Thursday, September 4, 2014

Value capture through sale of building rights

The economist Donald Shoup pointed to one of the biggest ironies of development, “Why is it so difficult to finance public infrastructure that increases the value of the serviced land by much more than the cost of the infrastructure itself?” This assumes significance in the context of positive externalities captured by land owners, in the form of increased land valuations, from public investments in infrastructure. As I blogged earlier, governments across the world have tried several approach to capture some share of the value increment from such investments.   

In this context, City Lab points to how the city government of Sao Paulo captures value from changes in zoning regulations to finance infrastructure investments. Brazil, following the French system of land use which separates property rights from building rights, has a basic FAR (generally 1:1 across the city) and a Master Plan permissible FAR for a specific area. In 2002, the Sao Paulo municipality mandated that developers wanting to build over and above the basic FAR (limited to the Master Plan FAR) would have to purchase Certificates for Additional Construction Potential (CEPAC) bonds issued for that area or locality. Each bond entitled the buyer to build one square meter of additional area. The government would sell these bonds (for each area) in a phased manner through an electronic auction, regulated by the nation's financial market securities regulator, thereby raising resources that would be used to finance infrastructure investments. Developers would have to purchase CEPAC bonds from the secondary market to get building permits for additional FAR.

The interesting feature of CEPAC is that it appears to kill three birds with one stone - achieve densification, capture value, and pay for supporting infrastructure. The challenge with densification by way of height relaxations, especially in existing cities, is that it is constrained by the limitations of the existing infrastructure carrying capacity. But improvements in infrastructure carrying capacity require investments, which local governments find difficult to mobilize. Theoretically the CEPACs can guide densification and also raise resources to support it. And by facilitating a transparent price discovery for the additional building right, it also solves, if atleast partially, the value capture problem.

However, the challenge, as it is always the case with such process innovations, is with adherence to the process during implementation. In countries where enforcement of Master Plan is deeply politicized and where regulators do not enjoy much credibility, such innovations generally run into implementation problems. For example, the local government may issue too many CEPAC bonds either in an anxiety to maximize revenues or from political pressure to give-away a potentially valuable resource at a cheaper price. 

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