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Wednesday, November 14, 2012

Why Favelas Exist

Favelas are generated when rapid urbanization causes population to outstrips the existing housing supply. The rapid growth in population drives up the value of housing. In a normal market, that triggers the development of additional housing until the two equalize. But  the essential input of housing is urban land. As the value of housing is rising, so is the value of urban land. Because of the durability of buildings, urban land can be developed only once per generation, so it makes sense to wait to develop until the value increase in urban land has stopped/slowed. While the present  value of urban land is high, the expect value of urban land in the future is higher still. As a result, rather than developing a property to its present ‘highest and best use’, landowners instead hold out for the future, when the highest and best user will be even more profitable.

With low land taxes, the cost of ‘holding out’ and waiting until a later time to develop is actually very low. 
Because the majority of the value of a land is actually  in its future value, the present value of land is largely irrelevant (especially in the context of high inflation), so interim uses are irrelevant—squatters and slums do not matter, insofar as they cannot claim legal title to the land, and can  be removed/cleared when the time is appropriate to develop the parcel.