ECONOMIC FACTORS RELEVANT FOR COMPETITIVENES IN THE LAND

MARKET

Rbert Magda Phd
Kroly Rbert College, Gyngys, Hungary

Abstract
This paper seeks to provide an overview of those economic and other issues which could be
relevant for land prices and tries to show what is behind them. In that case I think the
inflation, the real interest rate, the population, the GDP, the GDP growth rate could be
important. These factors were determinant in the past and I m sure that they will be important
in the future too, when we talk about the prices of the land.

Key words: land prices, inflation, VMP of land

Introduction
Before Hungary initiated the transition to market oriented economies, most of the land was
used by large collective units, which had the right to use the land, but were not necessarily the
landowners. This situation provided a special starting point for the return to the market
economy in the agricultural sector. In Hungary decided to implement restitution of land
ownership rights to former owners based on historical boundaries as a method to privatize and
open the land market. However, each eastern countries Hungary also - based on their
specific needs selected an implementation procedure for the desired land reform (Swinnen,
1995).

Material studied, area descriptions, methods, techniques
Land prices are needed to determine the optimal allocation of land resources among different
uses, as well as to determine the value of land as collateral for credit or to define land taxes.
On one hand the land prices will be capturing all the factors affecting the performance of land
markets, and the other hand the land market prices will not necessarily reflect the value of
land. Land prices are the result of the interaction of various factors in the land markets.
The land as an economic resource is mostly utilised by agriculture. The land utilisation occurs
in a competitive environment (market competition) and economic factors are primary for all
farmers. However it should not be forgotten that land is a natural resource at the same time.
No matter who the owner of a given piece of land is land constitutes part of the national
wealth and it must be used in an optimal way. The regulation of the land use activities is the
task of the government (e.g. environmental protection).

Results and discussion
The problem of how to define, determine and assign a price, or a value of the land, which is
an important issue in the economic literature. Land could be seen as an asset, but also as
production factor that serves production and consumption purposes. Land assets have three
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important characteristics: scarcity (land exists only in fixed amounts and cannot be created
easily), immobile, and durable (it cannot be destroyed easily). These characteristics make land
an attractive asset as productive factor, as collateral for credit and as store of wealth.
Present value (PV) and the land prices
In the economic literature on land prices agrees that the price of land can be obtained based on
the estimation of the present value of the stream of all future net returns to land, as in the case
of any other asset. However, this does not necessarily mean that the market price of land will
always equal the PV of the future rents because there could be different factors affecting the
market price of land, that do not affect the present value measure.
Land prices, which are primarily a function of net returns to land, are affected by a number of
variables defined by the socio-economic, legal and political environment where these prices
are formed. These variables affect the price of land through different means and their
importance as price shifters varies according to the way in which land is being considered
(only as productive factor, or as an asset , or both). When land resources are being used as a
productive factor and as an asset, the relative importance of the different sources of value (net
income and capital gains) will depend on variables not related to land directly, such as
inflation and expectations.
In the following part of my paper I focus on to discuss the expected effects of different
variables that affect net rents and the capital gains components of land prices. I will discuss
the variables that affect the component of land net rents, as well as the ones affecting the
capital gains component.
Land net rents are determined in the land market by the adjustments of supply and demand.
Supply and demand for agricultural land jointly determine the price at which land will be
allocated, that is the land rent. To simplify, lets assume for a moment that there are no costs of
owning land (property taxes, depreciation), then the land rent determined in the market will be
the net return to land.
If there is a fixed supply of land for agricultural production, rents are determined by the
demand for land for agricultural activities. The demand for land is determined based on the
value of the marginal product of land (VMP) that is the value of the production that can be
attributed to land (implicit land rent). The VMP is the result of the production conditions
(technology, input prices, capital level, and other production factors use) that can be seen as
the production function of certain output, and the output market prices.
Land rents will change if demand for land changes. The main reasons for changes in land
demand, considering land only as productive factor only for agricultural purposes, arise from
changes in the determinants of the VMP, such as changes in relative prices (output/inputs),
access to capital, technological improvements better machines and technologies - and in
production conditions. Of these changes only the ones related to technology can be
endogenous, the others are exogenous. If land supply changes (with constant demand for
land) rents will change as well.
Production infrastructure has also a positive effect on land rents, and therefore on land prices.
Similarly, better production conditions, such as irrigation systems or water availability are
reflected in higher land prices. In Hungary it means minimum 40% in the land prices and also
in the rental prices.
Marketing conditions, that determine the transaction costs of delivering output to the markets
(and/or inputs from the market) have also an important impact on land prices, and usually
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account for an important portion of land price differences among regions that produce the
same type of output.
In regional or local markets the main difference among producers is given by the distance
between the market and the plot of land, then among land plots with the same characteristics,
the more valuable land is the one located in the better position with respect to the market.
Fixed land zone laws have an impact on land prices. If land can only be used for agricultural
production then the rate of return of alternative uses of land becomes not important in the land
price determination. With fixed agricultural zoning regulations, the shadow price of land is
based only in the agricultural use of land (the VMP). This situation allows inefficient land
allocation, because land will be used for agricultural production also if there are more
attractive return opportunities derived from using land in other activities (urbanization,
mining activities, tourism).
The degree of land fragmentation could be affecting land prices. Once land is divided in small
units the cost for a buyer of obtaining an efficient size plot are higher than if the plot is not
divided and the buyer could choose the size of land he/she wants to buy. In the case of
agricultural land the degree in which fragmentation will affect land prices depends on the size
of an efficient agricultural exploitation, meaning that if land plots are above the efficient
(scale-efficient) size, land could have higher price respect to similar subdivided land.
Given that land is not mobile, and land supply tends to be fixed at local level, the local
demographic conditions have a direct effect on land prices through land demand. Population
growth and demographic variables could have an important effect on land prices at least
through two different channels, first through the demand of agricultural products (food and
fiber), and second, through demanding space (e.g. urbanization pressure).
Inflation has an important effect on land prices and one of the more controversial topics in the
economic literature on land prices. In the first place, when there is inflation and full
indexation (all prices grow at the same rate) then real output prices remain constant and so do
real land rents. Obviously, inflation is never homogeneous and there is not perfect indexation,
so one first effect of inflation on land prices arises upon the relative effect of inflation on
agricultural real output and input prices. During inflationary periods there is also a tendency
to observe growing nominal prices of assets as the money supply increases (Reinsel and
Reinsel, 1979).
The second, effect, and probably the most important one, arises from the use of land as store
of wealth. Real assets with fixed supply tend to hold its real value during inflationary periods,
and in that sense there is an inflation hedging motive for land purchases.(Castle and Hoch,
1982; Lloyd, 1994). One argument supporting the inflation hedging motive to buy land comes
from the assumption of the availability of credit to purchase land. Under inflation, the real
credit payments tend to decline over time, while the value of land remains constant or
increases. In absence of credit programs to buy land, land purchases still an attractive
investment opportunity as an inflationary-risk-free saving instrument. However, this type of
investments (buying land) involves high searching and management costs that act like a
disincentive to land purchases (Lloyd, 1994).
The attractiveness of land in inflationary environments is strongly related to the effect of
inflation on real interest rates. If real interest rates are negative, then interest-bearing assets
are no attractive, so investors search for other assets like housing and farmland (Daouli and
Demoussis, 1992).
Three other sources of price changes that need to be mentioned, although there are not explicit
studies about the effect of these variables on land prices reported in the literature reviewed.
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These variables are: the liquidity constraints; the transactions cost in the land markets and the
socio-economical and political environment where the land market is operating.
Liquidity constraints are important because of the direct effect in the opportunity cost of
money. In the case of long term investments, like most agricultural business, liquidity
constraints are usually the binding constraint. If there is no financial system, land can only be
purchased if one has enough cash to buy land, which will make demand for land small and
scarce, but land under leasing arrangements will have a large demand. If there is a financial
system the demand for land could increase proportionally to the access to financial tools (it is
usual to find that financial systems operate under credit rationing). If everyone can access a
loan to buy land, buy using the purchased land as collateral, land prices will tend to raise
(Shalit and Schmitz, 1982).
The transaction costs in the land market are the aggregation of a number of costs: legal
paperwork, searching cost, valuation of the asset, management costs, bargaining, etc. The
higher the transaction costs in the land market, the lower the incentives to do land
transactions. This disincentive to do land transactions has two important effects, it does not
allow land allocation to its best economic use and it reduces the demand for land as an asset
because it becomes costly to obtain the benefits derived from owning the asset. This last
situation is highly relevant for the use of land as collateral for credit. Banks are not interested
in land as collateral if they cannot easily sell the land and obtain money in a short term at a
low cost. Searching costs are relevant in the case of land because land is not mobile so there is
no physical market place for land transactions, and in that sense information systems play a
central role in reducing this costs.
Finally, but not least important, the socio economical and political environment where land
transactions are taking place is crucial. If there are no attractive and safe investment
opportunities, for example, land prices will tend to increase because of the higher returns and
security offered by this asset. If the legal system is highly complex or unstable, if there is no
security on land tenancy, if there is an unstable political environment no long term
investments will be done, and that will affect land prices. If there are land ownership risk,
prices will be affected negatively (Feder and Feeny, 1993). Every economic, social and
political context will offer distinctive features affecting land prices, all of them need to be
taken into account when analyzing land market performance.

Conclusion
In the beginning of the 1990-es in Hungary we could not speak about land market because the
state or state agencies own a significant portion of the agricultural land. The use (and transfer
systems) of these state lands, the regulations, and the land reform strategy followed by our
country defines the way in which land should become a private and tradable good, and who
(and how) can access it. As in the case of any other good in a market oriented economy, the
mechanism to access land (to buy or rent) is through the market land prices.
Government define a set of land prices based on land productivity. Some additional land
characteristics, such as location or irrigation, are incorporated in these prices. In Hungary land
price movements above the administrative prices set by the government are allowed, based on
market signals. However, there is no complete market determination of land prices. Land
markets are more active in regions with better agricultural opportunities, with larger presence
of private producers, or in the areas surrounding big cities.
In Hungary, governmental set land prices reflect the value of land considering only the value
of land as an agricultural productive factor. The qualities of land as an asset are not being
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included in these price measures. However, in regions where the land market is relatively
active, because of good location or attractive agricultural activity (Western region of the
country) market land prices tend to incorporate also the value of land as an asset.
To improve the performance of these administrative land prices towards a better land
allocation, at least two things should be considered: first, that this is a measure of the
minimum price for land (reservation price), and is based only on agricultural use of land; and,
second, that accuracy on land characteristics and the addition of specific market conditions
(location, distance to nearest market, relative prices, marketing costs) could provide a more
sensitive measure of land prices.
One important issue observed in Hungary is that if governments are interested in supporting
collective production units, reformed and private, and/or there are a number of regulations
that affect land transactions (zoning, not convertible shares, long leases to collective units,
high exit costs, etc.), administratively set land prices will not reflect the value at which land
could be traded in the market.
Probably, land transactions (buying and selling) will be relevant in regions with high levels of
decollectivization, while in regions with low decollectivization levels land leases will be more
important. Similarly, the degree of land fragmentation will affect the future transactions with
land. Regions with more land fragmentation will require more land transactions to reach an
agricultural structure based on economical efficient farms (scale-efficient).
When land markets are not well developed, landowners face high levels of uncertainty about
the future economic opportunities, and land transactions are costly in economic, social and
political terms, land prices tend to depend only on agricultural land rents. On the contrary, if
expectations about future conditions are positive, land will become an asset and a productive
factor, so land prices will be higher. In this situation, and based on the land owner's time
preference, leasing arrangements would be preferred to selling and buying activities, because
owners will have incentives to keep their land as an asset.
Finally, in Hungary due to the transition process there are high transaction costs to undertake
land transactions, reducing the economic attractiveness of these transactions. Transaction
costs are augmented by unstable economic environments (inflation, variable interest rates)
that affect the recognition and value of land as an asset. In the same sense, social, cultural and
political factors that define additional values for land are present in most of these countries
making it even more difficult to measure and define accurately land prices.
The issues discussed here reveal that land prices have an important role not only in the land
allocation, but also in the improvements on land use efficiency, on the distribution of assets
among the population (equity) and on the land reform performance itself.

References
1. Castle, E. and I. Hoch (1982) "Farm Real Estate Price Components, 1920-78"
American J ournal of Agricultural Economics 64, pp. 8-18.
2. Daouli, J. and M. Demoussis (1992) "Rents, Interest Rates and Real Agricultural
Land Prices: An Application to a Greek Province" European Review of Agricultural
Economics 19 (4), pp. 417-425.
3. Feder, G. and D. Feeny (1993) "The Theory of Land Tenure and Property Rights" in:
The Economics of Rural Organization, Hoff et al., (eds.) pp. 240-258.
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4. Lloyd, T. (1994) "Testing a Present Value Model of Agricultural Land Values"
Oxford Bulletin of Economics and Statistics 56 (2), pp. 209-223.
5. Reinsel, R. and E. Reinsel (1979) "The Economics of Asset Values and Current
Income in Farming" American J ournal of Agricultural Economics 61, pp. 1093-1097.
6. Shalit H. and A. Schmitz (1982) "Farmland Accumulation and Prices" American
J ournal of Agricultural Economics 64, pp. 710-719.
7. Swinnen, J. (1995) "The choice of Privatization and Decollectivization Policies in
Central and East European Agriculture" (ms)



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