Many people consider public land monetisation as a low-hanging fruit to raise public revenues. This post will argue against outright land sales to raise revenues, highlight the practical problems and distortions arising from it, and instead propose land transactions to meet policy objectives (affordable housing, industrial development), land leases, and land sales only when value capture is maximised.
There are two ways to allot government lands - administrative and auction allocation. The former applies to lands allotted to meet specific policy objectives. They include allocations to industries and institutions and sales by State Housing Boards or Corporations as part of affordable housing schemes. The latter applies to sales for other purposes and primarily aims to raise revenues.
While it appears a logically simple activity, the practical challenges with land monetisation are enormous. I had blogged here outlining the challenges with land monetisation - the market’s absorptive capacity, litigation, rent-seeking opportunities, political economy constraints etc. It’s also borne out by the reality that there are hardly any examples of institutionalised land monetisation from any state or city in India. Even the much-touted Canada Land Company, in more than 60 years of existence, has struggled to sell land.
Aside from allotments to industries and institutions, land sales nowadays are viewed primarily from the perspective of revenue mobilisation. The administrative incentives are aligned towards maximising the price at which land is sold. This has engendered some perverse incentives.
For a start, the land market in India is vitiated by the persistent and large wedge between the market value and the government-determined guidance (or registration) value. This wedge remains intact despite demonetisation and other measures. It’s a measure of the resilience and persistence of the black money economy. Since all government land auctions are conducted at full price, and given the sky-high valuations, there’s only so much land (at those prices) that the market in any city can absorb. The full price of land is formally incorporated only for premium (Class A) commercial real estate transactions, which is a very small share of all real estate transactions.
Other purchases of large parcels auctioned by governments end up as premium residential properties. Governments have sought to address the problem of the market’s absorptive capacity by subdividing lands into smaller parcels and then auctioning them. But this creates another set of issues. Given the acute scarcity of urban land and its attractions as investment, such smaller parcels tend to end up in unproductive end-uses.
It’s far worse than land being locked up with government departments to have the same land locked up as mansions and bungalows of the ultra-rich or as their investment assets, instead of being used for productive purposes. For this reason, sub-dividing and selling scarce government land that can end up as unproductive uses like high-end residential properties should be strongly discouraged.
The most damaging impact of public land auctions is to inflate land prices in the area. Since the government’s incentive is to maximise the sales price, the prices determined in the auctions end up becoming the benchmark for land prices in the area. Auctions, therefore, invariably push up the guidance values in the area in their periodic revisions.
Besides, the rent-seeking dynamics around real estate mean that insider information on auctions triggers land purchases in the vicinity by powerful interests. They have an interest in the land auctions boosting land prices. This, in turn, reinforces the existing institutional incentives within the bureaucracy to maximise sale prices. The insiders actively boost prices by bidding aggressively for one or two small parcels, thereby raising the benchmark prices in the auction. Even if the rest of the auction fails to find bidders, their purchases would have served the purpose of inflating the benchmark price in the area, and thereby increased the prices of their own newly acquired properties.
Ironically, the increased land supply by the sale of public lands, instead of lowering housing prices, ends up increasing land values in general through a combination of speculative activity and an expansion of the market in the land as an investment asset. In a market where land is in high demand as an investment asset and incremental additions will always be small (compared to the latent demand), such additions only fuel the demand.
While I’m not able to locate studies examining such practices, it’s a widely held view with compelling anecdotal evidence to infer that government land auctions have been an important contributor to property market distortions in cities like Hyderabad.
In fact, a common feature of all the scandals surrounding land auctions involves land purchases in the vicinity based on insider information, speculative transactions, aggressive bids for some parcels, and a sharp rise in market prices in the area. And it’s rare to find clean land auctions without these features and associated scandals.
In this context, here are a few thoughts.
1. Given its scarcity and critical (direct and indirect) role in shaping urban growth, governments should prioritise policy objectives over revenue mobilisation when allotting lands. Accordingly, administrative allotments for affordable housing should be just as important as those for industries and institutions. Sales to mobilise revenues should be used only sparingly.
Traditionally, government-owned housing boards/corporations across states have developed lands and allotted them through lotteries at administratively fixed prices. The prices were fixed to account for the costs and a small profit mark-up. The primary objective of these schemes was to expand the supply of land at affordable prices. Revenue realisation was only an incidental secondary objective. Such schemes allowed generations to benefit from access to lands at affordable prices.
At a time when land prices are unaffordable for all but the richest in the big cities, there’s a strong case to revive these schemes. It can be an important step to address the problem of housing affordability, which is threatening to choke urban growth. The only difference from earlier should be that these land allotments should be only for high-density developments. Accordingly, it could be allotted to societies to develop high-rise apartment complexes with only affordable housing units. And these allotments should be complemented with measures that incorporate desirable urban planning norms like transit-oriented development.
In this regard, the central government could come up with a model policy and a scheme for the allotment of public lands for affordable housing projects. This scheme should include a mortgage finance mechanism.
2. Land is arguably the most important privately appropriated natural resource. As cities have rapidly expanded, the land available for further expansion has become scarce. Land is also required for utilities and community infrastructure that are essential to support densification. It’s therefore important to ensure that governments retain control over a bank of public lands and use it for public purpose requirements that will inevitably emerge over time.
Therefore, instead of outright sales, governments could consider the option of long-term leases (say, for 25-33 years). Such leases may be easier to execute, less controversial, generate far less incentive distortions, and ensure that ownership remains with the government. The last part is especially important given that there’s only so much land available for posterity. In this context, it’s pertinent that China’s spectacular economic success was financed in large measure through revenues mobilised from long-term land leases.
One policy facilitator to promote leasing is to encourage banks to lend against leasehold lands where the government is the lessor. Currently, banks insist on free-hold title registration for loans. This deters private interest in leasehold rights. While there are practical problems associated with the repossession and re-lease of these lands, enabling measures should be explored to ease lending on leasehold rights.
3. Market sale of government lands should be undertaken only under exceptional circumstances and should be structured to maximise value capture. The end-use should be specified, and all the external and possible internal infrastructure should be completed. Ideally, the property development should be done as a PPP, with the government maximising value capture. Such sales should be confined to commercial Class A real estate development.
Such transactions require high institutional capabilities. It’s therefore appropriate that there be a dedicated entity in each state and for all central government departments that aggregates and undertakes such sales by maximising value capture, and that too only for specific use cases. Accordingly, any sales of government land by state or central government departments, agencies, or corporations should be done through this dedicated entity. Their transactions should be as per the suggestions above.
4. Another alternative to outright sales through auctions would be administered price (say, at the guidance value) sales to other government agencies for offices and other public purpose requirements. There’s considerable demand within state and central government departments and corporations for expanding their facilities. There should be a simple mechanism in the state and central governments that simplifies the transfer of government lands across departments and their entities.
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