Land based financing for cities – Lessons from Latin America

By Vishnu Prasad, IFMR Finance Foundation

In a recent report titled “Implementing Value Capture in Latin America- Policies and Tools for Urban Development“, Martim O Smolka of the Lincoln Institute of Land Policy discusses a wide suite of land financing instruments that have been used in Latin America. The report focuses on instruments of value capture, which are based on the principle of recovery by the public of land value increments (unearned income) created by actions other than the landowner’s direct investments. Although all such increments constitute unearned income, value capture instruments focus primarily on the increment created by public investments and administrative actions.

The tremendous opportunity of using value capture to fund urban infrastructure is evident from the case of Barra da Tijuca, Rio de Janeiro. Barra da Tijuca, an extension area of the city’s high income zone covering 82 km², was earmarked for development in 1967. By 1974, the creation of expensive public transit lines including an elevated expressway and direct access through tunnels led to skyrocketing land prices (the appreciation is estimated to be nearly 1900% between 1972 and 1976). However, the absence of plans to capture this appreciation in prices led to the control of 30% of the area by only three owners and presented a substantial loss to the city. The rest of the post focuses on examples of successful implementation of value capture policies from the report. The post concludes by looking at land financing tools used in India.

Betterment contributions

A betterment contribution is a charge or fee imposed on owners of selected properties to defray the cost of a public improvement or service from which they specifically benefit. As noted in the previous post, Bogota, Columbia is a prime example of a city using a system of betterment levies- almost a quarter of Bogota’s revenues consists of betterment contributions. A lesser known example is that of the municipality of Cuenca, Ecuador, which over the last decade issued 1,800 contracts for public works projects and collected close to US$200 per capita, much higher than Bogota’s US$150 in the same period. 90% of households in Cuenca made their contributions in less than four years, with 95% of the projects collecting 60% in betterment contributions.

Betterment levies are considered anti-poor by many critics, who argue that the well-serviced parts of a city are occupied by high-income residents, who were not charged when the services were provided. They advocate that it is unfair to charge people who receive these amenities later. However, evidence from Lima, Peru suggests that low-income households are often willing to pay against a guarantee of service. The city introduced a successful program featuring 30 projects that used a contributory tool to finance public works in the early 1990s. Ironically, it was the high-income households that failed to pay the contributions.

Exactions and other regulatory charges

Exactions are the most common value capture tool used in Latin America. Landowners are obliged to make cash or in-kind contributions to obtain special approvals to develop or build on their land. In-kind exactions may require the land developers to set apart some of the land for public facilities, including streets, schools, parks, or environmental conservation areas. The most common example in the region entails the land owner releasing between 15 and 35% of the area for public uses.

Gautemala uses an innovative instrument known as Impacto Vial, whereby the responsibility for road improvements is shifted to private developers. When a large private development project requests for a license, the municipality undertakes a road traffic study to gauge its impact on the community. An infrastructure plan is then designed to mitigate any negative impacts, together with a calculation of the share of the cost the developer should cover. The work is then executed by the developer under municipal supervision. If the cost of the work is higher than the developer’s estimated share, the value of the license is used to make up for the difference

Building Rights

This instrument of land financing is predicated on the separation of building rights from land ownership rights, which allows the public to recover the land value increment resulting from development rights over and above an established baseline. For instance, building rights in Brazil (known as Outorga Onerosa do Direito de Construir, OODC) is based on a basic FAR cap on the landowner’s building rights. The landowner is charged a fee for the right to build above this basic FAR on her land. Between 2002 and 2004, the city of Sao Paulo reduced FAR coefficients in most parts of the city to 1 and in 2012; the city generated about US$ 175 million in OODC payments. OODC payments are deposited in the Urban Development Fund (FUNDURB), which implements special plans and projects in urban and environmental areas. Projects created using OODC payments include bus terminals, transportation corridors, parks and green areas, slum regularization, historical preservation, and drainage.

Given the numerous difficulties in valuing a change in building rights, cities in Brazil estimate the willingness to pay of developers under market conditions by issuing Certificates of Additional Potential Construction Bonds (CEPACs). The idea is that new development potential, such as for different types of uses and additional buildings, created by rezoning and public investments in a well-defined area should not be available for free, but auctioned to developers interested in taking advantage of the economic benefits resulting from the public interventions. Municipalities in Brazil issue CEPAC bonds corresponding to specific building rights for purchase by competing developers through public electronic auctions. The total number of CEPACS issued is a function of the total additional development that an area can support. Between 2004 and 2010, Sao Paulo sold close to 640,000 CEPACS valued at around US$720 million.

Privatizing Public Land for Redevelopment

In 1989, the city of Buenos Aires proposed to redevelop 160 acres of the old port area of Puerto Madero. A corporation was created to spearhead the project with a mandate to promote economic growth and job recovery in the area. Over the last 2 decades, about 1.5 million m2 of floor space has been developed in this area. The state contributed the port land, which generated more than US$2.26 billion in private investments. By 2011 the corporation sold around US$230 million worth of land and the proceeds have funded public works worth US$113 million. Till date, the project has contributed 4 major waterways covering 39 hectares and 28 hectares of green space for the city, making Puerto Madero a leading tourist destination of Buenos Aires.

Use of land financing instruments in India1

Development impact fee is a onetime fee imposed by ULBs on new developments to fund a portion of the cost of infrastructure facilities necessitated by that development. In India, development charges are usually based upon the area of the land and the buildings, rather than on the actual demand for infrastructure generated by a new development. For instance, under the Karnataka Town and Country Planning Act of 1961, charges development fees that range from Rs. 20 to Rs. 75 per square metre of land area, and Rs. 2 to Rs.10 per square metre of building area. The state government is now in the process of revising the fee to 18 per cent and shifting the basis for charging the fees from area to value.

Lease or sale of landholdings is a common tool used by ULBs in India. For instance, the Mumbai Metropolitan Regional Development Authority (MMRDA) has garnered substantial funds by selling land in the Bandra Kurla Complex. The funds are being used to finance infrastructure investments in other parts of the city. MMRDA has also used the sale of additional FSI to raise funds. A major owner of land in India is the Ministry of Defence which is estimated to hold close to 2 lakh acres of cantonment land. Cantonments were initially set up outside city limits, but as cities expanded over the years, they have come within urban agglomeration. If cantonments can be resettled to outside the city area, large parcels of land would be freed, helping bring down the escalating prices of real estate in urban areas.

Land Pooling and Readjustment (LPR) is a process whereby a local government consolidates small parcels of land, without paying compensation to the land owners and undertakes collective planning of their land. The authority designs and sub-divides the consolidated lands for urban use and retains a portion of this land for creation of public infrastructure like roads, parks, gardens etc. Some portion of this land is then set aside for public sale to ensure the recovery of development costs and the remaining land is returned to the original owners. The owners gain from the increase in the overall value of their land. In India, cities in Gujarat are using these instruments (called Town Planning schemes) for city expansion. For instance, Surat and Ahmedabad have completed more than 100 such schemes each. In Surat, these schemes have covered 137 sq. km and appropriated 32 sq. km of that for public use. Surat has additionally constructed 617 km of roads and 10,000 houses for the poor.

Despite examples of use of land based financing tools listed above, Indian cities are yet to unlock the full potential of these instruments for financing infrastructure. Indian cities can learn from the experiences of their Latin American counterparts to better prepare our cities for the future.

1 – The section is based on Report on Indian Urban Infrastructure and Services (2011)