Myths and Realities of Public Land Leasing

Many scholars and analysts have suggested that public leasehold systems could allow governments to benefit from a share of future increased land value. Some have even argued that other policy objectives, including stabilizing land prices, controlling land uses and facilitating land redevelopment, could also be achieved through public land leasing. Although these proposals are persuasive at the theoretical level, there is only limited evidence to prove that governments could achieve these policy goals in practice. My research on Canberra and Hong Kong, which have two of the world’s most well developed leasehold systems, examines some of the benefits and problems of public land leasing.

Land Value Capture

Legal scholars have treated property in land as a bundle of rights. According to this perspective, the government can retain the right to own land and assign to a private party the right to use, develop, transfer, inherit and benefit from land. The private party can enjoy the land rights only for a specified time and as stipulated in the land contract. Theoretically, because the government is the landowner, it could retain a portion of the land value increments by asking a lessee to pay:

• a lump sum of money-called an initial land premium-at the beginning of the lease,
• an annual land rent,
• a premium when the lessee modifies lease conditions to acquire additional rights for land redevelopment, and
• a premium for renewing the land rights when the lease expires.

The Hong Kong leasehold system seems capable of helping the government recoup a large portion of development windfalls from landholders. For the period 1970-1991, I found that the government recaptured, on average, 39 percent of the increased land value from selected land sites through land leasing. This captured value financed an average of 55 percent of the annual infrastructure investment during the same period. (1)

More important, the money collected from leasing is not a substitute for property taxes in Hong Kong. Owners of residential properties must pay annual rates to the government that are 5 percent of the estimated rental value of their flats. Owners of commercial real estate pay a 15 percent property tax on income earned from their rental premises. Combining all land-related revenues, the Hong Kong government could recover, on average, 79 percent of the annual costs of public infrastructure investment.

In Canberra, by contrast, the percentage of infrastructure investment funded by lease revenues was only 5 percent. (See Figure 1.) There are at least two reasons for the difference: the abolition of land rent for residential leases and competition from other cities that weakens government’s ability to collect higher rents on public land.

In the first instance, then-Prime Minister John Gorton abolished all land rent for residential leases in 1970, an action that his opponents charged was designed to rally public support for his reelection. It was estimated that the government transferred 100 million Australian dollars in equity to lessees at that time, resulting in the loss of an important source of revenue. This incident raised the broader issue of politics in public land management, although leasehold systems do not necessarily induce “rent-seeking” behaviors for private or political gain.

Hong Kong’s government seems able to minimize this problem by establishing a tight internal control over the operations of leasing land. It also provides public officials with generous remuneration and fringe benefits to reduce the temptation of corruption. This demonstrates that, in designing a public leasehold system, a government must consider the need for a system of checks and balances to prevent opportunism or political maneuvering. No single person or department within a government should have the unchecked power to decide on the method and timing of allocating land resources.

The second reason for Canberra’s low lease revenues is its keen competition from other Australian cities in attracting capital. If the city government charged high land premiums and rents, businesses and industry would go to other cities. Thus, competition weakens the government’s bargaining position in negotiating with developers on the amount of land premiums or rent for leasing public land. Although Hong Kong also faces competition from other Asian cities, such as Shanghai, Singapore and Taipei, differences in taxation, government structure, business ethics and culture make capital flight less likely in Hong Kong.

This issue of competition is particularly important for developing economies where local governments are eager to attract investment. They may be willing to compromise by collecting a smaller amount of land premiums and rent from both domestic and foreign land investors. The use of land as a source of public funds may require some level of inter- or intra-regional cooperation to prevent developers from playing one government against another.

Land Speculation

In Hong Kong the government’s reliance on land revenues as a source of public funds presents another problem: its financial interest in land conflicts with its public role in stabilizing land prices. The government has relied heavily on initial land premiums because demanding premiums from lessees during lease renewals has proven to be politically difficult. In addition, the assembly of land rights for land redevelopment involves high negotiation costs because most land leases in Hong Kong have multiple leaseholders. These high costs deter private developers from undertaking land redevelopment by acquiring lease rights and modifying contract conditions. As a result, the government is unable to utilize this method fully to recoup land value. As for the land rent, before 1997 the amount of annual rent paid by lessees was fixed and bore no relationship with increases in land value. Hence, the amount of land rent collected has been minimal. (2) (See Figure 2.)

These difficulties have encouraged the government to retain land value at the beginning of the lease. Yet, this method can work only if officials lease land slowly to private developers. A rapid disposition of land when its value is low would impede the government’s ability to recoup land value in the future. Restrictions on land supply, however, have encouraged private land banking and property speculation, leading to high land and property prices and making Hong Kong one of the world’s most expensive cities. (3)

Officials of other countries could avoid this problem by relying more on lease renewals, contract modifications and the annual land rent than on the initial assignment of leases to capture land value. The plausibility of doing so, however, remains an empirical question. The experiences of Hong Kong suggest that such an attempt could encounter strong public resistance and high negotiation costs.

Managing Land Uses

In principle, public leasehold systems allow the government to manage urban growth by incorporating land use regulations into land leases. If lessees do not develop their land according to the lease provisions, the government has the right to take back the land, a contractual right not available to the government when land is privately owned.

To take full advantage of this special land right, the government must be capable of enforcing the contractual agreements. Despite having the ability to repossess land, there is no evidence to show that enforcement costs under public leasehold systems are lower than those found under freehold systems. This is partly because drafting a complete land contract is impossible. Neither public officials nor the contracting party has perfect information, so they cannot account for all contingencies when they negotiate. Contract language is imperfect and subject to interpretation, creating enforcement problems.

In 1995, a special committee was established in Canberra to review its leasehold system.(4) Analysts found that enforcing the lease purpose clause was a major problem in a town called Fyswick because the lease conditions were too complex and ambiguous. Local officials could not evict lessees who breached their contracts. Rather, they gave lessees an amnesty period to regularize their land uses by applying for lease modifications. In the end, lessees paid their modification premiums, but analysts who conducted the study argued that their payments were far less than the fair market value of the land rights obtained by lessees.

In Hong Kong, using lease conditions to control land uses has created a different problem. Although land contracting could give the government the flexibility to control land development in detail on a case-by-case basis, it is extremely inflexible in adjusting to changes in the overall zoning plan over time. As mentioned earlier, the government incorporates land use regulations into land contracts as conditions at the beginning of the lease. Unless lessees initiate a lease modification, these conditions will remain until the lease expires, which could be as long as 50 years in Hong Kong (and 99 years in Canberra).

When the government needs to update the master plan or revise land regulations to accommodate new urban development, the revised rules may be inconsistent with lease conditions established years ago. This problem has created confusion about which planning standards developers in Hong Kong should follow. To make matters worse, any regulatory changes that infringe on the lessees’ contracted land rights may trigger lawsuits against the government. The legal liability has impeded the government’s ability to modernize its land use plan for districts where outdated lease purpose clauses are still in effect.

Urban Redevelopment

Under public leasehold systems, the government can deny a lessee’s application for lease renewal if it needs the land to rebuild the neighborhood or for other public purposes. It can then take back the land and compensate the lessee only for the building. Thus, in theory, leasing should reduce the public costs of land acquisition for urban renewal or other public uses.

The government, however, must wait for leases to expire before it can assemble land for urban renewal. The long duration of land leases could again create a problem. Nor is there evidence that compensation negotiations for buildings are simpler than for both land and buildings. In Hong Kong, issues of holding out and disputes over compensation are as common as in countries where land is privately owned.

Conclusion

The difficulties that Canberra and Hong Kong face in leasing public land show that leasehold systems in and of themselves do not resolve land management problems. This does not mean, however, that leasing is not a viable means to manage land. In Hong Kong, the government retains a large portion of increased land value for public infrastructure investment. Canberra’s public leasehold system enables the government to obtain low-cost land for building the Australian capital.

The important lesson is that policymakers should not set unrealistic expectations on what public leasehold systems can achieve. Failure to deliver their promises could frustrate a well-intended reform and bring the effort to a halt. Because no land tenure system is perfect, the debate should not focus on the choice between leasehold and freehold systems. They are not mutually exclusive. Instead, future research should concentrate on designing specific institutions according to different political, economic and social contexts to minimize problems associated with both systems.

Yu-Hung Hong is a visiting fellow of the Lincoln Institute this year. He previously taught at Hong Kong University of Science and Technology in the Division of Social Science, after earning his Ph.D. in urban planning from Massachusetts Institute of Technology.

Notes

1. See Yu-Hung Hong. 1996. “Can Leasing Public Land be an Alternative Source of Local Public Finance?” Working Paper, Lincoln Institute of Land Policy.

2. See Yu-Hung Hong. 1998. “Transaction Costs of Allocating Increased Land Value: Hong Kong.” Urban Studies 35, 9: 1577-1595.

3. See Yu-Hung Hong and Alven H.S. Lam. 1998. “Opportunities and Risks of Capturing Land Values under Hong Kong’s Leasehold System.” Working Paper, Lincoln Institute of Land Policy.

4. Members of the committee included Justice Paul Stein, Patrick Troy and Robert Yeomans. Findings of the review can be found in the Report into the Administration of the ACT Leasehold, published by the government of the Australian Capital Territory in 1995.