Why Building Skyscrapers on Expensive Land is Not Always Wise

LEE HAN SHIH
Jan 11, 2009
*Special to asia!
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“Go into land, they stopped making it,” Mark Twain was said to have told a friend who had inherited some money. In San Francisco in the 1860s, there was plenty of unused land. But Twain was not asking his friend to buy just any plot. His advice was to focus on property near the city centre.

The great author knew it was in the nature of humans to congregate. The more a location is popular, the more it is likely to become even more popular, and the higher its price is likely to rise.

Twain’s observation on human nature and land price holds true today, especially when interest rates are low. Low rates reduce the cost of capital and the opportunity cost of land ownership. The lower the rate, the more it stimulates the demand for land, especially that which is already heavily used, such as property in the city centre.

This is the inflexible rule that runs through the property market of all great cities, from New York and London to Mexico City and Rio de Janeiro, from Tokyo and Taipei to Hong Kong and Singapore. It is now also exerting its influence in China’s new metropolises: Beijing, Shanghai, Guangzhou, Shenzhen and others.

As rates fall, prices of land in the central business districts rise. The falling rate also encourages companies to expand, thus creating more demand for space. Putting the two together, this creates a near irresistible temptation for developers to build as high as possible, to spread out the unit cost of land, and to accommodate what they see as rising demand for office space.

There is, of course, yet another reason for pushing the height envelope: ego. Owning a tall building is one thing. Owning the tallest building (of a district, a country or the world) is something altogether different, and infinitely more satisfying, provided the building yields good income and does not become a source of headache and bankruptcy.

In business, most decisions can be rationalised. Developers who go for superlatives often tell themselves it is a good business decision as trophy buildings stand a better chance of attracting good tenants.

This argument stands on very thin ice. Even before 9/11, it has been shown that the marginal increase in rental from a trophy building (against one that is merely tall) is outweighed by the increased cost of construction and maintenance. After 9/11, trophy buildings have become prime targets of terrorist attacks. There is now a trend for multinational companies to either avoid trophy buildings altogether, or to make sure their tenancy in such buildings receives as little publicity as possible.
Yet this does little to deter the building developers. “In normal times, when costs of land, material and construction are predictable, developers use well-tested formulas to estimate the economics of a project,” explains Carol Ann Willis, Director of the Skyscraper Museum in New York City. But in boom times, “the so-called rational basis of land value is disregarded. And the answer to the question “What is the value of land?” becomes “Whatever someone is willing to pay.”

This is a dangerous game to play. Boom time and easy money make for what Alan Greenspan called “irrational exuberance”. When two or more people with high expectations of a piece of land start bidding against each other for it, the price could— and often does—soar way beyond any economic justification. History is full of examples of developers going bust soon after the completion of their trophy buildings. But try telling that to those who are still eager to reach for the sky.

 

lee han shihLee Han Shih is the founder, publisher and editor of asia! Magazine.

 

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