Memorandum

To:           Mayor and Council, City Administrator, City Solicitor, Finance Director, Community Development Director

From:     Terry Rephann, City Councilman

Date:      8/28/2000

Re:          Jim Combs Project and rules for participating in subdivision development costs.

I have been trying to organize my thoughts about the Combs project and the proposed City participation in cost sharing of infrastructure for new subdivisions.  This memo summarizes my thoughts/findings.

 

FACTS: Jim Combs has asked the City to participate in the costs of developing two cul-de-sacs for 7-12 parcels of land that will eventually be improved with single level, ranch style homes.1   The value of each of these properties using current market prices may be in the $130,000-$150,000 range.   Cost estimates developed by the City Engineering Office for the improvements are approximately $50,000 for street improvements and $75,000 if A/E fees, water and sewer, etc are included.  However, these estimates are preliminary and may not include a contingency allowance.

 

Mr. Combs first petitioned the Mayor and Council for this participation after learning of how the City has been applying Section 129 of the City Charter.  Apparently the City shares the costs (50-50) of improving local streets that are ranked low in priority for improvement within the city Master Plan.  The section reads:

 

“The mayor and city council may whenever in its judgment the public interest or convenience require it, have any street, lane or alley, or parts thereof, in said city paved, repaved, graded, re-graded, curbed, re-curbed, guttered, re-guttered, sewered, re-sewered, surfaced or resurfaced, or otherwise improved and levy the whole expense thereof or any portion thereof, on the property binding on such street, lane or alley, at a charge on a front foot basis for each lot binding thereon, and collect the expense thereof as directed in section 132, and in case less than the whole cost is assessed upon the abutting property, the city shall pay the remainder thereof. The mayor and city council shall provide by ordinance for the giving of notice by publication or by service or written notice personally upon the parties to be affected by said construction or improvements, and allow them to be heard before any such construction and improvements are made, but nothing in this section shall be construed as preventing the mayor and city council from constructing any sewer or sewers or system of sewers and paying for the same out of the funds of the city, nor to prevent the said mayor and city council from charging a reasonable sum for the use of said sewer, either by an annual charge or by a charge for the right of connection therewith, in perpetuity; and nothing in this section shall be construed as preventing the mayor and city council from paving, repaving, grading, re-grading, curbing, re-curbing, guttering, re-guttering, surfacing or resurfacing and paying for the same out of the funds of the city, nor to prevent the said mayor and city council from charging a reasonable sum for said paving, repaving, grading, re-grading, curbing, re-curbing, guttering re-guttering, surfacing or resurfacing prior to the issuance of an occupancy permit and/or building permit, or any other type of permit for the abutting property or portion thereof, all of which powers are hereby granted the mayor and city council; and provided further that the said mayor and city council may only exercise the right to repave, resurface, re-grade, re-curb, re-gutter, re-sewer and otherwise improve, after the expiration of five (5) years from the time of the completion of the last paving, grading, surfacing, curbing, guttering or otherwise improving of said street, lane or alley which is to be repaved, re-graded, re-curbed, resurfaced or re-sewered.”

 

Mr. Combs originally argued that the wording of this section and the practice of the City sharing 50% of repaving costs for several existing streets is sufficiently flexible as to allow the City to share in the costs of developing the proposed cul-de-sacs.  However, this interpretation was not consistent with the City Zoning Ordinance and Sub-division regulations Section 3.01.01.6 which reads:

 

“In the event that utility systems, publicly maintained roads, or other improvements are required to be extended in a proposed Minor Subdivision, it will be the Subdivider’s responsibility to provide those improvements to City standard’s according to the procedures set forth in Section 3.02 and the standards set forth in Section 5.”

 

ANALYSIS:  It is pretty clear to everyone that the ordinance prevented city participation in the Combs ‘ project (which is why Ordinance No. 3337 “An Ordinance Establishing Procedures and Requirements for the Consideration and Execution of Development Rights and Responsibilities Agreements” was/is needed to allow City participation), but what is less clear to me is how the City arrives at the 50-50 formula used in street repaving.  Jeff (Interoffice Memo 12/18/98) suggests that we participate in the former because it is “a platted subdivision owned by a variety of individual owners.”  That is to say, a street already exists and the owners are simply seeking to upgrade its quality.  Although the City periodically makes street improvements, many low quality streets are lower in the City’s Master Plan priority list because they carry less traffic or judged to be in adequate condition for local traffic.

 

Presumably, however, a large part of the value of any street improvements will be capitalized into the adjacent property values, meaning in essence that the city could potentially be providing a windfall benefit to owners anytime a street improvement is made.  There are only three reasons I can think of why the City participates in this fashion: (1) the street improvements have certain diffuse benefits for all City residents/motorists and therefore should be at least partially paid for by all city residents (the question I have, however, is how do we arrive at 50-50?  If 90% of the traffic originates from the improved minor street, why don’t they bear 90% of the costs instead of 50%?), (2) this participatory formula is a useful tool to encourage residents outside City limits to agree to annexation of their properties, which in turn might have a positive fiscal impact on the City, and (3) the street improvements will increase property values, having positive fiscal effects, and possibly encouraging further investment in property improvements.

 

Now, lets look at arguments (1)-(3) in light of the City Ordinance revision/amendment.  Clearly, the Combs project flunks the first reason.  The proposed cul-de-sacs carry only local traffic—therefore, 100% of the value of the improvement will be capitalized into the adjacent properties.  Reason (2) is relevant because Mr. Combs is, in a sense, allowing his planned improvements to be “annexed” into the city.   If the City declines to participate, he is suggesting that he may simply not build the houses and allow the land to go to fallow.  However, like an annexed subdivision, we never really know if this incentive was ever really necessary to get them to agree to put their property on our tax rolls (some annexed subdivisions might have allowed the annexation without this additional financial incentive--meaning that the city loses money).   The third reason is the one that Mr. Combs often cites: his improvements will increase the tax base (through the appreciated value of his subdivided properties and the appreciated values of existing homes in the neighborhood.  These additional tax revenues will compensate for the street investments in a yet undetermined number of years.

 

There are a few additional complicating factors.  If this rule is changed to permit participation in the costs of subdivision development costs, other subdivision developers will expect similar treatment.  Currently, new houses are being built at the rate of 4-5 per year within the City (see Attachment A showing housing construction permits issued over the past five years).  If we assume for the sake of argument that 1-2 houses on average require some infrastructure improvements, then the city may be obligated to participate in their projects also.  Another thing to consider is the possibility that the City’s willingness to participate in infrastructure costs will encourage additional development.  City participation should decrease subdivision development costs 2-5%, some of which will be passed on to homebuyers in the form of reduced price.  However, price elasticity of demand for housing is typically pretty low.  It is difficult to imagine the subsidy would induce more than, say, 2 new houses to be constructed per year.

 

It seems to me that the city should be interested in this from both a fiscal (tax revenue) benefit standpoint and for the more diffuse economic benefits that might result.  Ordinary financial calculations would require that the discounted present value of revenues exceed discounted present value costs to the city (e.g., infrastructure improvement costs and use of other city services).  That is to say, all future streams of payments and costs would be valued in present value terms—future dollars being worth less than present dollars.  The Mayor has suggested that we use a “seven year” payback rule and Jeff has considered a less demanding “10 year” payback rule.  Basically, these rules of thumbs accomplish the same thing as discounting, but the choice of which “payback period” is better will depend on what one considers a reasonable discount factor.

 

We probably also want to consider the diffuse economic benefits that might result.  Some of these benefits might include: (1) the economic development impacts of new housing construction (local labor and construction material purchases and multiplier effects), (2) the resultant improvement in the quality and diversity of the city housing stock which might improve residential, commercial, and industrial recruitment prospects, and (3) social benefits arising from transportation cost savings due to the street improvements (likely to be very small in the “Combs” project case). 

 

Of these various types are impacts, the fiscal ones are comparatively easy to gauge.  I have made a crude attempt to quantify these impacts for the Combs development below:

 

FISCAL IMPACTS:  Fiscal benefits derive from the net increase in the assessable tax base.  Also, the city would benefit from federal and state intergovernmental transfers that are computed on the basis of the number of municipal residents.  Costs derive from: (1) city participation in sharing the costs of the street improvements, (2) marginal costs of providing usual municipal services (e.g., police, fire, snow removal), and (3) costs of administering this program (not negligible—already, I think, the opportunity costs can be measured in the thousands of dollars and the financial administration will involve potentially hundreds of dollars more per project).

 

The biggest unknowns are the marginal costs of providing municipal services to new residents.   The easiest way to estimate the marginal costs of municipal services would be to compute average costs (basically, divide expenditures for budget items by city population and multiply this ratio by number of expected new residents in subdivision).  There are, however, two reasons that an average cost estimate will provide an inflated estimate of actual marginal costs.  First, we can be relatively certain that there are excess capacities in some areas of municipal services or substantial economies of scale. So, the marginal costs should be lower than average costs.  Second, the type of resident who will purchase new intermediate/high cost housing will be drawn from higher socioeconomic level and is less likely to need fire, police, and other types of municipal services.

 

The basic parameters that I think are important in determining fiscal impacts are listed here as follows: (1) What is the assessed value of the unimproved land (BP)? (2) What will be the assessed value of the unimproved land after the improvements (AP)? (3) What will be the net assessed value improvement in the neighborhood because of the improvements (NP)? (4) What is the expected average property tax rate (TR) for the medium-term future? (5) What is the direct cost of municipal participation (50/50) in the street improvement (DC)? (6) What is the indirect cost of municipal participation because the municipality may find itself subsidizing similar projects that would have occurred anyway (IC)? (7) What is the estimated per capita intergovernmental transfer (IG)? (8) What are the estimated administrative costs [paper shuffling, cash management, etc.] of the program (AC)? (9) What are the marginal costs (MC) of city services (e.g., safety, waste removal, street maintenance)? (10) How many household residents are expected for each newly constructed house (RE)? (11) What is the interest rate (R)?

 

In terms of a formula, the present value of the net fiscal impact (PV) would be computed as:

 

PV=

 

BP=Value of the unimproved land (BP).

AP=Value of the unimproved land after the improvements.

NP=Net assessed value improvement in the neighborhood because of the improvements.

TR=Property tax rate.

DC=Direct cost of municipal participation in the street improvement.

IC=Indirect cost of municipal participation because the municipality may find itself subsidizing similar projects that would have occurred anyway.

IG=Per capita intergovernmental transfer (IG).

AC=Administrative costs of the program.

MC=Marginal cost of city services (e.g., safety, waste removal, street maintenance).

RE=Average number of household residents.

R=Interest rate.

i=time period i.

n=final time period under consideration for project appraisal (normally for public projects, n=30).

 

Now, we need to establish reasonable parameters for the variables listed above.  I’ll assume for simplicity that each subdivided parcel is 1-1.5 acres worth $10,000 (BP=$10,000).  The value of the subdivided parcel after construction will be $135,000 (the approximate assessed value of Jim Combs present residence) (AP=$135,000).  Because the houses that Mr. Combs will build will be of better quality/value than existing homes in the neighborhood (they appear to be worth about 70-100k), they will enhance the value of each home within 100 yards by a certain amount.  Real estate research shows that a “one-unit increase” in the quality of adjacent dwellings increases neighborhood value by about $1,000.  Therefore, let us assume that there are 10 homes in the vicinity and that they appreciate in value $1,000 each as a result.  Therefore, the assessed value of existing residences in the neighborhood increases $21,000 (NP=$10,000).  According to City Engineering Department estimates the cost of the street work will be $50,000-$75,000, depending on the scope of the work.  Lets assume it is the higher value and further assume that Mr. Combs builds 9 houses.  Therefore, the average direct costs per house will be about $8,000 (DC=$8,000).  According to the attached list, about 4-5 residences are built within city limits.  Probably only part of these required investments in municipal infrastructure.  Lets assume that for every two homes Mr. Combs builds, one house would have been built anyway.  Therefore, Indirect Costs are $4,000 (IC=$4,000).  Lets assume that intergovernmental transfers are determined strictly on the basis of census headcount.  Since there are currently about 21,000 residents in Cumberland and intergovernmental transfers for FY 2001 are projected to be somewhere in the neighborhood of $4,000,000, the per capita residential transfer is approximately $200 (IG=$200).  The average number of residents per household is close to 2 (RE=2).  Lets assume that the administrative cost of the new program is $500 per house.  Costs that might increase as a result of additional population are primarily in the public works and public safety categories.  Expenditures on these items are within the range of $3,000,000 and $10,000,000.  Lets assume an average of the two values $6,500,000.  Therefore, MC=$300.  The property tax rate is $1.30 per $100 of assessed home value (TR=.013).  Assume that the interest rate is .08 (R=.08). 

 

#1  Now, using these values, lets make a baseline simulation of the discount rule, 7 year rule, and 10 year rule when one property is developed with city participation.

 

Discount rule (n=30)           PV=$932

10 year rule                          V10= $-1,450 

7 year rule                              V7=$-4,615

 

#2.  Assume baseline case but that developed property price (AP) increases to $150,000.

 

Discount rule:              PV=$3,322

10 year rule                   V10=$500

7 year rule                   V7=$-3,250

 

#3: Assume baseline case but administrative costs (AC) are only $200 per parcel.

 

Discount rule:              PV=$4,609

10 year rule                 V10=$1,550

7 year rule                   V7=$-2,515

 

#4  Assume there are no indirect costs (IC) and neighborhood effects (NP) (IC=0 and NP=0)

 

Discount rule               PV=$7,016

10 year rule                 V10=$4,250

7 year rule                   V7=$575

 

#5: Assume that the City declines to participate and the Combs development is built anyway (DC=0 and IC=0)

 

Discount rule               PV=$16,609

10 year rule                 V10=$9,919

7 year rule                   V7=$7,619

 

#6: (Worst Case Scenario) Assume that entire city budget should be included in computing marginal costs (MC=$650)

 

Discount rule               PV=$3,971

10 year rule                 P10=-$5,450

7 year rule                   V10=-$7,415

 

 

 

#7: (Best Case Scenario) Assume that there are no marginal costs of extending municipal services (MC=$0)

 

Discount rule               PV=$11,964

10 year rule                 P10=$7,550

7 year rule                   V7=$1,685

 

CONCLUSION

 

Using baseline values that I think are plausible, the Combs development fails both the 7 and 10 year rules.  It barely passes the discount rule.  Using several different scenarios, the Combs project fails most applications of the 7 year rule.  However, if anyone wants to suggest other values, I can plug them in.

 

OTHER FACTORS TO CONSIDER

 

I am not suggesting that only fiscal impacts should be taken into consideration when making a decision of whether or not to participate in development costs.  As I mentioned earlier, one should consider the other external benefits (e.g., jobs, transportation costs).  Furthermore, the credit worthiness of the developer in question is important (to gauge the risks of incurring additional administrative costs if the project is not finished according to specs).  Finally, one should consider whether the new ordinance would be legally, ethically, or politically kosher.  I have listed below some of the “pros” and “cons” of the issue as I see them:

 

PROS  (Mostly Intangibles)

(1) Change in policy may have positive fiscal impact.

(2) Change in policy would augment city housing stock.

(3) Change in policy would might stimulate city housing construction.

(4) Change in policy could potentially help fill in city transportation grid.

(5) Change in policy could improve city esthetically.

(6) Change in policy would help iron out inconsistencies that exist with respect to other parts of the city code that address city participation in existing street improvements and annexations.

(7) Change in policy would signal to business community that city is serious about housing issues and is prepared to bear the potential costs and risks to affect the situation.

 

CONS

(1) Change in policy may lead to instances where project has a negative fiscal impact.

(2) Change in policy could lead to potential bias/favoritism in deciding city participation.

(3) Change in policy could introduce high level of complexity into decision-making that average person is not equipped to understand.  Most of the important parameters in determining whether the policy will lead to positive fiscal impacts are highly speculative.

(4) Change in policy might potentially result in a less transparency in decision-making.

(5) Change in policy leads to inconsistencies with respect to treatment of major subdivision developers if they are excluded.

(6) Change in policy would make the city a real estate market speculator (because neither future interest rates, property values, or participant reliability can be known with certainty).

(7) Even if the project yields a positive fiscal impact, the rate of return from the investment may be lower than what can be obtained by investing in short-term securities (e.g., money market).

(8) Although fairly common several decades ago, few if any municipalities currently offer subdivision municipal infrastructure assistance programs like the one proposed here.  Why not?

(9) If the program proposed here is desirable, why hasn’t the County offered to participate in some fashion as well?

 

1In addition, Mr. Combs has asked the City to provide water taps for the development because of his willingness earlier to consent to a property easement on Winifred Road.  This issue is distinct from the question of whether or not the City should in principle participate in such projects and should not be raised in the same.