46264 noTE no. 40 ­ Aug. 2008GRIDLINES Sharing knowledge, experiences, and innovations in public-private partnerships in infrastructure Unlocking land values to finance urban infrastructure Land-based financing options for cities George E. Peterson R aising capital to finance urban infra- debt financing can introduce. Land sales and one- structure is a challenge. One solution is time development charges also can be easier to to "unlock" urban land values--such as administer than property tax systems that require by selling public lands to capture the gains in periodic valuations of all taxable property. value created by investment in infrastructure projects. Land-based financing techniques are Land-based financing of infrastructure can be playing an increasingly important role in financ- divided into three categories: developer exactions, ing urban infrastructure in developing coun- value capture, and land asset management. tries. They complement other capital financing approaches, such as local government borrow- ing, and can provide price signals that make Developer exactions the urban land market more efficient. Developer exactions require developers to go Land has a long history as an instrument of infra- beyond installing infrastructure facilities at their structure finance. When Baron Haussmann rebuilt own site. They oblige a developer to finance part Paris during the Second Empire, he used public or all of the costs of external infrastructure needed powers to acquire the land that was converted to deliver public services to the site. Thus devel- into grand avenues as well as excess land that lay opers are required to build subdivision roads and along the path of reconstruction. The excess land also help pay for major access highways to the served as collateral for borrowing that financed area. They may be required to help pay for the new roadways, water supply, and natural gas and trunk lines that deliver water and for wastewater sewer lines. Gains in the value of city-acquired removal and treatment systems. In some cases land were used to repay the public debt. investment responsibilities are assigned through formal public-private partnerships. In the New Land-based financing is now becoming an impor- Cities area outside Cairo a private developer is tant element of urban infrastructure finance in undertaking $1.45 billion of infrastructure invest- developing countries, especially where cities are ments, including many that are traditionally the growing rapidly. Table 1 summarizes several recent public's responsibility, in return for free allocation land-based financing arrangements and compares of desert land (see table 1). their magnitude with other sources of urban capi- tal investment funds or total capital spending. The scale of land-based financing is surprisingly George E. Peterson is a consultant to the World Bank and large. other international institutions in municipal finance and infrastructure investment. Before retirement, he was senior As part of the capital financing mix, land-based fellow in international public finance at the Urban Institute, financing has significant practical advantages. Washington, D.C., and before that director of the Public Most techniques generate revenue up front, reduc- PUBLIC-PRIVATE INFRASTRUCTURE ADVISORY FACILITY Finance Center of the Urban Institute. This note highlights ing dependence on debt and the fiscal risks that findings of a forthcoming PPIAF Trends and Policy Options book of the same title. Helping to eliminate poverty and achieve sustainable development through public-private partnerships in infrastructure PUBLIC-PRIVATE INFRASTRUCTURE ADVISORY FACILITY TabLe 1 Selected cases of land-based financing in developing countries Location and activity amount and use of proceeds Comparative magnitude Cairo, arab Republic of egypt: $3.12 billion, to be used to reimburse 117 times total urban property tax collections Auction of desert land for New Cities costs of internal infrastructure and in country; equal to 10% of national govern- (May 2007, 2,100 hectares). build highway connecting to Cairo ment revenue. Ring Road. Cairo, arab Republic of egypt: $1.45 billion of private infrastructure Will provide infrastructure for a range of basic Private installation of "public" infra- investment, plus 7% of serviced services covering more than 3,300 hectares of structure in return for developable land turned over to government for newly developed land, without financial cost land (2005­present). moderate-income housing. to government. Mumbai, India: Auction of financial $1.2 billion, to be used primarily to 10 times MMRDA's total capital spending in center land (Jan. 2006, Nov. 2007, 13 finance projects in Mumbai's metro- fiscal 2005; 3.5 times total value of municipal hectares) by Mumbai Metropolitan politan transportation plan. bonds issued by all urban local bodies and Regional Development Authority local utilities in India since 1995. (MMRDA). bangalore, India: Planned sale $500+ million. On hold; land will be Minimum sale proceeds were projected of excess land to finance access used instead for ministry buildings to considerably exceed costs of highway highway to new airport built under and government-built industrial construction and acquisition of right-of-way. public-private partnership. space. Istanbul, Turkey: Sale of old $1.5 billion in auction proceeds, to Total municipal capital spending in fiscal municipal bus station and be dedicated to capital investment 2005 was $994 million. Municipal borrowing former administrative site budgets. for infrastructure investment in 2005 was $97 (Mar. and Apr. 2007). million. Cape Town, South africa: Sale $1.0 billion, to be used to recapital- Sale proceeds exceeded Transnet's total of Victoria & Albert Waterfront ize Transnet and support nationwide capital spending in fiscal 2006; equal to 17% property by Transnet, the national investment in core transport infra- of 5-year transport investment plan prepared transportation authority (Nov. 2006). structure. in 2006. bogotá, Colombia: $1.0 billion collected in 1997­2007, Betterment fees finance 50% of street and Betterment levy. and $1.1 billion planned for 2008­15, bridge improvements. Other planned sources for financing city street and bridge of financing: $50 million International Finance improvement program. Corporation loan; $300 million international, peso-linked bond issue. Land-based Source: Peterson forthcoming. financing can generate revenue up Developer exactions have become one of the main and ultimately to the purchasers of new housing front, reducingmechanisms for increasing private investment in and new business sites. "public" infrastructure. Developers recover the dependence cost of investment when they sell the developed on debt land. Much potential remains for this form of land- Value capture based financing. Consider the United States, where impact fees typically are designed to require that Value capture builds on the principle that the growth pay its own way when it comes to infra- benefits of urban infrastructure investment are structure costs. A subdivision developer may be capitalized into land values. Because public invest- required to pay as much as $35,000 per standard ment creates the increase in land values, many housing unit to finance the off-site infrastructure land economists have argued that government costs associated with growth. should share in the capital gain to help pay for its investment. Public authorities have used a variety Best-practice impact fees are based on urban of instruments to capture the gains in land value development plans that identify the incremental created by infrastructure investment. Betterment infrastructure costs associated with development levies, which impose a one-time tax or charge on at different locations within the urban region. gains in land value, are one such instrument. Most Formal analyses of this type may be impractical countries in the world have experimented with in developing countries given their planning and betterment levies at some point, typically taxing data requirements. But simple versions of develop- away 30­60 percent of the gain in land value ment fees likely will be used to shift larger shares attributable to infrastructure projects. of public infrastructure costs to private developers Unlocking land values to finance urban infrastructure Under modern conditions, betterment levies have proved difficult to administer. Attempts to identify with precision, parcel by parcel, the gains in land FIguRe 1 value resulting from public works projects have Infrastructure investments in Recife, brazil, create clear gains in land value proved both ambitious and contentious. And the Gains in value by distance from city center tax rates, at 30­60 percent or even higher, are too (US$ per square meter) high to impose unless accuracy in measuring the 12 tax base can be assured. For this reason, better- Land-based ment levies have fallen out of favor as a significant 10 Water supply revenue source, often in the face of court judg- financing also Road paving ments challenging the assessment process. 8 Wastewater comes with Colombia long has used a form of betterment levy, 6 important risks contribución por mejoras, to finance public works. 4 But reliance on the scheme declined sharply in the 1980s and 1990s, for the same reasons found 2 elsewhere. Gains in land value due to infrastruc- ture projects were difficult to estimate. The process 0 5­10 km 15­20 km 25­30 km involved high administrative costs and led to countless legal disputes. In the past several years, Source: Smolka 2007. however, Bogotá has simplified its approach and converted the betterment levy into a general infra- structure tax more loosely associated with gains in land values are affected by different types of urban land value. infrastructure investments, at varying distances from the city center. The author estimates that, on Rather than estimate parcel by parcel the gains in average, investing in wastewater removal leads to land value due to individual investment projects, gains in land value 3.03 times the cost of invest- Bogotá has packaged its street and bridge improve- ment, paving roads to gains 2.58 times the cost, ment program into a citywide bundle of public and providing piped water supply to gains 1.02 works projects, all financed in part through a city- times the cost. wide betterment fee that is broadly differentiated by benefit zone and other factors. Thus Bogotá has been able to revive valorización as an effective infra- Land asset management structure financing tool. The approach is being replicated throughout Colombia. Value capture seeks to recover gains in land value specifically attributable to infrastructure invest- Value capture through public land sale is another ment. Land asset management recognizes that the vehicle for recouping public infrastructure costs. balance sheets of many public entities already are It involves the sale of land whose value has been top-heavy with urban land and property assets. enhanced by infrastructure investment. If the At the same time the cities in which the property public sector owns the land, it can internalize is located suffer acute infrastructure shortages. the benefits of public investment and capture Under these conditions it can make sense for the gain through land sales. China has financed a public authorities to exchange land assets for infra- large part of its urban infrastructure investment in structure assets. They do this by selling or leasing this manner. For a major urban highway project, a publicly owned land and using the proceeds to municipality can transfer the land surrounding the finance infrastructure investment. Rather than highway to a public-private development corpora- using land-based financing instruments to finance tion. The corporation borrows against the land individual investment projects, public entities as collateral, finances highway construction, then undertake a strategic examination of their balance repays debt and obtains its profit by selling or leas- sheets and decide to exchange underused or vacant ing land whose value had been enhanced by access land for infrastructure. to the new highway. Several of the transactions summarized in table The potential for recouping infrastructure costs 1 are of this type. As can be seen, urban land from increases in land values is illustrated by sales have the potential to generate substantial metropolitan Recife, Brazil. Figure 1 shows how revenues. At the same time the sale of valuable, vacant land parcels accelerates private investment prices unduly, and distort urban development in locations that are critical to urban develop- patterns. ment. As important as the revenue yield is the policy rationale underlying the transactions: that municipal governments and infrastructure agen- Conclusion cies should adopt more strategic methods of land asset management. A critical element of this Land-based financing offers powerful tools that approach is to divest noncore land assets so that can help pay for urban infrastructure investment. government can concentrate its financial resources For an urban region considering this strategy, a and management attention on core infrastructure logical place to start is with an inventory of land responsibilities. The sale of government-owned assets owned by government agencies. Such an land has the added advantage of steering private inventory would identify current land use and the investment to areas where it is most productive and market value of land. The government can then filling in gaps in the urban development pattern. decide which land parcels would be more beneficial to urban development if sold to private develop- ers, with the proceeds dedicated to infrastructure Risks of land-based financing investment. Where such inventories have been carried out, the government typically discovers There are important risks associated with land- that public agencies own far more undeveloped based financing of infrastructure. Three risks in land than it had realized. particular deserve emphasis: Next, public officials should address the potential · Urban land markets are volatile, and recent transac- for developer exactions and related fees. Prelimi- tions may reflect a land asset bubble. Urban land nary analyses for Mumbai, India, for example, have prices in developing countries cannot steadily concluded that if Mumbai is to finance its ambi- increase by 20­30 percent a year. So it is critical tious long-term development plan, developer fees that proceeds from land sales or other forms of or similar new, land-based financing techniques land-based financing be used for infrastructure will have to generate more than $10 billion to investment and not be allowed to trickle over to finance infrastructure investment. Developers are the operating budget, where current spending receptive to such charges (which will be passed can become dependent on unrealistic expecta- on to buyers) as long as they help streamline the tions of future land price increases. process for development approval. · Land sales often lack transparency and accountabil- Value capture then can fill in specific gaps in ity. Many land sales are conducted off-budget the infrastructure financing plan. A generalized through private negotiation. Studies have shown approach to betterment fees, such as that used that competitive auctions can greatly enhance in Bogotá, becomes politically acceptable when a revenues--in some cases increasing the realized majority of the population believes that the bene- land price per square meter by a factor of 10 or fits of infrastructure improvements outweigh the more. Equally important is transparent public tax costs. This has been true most frequently of accounting for the use of revenues. Otherwise road improvements and other transport projects the large sums produced by land sales invite with highly visible payoffs. corruption or bureaucratic capture by the GRIDLINES agency that has legal title to the land. References Peterson, George E. Forthcoming. Unlocking Land Values to Finance Gridlines share emerging knowledge · Government authorities may be Urban Infrastructure. Trends and Policy Options Series. Washington, on public-private partnership and give an DC: PPIAF. overview of a wide selection of projects from tempted to use restrictive zoning to drive Smolka, Martim. 2007. "La regulación de los mercados de suelo en various regions of the world. Past notes can be up land values or abuse developer America Latina: cuestiones claves." Paper presented to the seminar found at www.ppiaf.org/gridlines. Gridlines are a exactions when strapped financially. "10 años de la ley 388 de 1997: sus aportes al ordenamiento publication of PPIAF (Public-Private Infrastructure Such practices can harm the PUBLIC-PRIVATE INFRASTRUCTURE ADVISORY FACILITY urbano y la consolidación de políticas de suelo," Bogotá. http://www Advisory Facility), a multidonor technical assistance local economy, raise real estate .territorioysuelo.org. facility. Through technical assistance and knowledge dissemination PPIAF supports the efforts of policy makers, nongovernmental organizations, research institutions, and others in designing and implementing strategies to tap the full potential of private involvement in c/o The World Bank, 1818 H St., N.W., Washington, DC 20433, USA infrastructure. The views are those of the authors and do PhOne (+1) 202 458 5588 FaX(+1) 202 522 7466 not necessarily reflect the views or the policy of PPIAF, PUBLIC-PRIVATE INFRASTRUCTURE ADVISORY FACILITY geneRaL eMaIL ppiaf@ppiaf.org web www.ppiaf.org the World Bank, or any other affiliated organization.