I’ve been thinking about an interesting and provocative article by engineer and Strong Towns advocate Charles Marohn. “Interesting” because it provides a novel way of thinking about the financial trade-offs inherent in urban development, including the allocation of costs between private property owners and the public in general, and between current residents and future ones. “Provocative” because it kills a few sacred cows along the way.

Marohn is best known as a critic of conventional suburban development patterns that involve large taxpayer-funded subsidies for infrastructure and expose communities to long-run fiscal liabilities that they are not prepared to address. But, as he discusses in the article, he’s also not a fan of attempts to simplify the issue down to a question of population density:

The most common question I receive by email is some variation of: what is the right density for a Strong Town? What is the magic number that makes all the math work and that we should plug into our zoning codes to get the optimum place?

[…] Let me restate the question: Something that I think would be valuable for planners and everyone else who finds it painful to think independently but instead to take comfort in misapplying “data” provided by others deemed experts (see parking codes as one of many examples) is to have a table of densities that will allow us to zone a Strong Town.

I hate density as a metric and whenever I hear someone talk about it my mind reflexively moves on to something more worthy of my time. Yours should too. Density is not our problem or our solution. Insolvency is our problem. Productive places are the solution.

This is a good critique. While you need data to make rational decisions, looking at the wrong evidence can be useless or worse. Density is not necessarily a good proxy for cities’ financial sustainability, any more than traffic volumes are a good indicator of the value that cities get out of urban streets. For instance, while low-density Stockton, California went bust after the 2008 financial crisis, high-density New York City teetered on the brink of bankruptcy in the economic turmoil of the 1970s.

Instead of density, Marohn recommends looking at the relationship between property values and the replacement cost of urban infrastructure:

Consider the following: You own a $200,000 house. I come to you on behalf of the city with a proposal. We are going to fix all of the infrastructure directly in front of your home. We’re going to fix the street and the curb and the sidewalk. We’re going to replace all the pipes and service connections. And when we’re done with this project – a once a generation undertaking – we’re going to give you the bill.

And when we give you the bill for the stuff that directly serves you – the stuff that you but nobody else needs – we’re going to also give you a bill for your share of the communal infrastructure. In other words, you are going to also pay a once-a-generation charge for the maintenance and upkeep of all the arterial streets, interchanges, traffic signals, lift station pumps, water towers, treatment facilities, etc… It will only be your share – everyone else will pay theirs – and you won’t be billed again for a generation.

Remember that you own a $200,000 house. What if I said your total bill was $200,000? Would you pay it? I’ve been asking people this exact question for the past two weeks and have yet to have anyone who didn’t immediately say “no, there is no way.” And, of course, nobody would pay this. If the house is worth $200,000 and my additional cost of maintaining the infrastructure to allow me to live in that house is an additional $200,000, than that’s a really bad investment…

It is only when I got to $10,000 where people in large numbers would agree they would pay and, at $5,000, I started to get universal acceptance. For a $200,000 house, it is definitely worth an additional investment of $5,000 to keep everything around it functioning.

I think this is a reasonable thought process and it points to a powerful conclusion. At a property value to infrastructure investment ratio of 1:1, everybody walks. Nobody sensible is going to invest $200,000 in infrastructure in a property and have it end up being valued at only $200,000. What’s the point?

At a ratio of 10:1, resistance starts to soften and we see people with different circumstances start to respond differently. Somewhere between 20:1 and 40:1 we cross over into no-brainer territory. Nobody is going to walk away from a $200,000 investment if all they have to put in is another $5,000 once a generation to keep it all maintained.

So instead of density, what we’re really talking about here is a target ratio of private investment to public investment of somewhere between 20:1 on the risky end and 40:1 on the secure end. If your city has $40 billion of total value when you add up all private investments, sustaining public investments of $1 billion (40:1) is a doable proposition. Public investments totaling $2 billion (20:1) starts to be risky with outside forces of inflation, interest rates and other factors beyond your control starting to impact your potential solvency.

Following Marohn’s approach, how financially sustainable are New Zealand towns and cities?

We can get some valuable insights from a quick back-of-the-envelope analysis. According to Reserve Bank statistics, the total value of residential property in New Zealand, as of March 2016, was $905 billion.

We can compare this to data on the replacement value of roads and pipes compiled by the Treasury’s National Infrastructure Unit. According to their 2015 review:

  • The total value of local roads (excluding land costs) is around $50 billion. State highways are valued at around $29 billion.
  • The total replacement value of urban water infrastructure – ie drinking water, wastewater, and stormwater – is $45.2 billion. However, much of this infrastructure is in unknown condition, or not meeting performance standards.

State highways are intended to be fully funded out of the National Land Transport Fund (NLTF) – ie out of fuel taxes, road user charges, and other revenues from users. Likewise, the NLTF provides around 50% of funding for local roads – leaving a substantial chunk to be paid by ratepayers, including people who seldom drive. However, water infrastructure is usually funded by ratepayers, sometimes with a contribution from developers for up-front capital costs.

If we assume that these funding splits continue, property owners will have to fund the replacement of around $70 billion worth of roads and pipes. In other words, New Zealand’s average ratio of residential property value to public infrastructure costs is around 13 to 1 (ie $905bn/$70bn).

This is above Marohn’s recommended range of 40:1 to 20:1 – not necessarily unmanageable, but nonetheless a signal that we need to take a cautious approach to developing our towns and cities. (By comparison, Marohn has found some cities in the US where long-term costs to renew/maintain public infrastructure are twice as large as the value of residential properties.)

However, averages conceal a lot of variation. In particular, when thinking about what will strengthen or weaken cities’ financial sustainability, we need to think about the marginal cost of infrastructure to serve new growth areas, not simply the average cost across the entire city. There, we have stronger cause for concern.

For instance, Auckland Council’s Future Urban Land Supply Strategy, released last year, estimates that the costs to provide ‘bulk infrastructure’, or arterial roads, water and wastewater mains, etc to service greenfield areas are in the range of $17 billion. These greenfield areas are expected to provide capacity for somewhere between 88,000 and 110,000 new dwellings.

Based on these high-level estimates, bulk infrastructure costs to serve greenfield growth areas will be in the range of $150-190,000 per dwelling. By comparison, as of August 2016 the median house price in Auckland was around $842,000. This implies that new developments will have a Marohn ratio in the range of 6:1 to 4:1 – even before accounting for local roads and pipes.

Yikes.

Now, the true picture might not be quite that bad. Some costs will be put back on users or developers, at least in the short run, while others might be avoidable (at least initially). And if the Unitary Plan is successful in providing more redevelopment and infill options in the city, we may not need to develop all of this infrastructure.

Nonetheless, a casual analysis suggests that caution is needed. Our current housing affordability woes mean that there is an imperative to develop more housing – but if we’re doing that in a financially unsustainable way, we might not be doing ourselves many favours.

What do you think of the financial sustainability of New Zealand cities?

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26 comments

  1. That ratio could be far worse. What if that housing stock is ridiculously overpriced? Is that 905B value based on CVs or market value?

    Marohn seems to be asking if someone essentially wants to pay for the lifetime rates bill for all their services. If you assume a generation of 65 years, then the bill is only 3000 a year. That isn’t unreasonable at all. I’m already paying that and then some for all council services.

    I agree though, urban sprawl is not financially sustainable any way you look at it. Or at least the method we use to fund it. I much prefer the swiss model. Cities get a share of the income tax based on their population. Encourages councils to avoid sprawl and make the best use of existing infra.

    1. I’m not sure the $3000 annual (rates?) bill you are quoting correlates to the numbers Peter quotes. You get a lot of other services bundled in for that, plus other parts of Peters sum are incorporated in your water bill.

    2. The Reserve Bank stats are based on market value, not CVs.
      As for the ‘generation’, it’s more common to think of a generation as 20 years not 65. Maybe closer to 30 years these days with people having kids later. As to precisely what Charles Marohn meant when he told his respondents ‘once in a generation’, or what they thought he meant, who knows.

    3. Yeah, I’m not sure if I’m 100% on board with Marohn’s argument, but it’s definitely one worth considering.

      His point is basically that *renewal costs* are the ones that don’t always get budgeted. Councils figure out ways of paying for up-front infrastructure costs (ie building the roads and pipes) and kludge on with maintenance (sometimes by neglecting it a bit), but at some point you just have to do a full rebuild of the pipes or reseal of the road. If a lot of those rebuild/resealing costs come due at the same time, then financial trouble ensues.

      If you go and read his site, he’s got lots of examples where private landowners are in fact *unwilling* to pay for infrastructure to service their property, and choose to offload the asset and hence the cost to local government. Which in turn creates a tragedy of the commons situation…

  2. I think that Ari is right on this, and that Marohn’s approach is fundamentally flawed. He has assumed that a house is an investment; it’s not. It’s a service. It provides shelter, warmth and a place to store all those things that fall down the back of the sofa. The services which supply the house are even more obviously a service – the clue’s in the name. If you asked people to pay their phone bill as a once-in-a-generation lump sum you’d probably get a big no for that as well, but the telecoms industry is a perfectly sustainable business model as it stands despite the disruption it’s constantly facing.

    The bigger point that infrastructure needs to be affordable is obviously true, but I don’t think this analysis helps very much with assessing what is affordable or sustainable.

    The Auckland example you gave might prove this. Most of the costs you list will be charged to the developers as an infrastructure levy, which they will build into the sale cost of the houses. They clearly think they people will still buy them despite this, which is completely at odds with Marohn’s findings.

  3. Thanks for the article Peter. Agree with others here about the flaws in Marohn’s approach, and would like to pile another reason on – how can we ever possibly make assessments about sustainability (financial in this case) by only considering present factors? Where is the discussion about the likely impacts of climate change on the financial sustainability of our cities? Rising sea levels and more intense storms already have profound implications for our infrastructure. I don’t believe it’s a factor we can afford to ignore without our analysis being consigned purely to the realm of the academic.

    On a unrelated note, what’s wrong with people holding cows to be sacred? Why do we speak of killing other people’s sacred cows with such glee? I know it’s only used metaphorically, but it seems difficult to separate the phrase from the colonial history of the British Raj’s domination of India and the subjugation of one culture by another.

  4. I think working off CV’s is more realistic than Average or Median House Prices, house prices have gone up significantly from 1986, but interest rates have gone down significantly since then too. Variable interest rates were sitting at 20% where now they are at 5%! If we ignored the fact you need 20% deposit for first home, it is more affordable now to own a house, obviously the 20% deposit is a bit of a barrier through.

    In the end the cost of infrastructure has rose, but I still believe financially sustainable, its more a question if the investment is done correctly. Which modes of transport for example to get the maximum of what we do build

  5. Interesting ideas. If we take out the rural roads (which are there to serve productive assets rather than simply residential properties) then the numbers improve. There are 66000km of rural and 18000km of urban roads. So pro-rata the urban roads are $10.7 billion of the 50. Add the pipes and you get $55.9 billion. That gives a ratio of $905billion/$55.9billion = 16.2. The question really is what do we go without if we try and lift that to 20 or even 40? I am happy to pay for more pipes to avoid crowding.

  6. That website is full of this kind of stuff. Most of it talks about ongoing maintenance costs rather than the initial cost of infrastructure. Things like resealing the road every so many years.

    The more interesting thing would be comparing different parts of town. Think of the difference in cost of providing services to 1000 people living on Hobson Street, vs 1000 people in lifestyle blocks.

    1. That would be an interesting comparison. Power lines cost from 4 to 14 times as much underground as they do on poles so maybe the two options might be similar. Water to Hobson Street requires a massive pipe and then a huge number of lines within each building both for drinking and fire fighting, not to mention bulk collection and a treatment plant. The lifestyle block just needs a bore and pump or rainwater system and tank. Sewage in the CBD needs pipes. pits, tanks, pumps and a trunk system back to an industrial processing plant. The lifestyle block only needs a domestic treatment system with a planted outfall. The CBD needs a stormwater collection, peak storage and treatment system. Stormwater on a lifestyle block waters the pastures. Transport in the CBD is less expensive but only if people also work there.
      Of course if you decide to ignore all the costs associated with CBD living and also decide to count every cost associated with countryside living then you might reach a different conclusion.

      1. I agree, you need to have fair and transparent costs for all the various choices to truly evaluate them.

        I cant fault your logic assuming everyone looks after their own water,power,wastewater,sewerage etc. But not everyone can afford or want to live on a lifestyle block. Alternately, if such a lifestyle were attractive to the majority, then wouldn’t our dying rural centres be far more attractive than they are currently?

        1. Yes I am not arguing we should all get a lifestyle block. Most of us don’t want the grief of spraying weeds. I am simply making the point that we need to compare apples with apples when looking at infrastructure costs. But instead the current dogma tends to be to assume all services in the CBD appear by magic and all services in the outer areas come at very high costs. We have apartments in Hobson Street only because the Auckland City Council followed by Auckland City spent and eye-watering amount of money separating the old combined sewers. Money which was borrowed at a cost to all ratepayers regardless of where they live. While the pipes themselves are now a sunk cost even they have a capacity which when exceeded will cost much more to improve than any lower density area just because of their size. But the way things get modelled is people ask ‘What do we want to show? Let’s build a model that shows that then!”

          1. Probably good to note that not all the sewers and storm-water in the CBD are yet separated. Still work to go on that!!! And yes many are still the old brick and mortar lines running beneath. Was involved in a re-lining project of one of them. I don’t know one person on here that thinks the services magically appear, however it comes down to the cost per person it services. I agree it would be helpful knowing this for all areas but its also important to display it accurately too.

      2. Underground powerlines are expensive, but powerlines in the CBD are a lot shorter than their rural counterparts. So it’s not a clear case of powerlines in the CBD being expensive.

        I’ve no idea really. Strong Towns is particularly pessimistic about the situation in the US. One of the premises is that low-density suburbs are doomed, since the cost of maintaining the streets alone is many times larger than the rates income from those suburbs.

        The problem with dying rural centres it that these days it’s really difficult to create jobs there. Agriculture employs a lot less people than it did 100 years ago.

    2. There are about 50,000 people living in 4 km^2 in the CBD, this would cover about 170 km^2 as 10,000m2 lifestyle blocks: all of Rodney excluding the Waitakere Forest and South Head. Somehow, I think all the roads in rural Rodney may cost a wee bit more than building the local pipes and streets in the CBD, expanding water treatment facilities by 3%, and building a 20km long trunk water main and the same for sewerage. Then we can get into the vastly higher cost of trunk roading and PT infra for all of the lifestyle blocks.

        1. By that logic nothing that we build could ever be financially foolish, because once we’ve built it, it’s a sunk cost.

          That’s too ridiculous a notion for economists to contemplate.

  7. I would add a further element – risk to adverse natural events. As New Zealand increasingly loses international insurance cover, this must inevitably be factored into how and where growth occurs.

    In all this discussion, in an era of increasing lack of trust in the press and news releases, how and what information is gathered and then how it is presented becomes very important. The question – are New Zealand cities financially viable? – can be answered very differently according to the figures used and presented. Perhaps a next step is to gather some sort of consensus on what the measuring tools should be. Consensus on the information can then support the city infrastructure and housing investments.

    The heartland is regarded as “where the export dollars are earnt”. By some measures that is correct, but we also know that cities generate economic activity without which New Zealand would be in a very bad way. Auckland’s housing boom clearly has an economic cost for perhaps 30% of its residents and therefore a political cost. However, there must be a huge economic activity benefit to NZ Inc, otherwise, it would have long ago have been shut down.

    Looking forward to augment a city’s economy with other industries of scale to supplement the housing boom, if a city’s financial viability can be better established, it builds a stronger case to provide the right sort of environment for say, food technology and medical technology businesses to locate operations in NZ to sustain those city populations through means other than residential property development.

    1. Absolutely. Given the damage to Wellington from an earthquake that struck nowhere near it, it’s possible that Wellington may not even be a viable city in the long term.

      1. “struck nowhere near it”
        Actually reasonably near it.

        Aftershock activity suggests that subsurface fault rupturing continued to within 60km of Wellington City Centre (off the Cape Campbell / Lake Grassmere area). The epicentre (near Culverden) is the point at which the earthquake began. In this case the rupturing developed mostly to the north across multiple faults. Surface fault rupture has been observed within 100km of Wellington at Kekerengu (between Kaikoura and Seddon). This likely continues off shore for some unknown distance northward (seabed survey by NIWA over the next week may show the extent). Maximum peak ground acceleration (i.e. shaking) happened to the north of the rupture area near Ward (approx 15km south of Cape Campbell).

  8. Solution in search of a problem?

    We already have the tools available – targeted rates – its just that Council’s don’t apply them properly and aren’t held to account.

    As an example, if you draw a catchment around Kumeu/Huapai – listed all the projects needed to enable the growth planned and divided by permitted number of dwellings – then the residents of that area will end up paying for the true costs of the development. Rates also have the benefit of spreading the cost over generations, which development contributions do not do.

    1. Debatable – if a shortage is pushing up prices and prices are the basis for the GV that rates are based on then that cost is front-loaded onto current home owners.

      1. A targeted rate doesnt have to be linked to house prices. It is an equal sum paid by each owner in the catchment. Just like the transport levy recently imposed on ratepayers for 3 years.

    2. Note that I didn’t propose any solutions, merely noted some data and a potential problem. Agree that we should get more use out of targeted rates.

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