Informality, Urban Poverty and Land Market Prices

The excessively high price of serviced land in Latin America is one of several explanations for the extent and persistence of informal land markets. Contrary to popular beliefs, informality is expensive and therefore is not the best or even an advantageous alternative to combating poverty, but it is usually the only one available to the urban poor. A more consistent policy to reduce informality, and in so doing reduce poverty, should be at least neutral or contribute to reducing high land prices.

Poverty Alone Cannot Explain Informality

Although the map of illegality corresponds to a great degree with that of poverty, the extent and persistence of informality cannot be explained by poverty alone. Not all occupants of informal settlements are poor, as many empirical studies in Latin America have proved in recent years. The rate of new irregular land occupations is much higher than the rate of increase in the number of new poor families. In Brazil, for example, the total number of favela residents has increased at five times the rate of poor residents, and a similar trend is seen in most large Latin American cities.

This spectacular growth in informal settlements has occurred through expansion on the peripheries and densification in “consolidated” irregular urban areas, even though the birth rate and the number of rural-to-urban migrants have declined substantially and the percentage of poor citizens has remained relatively stable. Other explanations for this growth in informality include the lack of sufficient social housing programs, inadequate public investment in urban infrastructure for public amenities and services (such as drainage and sewage systems) and, last but not least, the reality that informal arrangements are profitable for those who promote them.

The High Cost of Serviced Land

Conventional economics argues that free market prices reflect the level at which a buyer’s ability and willingness to pay matches a supplier’s ability and willingness to sell, but in practice no assurance is given with respect to meeting social needs. That is, the market for serviced land may be functioning well, even though many families (even non-poor ones) are unable to access such land, and some existing urbanized lands are being kept vacant intentionally.

On the peripheries of many Latin American cities, the price of a square metre (m2) of serviced land made available by private agents can vary between US$32 and US$172. These figures are close in absolute terms to those found in cities in the developed world, where the per capita income is typically 7 to 10 times higher than in Latin America. Even a family above the poverty line saving up to 20 percent of its monthly wages (US$200) would need 12 to 15 years to save enough to acquire an urbanized plot of 150 m2. These indicators suggest that the difficulty of gaining access to serviced land may be one of the factors that actually contribute to poverty.

The price of serviced land, like prices in other markets, is determined by supply and demand. The supply of land depends on the amount that is newly serviced (produced) per year, the amount that is retained from the market, and the intensity of the use of the existing serviced land. The demand depends on the annual rate of formation of new households, adjusted by their income and/or purchasing power, their preferences and the prices of other items in their budgets. It is difficult to provide a full discussion of all factors affecting the behavior of land prices (see Smolka 2002), but it suffices to mention certain determinants that are emblematic to understanding some apparent idiosyncrasies of the functioning of urban land markets in Latin America.

On the supply side, property taxes, a major potential source of revenue to finance the production of serviced land, are ridiculously low. Typically property taxes represent less that 0.5 percent of GDP, compared to 3 to 4 percent in the U.S. and Canada. Overall there is a sense that Latin America underspends on infrastructure and services compared to its per capita GDP. The substantive observed land value increments resulting from investments in urban infrastructure and services are basically neglected as a revenue source to finance such investments, due to weak sanctions on capturing land value increments or simply holding improved land from the market (Smolka and Furtado 2001).

In addition, the disposition of considerable amounts of land is controlled by agents that do not follow strict economic rules (e.g., some public agencies, the Army, the Church or even state-owned enterprises like the railroads for whom some statutory restrictions preclude the disposition of land according to the market’s highest and best use criteria). Furthermore, the limited amount of available land that is fully serviced is often subject to overtly elitist urbanistic norms and regulations (zoning) designed to “protect” those serviced neighborhoods by making it difficult for low-income families to comply.

On the demand side, many families, even those with relatively high incomes, work in the informal sector and are excluded from the market because they lack the credentials required by financial agencies to apply for a loan. The need to self-finance housing production on a piecemeal basis through nontraditional funding sources extends the time between acquisition and occupation of land, thereby adding to both the cost of financing and the overall demand for land. Further, the legacy of high inflation, ill-developed or inaccessible capital markets, and limited participation in the social security system are responsible for nurturing a well-established culture and preference by lower-income sectors to use land as a reserve of value and as a popular means of capitalization, which also adds to the demand for land. In other words, holding undeveloped land and the culture of land speculation are not exclusive to high-income areas.

Prices for Informal Plots

Beyond these conventional arguments about supply and demand, one may also consider the dynamics or interdependency of formal and informal urban land markets as a factor contributing to high land prices. Specifically, the high prices for serviced land in the formal market seem to affect the relatively high prices of unserviced land in the informal market, and vice versa.

Land prices reveal the difference that the purchaser has to pay to avoid falling into a worse situation (that is, farther from work; fewer or worse services, lower environmental quality, and the like). Thus, if the “best” alternative is a plot in an unserviced settlement, one would expect a premium on the existing serviced land, which would also reflect the value of the legal title that comes with serviced land. On the other hand, if the minimum price for serviced land (raw land plus the cost of urbanization) is still unaffordable, then whatever land one could have access to would represent an alternative. This alternative could range from outright squatter settlement, to invasion through the mediation of “pirate” operators or organized movements (both of which involve fees and other payments), to the more prevalent land market for irregular subdivision of large parcels into small plots with inadequate services.

The price of land in the informal market is, therefore, higher than the price of raw land but normally less than the sum of the raw land price plus the cost of providing services. At the same time, it tends to be lower (though not necessarily on a per square-metre basis) than the minimum price of fully serviced and commercialized land in the formal market. In effect the market values more “flexible” means to access land, such as plots smaller than the minimum lot size, or construction without building codes, or even the possibility of selling the roof of a house as buildable space.

Most low-income families do not choose an informal arrangement because it provides the best price option, but simply because it is often their only option. The “choice” of acquiring an informal plot is still expensive. Conservative estimates obtained from an informal survey of 10 large Latin American cities show the average price of land on a commercialized illegal plot was US$27 for one square metre (see Table 1).

Table 1: Prices and Profitability of Informal and Formal Land Markets (US$)

1- Rural land designated for urban use
Informal market: $4
Formal market: $4

2- Cost of urbanization
Informal market: minimal = $5
Formal market: full = $25

3- Final price in the market
Informal market: $27
Formal market: $70

4- Profit over advanced capital=(3-1-2)/(1+2)
Informal market: 200%
Formal market: 141%

The profit figure (4) explains at least in part the question (an apparent paradox): Why, in spite of a significant mark-up in the provision of urbanized land in the informal market, does one find so little interest in development from the private sector? As Table 1 indicates, the provision of informal land is more profitable than the provision of formally developed land. In fact, the figures for the formal market are largely underestimated since there are higher risks associated with financial, security and marketing costs, and other costs borne by the developer that are not incurred in informal developments. These data also help explain why formality begets informality and exposes the fact that the advantages of informal arrangements are not necessarily perceived by the low-income occupants, but by the subdivider or informal developer.

Unexpected Effects of Regularization

Let us turn now to the question of policy responses to this state of affairs. Given the apparent impossibility or impracticality of adopting any other policy, the prevailing notion has been that tolerating informal “solutions” to gain access to land and then regularizing the settlements after they are established is cheaper in the long run for public finances, and better for the low-income occupants (Lincoln Institute 2002).

The public finance argument claims that the existing arrangement is cheaper because it capitalizes on private (self-) investments in the consolidated settlements, thus relieving public agencies of social responsibility and expenditures otherwise associated with one’s full “right to the city.” This view is questionable on two accounts. First, the physical conditions and existing housing are often unacceptable as human shelter, in spite of the ingenuity and imagination of informal solutions under extremely unfavorable conditions. The poor standards of land use and density in these settlements are only tolerated because the damage has already been done. Second, with regard to infrastructure, some of the alternative technologies that look promising are ultimately shown to perform poorly and to require overly expensive maintenance.

The impacts on low-income occupants are also worse than expected. Not only are land prices much too high but there are additional costs: those without an official address (because they live in an irregular settlement) are often discriminated against when looking for a job or social services; rents as a percentage of property value are higher than the rates observed in the formal market; access to water from a truck or other temporary source is much more expensive than piped water; and the cost of insecurity is greater because of living in a more violent environment.

Regularization policies evaluated in a broader urban context may actually contribute to aggravating the problem it is supposed to remedy. That is, as a curative approach these policies may instead have perverse or counter-productive preventative effects, as noted below.

Price Signals

The expectation that an area of land will eventually be regularized allows the developer to raise the price. A purchaser often obtains a lot with written evidence that the developer does not yet have the services required by urban planning norms. At the same time the developer promises that as soon as enough lots are sold the services or infrastructure will be provided, even though such promises are often unfulfilled. At best, a relationship of complicity is established between buyer and seller. At worst, and this is quite common, the purchaser is tricked by the existence of services, such as pipes put into the ground, which the developer claims are part of the infrastructure network. Other problems in these arrangements that can harm poor residents are doubtful rights of tenure, payment terms that disguise the full amount of interest to be paid, and confusing or inaccurate details in the contract.

As in any other segment of the land market, the actual prices reflect, or absorb, expectations about the future use of the lot. The informal sector is no exception. The greater the expectation that the plot of land that is currently without services will get them eventually, either from the developer or, as is more likely, from the government through some regularization program, the higher the price at which the land is sold.

Regularization as an Attraction for More Irregularity

Research on the first arrival dates of inhabitants in informal settlements suggests that in many cases more people moved in just when some regularization program (such as the granting of titles or urbanization improvements) was announced or implemented (Menna Barreto 2000).

The idea that expectations about regularization have an effect on informality is also corroborated by the large number of invasions or occupations that take place either just before or just after electoral periods, when candidates promise new regularization programs. The victory of Miguel Arraes as governor of Pernambuco, Brazil, in 1986 led to 13 land invasions in just over a month (Rabaroux 1997, 124), and the Latin American historiography of the effects of the expectations created by populist promises is rich in other examples. Many of the existing settlements that need to be regularized today owe their origin to the irresponsible complacency of politicians turning a blind eye to the irregular occupation of public or unsuitable areas, or, which is worse, who ceded public land for electioneering purposes.

The Opportunity Costs of Regularization

Regularization programs, which are normally of a remedial or curative nature, have a high opportunity cost compared to the cost of providing urbanized land in a preventative manner. The rule of thumb cost per benefited family of a typical upgrading or regularization program has been in the range of $3,000 to $4,000. Taking the size of a plot to be around 50 m2 and adding 20 percent to account for streets and other public services, the cost works out to US$50 to US$70 per m2. This is considerably higher than the cost for servicing new land, which is less than US$25 per m2, and is similar to the price charged by private developers, even when allowing for a handsome profit margin. ECIA, a private developer operating west of Río de Janeiro, offered completely urbanized plots for US$70 to US$143 per m2 at 1999 prices (Oliveira 1999). The Municipal Secretariat of Urbanism in Río de Janeiro has a technical study, from 1997, which demonstrates that it is possible to commercialize urbanized plots for less than US$55 per m2. Along the same lines, Aristizabal and Gomez (2001) in Bogotá estimate that the cost of correction (“reparation”) of an irregular settlement is 2.7 times the cost of planned areas.

These figures suggest the limitations of preventative programs in favor of curative ones. It is also relevent that permission to develop a regular, formal subdivision may take from three to five years, whereas the decision to regularize an informal settlement often takes less than six months.

The “Day After” of Regularization

A well-executed regularization program (that is, one that effectively integrates the informal area with the urban fabric) would ideally result in the improved quality of life for all occupants and a stronger community. In particular, one would expect an appreciation of property values, causing some residential mobility as families with below-average incomes are forced to move. However, when the program is badly executed the area may be consolidated as a low-income irregular settlement.

The Favela-Bairro upgrading program in Rio de Janeiro is often used to exemplify the most comprehensive and successful experience of its kind. Abramo’s (2002) study of the impact of regularization programs found a relatively small increase in property values in the affected areas (28 percent). Applying this average figure to typical or modest houses with an ex-ante value estimated at US$12,000, the added value is about US$3,400, a number close to the average per-family cost of regularization programs. This result contrasts with the mark-up of more than 100 percent obtained in the process of servicing raw land through the market by private agents. This intriguing piece of information seems to show how little notice the “market” takes of the increased value of these regularized settlements. At the same time, full integration into the urban fabric turns out to be less frequent than had been expected. Many of the favelas that received important upgrading investments remain stigmatized as favelas even 15 years later.

Conclusions

Informality is expensive, and it exacerbates the conditions of living in poverty. The diagnoses of such agencies as the UNCHS (Habitat), World Bank, Inter-American Development Bank and others would seem to be correct in regarding upgrading programs as an essential ingredient of any policy to deal with urban poverty. However, because of the piecemeal and limited approach of such programs, there is no guarantee that the regularization of settlements alone will contribute to reducing urban poverty. In effect these programs not only reiterate and keep intact the land market “rules of the game” that contribute to informality, but they also generate some perverse effects. This situation poses both a dilemma and a challenge. The dilemma is that not regularizing simply is not a political option (nor is it a humanitarian option). The challenge is how to interrupt the vicious cycle of poverty and informality through interventions in the land market. The task ahead is formidable, but there are places in Latin America where local governments are beginning to set new ground rules.

Martim O. Smolka is senior fellow and director of the Program on Latin America and the Caribbean at the Lincoln Institute.

References

Abramo, Pedro. 2002. Funcionamento do mercado informal de terras nas favelas e mobilidade residencial dos pobres. Cambridge, MA: Lincoln Institute of Land Policy Research Paper.

Aristizabal, Nora, and Andrés Ortíz Gomez. 2002. Are services more important than titles in Bogotá?” in Land, Rights and Innovation: Improving Tenure Security for the Urban Poor, Geoffrey Payne, ed. 100-113. London: Intermediate Technology Development Group Publishing.

Lincoln Institute. 2002. Access to Land by the Urban Poor: 2002 Annual Roundtable. Cambridge, MA: Lincoln Institute of Land Policy.

Menna Barreto Silva, Helena. 2000. Programas de urbanização e desenvolvimento do mercado em favelas brasileiras. São Paulo: University of São Paulo: LAB-Hab.

Oliveira, Fabrício L. de. 1999. Valorização fundiária e custos de urbanização na XVII R.A. – Campo Grande: uma primeira aproximação com o caso do Rio de Janeiro. Cambridge, MA: Lincoln Institute of Land Policy Research Paper.

Rabaroux, Patrice. 1997. La Regularizacion en Recife (Brasil). In El acceso de los pobres al suelo urbano. Antonio Azuela and François Tomas, eds. México: Centro de Estudios Mexicanos y Centroamericanos del Instituto de Investigaciones Sociales de la UNAM.

Smolka, Martim O. 2002. The High and Unaffordable Prices of Serviced Land. Cambridge, MA: Lincoln Institute of Land Policy Research Paper.

Smolka, Martim O., and Fernanda Furtado, eds. 2001. Recuperación de plusvalías en América Latina: Alternativas para el desarrollo urbano. Santiago, Chile: EURELIBROS.