By Joey Shannon, Director – Infrastructure, Assets and Places, KPMG New Zealand
How to best fund infrastructure to enable new development is a perennial challenge for fast-growing urban areas. Development contributions, enabled under the Local Government Act, have been councils’ primary tool for addressing this challenge for many years, alongside rates.
Development contributions (DCs) are charges that councils can levy against landowners at certain stages of development. They are used to fund local enabling infrastructure. In some cases, they pay for most or all of an asset’s cost (particularly in greenfields development), but often they will only cover a part of the costs in proportion to the benefit that investment will accrue to new development.
The majority of funding is used for transport and water services projects. In general, DCs must be used for projects that have been specifically identified, or sufficiently similar ones.
The use of DCs has three main benefits:
- providing a critical source of funding for infrastructure to enable growth
- avoiding the windfall gain that would otherwise occur to landowners when the infrastructure investment is made or committed to
- incentivising development in more efficient locations where the enabling infrastructure costs are lower.
In recent years, DCs have risen substantially, particularly in Aotearoa New Zealand’s high-growth urban areas. With further increases signalled by some councils, concerns have been raised by the development community.
Table 1 provides examples of recent DC changes in suburbs or catchments in high-growth urban areas, split into areas more associated with greenfields versus infill development. Where a higher DC is currently being proposed, or will be phased in in the near future, we have used that value. Values are sourced from council DCs policies and consultation documents.
What is driving this increase?
The inflationary pressures raising costs for the delivery of growth infrastructure have flowed through to DCs and explain a portion of the rise. Beyond this, a number of other factors appear to be driving the general trend of increasing DCs.
Diminishing spare capacity for growth
Over the last decade, an increasing proportion of housing developments have occurred as infill. For many councils, increasing infrastructure demand, particularly from infill development, could historically be met within existing capacity. Increasingly, new infill developments are requiring additional capacity, increasing investments in existing infrastructure.
For example, Tauranga City Council has signalled for its upcoming review of DCs: ‘Some waters assets are reaching capacity and so will not support new growth … We intend to stop collecting DCs towards these assets and start collecting for new water supply and wastewater assets. These new assets are generally more expensive … which results in an increase in fees.’
Service upgrades and pace of renewals
While DCs only recover the growth components of projects, choices relating to ‘service levels’ and ‘renewals’ (the other two categories that infrastructure investments are categorised into) can still have flow-on effects for DCs. For example, many councils have substantially increased their pace of renewals investments for water services. This has brought forward a number of projects, which often also have growth components.
Additionally, increasing standards and expectations in areas such as stormwater management and wastewater treatment are contributing to the cost of providing these assets in a growth context. By effectively bringing forward these higher‑cost, growth-enabling investments, more of them are being captured through DCs, resulting in higher charges.
Extended timeframes for recovery
The most substantial policy change driving increased DCs is the inclusion of future infrastructure projects expected to be built outside of the 10-year Long Term Plan (LTP) timeframe. Until recently, it was rare for any council to try to charge DCs against projects that weren’t either historical (i.e., already delivered) or funded within the LTP time horizon. While the Local Government Act does not limit DC charging to this timeframe, it does require a presumed high degree of confidence as to which projects are required. As councils are increasingly planning growth infrastructure requirements beyond 10-year periods, some are identifying more projects that can be included in DCs.
Auckland Council has been at the forefront of this approach, which was initially applied to Drury and is now being considered for a number of other catchments. These additional projects constitute the majority of the relatively large DC increases in those areas where the approach is being applied (such as Tāmaki in Table 1).
How do rising DCs affect prices and development?
The relationship between DC levels and sale prices has long been debated, but with limited empirical study. Economic theory suggests that the level of DCs should have little direct impact on house sale prices, as prices are set by the overall market regardless of what costs developers bore.
DCs, like all costs, do influence development feasibility. Higher DCs should be reflected to some degree in lower land prices; however, there is likely a long lag for this to take place in practice. More importantly, there are limits on the ability of land prices to adjust, as the land value has a floor – its existing or alternative best use.
In greenfields, where the alternative is often primary production, that floor is low enough to be less of an issue. In infill development, the price floor is often the continued use of existing housing, which will be relatively high value. For a development involving the demolition of two detached homes and the building of six new townhouses, feasibility could easily be impaired by a large DC. Sufficiently high DCs will inevitably reduce the number of projects that can be profitably produced. This will have a long-term flow-on effect on prices that shouldn’t be ignored.
Funding the right infrastructure projects
If the projects underpinning DCs are truly necessary, we should be prepared to accept that this will lead to higher costs to develop and, in some cases, result in reduced development. Not all housing development should proceed, and the amount of new infrastructure required should be a factor influencing these decisions. This assumes, however, that the projects underpinning DCs are good value for money and necessary for enabling growth that doesn’t lead to unreasonable drops in service levels for other residents.
If DCs are rising quickly, councils should heavily scrutinise the capital works driving that rise to ensure that they are genuinely necessary for growth. There is a risk that, due to the easier politics of DCs over rates, there is a greater willingness to impose higher standards than we would accept if rate-funded.
An alternative approach: targeted rates for growth
An alternative approach available to councils – but not often used in New Zealand – is the use of targeted rates rather than DCs. A targeted rate approach has a number of advantages over DCs, particularly when looking to recover growth costs over longer timeframes. While DCs can be used to recover for projects decades into the future, there is an inherent uncertainty about needs that is difficult to overcome. There is a risk with a DC approach that councils become locked in to particular projects because they have been recovering for them, without appropriate reconsideration if growth patterns are different than forecast, or if the community prioritises other things.
For example, imagine a large greenfields development with an expectation of a need to build an aquatic centre in 15 years. Rather than charge DCs for it now, a council could communicate the expectation that residents of that area will need to pay a targeted rate once the project is ultimately approved. If residents are, in fact, not supportive or prioritise other investments, this would give the opportunity to re-test the project. Conversely, if growth was greater than forecast, the project could be built at greater scale, while still fully recovering the costs, which would not be possible with a DC.
A targeted rate can provide the flexibility of rate setting, with catchment-based targeted attribution of DCs. Part of the reason this approach is little-used is likely the political attractiveness of charging developers rather than home owners. Critical to addressing this challenge is very early signalling of intent, including forecasting of the expected targeted rate so that homebuyers can make informed decisions, and so that the prices they are willing to pay can reflect expected future charging.
About the author
Joey Shannon is a director in KMPG’s Infrastructure, Assets and Places team. He has a broad advisory background and frequently operates at the intersection of public policy and commercial issues. Shannon’s specialty is analysing government housing and infrastructure investments, and developing funding and financing models.