Urban versus Suburban

Here’s an article I wrote some time ago. In it, I was trying to understand why someone might pay $171,000 more for an urban townhouse, which was essentially the same as a suburban, much less expensive one, except closer into town. Was it a rational economic choice? Here’s what I concluded… then. Today, in an era of Covid-19, health calculations and work-from-home options might skew this analysis if it is shown that a suburban location is more resistant to a pandemic and work-from-home is as effective (or nearly so) as going into an office. But maybe not.

The City of Ottawa’s policy on densifying the national capital region is working, at least if price differentials are any indication of success: a new 3-bedroom townhome on Centrepointe Drive (located inside the greenbelt in what used to be Nepean) sold recently for around $401,000. A similar new townhome built by the same company in Morgan’s Grant (a western edge suburb in Kanata) sold for about $230,000. That’s a huge $171,000 price gap and the only real difference I can find is that one is closer to the urban core than the other.

It may even be that the suburban townhome is a bit nicer—if having a yard or garden is important to you. The urban town has zero private space. Plus, since it is part of a condo corp and the owner must pay condo fees, the urban town is more expensive on a monthly basis (assuming that the suburban owner values his or her time for lawn maintenance, snow removal, etc at essentially zero.)

So, I wondered why someone would pay $171,000 more for basically the same product. I think there is one simple reason: the urban town is (on an as-the-crow-flies basis) just 7.3 km from downtown while the suburban town is 20.9 km away. Now luckily for this analysis, the two towns were bought by colleagues of mine and they both work at the same place—the urban townhome is located about 6 minutes from their office while the suburban town is about 20 to 25 minutes away. So, we have a real-world, paired sample—rare in urban economics and urban design—and the comparative analysis is easy to do with no adjustments required for family size, time, design or location and, thus, highly accurate.

The colleague and his family who live closer save about 500 minutes per week in commuting time compared to the other family living further out. They also save petrol—about 53 litres per month. If we value their time at $45 per hour and gas at 90 cents per litre then the family on Centrepointe Drive is saving (time and gas) worth $16,185 per annum. On the extra investment of $171,000 (the increased price of the urban town), this represents a ROI of (a not-bad) 9.5% p.a. Most of this ROI derives from time savings—gas savings make up just 3.5% of the total.

While the builder’s costs are somewhat higher for the urban towns (because of higher land and construction costs), they aren’t that much higher—in part, because the closer-in development is being built at a higher density. In other words, the developer is getting a higher yield of towns on their land on Centrepointe Drive which offsets some of their higher costs. So, most of the price differential they are getting for their urban towns is probably going to their bottom line. This is good for the developer but is it good for the urban organism that is called Ottawa?

I would argue that higher land prices in the urban core is the right signal to send to the marketplace—it supports the goal of higher density since developers will act rationally to increase their yield on more expensive land.

From the homeowner’s point of view, they are clearly prepared to pay more for the benefit of saving time and gas—there are lineups to buy these urban towns. But they too are acting rationally. And both are serving the greater good by looking out for their own best interests, faithfully following Adam Smith’s principal of the invisible hand.

When people are prepared to pay this much more for an urban town, a virtuous circle results—developers act in a way that will result in an increase in the supply of the more urban and higher density towns because they command a premium price. There are certainly a lot of teardowns going on inside the Greenbelt in Ottawa where small-scale builders are buying existing single-family homes on larger lots and replacing them with doubles.

But what the City of Ottawa might also want to recognize is that there is still a market for suburban property where people trade longer commutes for lower prices and more space and that isn’t wrong either. The City just needs to get their price signals right and the market will respond…

Prof Bruce

ps. I posted the spreadsheet I used in .xls format at: https://www.dropbox.com/s/ytd77giah4x3rsr/TownhomeAorB.xls?dl=0 where you can download it and fool around with it yourself.

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