A sector that could do with much more financialisation is land markets in developing countries. This post presents an idea about the exchange trading of Transferable Development Rights (TDRs) issued by municipal governments to landowners who give up their land for road widening and other public purposes. TDRs could be an addition to Real Estate Investment Trusts (REITs) in being an exchange-traded land-related financial instrument.
These TDRs confer development rights to their owner over a pre-defined area and is therefore a derivative instrument on the underlying development right. This is a good compilation of the TDR policies of states across India.
In a co-authored working paper, we proposed the idea of a tradable Floor Area Ratio (FAR) where the municipality fixes the permissible additional FAR and periodically auctions them. The idea can be extended to operationalisation of the market for TDRs, thereby eliminating the large cost incurred in land acquisition for road widening and the like.
In the prevailing TDR regime offered by municipalities in many states, the person who loses his/her land is compensated with TDR equivalent to one to four times the basic/guidance value of the land extent that has been foregone. The TDR can be traded in specified parts of the city or, in some cases like Andhra Pradesh, anywhere across the state. The land loser is given a TDR certificate indicating the monetary value of the compensation.
The TDR comes with certain benefits. In general, across states, it allows the buyer with three exemptions on the existing regulations – additional FAR beyond the permissible ratio, additional floors over and above the standard height restriction, and certain setback relaxations. In other words, the builder can develop significant additional floor space beyond that permitted by the existing building regulations in an area. All this makes TDRs a generous compensation scheme.
However, its attractiveness depends on the land loser’s ability and ease in transacting the TDR. Unfortunately, this market matching suffers from information asymmetry and frictions. Currently, there’s no public disclosure of all the TDRs allotted in the state or city. All the transactions happen as informal private trade between the land loser and TDR purchasers, intermediated by brokers. The main TDR purchasers are builders. The land losers face prohibitive search and transaction costs in connecting with a buyer and selling their TDRs, enough to deter many from accepting TDRs.
In due course, land acquisition payment in general could be substituted with TDRs. Even a small shift to TDRs would be a big step. In theory, this would enable tradeable monetization of land acquisition. Besides, once the market is established, it’s possible that the TDR certificates could even trade at a premium for use in certain areas, thereby allowing for higher compensation for land acquisition land losers.
In this context, it might be a good idea to establish a state-wide TDR trading platform. This public platform could do the following:
Inventorize all the TDRs already issued in different cities and make them available in a user-friendly searchable manner. Ideally, also update the extent of utilization of those already issued.
Processing and issue of new TDRs by all municipalities.
Management of utilisation and retirement of TDRs.
Inventory of all the TDR transactions, with their issue and utilization details, including origin and destination. The information gathered from this can be invaluable decision-support for further refining the TDR policy design.
Moderation of TDR trades and provision of all support services. The platform can be linked to the Registration and other Revenue Department websites so that registration and mutation can be done simultaneously.
Currently, while some states have their portals that act as a window for applying, issuing, and storing information in a private view format (this and this are two examples), there is none that facilitates price discovery and allows for trading of these TDRs. The existing portals must be made public and converted into a TDR trading platform, and linked through APIs with the Registration and Mutation services of the Revenue Departments.
Alternatively, the TDR could be registered as an Exchange Traded Instrument (ETI) and transacted through the combination of a depository and exchange. Once transacted, the state government's portal could help with Registration and Mutation services.
This would help avoid the large expenditures being incurred on road-widening (and other) related land acquisition. It would also facilitate the monitoring of these TDRs and enable the simultaneous linkage to registration and mutation. Finally, this would be one more important step in formalizing and increasing the efficiency of land markets in the state.
Such TDR trading is also a very useful urban planning instrument. It can help decongest a very dense area by shifting some development potential outside, and conversely helping densify certain other areas. With appropriate incentives and enablers, it can be an instrument to densify, de-densify, support transit-oriented development, catalyse urban renewal, etc.
The success of this initiative will depend on the volume and liquidity of TDRs available in the market at any time and the demand for them. It’s therefore essential to calibrate the supply of TDRs such that they command a premium on their allotment value. Over-supply can distort the market (and municipalities and governments with the incentive to minimise land acquisition costs could generate an over-supply). In order to ensure the credibility of the market, it’s also important to clean up the TDR database and ensure that it contains only genuine certificates when the trading starts.
In the case of TDRs with utilization restricted to certain pre-defined areas, the TDRs will get differentiated and their prices will vary depending on the market supply and demand for each recipient area. This offers interesting possibilities for using TDRs to incentivise policy priorities like urban renewal and affordable housing.
Such financialisation comes with its distortions and abuses. It's inevitable that buyers and sellers will game the market, especially given the likely arbitrage opportunities available in a market consisting of extremely entrepreneurial realtors. Land markets are anyways rife with several abusive and fraudulent practices. It's therefore essential that such trading be tightly regulated, especially in terms of where a TDR can be utilised (the recipient zone). This is a good example of a policy that needs to evolve iteratively.
The Urban Development Departments of state governments could popularize the scheme through continuous engagement with Licensed Surveyors and Builders. This would increase awareness and credibility of the TDR trading model, and thereby reduce the reluctance among landowners to accept TDRs.
This is an example of an area where financialisation, albeit regulated and gradually and carefully phased in, can be promising in promoting urban development and minimising public expenditures on land acquisition. It's time to trade land like any other exchange-traded instrument.
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