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20181110 Ricardo’s Rent Theory, What has changed?

20181110 (Sat)

Ricardo’s Rent Theory, what has changed?

Ricardo, Thunen and Alonso all used the same basis – land rent. What it says in simplest manner is nobody would pay higher than what the land can generate.

However, in the old day the opportunity cost of land is zero. What this means is next to zero maintenance cost of land, anything else is good enough. Like next to not working on the land, a plot of land can be planted with corn. This will yield harvest rather than leaving the land idle.

In modern day, people do NOT plant corn in cities. People build structures. Let us take the example of buildings. What is the best outcome to a developer when considering developing a plot of city land? Build condo or shopping mall? So, many are doing both at the same time. This strategy will reduce the risk. Shopping mall with residential condo on the higher up.

For the sake of illustration, the opportunity cost of building Condo is the profit of building shopping mall. Which is better – shopping mall or condo? And, to make things more complicated, what is the density of the condo? 20 storey or 40 storey? Higher density will mean more to sell – thus more profit. However, can the market take it? In fact, authority might not even approve it. Or, it is too hefty a development charge to pay?

Therefore, buying expensive condo in city skyline is a risky investment. These theories point to one simple thing – is it worth the opportunity cost of the next best outcome? When the stake is huge, the development has to charge higher profit margin for the risk.

In comparison to investment in financial instruments, for example stock market and bond market. The risk of stock market is like in the city – high risk, thus higher return. The case of bond market, it is like kampung, lower risk but lower return.

This points to one simple rule – buying high risk high priced condo in the city is like taking risk in stock market. Can you hold?

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