Market-Based Models for Land Development for the Low/Moderate-Income Majority

Bruce Ferguson

Hybrid value chains (see Ashoka, 2008 and Ferguson, 2008 in this issue of Global Urban Development Magazine) provide a tool to analyze, improve, and create affordable housing projects and products.  Nowhere is the need and opportunity greater than in land development (Global Urban Development Magazine, November 2007).  

Virtually all net growth of 2.6 billion in world population between now and 2050 is projected to occur in emerging-country cities.  The majority of these new households will earn low or moderate incomes.  In effect, relatively poor countries must build the equivalent of a city of more than one million people each week for the next 45 years (Cohen, 2005)!  Rapid rural-to-urban migration (particularly in South Asia and Africa, where large majorities still live in rural areas) as well as in-situ population growth have created this surge in urban population.  Although these households will earn incomes well below those of affluent countries, the huge increase in emerging-city populations will drive growth in the world economy and demand for many products.  From 2001 to 2007, emerging economies grew at an average annual rate of over 6% compared to 2.5% in high-income advanced countries, and have resisted the current “credit crunch” (as of July 2008) far better than affluent nations.  The importance of emerging nations in the global economy will only increase in coming decades

Absent major change, the bulk of new residential land development will occur informally without integration into mainstream markets, at tremendous public and private cost.  Settling this wave of new urban residents far exceeds the challenge of upgrading existing urban shantytowns containing one billion people.  Experts (Global Urban Development Magazine, 2007; Freire, Lima, Cira, Ferguson, Kessides, Mota and Motta, 2007; Ferguson, 2007; Buckley, 2005) and housing developers agree that land presents the greatest constraint to sheltering the low and moderate-income majority.  Government programs, however, typically result in boutique high-subsidy projects incapable of reaching a scale commensurate to this challenge. New market-based approaches are essential to reach the enormous necessary scope.

This paper first presents a hybrid value-chain framework with particular attention to urban land development to provide a systematic method for guiding private-sector initiative.  It then uses this framework to analyze and specify how to improve two cases of market-based urban land development – one in Pakistan with a nonprofit as the developer and one in El Salvador where for-profit firms are the protagonists – based on interviews and reports prepared for this study.  This analysis also helps identify the roles of private firms, the citizen sector (variously called “nonprofits”, “NGOs”, and the “social sector”), and government in achieving massive low-income land development. 

A hybrid value chain approach to urban land development

Table 1 (distilled from Table 2 of Ferguson’s policy introduction on the value chain framework to this issue of Global Urban Development Magazine) lists the main steps of the progressive housing process used by most families in emerging countries, a set of overall criteria to assess outcomes, and products and services for streamlining this practice.  The key to creating value and markets in affordable housing is not only to lower the costs of each of these steps but also, more importantly, to innovate and combine products and services into new business models that address larger segments of the problem – i.e.  “value chains.” 

Modern companies develop competitive advantage by vertically integrating the sourcing, manufacturing, and delivery of packages of products and services (Porter, 1985).  Hence, these firms are well suited to squeezing costs out of the progressive housing process.  However, they typically have little direct access to poor communities, which they find dangerous and difficult places in which to work, and to low-income people, who usually do not trust them.  Citizen-sector organizations that work in these neighborhoods can perform an important function at critical junctures in the value chain.  As a result, the most effective value chains are “hybrid” efforts that join modern corporations with citizen-sector organizations. 

A broad summary of the context of residential land development in emerging countries cities serves to preface application of this hybrid value-chain framework to specific projects and products.

During the early phases of the great urban wave during the 1950s and 1960s, poor households migrating to cities from the countryside could, with some frequency, find centrally located low-cost parcels to invade.   This land offered a low-cost foothold near to the city center and jobs, which families could turn into a valuable asset. 

However, continuing urbanization has used up most land vulnerable to invasion.   As a result, most new low/moderate income households now settle in illegal subdivisions on the periphery and beyond, stretching over vast areas.  In effect, illegal subdivisions have become the default mechanism for urban land development.  Typically, clandestine developers acquire parcels, mark areas for dirt streets, divide the remaining area into lots, and sell these raw lots to poor households.    Most emerging countries and cities have officially made such unserviced land development illegal under their subdivision codes.   However, the bulk of these governments unofficially allow or promote unserviced land development as the only viable alternative for massive low-income settlement.  Others lack the enforcement mechanisms to control this phenomenon.

Table 1

Framework for assessing and improving affordable housing projects and products

Illegal subdivisions present an enormous dilemma.  They are typically the only affordable means of low-income settlement, have simple procedures, and deliver their product rapidly.  However, illegal subdivisions lock in many of the extremely high costs of progressive housing over time (Ferguson, 2008).  Households pay clandestine developers many multiples (often, 10x to 20x) their cost for individual lots without receiving full legal title.  They then struggle to keep physical possession and upgrade their rights to their lot (step 2) by keeping an adult family member (typically the wife) on site around-the-clock instead of working outside the home, bribing local police and officials, and paying the costs of  regularization and registration of property ownership.    In order to occupy the lot and begin consolidating their home and community, families build a makeshift shelter and acquire water and electricity via clandestine connections or by paying private suppliers many times the cost of publicly-supplied services for poor quality. 

Upgrading this infrastructure (step 3) and building a permanent home (step 4) destroys these households’ initial investment by retrofitting a new road/services layout to the community, typically at two to three times the cost of formal-sector development, and by replacing the makeshift shelter.  Households pay exorbitant rates both to save and to borrow to finance this process (step 5).  During the consolidation phase (steps 3 to 6), families and neighborhoods usually suffer from much higher rates of crime, violence, and insecurity of all types than formal settlements of a similar socioeconomic profile;  they combat insecurity by building community institutions (e.g. neighborhood associations and groups of all sorts), establishing alliances with supportive NGOs, and developing partnerships with public agencies (step six), particularly the police.   

In this context, creating value chains for land development involves making clandestine subdivisions legal through regulating and supporting their development in order to reduce the cost and length of this process. The following sections summarize two in-depth case studies of market-based low-income urban land development, and then apply this hybrid value-chain framework to rate and specify how to improve them.  The full versions of these case studies are available on Ashoka’s website at www.ashoka.org.

The progressive subdivision market in El Salvador

Progressive subdivisions started in the 1960s in the municipalities of the capitol, San Salvador (Barraza, 2007; Souza, 2001), and now serve 60% of new low-income households throughout the country, with sales of 5,000 to 8,000 lots per year.

Roughly 70 firms belong to the Association of Land Developers of El Salvador, and are active in this market.  The four largest firms (Argoz, Proyectos Dinamicos, Lotiversa, and Ivan) operate on a national scale and account for one-half of new lot production (Barraza, 2007; Souza, 2001). 

Typically (80% of projects), firms approach landowners of parcels near or on major roads on the urban periphery and in semi-rural zones, and offer to form partnerships to subdivide this land. The firm commits to execute and administer the subdivision, and pass on 60% to 75% of payments from individual households to the landowner.

The developer sets aside 35% of the parcel for streets, communal infrastructure, and, higher-end projects,  green space, and then divides up the remaining 65% into 20 to 35 lots of 150 square meters (in suburban zones) to 250 square meters (in semirural zones). The firm levels and prepares the terrain, demarcates lots and roads, compacts dirt roads, and, for higher-end projects, drills communal wells and leaves space for parks.  Electricity companies make individual households connections in parallel with the subdivision.

Marketing usually consists of putting a billboard at the front of the parcel advertising lots for sale with a telephone number.  Developers establish local offices to receive monthly payments and also make arrangements with banks to receive these monies on their behalf.   Low-income people buy the great bulk of these lots.   In addition, significant sales now come from the Salvadoran community in the US seeking to build a home to retire to their native country and investors.

Developers use a rental contract with promise of sale (contrato de arrendamiento con promesa de venta; hereafter, called a “rent-to-own contract”) for this purpose. This rent- to-own contract stipulates a monthly payment of US $15 to $70 per month for 8 to 12 years, representing an affordable 15%-20% of income of low and moderate-income households earning US$175-$350 per month.  This legal vehicle maintains ownership of the lot with the developer/landowner partnership until the last monthly payment, which reduces the risk and capital invested. 

Developers typically phase their subdivision over time, so that both the developer/landowner partnership and families that purchase early gain from the appreciation resulting from the occupation of the project.  Developers invest a small amount – US$300-$700 per lot – in starter infrastructure that approximates the norms set by government regulation.   Firms ignore regulations that would raise costs to levels that would price their product out of their target market segment.

Families then build the structure of their homes and pressure government for other services – most importantly, piped water – which generally arrives 10 to 15 years after the initial development – and paving of roads and schools, which usually takes longer.  Virtually none of these settlements have piped sewerage – the most costly type of infrastructure.  Instead, residents build unimproved pit latrines, which frequently contaminate underground water and wells – the main source of their drinking water. 

This modus operandi results in monthly payments affordable to a wide range of low and moderate-income households.  However, rent-to-own contracts can be highly problematic.  Arrears of three or more months in payment permit the developer to repossess the lot and sell it to another family.  On making the final payment, some families discover that the developer/landowner partnership has mortgaged or sold the land to others, and have problems getting clear legal title to their lot. 

From the perspective of developers, the low investment of capital in projects has allowed massive production of progressive subdivisions that has substantially exceeded demand but, nevertheless, turned a profit.  The three largest developers have produced an average of 10,500 lots per year compared with annual sales of around 3,000 lots per annum. Financial analysis of a typical project in one of the most active current markets (municipality of San Miguel) shows a net return of 25% to 35% per annum, around the national median profit rate for private-sector investment. 

Progressive subdivisions started in the 1960s, but occurred outside of national and local law until 1992.  In 1992, national government approved the Law for Urban Development and Construction and Regulation of Subdivisions (Barraza, 2007; Souza, 2001).  This law created a category called “Subdivision for Progressive Development” for low-income households, a Social Register of Real Property, and the Institute Of Liberty and Progress (model on and on Hernando De Soto’s efforts in Peru of the same name) in order to legalize informal settlements.  In addition, national government has established a Management Unit within the National Real Property Registry Office to approve these plans while municipal governments – which are constitutionally in charge of land-use – also review progressive subdivision applications if they have land-use plans.  These and other agencies including the Ministry of the Environment participate in an inter-institutional committee to review progressive subdivision applications, which constitutes a “one-stop shop” (“ventanilla unica”) that coordinates the approval process for developers. 

The progressive subdivision industry and its regulatory framework in El Salvador have produced marked positive and negative results:

The regulatory framework adopted in 1992 has succeeded in converting an illegal industry into a legal one that has rapidly expanded and now serves 60% of new low-income households.  Government review has helped keep development away from the most environmentally-hazardous locations.  In contrast to the 1960s when illegal subdivisions occurred on hilly lands and floodplains, regulation has influenced developers to locate new projects on flat land with suitable soils, although at increasing distances from city centers.

On the other hand, unoccupied progressive subdivisions now consume large areas in semirural regions as well as the urban periphery throughout the country, displacing other land-uses such as agriculture.  Transfer of legal title to households on payment of the last installment of the rent-to-own contract continues to be a major issue; a substantial backlog of progressive subdivisions (mainly from before passage of the national legislation in 1992) remain illegal.  The government review process still creates some dilemmas for developers; in particular, the minimum lot size of 100 square meters for urban areas is large compared with other Latin American countries.

While some regulatory issues remain, the low amount of funding for new water and sanitation infrastructure is now clearly the major bottleneck to low and moderate-income settlement.  The water and sanitation system of El Salvador suffers from weak governance and under-capitalization.  Municipal governments receive a very low share of national tax revenues in intergovernmental transfers (8%) compared to the Latin American average (15%), and lack funds for local capital investment.  The lack of funding for infrastructure contributes to causing the central problem of progressive subdivisions: although the progressive subdivision system effectively settles a large share of the low/moderate-income population of the country, it  provides virtually no support for consolidating the resulting communities over time. 

The Low-Income Land Development Projects of Saiban in Pakistan

Public landownership in Pakistani cities is high, ranging from 20% to 40% of urban property.  The lack of housing finance, urban development funding, and property tax systems discourages private real property owners from development and encourages them to hold raw land for speculation at prices unaffordable to the majority (World Bank, 2006).  These factors throttle legal land markets and create a perverse dilemma for low-income housing.  Pakistani cities and Karachi (Dowall, 1991), in particular, have ample vacant land including many unoccupied formal subdivisions.  However, most low and moderate-income households cannot afford the prices landowners ask for these lots.

Lacking any legal alternatives, most Pakistani families either participate in unorganized land invasions or buy lots in illegal subdivisions, which account for the bulk of urban settlement since the 1960s as parcels suited to land invasions have become scarce.

The public sector has an official and an unofficial response to these severe bottlenecks in housing and land markets, and the lack of affordable housing.  Officially, government agencies have experimented with a wide range of housing programs including sites and services, low-cost core units, and slum upgrading.  However, government-produced housing covers a negligible part of need and demand. 

Unofficially, public officers enter into arrangements with private-sector builders to develop publicly-owned land informally – i.e. the default mechanism of informal subdivision that predominates in most emerging-country cities.  Clandestine developers collude with government authorities to use public land on the urban periphery without formal legal transfer.

The former head of the urban development authority in Hyderabad, Tasneem Siddiqui, started Saiban, a citizen-sector organization, in 1987 in order to improve upon and formalize informal low-income settlement and has continued to lead the organization.  Essentially, Saiban has sought to copy the informal sector’s affordability, simple procedures, and rapid delivery, and join them with planned infrastructure including a sewerage system, a safe environment, legal title, and access to social services (Siddiqui).  Three projects have created 6,000 affordable titled lots to reach 35,000 low-income urban residents.  A comparable number of lots are in the pipeline.  This total of 12,000 lots exceeds direct government production but represents less than one year of unmet need (new household formation) in the Karachi/Hyderabad area.

Saiban’s City Of God project serves as an example.  Saiban acquired a 100-acre site for a portion of the City of God project (KKB-3) from the Malir Development Authority on the outskirts of Karachi.  This nonprofit organization subdivided the land on a gridiron plan consistent with government zoning regulations; 20% of the site was allocated for commercial services and collective functions (schools, medical clinics, parks etc.) and 30% for roads – much larger shares than informal subdivisions typically designate for these collective functions.  The remaining 50% was divided into 80 square-yard residential plots. 

The process to apply for and buy a lot is handled on-site and involves minimal paperwork.  Saiban offers a flexible payment schedule consisting of a downpayment of 20% to 40% (about US$175) of the total price.  Households pay the remaining amount of  US$525 in monthly installments over 100 months.  The resulting payments of US$5.25 per month are affordable even to the lowest-income households and virtually none drop out of the process.  Saiban keeps ownership of the lot until the last payment, after which it delivers full legal title to the families.  Saiban has also worked with commercial banks to offer mortgage finance to those earning US$3 per day and upwards. 

In order to discourage speculation, Saiban requires that a poor family stay at a reception site for up to two weeks to demonstrate need.  On making the downpayment at the end of the two-week waiting period, the family gains possession but not title to the plot, which is delivered to the family on payment of the final installment. 

The initial infrastructure is minimal – partly to discourage speculation – and consists of communal water supply, a soak pit for sanitation, and public transport from private suppliers.  The remaining infrastructure – including underground sewerage, piped water, electricity, and paved roads – is extended incrementally as installment payments are made.  Saiban develops the infrastructure internal to the subdivision including underground sewer and water pipes, electric poles and wiring, and internal paved roads funded by the monthly installments from purchasing households.  The relevant government agencies develop external infrastructure including trunk sewer lines, sewage treatment plants, bulk water and electricity supply, and access roads. 

In addition, Saiban arranges for a wide variety of other services.  Perhaps most important, Saiban transfers clear title to the lot when households make the final payment on their land and ensures public safety in its settlements through agreements with local police (usually, not to intervene) and others.

Financial analysis shows that a typical Saiban project (City of God KKB-3 of 2,800 lots) generates a highly positive net return (US$179,000 more than the total of the purchase cost of $430,000 plus subsequent development expenses of US$1.32 million).  Thus, Saiban’s modus operandi is financially viable and market-based.  However, it depends on the sale of parcels from government to Saiban.  Given the ample amount of urban land owned by the public sector, scaling up the Saiban model appears, in principle, a sustainable way to address low-income land and housing problems in urban Pakistan. 

In practice, however, the large financial benefit to public officials of illegal subdivisions and of government “sites and services” projects has substantially slowed the expansion of Saiban’s production.  While the money Saiban pays to purchase public land goes to the government treasury department (“exchequer”), illegal subdividers pay under the table directly to individual government officials.  Similarly, officials receive large commissions from contractors who over-design and over-estimate the cost of infrastructure for government sites-and-services projects, also under the table. 

As a result, individual officials prefer to sell public land to clandestine subdividers for their own personal gain rather than Saiban.  The founder and chair of Saiban – Tasneem Siddiqui – states that this organization has sought to purchase an additional site from the Malir Development Authority to expand Phase 3 of the City-of-God project near Karachi for the last three years.  This Authority has yet to sell more land to Saiban.  Illegal subdividers, however, have acquired the use of parcels adjacent to this Saiban project in collusion with the Malir Development Authority, the Board of Revenue, and the police.  In Islambad, Saiban has yet to get permission to develop land purchased from private owners four years ago, while illegal subdivisions proliferate.

Analysis

Table 2 applies the hybrid value-chain framework to analyze the progressive subdivisions of El Salvador and Saiban’s low-income land development projects in Pakistan.  Each factor was rated on a scale of “0” (negligible/never) to “3” (high/always) along with a brief explanation.  These ratings of individual factors were used to create average ratings for the settlement phase, the consolidation phase, and overall.  An examination of these average ratings provides a broad assessment of each case:

The progressive subdivision system of El Salvador scored 2.0 (out of a maximum of 3.0) for settlement, 0.4 for consolidation, and 2.0 overall.  The reasonably good score for settlement reflects that the progressive subdivision system of El Salvador allows 60% of new low-income households to acquire a lot in distant but developable areas.  Although this system avoids extreme environmental hazards, it results in contamination of groundwater by unimproved pit latrines, the proliferation of vacant subdivisions, and significant legal and physical insecurity.  The very low score for consolidation reflects these deficits and the minimal, haphazard support for turning these settlements into viable communities by extending infrastructure and for building shelter.  Overall, the massive scale and good affordability compensated for the negative environmental impacts and the distant location of these projects to achieve an average rating of 2.0.

Saiban’s low-income land development in Pakistan scored 2.3 for settlement, 1.9 for consolidation, and 2.2 overall.  Saiban – an NGO – does a superior job not only at settlement but also in supporting consolidation over time of the resulting communities relative to the for-profit subdivision firms of El Salvador.  The Saiban case demonstrates the potential value-added of citizen-sector organizations to the progressive housing process.  However, Saiban’s dependence on unreliable governments for acquiring new parcels (“political sustainability”) and the resulting limits to scale resulted in an overall average rating only modestly above that of the El Salvador case (2.2 compared with 2.0).