Building Rights and Municipal Finance – The Experience of São Paulo, Brazil

Revenue from building rights, or land value capture, plays an important role for municipal finance. Martim O. Smolka and Camila Maleronka report on the specific challenges and achievements in the city of São Paulo.

Conventional fiscal policies largely neglect the fact that the costs of providing adequate infrastructure and services to meet more intensive land use are borne by all taxpayers, but their benefits accrue to certain property owners. Charges on the land value increments that these landowners receive from public actions – such as conversion of land from rural to urban use, or changes to zoning regulations that allow higher-density development – should (as consistent with the Brazilian Constitution) fall under the legal principle that no one is entitled to unjustly earned income.

The public sector works on the equity principle that one citizen cannot be favoured over another. Typically, this is laid down in national legislations preconizing charges to building rights (or more broadly land value capture) policies and tools. Following this principle, the government must take measures to redistribute the benefits and burdens of those investments and regulations.

Charges for Building Rights in São Paulo

The instrument that regulates charges for additional building rights in Brazil (Outorga Onerosa do Direito de Construir, OODC) is based on the notion that the landowner’s property right is limited to a basic floor area ratio (FAR), that differs from the maximum FAR the area could support. The right to build at a density up to the basic FAR is free, but developers wanting to build at a higher density up to the FAR established by the zoning law must pay compensation to the city.
After a long transition, in 2014 the City of São Paulo instituted a universal basic FAR of 1.0 as the building right applied to all landowners. The FAR scale ranges from 1.0 to a maximum of 4.0 based on zoning. Note that the charge to building rights is not considered a tax under Brazilian law. In effect, these rights are understood as a public asset that may be purchased by landowners willing to add the additional building rights to their patrimony. Thus the reference to them as ‘created land’ (Solo Criado) when first established/instituted in 1976 in São Paulo.

Calculating the Value of Building Rights

While several formulas have been used to calculate the land value increment resulting from the OODC, they all have limited accuracy. In theory, the value of land developed with a FAR of 2.0 compared with a basic FAR of 1.0 should be the difference between the residual values of their respective highest and best uses. In practice, the calculation is much more complex because no two buildings in an area are the same and changes in some plots affect the highest and best use of nearby plots.

The prevailing method, the so-called virtual plot method, only partially addresses these complications. Under this calculation, a developer interested in building a 500 m2 structure in a zone where the basic FAR is 1.0 and the maximum is 2.0 could acquire a plot of 500 m2 or a plot of 250 m2 and acquire building rights to build the additional 250 m2 on that plot. For this additional area, the developer would pay the equivalent of one more plot of land with a FAR of 1.0 in the same area zoned for a maximum FAR of 2.0.

Revenue Generation From OODC

Since 2002, over 2,500 high-rise licensed projects in Sao Paulo acquired additional building rights, raising over US$1 billion in public revenues. To get a sense of the revenues to be generated from particular projects, consider the following example.

A typical building project in Sao Paulo is a residential development on a 2,000 m2 plot, with a basic FAR of 1.0 and a maximum FAR at 2.0. The developer acquired the full maximum building rights available. The compensation for the additional 2,000 m2 of building area was US$837,468, or US$419 per m2. Note the significant redistributive power of these building charges – the ‘land’ for the 20 additional high-income apartments (assuming 100 m2 per unit) would subsidize about 25 fully built social housing units.

However, the compensation calculated here is well below the proxy market value from sales tax quotes in the area at US$4.45 million, or US$2,225 per m2. The discrepancy reflects the difficulty of obtaining a virtual plot value, that is, the value of a plot that reflects its use at a FAR of 1.0 when all plots in the zone have a maximum FAR of 2.0.

Potential Left Untapped

Revenues from the OODC have fallen short of their potential for several reasons. As already noted, a citywide basic FAR was not set before 2014, and cadastre values used to benchmark the charges are known to vary as much as 30 per cent from the full market value. Discounting factors applied for certain structures (e.g. environmentally sustainable buildings) and non-computable areas of high-rise buildings (e.g. garages) further reduce potential net collections from public sales of building rights.

Developers in the City of São Paulo launch an average of 30,000 multifamily housing units per year, amounting to US$5.95 billion in sales. Based on the calculations provided above, with a conservative estimate of OODC at less than 6 per cent of land value, additional building rights charges would have been about US$360 million per year.

Adding to these potential revenues from building rights charges from individual plots, the auctioning of Certificates of Additional Building Potential (CEPACs ^[1]The CEPACs are bonds issued by the municipality and sold by electronic auction on the São Paulo Stock Exchange Market. They are used in urban operations (UOs), which are delimited urban areas (polygons) subjected to rezoning (for land use and density) and supported by improved urban infrastructure. All revenues resulting from the sale of these bonds revert to the UO to be invested in urban infrastructure but also in social housing.) results in average proceeds of about US$250 million per year – about half the amount that this city of 11 million inhabitants collects in property taxes. Most importantly, these additional revenues in practice doubled the overall investment capacity of São Paulo within a 10-year period, from 2004 to 2014.

A Fairer Distribution of Costs and Benefits of Urbanisation

Value capture policies and tools are undeniably gaining acceptance around the world. But assessing land value increments through public administrative action is still a challenge for many jurisdictions. The São Paulo experience illustrates more than one way to make these valuations. Although imperfect, it demonstrates that it is feasible to charge for building rights. The fees generate much-needed financing for urban infrastructure and social housing, while also imposing a fairer distribution of the costs and benefits of urbanisation.