This blog is the thirteenth in our series on the key concepts to consider when thinking about local economic growth policies. We’re using the series to test-drive a way of explaining concepts in economic growth that we hope to use in new training and resources. We are keen to hear from readers, particularly those in local and central government, about whether they find these useful and accessible, and if there are other topics you would like to see us cover.
What is capitalisation?
Capitalisation happens when the local benefits of a project drive up the price of land or other capital assets.
For example, regeneration projects often improve housing quality or develop community assets. The aim is usually to improve wellbeing of local residents and sometimes to deliver local growth. However, the amenity benefits from regeneration (e.g., better housing, a safer place), make regenerated areas nicer places to live. If this results in more people wanting to live in the neighbourhood, this will tend to increase property prices. This is an example of capitalisation – the regeneration benefits get capitalised in to house prices.
Changes in local public services and taxes, or anything that improves a neighbourhood can produce capitalisation. For example, high street improvements may be capitalised in to commercial rents.
Why do we need to think about capitalisation?
Many place-based interventions aim to improve people’s lives – for instance through providing a new park, easier access to jobs and schools, or a more attractive neighbourhood. It’s rare that government sets out to increase property values, but this is often an unintended consequence of many interventions. If the benefits arising from an intervention are capitalised in to residential or commercial property prices, the outcomes of the intervention may be different to the ones expected.
For example, a regeneration project in a deprived area may aim to increase safety, pride or quality of life for their current residents. However, if property values increase, leading to higher rents, the current residents may be displaced by new residents with higher incomes, which defeats the purpose.
The same may occur from a high street regeneration project. Some benefits of a nicer, safer or more accessible high street may be felt by the small businesses based on the high street through increased footfall and turnover. However, over time commercial rents may go up in this nicer area (due to capitalisation), and existing businesses may lose out due to these increased costs. The benefits of the programme have been ‘capitalised’ in to rents – benefiting landlords rather than businesses.
Private actions may also be capitalised into prices. This is one reason why homeowners tend to spend more on maintaining and renovating their properties. And sometimes these private actions may be capitalised into assets not owned by the individual. Well maintained properties tend to generate positive price effects for nearby houses (and vice-versa when a property becomes run down). These capitalisation effects, and the presence of externalities, may justify government intervention – e.g. to improve derelict lots.
Considering capitalisation will lead to a clearer assessment of who ultimately benefits from a policy intervention.
What to consider when thinking about capitalisation?
When property prices change, there are winners and losers. Property owners and landlords will likely benefit from the increase in the property market price, while tenants and buyers may face higher rents and mortgages. A key question we want to ask around implementing any policy intervention is “who will benefit from this?”.
In the case of regeneration programmes, looking at what happens to market rental values will give a feeling for how capitalisation is occurring. Tracking data on neighbourhood composition can help assess whether this is affecting residents. Similar strategies can be used for keeping track of the effects on businesses.
We may also want to consider mitigating measures to reduce the negative effects of capitalisation on the ‘losers’. One way to reduce capitalisation is to provide more of the good whose price is rising. In particular, responsive residential or commercial property supply will reduce capitalisation.
How can I learn more?
Evidence of capitalisation of central government grants into local house prices in England is presented here.
A synthesis of the economic implications of house price capitalisation– is presented here.
This is the last blog in our understanding key concepts in local economic growth series. If there are other topics you would like to see us covered, please contact us.
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