Paying for the infrastructure

A great map made the rounds on Twitter a couple of weeks ago showing all the places in New Zealand where there are no people living within a square kilometer.

Ping everyone claiming NZ is full and we can't have more immigrants... https://t.co/Xy22pa8TEP

— Eric Crampton (@EricCrampton) December 10, 2017

Somebody asked who'd pay for the infrastructure for all the new people. Stephen Selwood in the Herald has one good answer: let the new residents pay for their own infrastructure via municipal utility districts.

I gave a short talk on MUDs a couple of weeks ago and put together this note on them for the attendees. It might be useful background for others too.

Problem:

Infrastructure financing has proved to be a binding constraint on development in growing communities where Councils are approaching their debt limits. In those cases, issuing bonds to finance new infrastructure for development can pass cost-benefit assessment, but would breach debt covenants and trigger higher interest rates.

As consequence, New Zealand’s housing affordability has suffered. Councils zone what seems to be sufficient land for development and growth, but market prices reveal substantial value uplift when land is zoned for development, suggesting that zoned land is actually scarce. Regulatory scarcity of land on which development is allowed also enables land-banking.

Better infrastructure financing mechanisms can be transformational. Credible measures for rolling out more infrastructure for development and for routing around or leapfrogging current landbanks would completely change the dynamics of land markets in constrained areas. If owners of banked land expect that development will leapfrog them and that future housing costs will consequently be lower, they will wish to bring their development plans forward – and quickly to beat the rush. Market prices can then adjust to restore housing affordability where urban housing costs would be limited by the cost of building houses and infrastructure on paddocks outside of town.

Potential solutions

National proposed new infrastructure financing vehicles to allow new infrastructure roll-out without hitting Council books. That will help. Phil Twyford has suggested a suite of other measures that also are credible, including value uplift charging.

Municipal Utility Districts (MUDs) are an excellent complement to the changes currently under discussion.

Current within-subdivision infrastructure is typically funded by the developer, and interconnection costs or trunk infrastructure upgrade costs are handled through developer contributions. Both of these load costs onto the developer very early in the development cycle and then are reflected in higher section prices and higher house prices. In the end, the infrastructure winds up being financed at the new homeowner’s mortgage borrowing costs when the new owner borrows to purchase the serviced section or house.

The MUD alternative sees a developer establish a special ratings area over the new development. The MUD is able to issue bonds to fund infrastructure development, and the bonds are paid off through a special rating on owners in the development. Where the MUDs borrowing costs are lower than the homeowner’s mortgage interest rate, this reduces costs to homeowners over the longer term. It also reduces costs to homeowners by shifting the timing of costs and the underlying riskiness of the related debt. A developer is a more risky proposition than a stream of tax payments from a new development, so bond financing costs backed by taxes on a new development can be lower than the capital costs for a developer.

MUDs are most prominent as part of Houston’s overall story of housing affordability. Typical MUDs range from 200 to 400 acres (81-162 hectares), with the District covering water, sewer and drainage facilities. Some MUDs also cover major roading thoroughfares, and also parks and recreational facilities. They result in masterplanned communities where the community’s residents bear the costs of their infrastructure and take over the management of their infrastructure.

They must purchase access to wastewater treatment services, or provide their own local or regional treatment facilities. They also share in central city water infrastructure costs.

MUDs can also be used for in-city development on brownfield sites where Council cannot handle the resulting infrastructure costs - though they may be most suitable on larger brownfield sites.

The New Zealand Initiative has explored the potential for Municipal Utility Districts to unlock infrastructure in two reports. Different Places, Different Means: Why some countries build more than others described Municipal Utility Districts in Houston and Austin, Texas. Free to Build:Restoring New Zealand’s housing affordability applied the lessons to a New Zealand context.

The Initiative argued that where a group of landowners or developers wished to establish a Community Development District (CDD), they might submit an application to the regional or unitary council outlining the geographic scope of the development, its environmental impact, its water source, and the financing arrangements. A developer board would be established and building would begin. The developer would be reimbursed for initial infrastructure costs on the CDD issuing its infrastructure bond. The debt would be paid off through a tax on homeowners, businesses and commercial enterprises in the new CDD. And as later stages of development proceeded, more bonds would be issued. And control of the CDD would pass to a residents’ board as sections were developed and sold.

Council Long-Term plans would need to specify any areas they viewed as unsuitable for CDD development on grounds of environmental or cultural sensitivity, or notified practical considerations but the total area excluded could not exceed a set proportion of the jurisdiction’s area. Regional water and electricity lines companies would check that compatibility with broader networks were maintained when approving infrastructure plans. And, once approved, the CDD would be exempt from RMA constraints on any decisions regarding their internal operations except for issues like storm water overflow that might impose costs on neighbours.

We suggest further that where debt issued by CDDs would be subordinate to any Council tax claims on properties, this debt should not affect Councils’ balance sheets.

The key benefit to CDDs, or MUDs, is that they enable new development to occur wherever there is demand for it by uncoupling infrastructure provision from Council debt constraints. They can leapfrog existing landbanks or existing planned trunk infrastructure rollout and, in so doing, can make all urban land more affordable. And the new Auckland Unitary Plan allows for new development outside of traditional urban boundaries.

CDDs then provide a nice complement to other measures currently under consideration.

MUDs aren't just a way of unblocking an infrastructure financing constraint. They're a way of making the supply of local government services like infrastructure contestable - and making housing far more affordable in the process.