Identifying a suitable location for investment is among one of the first decisions to be made once a company has committed to entering a local market for an FDI project. Many assume that foreign companies would automatically seek to acquire land in the most secure and legally available option – typically either purchasing freehold from a private seller or in a long term lease from the government. Doing so would allow the investing company to earn income over time on the asset (such as foreign investors have done investing in bungalows in Singapore), maintain complete control over land use and possibly use the property for collateral.
However, this assumption is at times contradicted by the facts. Many foreign companies investing abroad may actually prefer to acquire land in the form of lease contracts. A recent example of this is the announcement by George Soros-backed Adecoagro to acquire land for its Brazilian agribusiness/sugar investment by entering into a long term lease contract. This could be because lease contracts often are easier to obtain and provide better protection against basic investor risks. How?
First, lease contracts allow foreign companies to protect against expropriation risk – losing relatively little of their investment in the land if the government decides to expropriate the land for its own use (as was the case recently in Venezuela). Second, lease contracts protect against currency devaluation or economic crisis risks, allowing the company to avoid exposure to long term obligations – required by purchasing land (many wealthy foreign investors have recently learned this lesson in Dubai). Finally, leasing may also make life easier on foreign companies entering the local market. In some cases, government approval may not be required for industrial investments, while such approval is almost always required for land purchases (see example of China Shenhua Energy Co. first having to get an approval from New South Wales state before it could invest in Australia).
Despite the benefits of leasing, the choice of how to acquire land is generally made on a case-by-case basis. I believe that there are three main points of decision when a foreign-owned company thinks about what type of acquisition to seek for its FDI project:
#1: Sector of investment. The choice of whether to lease or own land for an investment project is often highly dependent on the sector in which the company is investing. Sectors which are capital intensive and require large investments in physical infrastructure to begin operations (machinery, electronics and pharmaceutical manufacturing) typically prefer to purchase land in freehold for their investment. On the other hand, investors entering garment, retail, hotel, agribusiness, and service sectors typically prefer to lease land so that they can quickly exit if/when investments turns sour.
The World Bank Group Enterprise Database confirms these observations: more than 60 percent of foreign majority-owned companies around the world surveyed held land in lease contracts for garments, retail and hotel industry investments, while less than 30 percent leased the land for investments in metals, electronics and chemicals sectors – choosing instead to purchase the land for the investment project.
#2: Size of investment. A second important consideration for companies acquiring land abroad as part of their investment project is the size of their investment. As one would expect, the larger the size of the investment, the more security investors will seek in their acquisition of land. Again, the World Bank Group Enterprise Database points to this conclusion from majority foreign held firms operating abroad: more than half of those firms interviewed with 50 employees or less held land in lease contract, while fewer than 35 percent of firms with more than 250 employees held land in lease contract, opting instead to own the land where possible.
The bottom line is that there are a lot of considerations for foreign-owned companies when trying to access land for their FDI projects. If this has caught your fancy the same way it has for me, I would be curious to receive your comments.