Coasean economics in Irvine

Irvine is a master planned community in Orange County, California, with a population of just over 300,000. It is one of the few areas of coastal California where home building is still quite robust, perhaps due to the influence of the Irvine Company.

A recent article in the Orange County Register provides a good example of Coasean economics in action. Recent growth in Irvine has pushed new housing construction ever closer to an asphalt manufacturing plant.  (New housing construction is in the upper center of map below, the asphalt plant is on the right):

This led to an “externality problem”:

Odors from the plant are particularly strong in the nights and early mornings, Lien said. Every night, he checks his hood ventilation and laundry room ventilation systems to ensure odors won’t seep through.

“We basically keep our house shut. It’s all sealed, and (we) never open windows,” Lien said.

Due to the large number of homeowners, it is difficult to negotiate a satisfactory solution to this problem. But this case was special in several respects. First, real estate development is extremely profitable in Irvine, if you can find available land. In addition, the Irvine Company plays such a major role in Irvine that it needs to maintain a good relationship with the city.  

In the end, the plant was sold to the Irvine Company for $285 million. I’m not expert on asphalt plants, but that seems like a huge sum of money for such a modest sized facility (see picture in the article). The article suggests that the owners had no interest in selling, and only did so because they reached very favorable terms:

“All American Asphalt plant was not interested in selling, and they are only selling right now because we’ve been able to reach a price that they feel is commensurate with the long-term profits that the asphalt plant would have generated,” said Chi.

I suspect that “commensurate” is an understatement, as they knew they were in a strong negotiating position. Of course, the value of land in places like Orange County is strongly dependent on whether the local government will grant permission to build new homes. As part of the deal, the city of Irvine will allow the Irvine Company to develop a modest portion of the land.  

The funding for the purchase of the plant is set to come from a “concurrent deal” the city made with Irvine Company. In the deal, the Irvine Company will give the city approximately 475 acres of land, with about 80 acres (worth around $330 million, according to city documents) allocated for housing development.

For you land developers in Oklahoma City, that’s not a typo. In Irvine, 80 acres of buildable land is worth $330 million. (BTW, I believe that some of the 475 acres being donated for parkland is extremely hilly land, which is difficult to develop.)

This example illustrates the complexity of the Coase Theorem. In some cases, negotiation among the parties leads to a free market resolution of externalities. In other cases, regulation might be required due to the existence of “transactions costs.” Master planned communities make it easier to overcome the problem of externalities, which is one reason why Irvine allows more new construction than do other Orange County communities.

In this case there are several externalities lurking in the background, which impacted the final result. In addition to the bad smell, Irvine residents worry about traffic congestion. As a result, they are not always happy to see new development. The Irvine Company (implicitly) struck a deal with the city that will eliminate the bad smell problem while slightly worsening the (less severe) traffic issue. This overcomes the normal “public choice” problem by turning nearby homeowners from being the most opposed to new development to the most supportive of new development. 

NIMBY policies impose external costs on an even more invisible group—people that would like to live in Irvine but cannot afford to purchase a house in the city. That’s a more difficult problem to solve. In recent years, the state government in California has been pushing local governments to allow more housing construction. Almost everyone wants more housing—but somewhere else.