Territorial Gains: Land value capture in the post-Covid-19 era

12 Apr 22
Could the impact of Covid-19 on land prices scupper models designed to capture the uplift in values brought about by development?

Any economist will tell you that investing in infrastructure is critical in driving growth, not least when attempting to rebuild an economy following a severe downturn. Well, economic downturns do not come much steeper or deeper than those prompted across the world by the Covid-19 pandemic.

The problem is that the pandemic also cost governments eye-watering amounts of money. As a result, many are reluctant to borrow more, for fear of spooking the rating agencies and thereby landing themselves with higher interest rates and higher borrowing costs, which in turn would make paying down the debt all the more difficult. Whatever its public justification, the UK government’s decision to effectively axe the eastern leg of the HS2 high-speed rail link at the end of last year was likely to have been partly based on considerations surrounding debt.

Land value capture mechanisms may be able to help. While they vary enormously (see panel, p30), LVC schemes allow governments to demand a cut of any increases in land value that occur only as a result of their actions.

Putting in place effective LVC policies is therefore an attractive proposition, so long as they are not so punitive that they discourage private sector development. So, how should governments approach LVC in the wake of the pandemic?

First up, let us define terms. “Land value capture is a policy approach enabling communities to recover and reinvest land value increases that result from public investment and government actions,” according to the OECD. “It is rooted in the notion that public action should generate public benefit.”

Regardless of Covid-19, the OECD believes that macroeconomic trends are making LVC ever-more important for cities around the world.

“As challenges mount from rapid urbanisation, deteriorating infrastructure, climate change and more, this funding source has never been more important to the future of municipalities,” it says. “When used in conjunction with good governance and urban planning principles, land value capture can be an integral tool to help governments advance positive fiscal, social and environmental outcomes.”

Community infrastructure levy

There are, however, challenges.

In the UK, for instance, one form of LVC is to be found in the relatively recently introduced community infrastructure levy scheme. Under the policy, local authorities are able to draw up charge sheets, setting out how much developers will be charged per m2 for different types of development in various locations.

Drawing up such documents is complicated and time-consuming – and can be challenged – but the ability to implement a CIL also appears to be a luxury that, mainly, only already wealthy areas can afford, which rather undermines at least part of the point of LVC.

Areas with low land values, after all, tend to be desperate for investment and do not want to create impediments, while developers argue that they are already dealing with lower profit margins in such places.

“In particular locations, it does work quite successfully,” says Malachy Buck, an academic at the University of Liverpool. “In London, the South East and a few other areas, the CIL works really well.

But in the lower-value areas, where there are issues with viability, it is a bit more challenging. Often, it is about developing brownfield land, so there are remediation costs and other expenses in the development process.

It means that often there is not enough money.”

Buck believes that the CIL needs to be reformed by introducing a redistribution mechanism, whereby some of the receipts from the CIL in areas of high land value would be sent to lower-value areas.

“Without there being some kind of mechanism to share the benefits from high-value to low-value areas, it does become a bit of a vicious circle,” he says.

Despite the problems, the potential for LVC policies to deliver for the public good is substantial – and it has never been more important that they are implemented effectively and efficiently.

In a recent paper, Olga Kaganova, a consultant to the World Bank, points out that the extra financial distress inflicted by the pandemic is huge.

“The Covid-19 crisis has created additional strains on municipal infrastructure and service delivery budgets,” she says.

“As a result, local governments around the world are examining opportunities for further revenues and savings, along with new ways to deliver public services. In this regard, LVC instruments have come into focus as tools that can help cities to both enhance their municipal incomes and to reduce their expenses.”

However, any LVC system would need to take account of changed circumstances.

Firstly, it is not entirely clear what the long-term effect of the pandemic will be on infrastructure requirements. If, for instance, a substantial proportion of a city’s workforce continues to work from home – or only commutes into the city centre a couple of days a week – is that shiny new mass-transit system required any more?

Then there is the question of what impact the pandemic has had on land and property values.

This is a complex picture that varies across different property sectors. On the positive side, the latest market report by the Royal Institution of Chartered Surveyors makes it clear that owners of designated industrial and logistics sites have seen values surge after Covid-19 turbo-charged the already established move towards shopping online and having goods delivered. On the flip side, retail sites have plummeted in value for exactly the same reason.

Space outside the city

Residential values have also been affected. In the UK, values fell at the start of the pandemic, but, according to real estate adviser Savills, both land values and market activity had returned to pre-pandemic levels by the end of 2020. However, the more interesting story is a spatial one, with many people looking to move out of cities in order to find more space – a trend that is not unique to the UK.

“In the short term, there has been a pronounced shift in terms of property prices and the value of land,” says Jeffrey Matsu, who is currently chief economist at CIPFA but has previously worked at RICS.

“We have seen the gap narrow between, say, inner London residential prices and those of the suburbs,” he adds. “That reflects the idea that because we have had two years of working from home and employers and managers have become more comfortable with this arrangement, a lot of professional jobs can be done remotely. As a result, there is a premium for being outside the city. Whether that will be sustained, I do not know.”

Such uncertainty makes life very difficult when it comes to LVC mechanisms that are predicated on charging developers at the point of gaining planning permission, based on assumption of future sales receipts. In addition, many developers would recoil at any proposal that would hit their pockets just as they themselves are emerging from the pandemic.

Upfront charges levied before a developer or housebuilder has actually realised any value from a project would be strongly resisted and could be hard to implement.

The political dimension may bring another significant problem, warns Matsu. “Something that seems economically sensible and reasonable may not be palatable politically, as there are vested interests,” he says.

“Homebuilders are big supporters of political parties. That is just the reality of politics and how lobbying takes place. It is not unique to the UK by any stretch of the imagination. These types of dynamics exist in the US and around the world.”

Time to innovate

That does not mean that it is impossible to introduce another form of LVC, however. Adam Mason, director of infrastructure and transport strategy at consultancy KPMG, says that a proportion of the uplift in value could be demanded at the point when the value is derived.

“There is a feeling that capturing a share of the windfall when it is realised would make most sense to people,” Mason says. “It is when it is most palatable. Having to pay an upfront levy creates an issue in terms of cashflow.”

Such an approach, of course, would mean the public sector waiting longer for payment, but Mason points out that governments can generally take a long-term view. “Governments have a low cost of capital, and, with any of these changes you would need to take a long-term view, which governments are probably best placed to do. Within a period of time, that issue goes away. There is always going to be a transition.”

So, designing effective LVC instruments is inherently complicated – if it was not, a preferred model would have already been implemented. However, given the state of global public finances following the pandemic, pursuing such strategies is more important than ever.

“I think that certain cities will come back to some extent, so value capture conversations will start again,” says Mason. “There is a need to invest, and, with public finances around the world constrained over the next few years, you are going to have to get the beneficiaries of investment to pay more, rather than looking to the general taxpayer.”

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