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Metro rail, the national capital's new subway system, had generated well over$2 billion in new land values in the Washington area by the end of 1980. The implications of this finding for economic development, for financing the completion of the subway system and for meeting its annual operating expenses are only dimly perceived. Because they are not better understood, development opportunities are being forfeited. And rapidly rising land values are incorrectly perceived as the problem rather than an answer to the fiscal prayers of local officials and Metro managers.

An analysis of Metro's contributions to land values was undertaken in the fall of 1980 at the urging of Congressman Henry S. Reuss, then Chairman of the House Banking, Finance and Urban Affair! Committee. Long before the 1980 elections and the advent of an Ad' ministration inclined lo reduce federal support of focal transportation. Congressman Reuss was concerned that, despite heavy federal subsidies, local Washington area officials were gloomily forecasting the inability of their jurisdictions to meet their shares of Metro budgets.

Yet the study shows that Metro, through its contribution to land values, is in effect providing its own source of income. Neither Metro nor the local governments are doing an adequate job of recapturing these publicly created land values. This aggravates (he system's unnecessarily dismal financial prospects and also contributes to forms of land speculation that interfere with orderly development.

A brief overview of the subway system and a summary of the land value study provide insights into how public and private development strategies, citizen action, and taxing systems interact to maximize -- or more often, unfortunately, fail to maximize -- the potential of a rail transit network.

Washington's Metro

The first small segment of the Metro-rail system opened in the District of Columbia in March 1976. Today, 39 percent of the full 101-mile system is operating in D.C. and the surrounding Maryland and Virginia jurisdictions. Just under half of the stations -- 41 of the 86 proposed -- are functioning. The system is operated by the Washington Metropolitan Area Transit Authority (WMATA), which also runs a regional bus system.

When subway construction began in the 1960s, total capital investment in the project was estimated at S2.5 billion. By 1976, this was raised to 54.6 billion, a year later to $3.5 billion. A more recent estimate called for $8.2 billion to complete the system by 1990. Unofficially, estimates of $l0 billion have been cited. To date, expenditures for site acquisition, plant and equipment exceed $3.5 billion.

Operating expenditures for the rail system were estimated at $94 million for fiscal year 1981. Fares were expected to cover the biggest share of that, nearly $60 million. Local governments were to contribute another $28 million of their own funds and pass through to WMATA their $7 million of federal Section 5 transportation assistance grants.

Additional annual expenses are required to meet debt service on bonds floated to finance the local share of construction costs. Interest on the debt will reach $77 million in fiscal 1981. The federal government assumes $51 million of this and local governments pick up the rest.

These budget figures illustrate what a massive public works program is being undertaken and what a tremendous financing challenge it poses to local jurisdictions, a challenge magnified by cutbacks in federal contributions. As Stephen H. Detwiler, Board Chairman of suburban Arlington County, Virginia, noted recently. "Metro will soon become the most costly public service in Arlington-, more than the schools and the police department."

Public response to Metro, meanwhile, has been excellent. Riders give high marks to the aesthetics of Metro rail stations, the cleanliness and comfort of subway cars, and the general quality of service. Until the latest round of fare increases, riders hip was increasing steadily, reducing auto commuting. Surprisingly high midday use of the system benefits commercial, shopping and eating establishments in locations that were previously much less accessible.

Focus on Land

Public awareness of the subway's impact on local real estate values was spurred by newspaper and magazine articles with headlines such as "How Close Is Metro? Houses and Condos Near Future Metro Stations Can Be Gold Mines" and "Downtown Newest Boom Area: Land Prices Soaring in Once-Neglected Neighborhood."

In July 1979, the Federal City Council, a business-oriented civic organization, measured the private investment attributable to Metro. With only 30 percent of the subway built at the time, the Council found that Metro played a major role in the development of $970 million worth of buildings, completed or under construction, near Metro stations. The Council identified an additional $1 billion of pending investments linked to presumed completion of the Metro system.

The House study examined land values rather than development values. The two are closely related: land values reflect the degree of new opportunities being created; investments indicate how well the community is taking advantage of these opportunities. Some analysts disregard land values, arguing that urban sites have little value unless they are producing cash flow. If that were the case, vacant parcels and rundown properties would sell for a song. Investors trying lo acquire such properties confirm what land economics theory teaches: it is not the current use so much as the potential use that determines the value of a site.

To assess the new development potential being put into place by Metro, it was crucial to uncover the new land values emerging along its path.

Methods and Findings

The methodology of the study was simple and direct. Assessing offices, homebuilders, commercial developers, leasing agents, appraisers, real estate brokers, zoning specialists, development offices, land economists and land use planners were interviewed and their records analyzed. Benchmarks were derived to measure changes in land value or "location value" that could be clearly attributed to the proximity of Metro stations.

These benchmarks were applied in the neighborhoods of 16 working Metro Stations. Only commercial values were assessed in downtown District of Columbia and in the Silver Spring area of Montgomery County, Maryland. Only residential values were assessed in Arlington County, Virginia. In Prince Georges County, Maryland, both residential and commercial values were examined.

Metro differentials, the extra price people are willing to pay lo enjoy access to the subway, are most pronounced in the older, more deteriorated sections of downtown District of Columbia. Such differentials also occur in prime locations, but so many other factors contribute to a strong market in those areas that it is more difficult to isolate and quantify "pure" Metro effects there.

Rental differentials for building space were the starting point in our calculations. For "prime" blocks, those containing a Metro exit or directly across the street from one, we identified a $2-per square-foot Metro factor. For "secondary" blocks, those adjoining prime blocks, we calculated a Metro factor of only SI per square foot. (Effects of Metro on property values three or more blocks from stations were disregarded.) These observed building rental differentials were converted into land rental differentials by taking account of the built-up or buildable land in the 43 prime blocks and 81 secondary blocks around eight downtown stations, and the number of stories (more technically, the floor area ratios) permitted under current zoning. Annual ground space rentals were then capitalized, using a 15 percent interest rate.

This produced a finding of $1.6 billion in new downtown land values attributable to Metro in the sample area. More typical interest rates would have raised the figure to $2.4 billion, but the most conservative alternatives were chosen throughout the study.

In Arlington County, Virginia, $81 million in new residential land values was attributable to Metro. Some $60 million of this was along the Rosslyn-Ballston corridor and $21 million near the Pentagon City station. Matched pairs of townhouses and apartments, comparable in size, neighborhood and quality, were found adjacent to and away from Metro stations. Differences in sales prices reflect what realtors refer to as the "Metro premium" that home-buyers are paying. (See table for comparison of townhouse complexes in the Pentagon City area.)

Similar studies at the most distant operating station in Prince Georges County, Maryland failed to produce satisfactory proof of a Metro premium for residences in that area. However, clear evidence of a Metro factor, amounting to $5 million in subway-induced land values, was apparent in the compact commercial and industrial section near New Carrollton know as Metro East.

Dramatic changes in commercial land values in Silver Spring, Maryland have occurred since the subway began operating there in 1978. Comparisons with areas not served by Metrorail, and statistical analyses by the Montgomery County assessing office, indicate that sites close to the Silver Spring station increased in value by at least $31.2 million more than they would have in the absence of the subway.

Increased land values in the sample area alone totaled nearly 12 billion. Virtually all land experts agreed that many of the areas excluded from the calculations are experiencing intense bidding-up of site values, substantially above the general price rise in the Washington area.

Based on die findings of this study, what is Metrorail's total contribution to area land values? It seems safe to say the figure is well over the $3.5 billion already invested in the transit system. Present trends suggest this amount will triple by the end of this decade.

Growth Not Automatic

Many believe that mass transit systems automatically spawn private investment in their paths. This is not necessarily true. First, there must be strong market demand for new growth. This is certainly the case in the Washington metropolitan area. Also, the zoning, planning and taxing climate must be hospitable to growth.

Politicians who promote mass transit as a means of upgrading their communities nevertheless often enact or tolerate land use practices that pose insuperable barriers to logical development. And the same citizens who cheer the notion of revitalization often balk at rational growth in their own neighborhoods.

For example, in the course of our study, we observed townhouses approved by county officials mushrooming within a stone's throw of a Metro station on parcels that market experts consider ideal for mixed commercial and residential high-rises. The town-houses would have served as well, or better, a few blocks away, but not the high-rises. The lower use preempts the higher use for a generation or more. Besides, people moving into the town-houses comprise a pressure group that may oppose appropriate development near the station.

The unique productive power of a Metro location has thus been diluted. Observed land values now reflect a bare minimum of the development potential, not the higher potential that would exist if impediments to orderly growth were corrected. Deflating the land value base, of course, reduces the tax revenues of local governments.

To complete the circle, the Metro system which generates the potential is also hurt by this kind of land use distortion: for Metro rail to operate most efficiently and economically, high concentrations of people and business activity are required along its routes.

Status Quo vs. Growth

These planning-development problems have their roots in the fact that the Washington Metropolitan Area Transit Authority and its constituent jurisdictions constructed Metro rail as if it were only, or chiefly, a transit system. It is that, of course. But it is also a potent land use instrument. Wherever it funnels thousands of people in and out of its stations, new business opportunities emerge for retailers and builders, for the people who hawk eggrolls or flowers at the top of the escalators no less than for corporate giants. And Metro station neighborhoods are prized by those seeking housing that is easily linked to work locations. European and Canadian cities have demonstrated numerous ways to design subways in coordination with planning and financing devices to enhance these commercial and housing opportunities. WMATA and tocal governmental offi- ciah were not unaware of these opportunities. But back in the 1960s, those who tried to carry out an integrated system of public works, development planning and financing backed off because of the pervasive no-growth sentiment in many neighborhoods. Residents wanted a subway but they did not want it to change by a hair the character of their neighborhoods. A lesson slowly emerging from that experience is that the debate should not be between growth and no growth, but between disruptive growth and balanced growth. The desire for neighborhood conservation and stability is legitimate. But urban "experts"-planners, developers, politicians, architects, journalists, economists and citizen group leaders-have done a poor job of articulating strategies thai can meet this desire and simultaneously serve a community's new development needs. Attempts to protect the status quo everywhere lead to chaos. Paradoxically, it is essential to a pro-conservation stance that growth be accommodated in appropriate areas. Logical places for concentrations of high-density growth are central business districts and transportation nodes such as subway stations. If intense growth is not allowed to occur where the market calls for it (as revealed in land value peaks), then large commercial buildings and apartments will be forced to disperse willy-nilly throughout the community. Low-rise neighborhoods are invaded by oversized buildings precisely because of the failure to plan for orderly development. In short, those pushing no-growth and anti-growth policies tend to generate the very neighborhood instability they fear. The District of Columbia has been slow to develop planning strategies. Thus developers, lacking official guidance, have preempted the shaping of much of the city. To counteract this, the Greater Washington Board of Trade, in an excellent 1981 report, "Downtown -- A People Place," recognized that the District govern men! should play a stronger role and that historic preservation, an, eateries, festivals, residential facilities and small business, as well as the needs of larger merchants and providers of office space, must be accommodated.

In Arlington, where the town ho use example cited earlier was all loo typical, it is encouraging that officials, business groups and major citizen organizations are now making a comprehensive growth strategy for the Rosslyn-Ballston corridor one of their top priorities._

Montgomery County planners have led the way in trying to maximize growth around subway stops. While recognizing the social advantages of dealing with development pressures, good planners arc also sensitive to times and places where historic, architectural and neighborhood values take precedence over market signals.

Land Value Bonanza

Orderly development and adequate financing both require that WMATA and its constituent governments do a better job of recapturing the billions of dollars in new land values that the subway is generating. A small portion of these values are recouped via higher property tax assessments. But the giant share of this bonanza is being reaped by a relatively small number of landholders who simply happen to occupy prize locations.

The dozens of land specialists interviewed for the study testified to rampant land speculation along Metro routes. This is an important reason why the new jobs and businesses expected to follow the introduction of the rapid rail system have not materialized to the extent anticipated.

To stem this speculation and put more money into public coffers, some D.C. City Council members favor a site value tax -- lowering the tax rate on homes and commercial buildings, while increasing the tax rate on land values. Councilman Arrington Dixon has argued that this would favor land use as opposed to land holding. Under the typical property tax, assessments and taxes rise in proportion to the intensity of development. This penalizes owners who use their properties fully, inducing many to keep their sites idle or underdeveloped. Councilman John Ray urged an official D.C. site value tax study, noting that in Pittsburgh, where land is now taxed five times higher than buildings, commercial and housing construction were booming.

The District of Columbia already has enabling legislation to tax land and buildings at different rates. Virginia would require legislative action to go that route, while Maryland would need to amend its state constitution. In the meantime, there are other ways for the public to recapture the "Metrodollars" it is pouring into private pockets.

One way is joint development, a cooperative public-private venture. Businesses are given access to the pedestrian traffic attracted to Metro stations, and the public receives rent for making the locations available. At the time of our study, only 4 of the 86 stations were earmarked for joint development. It is not too late to expand such projects.

Special assessment districts were a traditional American way of paying for public works before federal grants became prevalent. Adjacent landowners pay for the benefits bestowed on their particular sites.

The point is the subway is creating a fiscal reservoir that can help pay for its construction and operation, and for the ancillary services needed to make it function well. Site value taxes, joint development and special assessment districts are among the ways to reclaim these revenues.

The failure to recycle publicly created land value increases is not merely a fiscal mistake. It also encourages land use behavior that works against good planning and good development. If local governments in the Washington area successfully tap their fair share of the billions of dollars of new land values, they will set a pattern for transit-related development worth replicating in large metropolitan areas throughout the nation.