Making easy money out of land: cultural expectation or legal reality?

Perhaps in our settler society, there is a deep-seated expectation that land ownership brings the privilege of unfettered use, to enjoy our castle and to make a killing in property market trades if we possibly can. If this is a cultural expectation about the rights attaching to land ownership in Australia, it is completely at odds with the legal reality.

The only right that property owners have is the continued enjoyment of lawfully sanctioned uses of their land, and to trade in the land, within these limits, if they so wish. This right cannot be taken away without compensation, as we see when governments compulsorily acquire property for roads, airports, hospitals and other public purposes.

Every other right as to how land may be used or developed is reserved by the community through planning laws.

There are two means by which the community may grant permission or a licence for uses and development other than that which is already lawfully established on a site:

• One is by requiring compliance with permitted uses as set out in codified rules embedded in local zoning. For example, in some areas, the suburban house owner may be allowed under planning rules to construct a granny flat in the backyard without special approval from Council. However, this is not a right that attaches to land ownership. The zoning rules could be changed at any time to prohibit granny flats or to make them subject to stricter development standards, and no compensation would be forthcoming for the lot owner.
• The second means by which the community grants a licence for uses and development is through the town planning permit or development approval process. In these situations, the only time the landowner can count on having a development right is when they have a duly issued permit or a development approval (DA).

That the community reserves, and licences access to, development rights is down to basic economics. In a theoretical world, if property owners could use their land for whatever purpose that provides the greatest satisfaction to them without consulting neighbours or other affected parties, we would inevitably get less functional and less livable neighbourhoods, suburbs, towns and cities. This is because of externalities.

Land use and development regulation is inevitable if we want great cities

The commercial choices made by individuals acting in their self-interest will only coalesce into a good outcome for the community if there are no externalities, that is, adverse consequences for third parties. Urban development is rife with externalities, both positive and negative.

They include overshadowing, overlooking, noise intrusion, air pollution and discharges to environmental assets like creeks and streams, disruption of neighbourhood character, loss of heritage values, cultural values and other distinctive and appreciated features of a place, loss of native vegetation, aggravated heat island effects, saved congestion and vehicular emissions through the creation of public transport friendly and active transport friendly urban forms, productivity gains made by building clusters of related firms and formation of vibrant town centres by managing retail and related flows into hierarchies of activity nodes, to name just a few.

Development rights are reserved by the community to correct these externalities. Access to them is rationed in accordance with a community endorsed plan for a neighbourhood, suburb, town or city. Not doing so would lead to immense value destruction.

While regulation of land use and development is essential in the face of externalities, it can be done in a smart way, or it can create unnecessary costs by unduly constraining what can be done with a property.

The trick is to carefully hone land use and development rules to mitigate negative externalities and promote the desired urban form (positive externalities) while giving developers ample scope to identify and meet market preferences.

Whether we are good or bad at striking this balance is a topic for another day. The key issue in the current debate over a planning windfall tax is that regulation of land use and development is inevitable if we want a good city, and this necessarily means community reservation – ‘nationalisation’ if you like – of development rights.

The community should be able to extract a fee commensurate with the value of development rights

If access to development rights must be rationed, it makes sense that the community should extract a fee commensurate with the value of these rights when they are awarded through the planning system. Otherwise, we can expect serious adverse consequences for productivity and fairness.

A piece of land that carries permission for more remunerative use – for example, building an apartment block or a shopping centre – will be worth more than an otherwise similar piece of land that carries no such permission due to the limits embedded in the planning scheme. The difference in value between these two properties is the value of the additional development rights.

If there is no charge made for these rights, market players will have a great incentive to spend a lot of time and money securing them, whether or not they are actually interested in building the apartments or shopping centre. Their prize is the windfall associated with the planning permission. They can realise this by selling on the site to bona fide developers.

Chasing windfalls associated with unpriced planning permissions absorbs entrepreneurial effort and administrative resources on both the proponent and regulator sides. This expenditure results in zero extra value for the community. We still get the same apartments and shopping centres and so on, albeit perhaps with a marginally different spatial distribution. In other words, not charging for development rights wastes resources that could be used productively elsewhere in the economy.

In some circumstances, the chase for windfalls associated with unpriced planning windfalls leads to outright corruption, as is evident in the Independent Broad-Based Anti-Corruption Commission’s (IBAC) investigation into the rezoning shenanigans in the City of Casey in Victoria. Such behaviour is not only abhorrent in civilised society; it will likely lead to tighter regulation and higher transaction costs which will weigh on the development sector for years to come.