Why the Grattan Institute is wrong on value capture
Sebastian Davies-Slate, Rohit Sharma and Peter Newman, Curtin University | 20 March 2017
The Grattan Institute has produced a worrying report on value capture. It appears to be doing the bidding of traffic engineers who are very worried by the shift away from their “dark arts” to one involving the urban development market. Last week there were three seminars/conferences in two days in Sydney and one in Perth. All were heavily attended by people looking to find out how we can make an Australian model using value capture, or what we call “value creation”. The Grattan report gives no help whatsoever on how to do this but, like the Infrastructure Australia report before it, says, “Let’s be realistic”, which means, ‘Let’s not change.” Here are our detailed comments.
There appears to be a consensus forming among policy institutes and commentators in Australia that there is limited scope for alternative methods of funding infrastructure in this country.
This view is understandable if value capture is viewed only as a potential new source of funding or financing for what is basically a business as usual approach to transport procurement. This BAU approach involves determining the need for a particular transport project first, with the associated development and city-shaping opportunities considered after all of the transport planning decisions have been made, if at all. This is an improvement on the current situation, but much more is possible.
This is reflected in the Grattan Institute’s value capture report, which suggests that the only workable way to capture value is through a government levy, while neglecting the potential for private participation in the process. This is clear from the Sydney case study mentioned in the concluding section of the report.
The Curtin University Sustainability Policy Institute contests this pessimistic view of alternative funding options for public transport.
One contemporary example is the Réseau électrique métropolitain in Montreal, Canada. This project is a 67km metro system, estimated to cost C$5.9 billion. Of this, the provincial pension fund Caisse de depot et placement du Quebec has offered to provide C$3 billion, from the funds it manages.
Although the Caisse is ultimately owned by the Government of Quebec, it is contributing to this project on commercial terms, and under an agreement with the Government that guarantees its independence.
Sources of funding
CUSP contests the premise in Recommendation 1 of the Grattan Institute’s report that infrastructure can only be funded through taxes or user charges. Development-based models, such as those employed in many East Asian cities, are neither of these.
Through land ownership, the additional value created by new rail infrastructure can be directed towards funding that infrastructure. This sort of funding is additional to user charges and taxes.
Betterment levies and other government taxes or charges
Area-specific betterment levies to fund transport infrastructure are an improvement on the current situation, but are not ideal.
As the Grattan report has described, there are a lot of complications around identifying the appropriate catchment area and agreeing on the effect that the infrastructure has on a particular property. This has resulted in resistance from the property industry, concerned that they will be subject to additional taxes.
However, cities have an existing tax base to capture any windfall gains due to rail. Econometric models such as the hedonic pricing model can show this windfall gain. Even in the case of a recession resulting in a falling land values, the residents would still pay the existing taxes though the rate can fall.
By contrast, CUSP has proposed a new approach titled the Entrepreneur Rail Model, which involves harnessing the profits from land development and land use change to fund urban public transport infrastructure. This is the value creation approach.
The Entrepreneur Rail Model
The Entrepreneur Rail Model reverses traditional transport and city planning by putting development opportunities first, with the transport solution planned afterwards, to meet the desired development outcome.
Much of the first generation of railways was built in this way. This included tramway estates, built by land developers, such as the Nedlands Park Tramway Estate in Perth. Another example was the Midland Railway extended far to the north of Perth, through undeveloped wilderness areas. The company received no cash subsidy, but rather grants of undeveloped land that required a rail connection.
This same concept underpins the highly successful rail development models employed successfully in Hong Kong, Tokyo, Singapore and other cities. The approach has been heavily supported by the federal government and at least three state governments in the east are pursuing this model.
In Perth we have suggested that the sites for redevelopment that could be unlocked in value by a modern light rail include: Curtin University’s planned new campus, sites along Kent Street, Albany Highway, the Waterbank Development at the Causeway, sites along Wellington Street or St Georges Terrace, sites along Charles Street and Scarborough Beach Road, Osborne Park and the planned Stirling City Centre.
The link to UWA/QE2 could be completed later and enable the new Children’s Hospital as well as the old site to be given a more complete future. Extensions to Scarborough beach at one end and through Manning Road to Cannington City Centre at the other end, are obvious as well.
The Hong Kong model
Hong Kong MTRC’s Rail + Property program is a commonly-cited example of value capture (or at least alternative funding of infrastructure based on land value uplift, depending on the definition of value capture).
As the Grattan Institute paper notes MTRC receives no cash subsidy from the Hong Kong government. This model is highly successful in Hong Kong, but the paper states that this model would not work in Australia, because density is much higher in Hong Kong that in Australian cities, because car ownership rates are lower and because all land in Hong Kong is ultimately owned by the government, and only long-term lease rights can be acquired by the private sector.
It is true that all of these factors make Hong Kong well suited to transit and the MTRC model, and this report is not the first report to make these arguments. However, none of these arguments rule out a similar model being developed in Australia.
It should first be noted that MTRC achieves substantial profits from its transport and development operations, so their performance is not a reasonable benchmark for this country. Total profit in 2015 was HK$13.1 billion (AU$2.3 billion), and this was its lowest profit since 2010. Operating profit before depreciation, amortisation and variable annual payments was HK$19.0 billion (AU$3.3 billion), of which HK$16.1 billion (AU$2.8 billion) was profit before Hong Kong property development.
In the Australian context, a project or agency could be considered successful at far lower returns than these, as both roads and public transport are heavily subsidised at present in all states and territories. A similar model employed in Australia would not achieve these sorts of profits, but we cannot conclude that it would be completely unviable.
There are also two factors offsetting the apparent density disadvantage in Australian cities. First, in Australia such a model could be applied to lower cost surface light rail, rather than the high standard underground rail delivered by MTRC. Second, such a model would involve developing land around any new stations to high density by Australian standards, so the density differential within a line’s walkable catchment area might not be so great.
On the matter of land ownership, Australian governments don’t own all of the land in our cities, but they do own a lot, and have powers to acquire more. These powers are regularly exercised when transport infrastructure is built. In Western Australia the Metropolitan Region Improvement Tax is used to fund a process of continually acquiring land for long term planning of highways and public open space. This process is funded by an increment on land tax within the metropolitan area, and the purchases are generally made on a voluntary basis, unless a project has immediate need for a particular parcel of land.
It is standard practice for excess land to be sold off once a large transport project has been completed. Examples from Western Australia include a corridor of land over the top of the Northbridge Tunnel, land to the east of Leach Highway in Bentley and the 140 William Street development, involving a 19 storey tower built on land acquired to build Perth Underground Station as part of the Mandurah Line.
In summary, there is no justification for writing off a Hong Kong-style model of rail funding and development in Australia. Lessons can and should be taken from what is one of the most successful public transport systems in the world.
There is a wealth of empirical studies demonstrating that public transport infrastructure increases land values, from Australian and international data. We have just completed work on Bangalore that showed a 23 per cent increase in land value in the one kilometre catchment and of great significance it appears to have increased land values over the whole city (up to 30km out) by an average of 4.5 per cent. Thus it’s not just shifting value increases from one area to another, it is creating new value through new agglomeration and accessibility benefits.
There is a compelling case for building more infrastructure in our cities. Without some mechanism for directing these land value increases to fund the project that generates them, infrastructure will continue to be under-delivered, and the financial benefit from the projects that are built will continue to flow to a handful of fortunate land owners.
The federal government can assist in the development of an Australian model for value capture. They can help with probity for those public-private parternships trying to create such opportunities by providing a loan for such infrastructure projects where land value is likely to increase and provide the returns required. They could provide viability gap funding (VGF) attached to specific objectives, like hedonic price modelling to quantify the windfall gain and place-making, activity centres, re-zoning, bike policy in the catchment area of the railway. VGF can be in terms of a percentage amount of the total project. This will ensure funding from the federal government is attached to enabling value capture, shape sustainable development of the city and ensure agglomeration benefits. This will increase the financial attraction of the project for private participation. There are bound to be other mechanisms that we can work on in partnership. But we should not give up on this journey before we have begun, as largely suggested by the Grattan Institute report.