Wokay!

Time to answer the questions raised by my post on using real estate options to pay for acquisition of land. I’ll answer the questions raised in the comments first, and then address some other issues.

Will the options be provided to displaced people free of cost, or sold? Will they be given loans to buy them? And who sells them the options?

I envisage free of cost, but that isn’t necessarily the right answer. I think that the right price will be something arrived at through trial and error, after seeing the results from many such compensation schemes. But you can have any nonzero inital price of the option, with a corresponding change in the price you exercise it at.

The options will be paid for by whoever is acquiring the land and displacing the original landholders. They will be sold by competing real estate agencies and property developers.
Does this mean that displaced people will move to the about-to-benefit regions?

No, it doesn’t. It just means that they become the landlords of the about-to-benefit regions (if they exercise the option). They collect the rent or the mortgage on the land. They don’t necessarily move in. But I’ll come back to this later.

If the government won’t even move them to any region, why will it move them to an about-to-benefit region?

Excellent question. For the government-backed Sardar Sarovar Authority, or indeed any developer, resettlement is a cost which they’d like to minimize. But if selling land to displaced people was a profitable activity, and multiple real estate vendors were competing to sell them land, this wouldn’t be a problem.

How do we reach this happy state? Well, real estate options are financial assets. You can borrow against them just as you can borrow against actual property or against shares. They become security for a property loan- and now the displaced family chooses where to buy property instead of just settling for what the government gives it.

Now, the objections I thought of myself.

This won’t work for the Narmada Dam victims, will it?

Sadly not. It’ll not work for anything at this point of time. It needs a lot of infrastructure in place before it can work.

Like what?

Ah, now we come to the meat of the matter. To make it truly effective, you need an existing large and liquid market in real estate options. The problem with this is that trading in real estate options did not actually begin until this year at the Chicago Board of Trade. Still, there’s no reason it won’t eventually catch on in India.

What if the option holder exercises the option, becomes the owner of the property, and chucks out the tenants?

Well, he would be in his rights to do so (assuming the local laws were actually biased in favour of landowners instead of tenants), but there are some ways to avoid this:

1. Don’t allow delivery against the option. Just allow the option to be sold back to the original holder, so that the holder only gets the difference in prices, and not the real estate itself. I’m not a great fan of this one.
2. Instead of an option on the real estate itself, make it an option on a mortgage-backed or rent-backed security, i.e., the holder will not own the real estate itself, but the right to collect all future mortgage payments or rental payments on it. This could work, but it assumes the existence of mortgage backed securities. Then again, if the Indian financial system can evolve to offer real estate options, it can surely offer mortgage backed securities, which are in much higher use.
3. The developers of the property which is being optioned actually create surplus capacity for the prospective options. It could be done, but it would saddle them with an investment that offered no return for the life of the option. I don’t see this becoming very feasible.
4. My personal favourite: instead of making it an option on actual real estate, make it an option on a real estate index.

What’s a real estate index?

Just as the Sensex measures the value of 30 specific stocks, and converts it into one single number, a real estate index would check property values at certain locations and convert that into a single number. You could have an all-India commercial property index based on office rents in Bangalore, Mumbai, Gurgaon, and Chennai. A Bombay residential property index based on flat rents in Andheri, Powai, Dadar, Colaba, and so on. This addresses one of the difficulties in deciding the market price of an actual piece of real estate.

What if unscrupulous property dealers offer low prices to the displaced people for their options? Those displaced people would take any amount of cash and spend it on booze instead of holding on to a piece of paper.

This is an argument against financial illiteracy, and not against options. After all, you could as easily ask ‘What if unscrupulous property dealers offer low prices to displaced people for the land they get as compensation?’.

So you do need to educate people on what the option actually does and how it can be used, but it isn’t a horribly difficult concept to explain.

And I’m not being facetious here, but cellphones can be a very powerful weapon where this is concerned. If fishermen can use them to find the market price of fish, displaced landowners can use them to find the market price of an option.

What was that you said about turning resettlement into a profitable activity?

Look, people who build a dam are good at civil engineering and project management. Not at buying land and helping people they’ve displaced to move there. So for starters, the people building a dam shouldn’t be in charge of resettlement- just pay for it.

But then should there be a single agency in charge of resettlement? No, dammit. Throw resettlement open to competition. Treat displaced people as consumers and entrepreneuers who want to buy income-generating property, not as refugees. Give them liquid assets like cash and real estate options (or even ownership-equity in the developing body) which they can use to buy land. Who sells them land? Competing property developers. Who provides them the options? Competing real estate agencies, anxious to close a deal. Once competition enters the sale of options as well as the purchase of land, displacement victims will get a much better deal. Also, the kinks in this new and untested scheme will be ironed out much faster.

I’m still doubtful about the whole thing.

I’m not surprised, because it is a whole new idea. But that’s why I’m plumping for a market in resettlement, because it’ll work out the problems much faster than I ever can.

That wraps it up. I don’t think I’ll have any more individual posts on this, though I’ll of course address all further questions in the comments.

A few months ago, a Tehelka reporter was interviewing some of us at IIM Bangalore for a special feature on the perception of leftism on Indian campuses. The interview drifted from perception of the left parties, to the question of who would speak for the poor, and then to the Narmada Bachao Andolan. Someone- I can’t remember if it was the reporter who asked if we believed in it or one of us who stated that he did- brought up the concept of ‘sacrifice’ – that the displaced people should be willing to sacrifice something for the good of the entire nation.

It’s sad. As managers, we’re supposed to look for win-win solutions. But we’re conditioned so badly by the national discourse on the Narmada dam that everything turns into a sacrifice: either the displaced people should sacrifice their land for the benefit of farmers and agriculturists, or urban residents should sacrifice their comfort to maintain traditional tribal lifestyles.

But why must either side sacrifice anything?

The transaction looks like a sacrifice because it’s terribly onesided. The victims of displacement get only land- if the incompetent administration gives it to them in the first place- while the beneficiaries of the dam get water and benefit from increasing real estate prices.

Is there any way to ensure that the people who lose their land benefit to the same extent that the people who get the water do? Yes, there is- and it relies upon the concept I introduced in the previous post– financial options.

If the development- whether it’s building a dam, or building a township on agricultural land- does what it’s supposed to, land prices will rise significantly in the area that is being developed. If the development is a dam, the acquired land will not see a price rise, but the land that does get access to irrigation thanks to the dam will see a rise in value. For a real estate development, things are even more straightforward- the acquired land is developed, and sees a rise in value.

What if you compensate the people whose land you are acquiring with call options on the land which benefits? The option can have an exercise price equal to the current price- or perhaps with a modest premium- and it can be exercised on a date after the development is expected to be complete.

(Of course, I am not suggesting that compensation should be purely in options- just that options should form part of a compensation basket that also includes land and cash.)

As you’ll recall, a call option means the option holder can buy the asset at a fixed price (which we’re assuming is the current price). Let’s say that prior to the construction of the Narmada dam, Ahmedabad residential property is trading at Rs. 300 a square foot. Displaced people are given call options to buy say, five hundred square feet of Ahmedabad residential property at exactly this price: Rs. 300. After the construction of the dam, and diversion of water to Ahmedabad, residential property rises in value thanks to improved availability of water. It’s now worth 500 rupees a square foot. Multiply the difference- two hundred rupees a square foot with the number of options: five hundred square feet- and that’s one lakh rupees. (Of course, these figures were just to illustrate the concept.) And with some neat usage of financial derivatives, we’ve solved the problem of unequal gains.
There are some problems associated with this idea that I can think of off the top of my head. I’ll discuss how to solve these in another upcoming post.