Land Leverage Dynamics In Housing Markets

This paper develops an empirical test of the land leverage hypothesis applied to the Perth (Western Australia) housing market over the period 1988-2009. Land leverage reflects the proportion of the total property value embodied in the value of the land (as distinct from improvements), as a significant factor for establishing the future path of house prices. It follows that the value of land and value of improvements on that land are likely to evolve differently over time. Since total property price change is a weighted average of change in both land value and improvements, properties that vary in terms of how value is distributed between land and improvements will show different price changes over time. The land leverage hypothesis suggests that the magnitude of price responses should be positively correlated to the level of land leverage. The hypothesis is empirically tested using data on individual housing transactions in Perth Western Australia. Vacant lots subsequently selling as improved properties are identified and analysed in order to measure the influence of land leverage over a sample period 1988-2009. The results confirm a significant relationship between the extent of land leverage and house price changes over time together with some significant temporal influences corresponding with variations in housing market conditions throughout the sample period.