The monocentric city model, despite its simplicity, provides fascinating insights into how cities form and what factors influence real estate prices, such as location, spatial growth, population growth, and more.

Model Assumptions:

  1. The city has a circular shape with a single central area where urban services are accessible.
  2. Surrounding the city are agricultural lands.

Rent Decomposition:

In the model, any real estate rent is divided into three components:

  1. Agricultural Land Rent: This is the opportunity cost of urban development. At the city’s periphery, building a house requires land that generates income through agricultural production.
  2. Construction Rent: This portion of the rent is derived from the cost of building a house. For example, if you own the land and take a perpetual loan to build the house, the annual interest rate represents the construction rent.
  3. Location Rent: This is determined by the property’s distance from the center. Transportation costs (in a broad sense) for accessing urban services vary with distance. The farther the property is from the center, the higher these costs, leaving less money for location rent.

Example Geometry:

Given these parameters:

  • City radius: 13 km
  • Population: 1 million
  • Annual agricultural rent per hectare: $500
  • Average household size: 2.5 people per house
  • Construction cost per house: $50,000, with a 10% annual rent
  • Annual transport cost per person: $500

The location rent is represented as a gray curve in the diagram, showing that the total rent in the city’s central areas is four times higher than at the periphery. These calculations are based on per-hectare values in an Excel file.

Financial Picture:

The financial landscape is shaped by factors such as city radius, population density, income levels, construction and interest costs, average household size, and consumer behavior. These cultural and financial differences explain why real estate prices vary between cities.

Impacts of Parameter Changes in the Model:

Population Growth

Principle I: The larger the city, the higher the location rent:

Population growth, with constant density and transport costs, raises the average location rent, even as the city expands. If population grows without expanding the developed area, location rents increase near the center, steepening the slope of the rent curve.

Principle II: If population grows alongside spatial expansion, rents increase more toward the periphery. If density rises instead, rents increase more toward the center.

Reduced Transport Costs

  • If transport costs decrease and savings encourage suburban expansion, location rents fall near the center and rise at the periphery.

  • If reduced transport costs do not lead to expansion, the slope of the rent curve decreases, lowering location rents near the center.

Principle III: Reduced transport costs always decrease location rents near the center. The impact on the periphery depends on whether the savings are used for developing new areas.

Increased Income Per Capita

The effect of income growth on location rent is ambiguous:

  1. Increased income might lead to the purchase of suburban properties, larger homes, or inefficiently large spaces (e.g., private sports fields), reducing the slope of the rent curve and shifting location rent outward.
  2. Higher income also increases the opportunity cost of travel time, raising transportation costs and steepening the rent curve, which could counteract the effect of city expansion. Principle IV: Income growth has a dual effect. It can lead to outward rent shifts due to suburban expansion, but higher transportation costs for wealthier individuals tend to increase overall location rent levels.

Source:
Commercial Real Estate Analysis and Investments by D. M. Geltner, N. G. Miller, J. Clayton, and P. Eichholtz.