Establishing Infrastructure Beyond Access

Published on

September 20, 2020

The amazing American land rush required access to the vast offerings across the contiguous United States, and the railroads combined with public policy incentives created this access. By such, the seeds of the real estate development industry were sowed, but the crop was far from ripe.

Access put strangers together in new places with few rules of engagement. Developers sold property to strangers through unfamiliar and poorly defined business arrangements. Strangers came with wide-ranging expectations fueled by the excitement of “my property” and not much experience with “your property.” The fledgling industry scrambled to solidify its foundation while public entities pondered new roles. The first half of the 20th century was a busy time for real estate development.

Deed Restrictions: Value Protection or Infringement?

The railroads are remembered primarily for connecting both ends of the contiguous United States without enough investigation into the short connections critical to early land development. Short tracks easily connected the land on the outskirts to city centers, and those who could afford to move out of dirty, congested (at the time) downtown areas of commerce obliged the new suburban developers. The affluent could live in a resort and take a quick daily trip to work and back. To differentiate the new suburban resorts, developers recognized the need for new rules to predict and protect property and value. They satisfied this need with private deed restrictions.

The initial land-use concept of deed restrictions began as private contracts between the developer and the buyer that limited the buyer to uses compatible with the developer’s vision of value and community. The developer would enforce the vision to maintain value over time, as well as deliver predictable expectations among strangers to protect individual property.

Today, one would recognize private deed restrictions as neighborhood covenants, conditions and restrictions—a concept conceived in the early days of the last century. Competition within an industry to meet market demand nurtures invention.

Deed restrictions can be narrow or can be wide ranging. For example, I can sell you a piece of land next to my land with a restriction that you can put on building within 50 feet of our common property line. Or I can sell it with a restriction that you must not affect the quality of the water in the stream that flows across your property to mine because my livestock drink the water. The first is well defined and easily enforced. The latter is open to interpretation if my cow kicks the bucket. As a private contract, deed restrictions can be anything two parties agree upon, but enforcing the contract over time can be tricky. Especially difficult is the enforcement as properties change hands to new owners who were not parties to the original agreement.

Deed restrictions can also be an infringement on a buyer’s rights while complicating a basic tenant of real estate development: subdividing land. Can restrictions be written in that you cannot further subdivide your land if you decide to become a developer? Is that an infringement upon your rights as a property owner? By all means it is, but a buyer can choose to not buy the property with that restriction when the rules of engagement are defined and transparent. It’s a private contract, so it would not differ from a lack of agreement on a purchase price for the land. If we can’t come to terms, you could take your business across the street and buy somewhere without restriction.

Often buyers did just that, not wanting to relinquish any component of the full bundle of rights in fee simple ownership, just as many people today do not want to buy property that is controlled by a homeowners’ association. They think they go too far for that same reason. They can tell you what color to paint the house and what kind of roof and fencing to use, or if you can put a satellite dish or solar panels on your roof. At the end of the day, it’s a private agreement intending to protect property with difficult enforcement and little consensus of value among buyers.

Public Land Use Control

Private deed restrictions did, however, reinforce a consensus that my property should be protected from damage of value or use. To that end, new conversations began about the role of public policy to protect property and protect public resources. After numerous legal challenges, the landmark case in the 1920s of the Village of Euclid versus Amber Realty Company laid the legal basis for public land use controls that collectively today we call Euclidean zoning.

Public land use controls to protect the health, safety and welfare of the constituents were implemented throughout the land as a component of the police power of local government enabled typically by state legislation. An example of egregious damage in the early days of zoning was when fire could “jump” from one property to the next, so the fire recipient has damage caused by careless behavior by the fire instigator.

Another is the earlier example mentioned a stream. If my property, business and livelihood are associated with raising cows to produce milk, and I have a stream on my property to serve the cows, the stream is fundamental to my health, safety and welfare. If you live north of me and your business is slaughtering chickens, you might expect your welfare allows the disposal of carcasses in the stream. Your actions, however, are taking a fundamental right from me, and we grant a monopoly in force to the police in order that they protect my individual rights. As a proactive measure, governments ultimately decided that prohibition of perceived incompatibility was the best property protection.

Public control and restrictions on the use of property took the form of dividing property under the control of the local government into zones of specific uses with a higher expectation of compatibility. All property within a zone, therefore, should have an equal treatment on restrictions that prevent one citizen from infringing upon the right of another to enjoy private property rights.

If someone operated a live music room late into the night next door and you could not sleep, that is a demonstrable damage that should be eliminated to protect your rights. If there is a reasonable expectation that a music room would do so, zoning would restrict it before it even gets started based on that expectation.

Private deed restrictions did not go away but generally evolved toward exclusivity as public controls became a major influence on real estate development. Debate ensued as to actual versus perceived damage along with the role of public comment in the land use arena.

The concept of use zones created a regulatory structure of segregated uses in anticipation of nuisances created by differentiated use in close geography. Perceived damages replaced actual damages as public comment became a significant political force in our land use discussions. When combined with suburban growth and transportation that we will discuss in the future, segregated, homogeneous land use became the norm.

Defining the Financial System’s Infrastructure

Real estate development was well underway, and the rules of engagement were quickly evolving, but a primary piece of the puzzle was still missing. Real estate ownership was limited to the few with the financial wherewithal to purchase with cash, or the limited developers or builders that would finance the purchases. Builder mortgages were being used, but we were missing a defined infrastructure associated with a financial system.

A defined market to create trust among strangers had not been conceived, and real estate took a major punch in the 1930s during the Great Depression. While the entire country was in bad shape, the individuals with builder mortgages were particularly hard hit. During the Great Depression, about 50% of home mortgages—mostly privately owned homes—were in foreclosure, compared to a high of around 7% during the recent real estate downturn in 2009. The builders holding the mortgages had few options even if they took the homes because there was not a mortgage system to be used by others to step in and buy.

While free markets motivate invention, so does catastrophe and necessity. Public policy emerged to stabilize real estate during the Great Depression, and another critical piece of the real estate development puzzle was in play. A federal financial infrastructure was conceived and implemented to provide stability to banks involved in real estate.

Further, federal programs were created to foster homeownership while provided semi-public backing to real estate loans. The Department of Housing and Urban Development (HUD) was created, and within that department, lived the Federal Housing Administration (FHA). The FHA created mortgage insurance to encourage high loan to value lending for home purchases and laid the groundwork for minimum property standards for developments. The Federal National Mortgage Association (Fannie Mae) was formed as a government-sponsored enterprise (GSE) to create a secondary market for home mortgages to insure constant liquidity in the industry. The Federal Savings and Loan Insurance Corporation was formed under the Federal Home Loan Banking system to insure deposits. Later, the Federal Deposit Insurance Corporation took over this task on a broader level.

Leading into World War II, the real estate development industry had a structure that included access to land, defined rules of engagement, and financial stability to encourage the trade of property.

World War II

On the heels of the Great Depression, the United States again experienced disruption during the years of World War II. The real estate development industry emerged, however, with additional public policy support and a manufacturing mentality that was on display during the war. Unfortunately, a devastating number of young soldiers did not come home from the war, but patriotism demanded support for those who did.

The support that had the biggest impact on real estate development was the National Housing Act that became known as the “GI Bill” because it provided easy access to financing for veterans to purchase housing. The change in mentality was demonstrated through a recognition that land development and housing could, in fact, be manufactured. Roads and automobiles had replaced railroads to provide access into the outer areas of cities, and large areas of affordable land became available for tracts of housing development.

The best-known example is Levittown outside of New York City, developed by Levitt and Sons. The term “tract housing” referred to subdivision development to accommodate modest homes similar in footprint and design. And yet another defining concept is introduced that further solidified real estate development as a uniquely American entrepreneurial endeavor.

Land, transportation, predictable rules and regulations, public policy support and financial infrastructure led the land development industry and the country out of an agrarian economy in the early 1950s toward the service economy that continues to shape real estate development today.