enormous negative impact. That’s a high cost in lost production, job opportunities, and foregone innovation.

As the authors note, their figures take into account the possibility that many workers can work remotely. And the vast majority of jobs still require workers to be in person at least part of the time. Thus, the remote-work revolution has only modestly reduced the need for people to be able to “move to opportunity” and work in the places where they can be most productive. It’s also worth noting that working class and lower-middle class people are more likely to need to work in person than upper-income professionals. Thus, commercial-use restrictions (like residential zoning restrictions) disproportionately harm the poor and disadvantage.d I discuss the remote work aspect of the issue in more detail in Chapter 3 of my book Free to Move: Foot Voting, Migration, and Political Freedom.

In our forthcoming Texas Law Review article, Josh Braver and I argue that exclusionary zoning rules restricting housing construction violate the Takings Clause of the Fifth Amendment (unless the government pays “just compensation” to the owners, which it rarely does). Restrictions on commercial development are a more complicated case. But under the originalist theories discussed in Part II of the Article, such constraints also violate the “right to use,” which part of the  ” private property” protected by the Takings Clause. The exception is regulations that protect against serious threats to public health or safety, and thereby fall within the “police power” exception to takings liability (see Section II.C of the article). But most commercial-use restrictions cannot be justified on such grounds, certainly not most that restrict height and floor space. Things are likely to be different under the living constitution approaches covered in Part III of the article, which focus more exclusively on housing.

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