What's in your city's wallet?
We recently presented results of a fiscal sustainability model to the City of Bastrop, Texas. If you’d like an overall synopsis you can read this article in the Austin American Statesman (there’s a paywall). I’d like to focus here on a few small portions I find particularly interesting. Before we move on I need to applaud the City of Bastrop City Council, Mayor Connie Schroeder, City Manager Lynda Humble, and the rest of the city staff I’ve gotten to work with. They’ve been one of the best elected-official/city-staff combos I’ve had the pleasure of working with.
Revenue per acre vs. revenue per structure
Most of what I’m going to talk about in this post revolves around two charts (Figures 1 and 2), which will need some explaining here. Figure 1 (below) illustrates the average taxable value of residential structures, along with the levy generated per acre by lot size. The values along the right axis of Figure 1 and the bars describe the average taxable value per structure, while the values along the left axis and the line represent the levy per acre. The different columns represent the different lot sizes used for analysis. The first column represents lots between 0.02 acres and 0.2 acres, while the second column represents lots ranging from 0.2 to 0.3 acres in size, and so on across the rest of the chart. Figure 2 illustrates the same data, but for commercial properties.
Moving left to right on these charts, you see a striking trend: the bigger the property, the smaller the levy per acre (left axis values, blue line). The drop-off is significant.
Figure 1: Residential Properties – Property Tax Revenue (Levy) Per Acre & Average Property Tax Revenue (Levy) Per Structure [Bastrop, TX, 2017]
For residential properties (Fig. 1), those smaller than 0.2 acres generate $5,600 per acre in property tax revenue, while properties larger than one acre generate less than one-tenth that amount ($538 per acre). How is this happening, exactly? Take a look at those bars in Figure 1—they represent the average value of the structure that sits on the land. As you move left to right, the average value of the buildings increases slightly, but overall does not differ much based on lot size. So, you have an average home value worth $155,000 on lots smaller than a fifth of an acre (far left bar), compared to an average home value of $162,000 on properties with five acres or more (far right bar). Not hard to see which arrangement has a stronger fiscal performance for the city.
Figure 2: Commercial Properties – Property Tax Revenue (Levy) Per Acre & Average Property Tax Revenue (Levy) Per Structure [Bastrop, TX, 2017]
The revenue-per-acre trend (the blue line) is similar for commercial properties (Fig. 2). Smaller properties generate a significantly greater revenue (levy) per acre value than larger properties. The drastic difference between the average value per structure based on lot size (green bars) represents the biggest difference between this chart (Fig 2) and the residential chart (Fig 1). This makes even clearer the trend identified in Figure 1. As lot sizes increase the revenue (levy) per acre declines, even when the overall values of the lots increase.
We observed a similar trend in a recent preliminary study shared with the City of Cedar Hill, Texas. Figure 3 describes the appraised value per acre (green center column) for parcels in the city, and the average structural value (rightmost column) by lot size (far left column). The residential properties in Cedar Hill follow the same trend as those in Bastrop.
As the lot sizes increase, the average structural value also increases, but the value per acre drops.
Forget about target home values
These charts contradict some conventional thinking about the value of development patterns, and what character of development will best support a city fiscally. I’ve heard some developers promise to build a development to a certain price point, which according to their math should pay for all the required public services and infrastructure. I’ve also heard elected officials and city management officials ask for an average value per structure that can balance the books. They’ve both missed the point these charts begin to make clear.
Cities need to focus far more on the revenue (levy) per acre than the overall levy of any particular lot. The crux of this issue lies in the cost and revenue structures cities operate with. Many public services and facilities have more of a geographic cost footprint than a volume cost footprint.
We can observe a geographic cost footprint in many of the services and facilities funded by property taxes through the general fund. Police and fire protection often set up their facilities based on a response time which creates a definable and limited (geographic) service area. Within that structure, the cost of service remains constant until the demand for that service exceeds a maximum service volume. Cities most often invest in new police and fire services when development grows beyond these defined service areas—not as a result of exceeding call volume capacity.
If cities paid for public safety by volume rather than by geography then they’d charge people every time they called the police or the fire department for service. The level of available service and the price for that service would rise and fall with demand, making it unreliable and/or cost prohibitive. We can observe the same pattern with other general fund costs such as libraries, parks, and city administration.
This emphasis on geography versus volume becomes clear again when we look at the return on investment (ROI) maps we completed as part of the City of Bastrop’s fiscal analysis (Figure 4). ROI comes from dividing the property tax revenue by the cost of services funded by that property tax revenue. So for every dollar the city of Bastrop spends providing public services it gets “X” amount of dollars back. That means any return below $1.00 represent a loss. A return of $0.60 on the dollar means that the city loses $0.40 for every dollar it spends serving that lot.
Similarly, a $1.20 return on the dollar gives the city a $0.20 profit for every dollar it spent to provide service to that lot. In the maps below you’ll see some parcels that have a high ROI but many that don’t. While some parts of the city do well, the overall net is still a large annual loss of just over $7 million. Lastly, notice that most of the lots that have a high ROI also have smaller footprints.
The takeaway? We need to stop looking for a silver bullet home value that covers our costs, and stop listening to people pushing that metric as anything useful for analyzing the fiscal sustainability of a city. For one, we cannot legally and should not ethically zone our cities for price. That’s redlining for economic class which should disgust every good city staff member, elected official, developer, and citizen—because it’s disgusting.
Moreover, it’s not the right metric to look at anyway. Looking at Bastrop’s map again, if they can steer their development pattern to facilitate more of the tall dark green bars (high ROI developments) then they’ll perform better fiscally in the future. A higher ROI for Bastrop could mean operating without a deficit. It might also mean operating with a similar revenue stream on a lower tax rate. I think just about everyone could get excited about that.
Operating more like a developer
A good developer will always identify their costs and revenues, and won’t proceed with a project unless they can reasonably expect it to pencil out. However, a developer’s pro forma, unlike a city’s, often focuses on an initial capital investment for a limited suite of infrastructure facilities and an overall revenue projection of the lots available for sale. A developer’s pro forma consists primarily of volumetric value measures, not geographic. Cities, on the other hand, operate in a geographic fiscal environment with ongoing maintenance and operation costs that tend to grow over time.
Lastly, developers will often phase a large project so that revenue from earlier phases can support costs in later phases. This helps a developer limit cost burdens over the length of their project. They often develop the lots closest to existing infrastructure first. Then they build infrastructure sequentially for each phase, adding as they go so to avoid installing costly infrastructure across property they don’t intend to develop until later. The orderly development of a project often plays a critical role in determining whether a development project will end profitably or not. In contrast, cities essentially publish their development plans—that is, their future land use map—as a giant single-phase development without any sort of pro forma. Perhaps it should come as no surprise that many of our cities find themselves operating with a growing deficit.
The City of Bastrop has decided to take a more informed approach. I hope other cities will decide to follow suit.