Municipal New Subdivsion Project Financial Analysis – A Case Study
Series: Urban sprawl municipal budget impact
Apart from its commonly known costs, suburban sprawl is hitting municipal governments with hidden costs as a result of misguided policies.
In a growing city such as Maple Ridge, BC, leapfrogging suburban developments are adding more inventories to the city’s asset base and making its infrastructure deficit worse than it already is.
A real life example is used to illustrate how the discipline of a business case analysis can and should be applied to determine the implications of a new development project to the finance of a municipality.
See how a blighted and run-down block built in a traditional pattern compars against a shiny and new auto-oriented block built for a drive-through fast food chain restaurant when it comes to tax revenues to the city.
Lured by no-money-down and an immediate boost in property tax revenue, a city often approves development projects which end up with negative returns down the road. This concept only becomes obvious after digging into the income and expenses over a lifecycle of a project.
I recently attended a webinar presented by InfraCycle, a company which provides consulting service and software tools to help municipal governments evaluate the financial implications of new development projects. A real life example was used to illustrate the concept of how a business case analysis commonly used in the business world can be applied to municipal projects.
As the rationale for an urgent need of a formal business case analysis being a requisite part of all development projects has been stressed in previous articles (here, here and here), this case study serves to illustrate one of many ways in which this basic business discipline can be conducted.
Before going any further, some disclaimers are in order.
Big Fat Disclaimers:
I am not affiliated with this company in any way and did not know much about the tool prior to the webinar. Secondly, I do not have any first hand working knowledge of or experience with this tool, so the true capability of the tool as presented has not been personally verified. Analyses like this one can get complicated if second or even third order effects are taken into account. But fortunately construction and service cost estimations are not quantum physics either.
The development project used in the case study is a green field development proposal located in Mission, BC. The proposal calls for 170 half-acre-lot homes on a 131-acre property with net 89 residential acres. A new three kilometer road will connect the new subdivision to the existing road network.
The location of the proposed new sub-division relative to the city of Mission is shown in red in the diagram below.
Two scenarios are considered in the exercise. Scenario #1 is a bare land strata model, a typical condo residential subdivision whereby onsite recurring infrastructure costs are borne by home owners. Scenario #2 is a fee simple model whereby recurring onsite infrastructure costs are borne by the city.
All upfront capital costs are borne by the developer under both scenarios.
Onsite infrastructure costs include: local roads, street lights, water/sewers, storm main, etc.
Offsite infrastructure costs include: collector roads upgrades, water/sewers and lift station improvements, etc.
Soft costs also included in the analysis include: police/fire services, planning, recreation administration, parks/leisure center/recreation services, engineering, public works, water/sewer utilities, waste management, equipment and vehicles, buildings and contents, finance/planning and others.
Not included in the soft cost analysis were transit (none planned) and economic development (residential only).
Sensitivity to Assessed Home Values
One variable which has a strong influence over outcome of the analysis is the assessed home values expected. An average value of $650,000 was used by the developer whereas the municipal came up with a value of $500,000 from its own research.
The assessment values of the homes are critical from the municipality’s point of view as it will be the only source of ongoing revenue to cover all ongoing costs.
Outcome and Observations
1. Revenue projections
Based on the cost inputs and assumptions the revenues are projected from one, 10 to 20 years out under both scenarios.
Under the bare land strata scenario, the city will end up with a net gain of under a million if an average home assessed value of $650K is achieved, versus a net loss of half a million if the assessed home value achieved is $500K as the city expects.
Under the fee simple scenario, the city will end up losing between $1.5 and $2.9 million in 20 years depending on same two assumptions on assessed home values.
2. Efficiency factor
Another measure one can look at is the efficiency factor of the project based on the expected revenue over the cost outlay over 10 years. When applied to the only scenario which is net revenue positive (bare land strata, $650K average assessed home value), one gets an efficiency factor of 10%.
Some questions the city ought to be asking:
- There is a 10% buffer before the project would just break even or become net negative. How adequate is that buffer against variables like cost overruns and assessed values less than $650K?
- For city staff, should that $5.8 million be spent here? Are there other projects which would yield better returns?
3. Life cycle costing and return on investment
The exercise of bringing into full account all possible costs – capital costs, maintenance costs, replacement costs, expected services and soft costs, incentives and financing, etc. – would give the city a much clearer view of the ROI of a project through a quantitative, financial lens, as illustrated in the diagram below.
The exercise would give the city a much better view as to when revenue is expected to catch up with costs (ROI begins) and when it will get its investment money back.
Doing a round of cost analysis would also bring the right people to the table where valid questions can be raised by/to the departments involved:
- Can the current fire/police capacity handle the new demand? If not, that would mean an extra shift and potentially new staff, vehicles and station.
- Can the local school handle the new population? Is there even a local school?
- How are parks, recreation and community services provided?
- Does public works need new vehicles, equipment and/or staff?
- How would incentives increase costs and/or lower revenues, and, subsequently, push out the breakeven year?
Fortunately, such an exercise does not have to be resource intensive, according to the webinar presenter. As there are plenty of historical data available, the data inputs required should take city staff hours to generate, not weeks.
So what is the point of this case study?
Well, for one, it is not to conclude that all green field development projects will be money losing for the municipality. It is also not about what specific tool one should be using, as the predictive value of any modeling tool is only as good as the underlying assumptions and data that are fed into it. In fact, the methodology being used, be it a sophisticated software tool such as this one, a well designed spreadsheet , or a pencil and the back of a used envelope (okay, I am exaggerating here. Slightly), is ultimately not critical.
What is critical, however, is the discipline in conducting such an exercise. A sound business case from the municipal financial viewpoint should be a prerequisite for any new development project to be approved.
- Webinar December 11 2014 “Financial Tools BC Municipal Act Section 882 Financial Reporting and Measuring Financial Implications”
- all images were lifted from the webinar.