How to eliminate property industry rent-seeking

The property industry, and the political elite whose pockets are lined by awarding favour, have successfully hidden the greatest rent seeking scam in Australia – town-planning amendments.

Australia’s rich list is littered with fortunes made from an industry that on the surface appears competitive, and should not be overrepresented.  Such a pattern suggests there are rents being secured at low cost, making property development especially lucrative.

Here’s why.

Each time an area is rezoned to increase the potential development density, by relaxing height and density restrictions for example, the landowner is gifted a new property right that greatly increases the value of their land.  They pay nothing for the privilege – it is a pure economic rent.

This rent is the prize pay-off for the development lobby groups, whose land-banking members make most of their money by lobbying for favorable planning changes in areas where they have bought land at a price reflecting lower value uses.

It makes sense to plan a city – to direct development to align with geographical, environmental and structural goals.  But it also makes sense to change the town plan when circumstances change.

So why do landowners receive new development rights created by town planning changes for free?

Miners pay royalties as a fee to the State for their rights to minerals.  Farmers now need to buy rights to water from rivers and groundwater systems if they want to expand their irrigation.  Even greenhouse gas emitters will soon need to pay for the newly created rights to pollute. But when rights are created under planning schemes, they are simply given away. And all we hear is silence.

There is a better way that simply borrows the principles applied elsewhere.  When the government (in this case, usually the Council) creates a new property right, it sells it, rather than giving it away for free.

These development rights could be auctioned or sold at a fixed price, and would most likely ‘attach’ to the land title once bought by the landowner.  There would be no limit on the quantity available in a particular area, but physical limits of developable sites would mean a finite amount of demand for these new development rights in any case.

Selling and trading development rights is not uncommon globally.  In Brisbane, the right to develop the air space above Milton Rail Station was sold to a private developer.  The Brisbane City Council has considered selling development rights that may have existed on the site of City Hall, which would attach to the property title of the buyer’s other CBD property.

Victoria is considering similar programs of tradable development rights as a way to better manage urban sprawl.  In Germany, a simulation study of 14 municipalities has been undertaken to examine the usefulness of tradable development rights to conserve agricultural land – essentially it is an urban development cap and trade scheme.

I am sure there are plenty of town in the US experimenting with similar programs.

But why should such rights be gifted in the first place, whether they are tradable or not? The physical attributes of property rights are a gift from nature, while legal property rights are costless for the State to produce.  Yet the rights are extremely valuable in the private market.

The chart below shows the gains to private property owners when town-planning rules allow them greater development intensity.  In red is the property value reflecting the previous highest and best use allowable under the plan, or the property right as it was previously defined.  The blue area is the gain – the economic rent, or the value uplift – that the owner receives for doing absolutely nothing (except maybe some political lobbying).

The dotted box is the revenue I expect the government to make from selling new development rights created under planning instruments to land owners, which will probably be a fraction less than the full rent.

How does this work in practice?

A property owner would seek a planning approval under existing planning assessments. The approval would stipulate how many of the rights they would be required to purchase to proceed. If they gain an approval for the maximum allowable development, they need to buy that amount.  But if they seek approval for a lower density development, they may only need to purchase the rights reflecting the proposed density.  These rights could be packaged in increments of Gross Floor Area (GFC), say 100sqm, for each type of land use allowable under the plan, such as commercial, industrial or residential. The would sit in a pubic register, and transaction recods would be publicly available.

The relevant council entity could determine a set price for the new rights for each area under the plan using simple valuation tools.  Alternatively they could host auctions periodically for a fixed quantity of rights.

This proposal has a number of benefits

  1. Development below the ‘highest and best’ use can be profitably achieved, since development rights only need to be acquired for the scale of development proposed. This may be attractive for many small scale developers.
  2. The market for speculation, or ‘landbanking’, in order to appropriate gains from future planning changes will close.  To avoid speculative market behavior, a secondary market in these new rights should not be allowed (meaning all rights must be purchased from the local government directly).
  3. It would create a partial land value tax from the time of implementation onward.

The revenue to councils can be used to reduce other distortionary taxes and fees, and support better provision of local community services.  It would also level the playing field in the development industry by removing the rent-seeking element of competition, and is an effective way of sharing gains from urban development with the broader community.

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  1. Only those caught with property banks at the implimentation time will be penalised. After that, it’s back to normal.Development costs will be factored in to the project, no matter what they are at the time.

  2. Too much complication for no real benefit.

    Start with reasonable zoning and town planning rules, and you dont need constant rezoning. Town planning in this country is absolutely woeful, and the infrastructure mess and ridiculously complicated planning rules are a direct result.

    I think most would agree that the quality of property that was built before all these extra codes and rules were brought in is better than the stock of property being built today. None of it is needed.

    There is no thought to unintended consequences either. I’m not allowed to cut down a tree in my backyard. As a result, i will not plant any trees. That rule doesnt actually help keep suburbs green (its not like trees were absent before this stupid rule was put in place).

  3. Landbanking likely sites and waiting for cities to grow or lobbying for rezoning is one of the oldest profit machines around. Your conclusion – developer levies – is far from a complete answer to the problem of private capture of public investment and rising wealth. Government would have to identify where the alleged uplift occurred, fight those landowners endlessly through the courts while they rolled out teary widows and hardship cases – an administrative nightmare the next government would instantly reverse.

    Better to let market prices show who benefited and claw some of this back.

    If we used Land Value Tax to capture some of this uplift, we could eliminate a great deal of the tax burden on wages and enterprise. See: Australia’s Future Tax System.

    LVT does not distort economic activity as it cannot be passed on or evaded or offset.

    Further, LVT drives landowners to put their holdings to their best and highest use – because that is what they are assessed upon. Here is a giant spur to development. No Stamp Duty makes buying and selling a breeze, increasing the velocity of land sales.

    And even better, if government builds a dud rail line or road, land prices wont rise, so no LVT for them!

    This is the great reform western economies are screaming for, but one that would be resisted by the 1% and every two-bit negative gearer out there who thinks they have boarded the gravy train.

    • I am also a proponent of land value taxes to replace distortionary taxes (such as income taxes).

      However, one problem I see with land taxes is one of the reasons you support them –

      “LVT drives landowners to put their holdings to their best and highest use – because that is what they are assessed upon. Here is a giant spur to development. No Stamp Duty makes buying and selling a breeze, increasing the velocity of land sales.”

      Imagine you’ve just bought a plot of land and built and warehouse. Then with a change in government the area is rather quickly rezoned to a much higher value use. You have just sunk millions into you business (land and construction), and now you will be slugged with a massive land tax because of a political decision.

      My proposal avoids this, and the value of the new development rights does capture close to all the rent (after all, it is simply the capitalised rent on the new rights).

      It allows people who have bought into an area in good faith that their right is ‘secure’ to not be exposed to ‘paying the rent’ until they actually derive a benefit from the rights.

      • Cameron – property owners lose money every day on political decisions to change road use, parking areas, access, signage regulations.

        Look what the parking restrictions did to the retail in Milton Road at Auchenflower (ex Nightowl premises and surround)

        Values were halved on the stroke of a pen to change parking.

        You won’t find a perfect solution.

        • I agree 100% Peter. But reducing unanticipated political mingling in markets is generally a good idea, and I would hope that my proposal would be one step in the right direction.

          • Well I support the principal 100% and I think that discussing the issue and looking for solutions outside the old world square is commendable, but it’s no easy task.

            I wish you well – have you got that sort of pull in the Qld corridors of power?

            There is also the lack of any serious political leadership both at state and federal level to deal with.

            The mountains are high and the rivers deep where you are trecking, but best of luck.

  4. That is an interesting proposal. Certainly developers do benefit financially from a zoning change, so there is likely to be merit in this, although charging for the right to a greater density or the right to subdivide won’t reduce the coast to the end consumer. They will pay.

    What do you propose for area rezoning that wasn’t requested by the land owner, but is as a result of the local authority intentionally encouraging unit or commercial development in older residential areas. The land owner does get a financial benefit, but it may not be wanted, and they are asked to contribute higher rates as valuations rise accordingly.

    EG if the BCC suddenly rezoned all lots on the southside of Waterworks road as commercial – many residents wouldn’t even know for some time.

    You may cause some social problems, and get the reformist council voted out.

    I still prefer a state land tax which financially encourages homeowners to sell allowing development of land that would otherwise possibly wait until that homeowner passed away and the estate was sold in the normal course.

    You could say that was similar to a higher rate payment, but a broad based land tax could replace the stamp duty on sales making our workforce more mobile.

    Our current system gives excessive rights to the individual to simply sit on the land if they choose not to sell, but we can’t just eliminate all of an individuals rights.

    Anyway congratulations for having a go at thinking outside the square – all great ideas have to start somewhere and then become refined by debate, either in public or private.

    Anything that stimulates debate and increases awareness of the internal problems within the system is a step forward.

    • Thanks for the support Peter.

      You say ” although charging for the right to a greater density or the right to subdivide won’t reduce the cost to the end consumer”

      It won’t add to the cost either. It is just a transfer between landowner and the state.

      To your question – “What do you propose for area rezoning that wasn’t requested by the land owner, but is as a result of the local authority intentionally encouraging unit or commercial development in older residential areas. The land owner does get a financial benefit, but it may not be wanted, and they are asked to contribute higher rates as valuations rise accordingly.”

      My proposal would mean they pay nothing extra (their property value would only rise incrementally as its relative location in the city improves). But they get almost no financial benefit either.

      Remember, though, we are not eliminating any rights. The council become in the business of creating new rights and selling them to the market. That would align council’s incentives even more in favour of new development (since they receive more revenue when people take advantage of new planning controls). But is allows the market to function quite fairly within the rules.

  5. Yes but did you take into account that most landowners/purchasers are aware of this and factor this in to the sale price…?

    • Another beautiful feature of LVT: when the market recognizes potential by repricing land, that new valuation becomes the reference for the tax base. If the potential is acted upon with development, all benefit – INCLUDING THE LANDOWNER!

    • Indeed, awarrumbungle. Many people seem to believe it’s when the town planners hatch in a new colour on the lots in a planning scheme, or when council grants greater intensity within a particular zoning, that the market value of allotments increase.

      People acquainted with the land market know that values rise very close in anticipation to any new permissable development potential well before this happens. These windfalls are rarely, if ever, overnight phenomena. Therefore, David Collyer’s assessment that annual capture via LVT will pick up these increases whenever they occur–and factor them into future years too–makes sense.

      The problem of inadequate land value capture over the years could be addressed by bringing everyone into the land tax net and abolishing stamp duty and payroll taxes, as Ken Henry has suggested.

      • BK –

        + Yes.

        I think that we almost have a concensus here, but not in the electorate where it matters.

        But it’s a start.

      • “…values rise very close in anticipation to any new permissable development potential well before this happens. These windfalls are rarely, if ever, overnight phenomena.”

        Bryan, this is exactly the type of speculation that will be eliminated in my proposal (although maybe I wasn’t clear on that point). After all, the rise in value in anticipation of planning changes is simply the price of a gamble. Governments come and go, and back-flip on their planning intentions from time to time. And the odds on this gamble can be improved when you have close political connections.

        Why bid up land in anticipation when you know you will have to buy the new rights to develop anyway? There may be a little price action, but it will be treaty reduced.

  6. Interesting thoughts. I think we should be encouraging more development though. I would even go as far as removing the GST on new properties.

    • I would end GST completely. This is a subtle version of the old British Corn Laws (they taxed bread, which the poor must eat). Low and middle income earners pay a greater proportion of GST as they consume most of their incomes. The wealthy save more, consume financial products like interest and take overseas holidays – none of which are GST-able.

      • But bread attracts not GST? I say increase GST as it hits at consumption (but continue to make necessities GST free- sorry another blog topic)

      • David – and then the black marketeers would pay no tax at all.

        Sure the tax is a little onesided, but making it completely one sided is not a step forward.

        And then there is the inevitable increase in personal income tax which will be needed to replace the GST – is that really equally spread across all, or do some enjoy tax breaks?

  7. Google “Badgery Creek McGurk”
    Any thing that can get rid of sleazy Ba#@#@ds involved in this racket in NSW, is most welcome.

    • Totally agree, the only issue though is the big guys behind all of this never seem to get fingered, google, tripodi, keneally and badgery creek which was to be the 2nd airport. Also another good one is Arib and Roesandal. I am becoming more and more convinced we need a Wat Tyler. The other side are no good either particularly the Hillsong faction with their links to ACR ( australian capital reserve)

  8. Wouldn’t simply freeing up property development as per the suggestion of several Macrobusiness bloggers be the best thing to do? This would eliminate the incentive to land bank in the first place.

    • +1. Cam’s proposals treat the symptoms whilst ignoring the cause. ‘Planning gains’ as articulated by Cam are only possible in markets where land is constrained in the first place, usually via regulation / government interference. Remove these constraints and the opportunities for planning gains evapourate.

      Cam’s suggestions are sound under the current system. But better outcomes could be achieved by overhauling the system instead.

      I’ll elaborate in a seperate article soon.

      • Exactly!

        Taxing windfall profits only short circuits the markets ability to respond to rising prices or even massive profits around development.

        Sure it prevents to a degree the market going into a condition of glut but it has no ability to prevent price going stratospheric.

        As you say fix the problem. Taxing windfall profits as they call them only makes it worse.

        Should add to a large extent what Rumplestatskin is talking about already happens, particularly in the Sydney basin. Exactly why on the one hand the government can say; “but we released enough land why is no one developing it, not our fault”. In many cases it is not viable to develop post taxes whatever the planning regime is for the area. Unfortunately when a beureucrat sits down and calculates what the cost of a development is v the potential profit they fall well short of what a developer is prepared to take on as risk. This is especially true of the fringe areas like the central coast.

        I actually think this issue is at least as important to costs / prices of new supply around Sydney to town planning issues. Indeed this can be evidenced in the low cost per block of procuring the land compared to the overall cost of development, the biggest chunk of which on the outer fringe is federal (GST), state (developer levies) and local (S94 contributions) taxes.

        Finally what would one think the government would do if given this situation of taxing the profit / windfall gain on planning relaxations. Given they are in the unique position to increase what this windfall gain is on a block I can make a few obvious suggestions to increase it…

        • tom32,

          ” Exactly why on the one hand the government can say; “but we released enough land why is no one developing it, not our fault”. In many cases it is not viable to develop post taxes whatever the planning regime is for the area.”

          If they can’t develop for a profit, they paid too much for the site. Every developer knows you make your money on the site purchase.

          • Agree it all starts when you buy the lot in the first place. This is why they sit on the market. Meanwhile some punter wonders why no one will pay 2million for his 6ha. of land when the final achievable price post development is well in excess of 10million for all the individual finished blocks.

          • Look forward to it. I think we’ve wasted enough column inches trying to argue this with Cam before.
            Alan W. Evans’ text books are the last word on this. His discussion of “planning gain” and its relationship with fees, is very illuminating. Fees are not an “addition” to “planning gain”, they are a “share of planning gain”. They lower the amount realisable by the original seller of the land to the developer.

          • Phil. You say “Fees are not an “addition” to “planning gain”, they are a “share of planning gain”. They lower the amount realisable by the original seller of the land to the developer.”

            Which is exactly my point here. The payment to council for new development rights would approximate the bulk of the planning gain (shared mostly with council rather than the land owner), which you rightly point out, would all come off the price paid for the site to the previous owner.

          • And the point is…….?
            Keep housing bubbles inflated, keep cycles volatile, perpetuate wealth transfers from the young to the old, destroy productivity and economic competitiveness….? Just as long as government gets close to 100% of the planning gains that cause all this, you have no problem with the rest of it?
            Do you propose to quantify the price increase effect of fringe “planning gain” on ALL urban land, and have government appropriate this too? Why stop at the owners of fringe land?
            In fact, MOST of the wealth transfers from the young, involve their purchase of their first home in established areas that have had the prices inflated by the natural effect of “differential rent” i.e. the advantage of location over that of the fringe.
            IF it is electorally a given that urban growth must be strictly planned and controlled, then I say the government must compulsorily acquire land at low prices for the purpose of development in the “approved” fashion – eg “T.O.D.”. Otherwise, the plans will deliver a response in prices to a far greater extent than they will deliver an actual change in urban form. Increases in the prices of Real Estate at the planners favourite locations will “price out” new entrants to that location long before the numbers desired by the planners, have actually re-located.
            But you can bet that IF “saving the planet” WAS the real reason for all this, and hence compulsory acquisition was perfectly excusable, all the property owning interests who are the “money talks” factor, would suddenly change their opinion about “saving the planet”.

  9. The ACT (Canberra) has already been experimenting with this through two mechanisms:
    1. changing the relevant legislation to make use a ‘development’ (in 2005)
    2. setting a change-of-use fee that is determined by the increase in land value due to a change of zoning or use (densification is a good example).

    There was recently a few upset developers when the CUC fee was changed to actually reflect increased values rather than being the token fee that had been charged.

    Note: All land in the ACT is technically leasehold, but people pay freehold prices becaue the lease is pretty well a perpetual 99-year lease.

  10. The idea of transferable development rights is currently used in the Sydney CBD. Developers can purchase ‘heritage floor space’, which is brokered via Council, to achieve a density bonus on a site. The heritage building the floor space originates from is then protected from further development. This is obviously a localised situation, but the principles are the same for the Victorian experiment with agricultural land.

    Still, there would be huge impacts on land owners if this was implemented, and not just land bankers.

    Property is an asset purchased for a number of reasons, one of which is investment/speculation/potential growth, however you want to say it. Would you propose a similar ‘profit cap’ on speculating on shares for companies that might be bought out for a higher price? I realise this is not a direct comparison, but where to stop…

    • Actually, I don’t see it having much of an impact on most property owners. It won’t stop investment, it merely transfers the valua gains from new rights from the previous land owner to the council.

      It is not a profit cap, just and the development rights trading in Sydney is not a profit cap.

      One principle aim is to stop speculative buying that is essentially gaming planing changes and is susceptible to political lobbying.

      • Good luck – you have learnt very little from reading Alan W. Evans.

        In Britain, “shares of planning gain” now get explicitly negotiated for YEARS, between incumbent land owners, developers, councils, consultants, local interest groups, and more recently the national government has decided to get in on the act too.

        No-one here gives a rap for the first home buyer – “planning gain” is something to be maximised, not minimised.

        “Affordable Housing” means MINIMISING planning gain. Simple. Not rocket science. This is how it works in markets unrestrained by planning constraints.

        I am pleased to see that the NZ Housing Affordability Commision of Inquiry has correctly identified that “planning” for urban growth needs to involve the provision of between TWENTY and FIFTY YEARS supply of land, if housing affordability is to be maintained. Full marks to them. Evans is one of their sources.

  11. Jailing a few dozen local councillors and town planners for taking kick backs would be a good start.

  12. SkoptimistMEMBER

    This is a fantastic idea. Lets hope that more governments adopt this approach.
    I am certain there will be loads of resistance.

  13. Rump, your analysis conveniently leaves out the fact that the impact of increased density limits also increases the amount of rates due to the council each year into perpetuity (which would be valued at a significant premium to a developer’s once-off development profit!). Also the higher density would require higher infrastructure contributions to council from the developer. Also, if the developer makes a higher profit, the gov’t benefits from higher income tax and GST on the sales of the new dwellings. Finally, council gets efficiencies from the delivery of services to a concentrated area as opposed to an increasingly wider urbanised sprawl.
    Seriously, sometimes you economists need to talk to some real people instead of just playing with your numbers all day. But then, it is just too easy to beat up on the grubby, rich developer isn’t it? ;-P

  14. Very interesting piece.

    You are suggesting the cause of this issue is lobbying from industry groups interfering in the town planning process. Do you really believe that introducing a secondary market for development rights will eradicate this activity? I’d suggest that all you will achieve in practice is move the lobbyists interference straight into the secondary market.

    • My experience suggests that the ‘free money’ from changes to the rules of the game is the key driver of rent seeking. I’ve been involved on both sides of this little game.

      You are right that the game would shift to the secondary market for development rights. But, I proposed NOT to have a secondary market. You can only buy new development rights from the council, that would attach to your piece of land (you would need to show ownership, or an option to buy the relevant block of land to purchase). If the developer cannot then get the project off the ground, the rights stay with the property when they sell.

      • Same point with buying direct from the council, lobbyist perhaps having even more influence over councils on price setting. I think there are definitely benefits to your suggestion, it is just whether they outweigh the costs.