SÃO PAULO, Brazil — José Uilton has seen a lot of things change along Luís Carlos Berrini Avenue since he took over a bar here 17 years ago. Most of the squatter settlements, known in Brazil as favelas, have been cleared out. Meanwhile, luxury high rises have gone up, making this one of the most expensive areas in São Paulo.
Uilton may not be one of the new rich people in this neighborhood, known as Água Espraiada. But he believes the changes have been for the better. “I have witnessed a complete transformation of this area,” says Uilton, whose bar sits in one of the area’s last untouched favelas. “Now we have a medical center nearby, a good avenue and everybody is living together in harmony.”
If Uilton’s approval of all this gentrification sounds unusual, that may be because the rules behind redevelopment here are a bit different, too. Água Espraiada is one of two São Paulo neighborhoods to benefit from an innovative financing tool that has become something of a model in Latin America. The strategy has raised phenomenal amounts of public revenue to pay for infrastructure projects in the area — including public housing projects for the favela residents to move back into.
Here’s how it works. City leaders identify a redevelopment zone, and issue a number of bonds to be sold to developers at auction. The bonds entitle the developers to build bigger buildings than the law would normally allow. Revenue from the bond sales are invested back into housing, roads and other infrastructure in the same redevelopment zone.
Developers don’t seem to mind bidding for these bonds, at least in areas such as Água Espraiada where there is tremendous demand for new construction. And the auctions have yielded the city a massive windfall. In 12 years, São Paulo has raised about R$ 4.5 billion, or close to $2 billion in U.S. dollars, through these sales. About three-quarters of that total came from the Água Espraiada area alone.
Many ways to tap value
São Paulo’s model is one of many mechanisms cities around the world use to do what is known broadly as “value capture.” The idea is that cities sometimes do things through regulation, planning and investment that unlock massive amounts of land value. And when they do, the public — not just landowners and developers — should enjoy some of that windfall.
In São Paulo’s case, the action to unlock land value is “upzoning” an area for more intense development. In other cases, the city action might involve public investments, such as building a transit line through a certain area or building a park as a neighborhood amenity. The principle works in rich and poor cities alike. Paving over a dirt road can increase surrounding land values in a city, as can introducing reliable water service to an area for the first time.
“Many administrative actions result in huge increases in land prices,” says Martim Smolka, a senior fellow at the Lincoln Institute of Land Policy and the author of a 2013 study on value capture mechanisms in Latin America. Value capture, Smolka says, is about “equalizing and redistributing the benefits to all the citizens.”
The tools cities can use depend a lot on the land laws and traditions of their countries. São Paulo’s approach was authorized under Brazilian law, which was itself fashioned after policies in Canada and France. That particular approach of selling building rights would be less effective in countries where landowners generally have more property rights, such as the United States. In the U.S. context, value capture is more likely to occur through property taxes, special assessments on developers, tax-increment financing, or simply negotiating with developers to pay a share of infrastructure costs.
In the Dallas-Fort Worth area, a proposal to build a 62-mile rail transit line linking 13 cities, the international airport and multiple existing light-rail lines would rely on value capture to pay for a significant amount of the project. The plan calls for a transit-oriented development district along the corridor with dense but walkable neighborhoods around the stations. Landowners would contribute some of the upfront rail construction costs, while other revenue sources captured within the special district would provide funds to pay back the financing.
“Value capture is not a magic bullet,” says Scott Polikov, a value-capture enthusiast and founder of Gateway Planning, a Dallas-based consultancy working on the project. “It’s a way to fill a financing gap when there’s a gap. But you still have to have a large proponent of the public infrastructure on the public-sector side. Value capture will never fully close the gap.”
In São Paulo, the idea began to surface in the mid-1980s. At the time, Brazil was emerging from a 20-year military regime that had largely ignored social problems such as the growth of favelas. Redevelopments in slum areas, known as “urban operations,” began. Developers could receive density allowances if they included social housing for displaced residents, or made a payment to the government.
The idea evoked both criticism and praise. Supporters saw advantages to eliminating favelas from the city’s central areas quickly and replacing them with modern development. Opponents argued that local residents were rapidly being displaced from central areas to the outskirts of the city. Transparency was also a problem, as deals between the city and developers were negotiated on a case-by-case basis.
The process got an overhaul in 2002, setting up the more transparent, market-based system in place today. The city sets out an area to be redeveloped and sets aside a certain number of “CEPACs” — or certificates for additional construction potential — that entitle developers to build extra density in that area. These bonds are auctioned through the Bank of Brazil, and the sales are overseen by the national Securities and Exchange Authority. The market is robust enough that CEPACs are widely traded and have become an established investment vehicle for pension funds and others looking to invest in Brazilian real estate.
Each sale of CEPACs gives the city government a new pile of cash to invest in the redevelopment area. That up-front revenue has been key to the program’s success, says Claudio Bernardes, president of Secovi, the association of companies involved in the housing and construction sector. CEPACs, Bernardes says, have been a “very positive mechanism, which allows the municipality to anticipate revenues and perform improvements before the private sector projects fully occupy and densify the area.”
Raquel Rolnik, an urbanism expert from the University of São Paulo is more skeptical. She says targeting certain neighborhoods where developers want to build is distracting city leaders from making more universal urban plans for the whole city. “The companies want to invest in a certain area,” Rolnik says, “so the city designs a plan for the area and offers CEPACs. The market buys the papers and the mayor says the plan was a success. It is all like a dog biting his own tail.”
Another criticism is that some CEPACs have led to wasteful spending. In Água Espraiada, the bonds raised R$ 3.5 billion, or about $1.5 billion in U.S. dollars, all of which by law had to be spent in the same area. Some R$ 300 million ($135 million U.S.) was invested in an enormous bridge. While the bridge’s X-shaped tower and white cable stays have become an iconic postcard image of the city, many think it was not really needed, and it has not produced much benefit in terms of mobility.
São Paulo’s city council is currently debating a couple of changes to the program. The first would address the bridge-to-nowhere problem by allowing some CEPAC money to be spent in neighboring areas. That would allow funds to be spent on public transportation, since buses, trains and subways pass through different areas of the city.
The other proposed change would require one-quarter of the CEPAC money to be invested in low-income housing. Current law forces that housing to be located directly within the redevelopment area. The new plan would allow it to be located in an adjoining neighborhood. “This will ensure affordable housing in areas under intervention,” says Nabil Bonduki, a former housing secretary of the city who is now the councilman behind the proposed changes.
These reforms have passed one city council vote but will need to pass another to take effect. Neither of them, however, would address the last major criticism of the CEPAC mechanism: When should its use come to an end?
That’s a question made more acute by the role CEPACs have come to play as an investment vehicle in financial markets. At some point, all the bonds will be sold and all the public revenue invested — but financiers will surely want to hold on to their CEPACs as investments. Bonduki says the council is aware of the problem and will prepare a response to it.
Raquel Rolnik argues there should be a deadline for the use of CEPACs. And on this count, Claudio Bernardes agrees with her. “Current laws do not provide a ‘way out’,” says Bernardes. “The law does not say how or when the zone returns to the normal rules of the rest of the city.”
This story originally appeared on Citiscope, an Atlantic partner site.