Focusing on density is comfortable for today’s professionals because it allows them to continue within the current development paradigm. Density is accomplished by building large projects, all at once, to a finished state. It maintains the illusion of cities as static models, where mechanical variables can be calculated, predicted, and planned, without all the messy feedback loops. This is not the way complex, human habitat works.
Instead of density, the math we must focus on is the relationship between private investment and public investment. Is there enough private investment to support the community’s public investments? Said another way: When we build or take over a community obligation, do we have enough private wealth to financially sustain that commitment?
When I examine the farm where I grew up, the answer is: yes. The farm was very low density and it didn’t generate a lot of tax revenue for the community. It also didn’t cost very much. The only public infrastructure was a road, of sorts, something slightly more intense than a two-tire path through the field. For the city, this was absolutely a cash-flow-positive situation, despite the low density.
On the other end of the density spectrum, consider the Empire State Building in New York City, which is appraised at $2.5 billion.1 There are a few million dollars of asphalt, concrete, and pipe in front of the Empire State Building’s entrance, infrastructure that is essential for the functioning of the building. The likelihood that this street will deteriorate from lack of funding is very small. The possibility that the Empire State Building will be abandoned from lack of water or sewer service or inadequate street access is nearly zero. There is plenty of wealth in the building to justify, and accomplish, maintaining the essential infrastructure.
There is no information on what a financially viable ratio of private to public investment looks like. When I used to do engineering work for developers, a common pro forma metric was that infrastructure costs would be roughly 5% of the home cost. That’s a 20:1 private to public ratio, assuming the infrastructure would become a municipal obligation.
What this doesn’t take into consideration is all the common infrastructure that can’t be attributed to a specific property, things like traffic signals, interchanges, arterial roads, lift pumps, and water towers. As a rough rule-of-thumb, modern development patterns require equivalent levels of investment in common infrastructure and site-specific infrastructure. While this varies based on the extent of horizontal development – as in West Coast cities, which are more auto-oriented and thus spread out, will be higher, while more compact East Coast cities will be lower – an equivalent investment means a private to public investment ratio of 40:1.
These are targets, and I think knowledge of optimum ratios will evolve over time as our cities transform. In the near-term, however, a prudent target ratio of private investment to public investment will be somewhere between 20:1 on the risky end and 40:1 on the secure end. If a city has $40 billion of total value when all the private investments are calculated, 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 the community’s control threatening to impact potential long-term solvency.
This ratio is important because we’re done adding infrastructure. Any community serious about their own financial stability is going to take the obvious first step and stop adding more liability. There is no reason for any North American city to build another foot of roadway, or put in another length of pipe, to serve any new property anywhere. Our infrastructure is maxed out; we’re done expanding and, in fact, I anticipate nearly all our cities contracting their obligations to some extent.
Our challenge now is not about expanding our infrastructure networks but making better use of what we’ve already built. We must put meat on the bones, so to speak, a shift in focus to building more wealth within the framework of our current investments.
To make that happen, we first need to understand where our wealth lies.
The Financial Strength of the Old and Blighted
In my hometown, there are two identical blocks along a roadway in the core of the city. They are separated by a single block. We can think of one of these blocks as Old and Blighted while the other has been transformed into something Shiny and New. They sit on the same thoroughfare. They abut the same neighborhood. They are the same dimension, have the same area, and are serviced by the same amount of public infrastructure. They are identical except for the development style.
The Old and Blighted block is a collection of pop-up shacks built in the 1920s. At that time, these three blocks sat on the far edge of town. These were the small experiments of their day. As my city was growing incrementally, these three blocks were the next increment outward. The people who built these pop-up buildings certainly anticipated that, as the city grew, their land values would increase and these cheap, one-story buildings would be expanded and improved. That had been the pattern of development for cities for thousands of years.
Of course, that is not what happened. Within a decade of these blocks being built, the country entered the Great Depression, then World War II, and then launched a new economic model with an experimental pattern of urban development. These three blocks were passed over in favor of new development further out on the edge of the city. They have stagnated in a state of development infancy for nearly a century.
The city government labeled these blocks as “blighted” and, in the official planning documents, called for their redevelopment. They identified the specific types of businesses they would like to have instead of the ones currently there. In what they labeled the General Commercial area, they indicated:
The intent of this designation [General Commercial] is to provide areas for highway-oriented businesses. Examples of these could include highway-oriented businesses such as fast food restaurants, convenience stores, gas stations and other auto-oriented businesses as well as a number of large retailers.2
After this designation was made, the city received an application for redevelopment and subsequent construction of a fast food franchise called Taco John’s. This development was approved, the old buildings removed, and in their place the new drive-through restaurant was built. The taco franchise not only met all the development goals of the city, it complied with all the zoning and development regulations. In terms of vision leading to plan and then to implementation, this was a home run.
On that, everyone seemed to agree. The city was able to get rid of blight. In its place was now something shiny and new, which was exciting. There is now plenty of convenient off-street parking. The city was able to remove the on-street parking, which allows the traffic to now flow more quickly. There is even a new sidewalk and a bit of greenspace. These are all welcome signs of progress.
While the Shiny and New block is now a Taco John’s franchise, the Old and Blighted block remains a collection of marginal commercial businesses. There are nine businesses on 11 lots within that old block, including a pawn shop, a bankruptcy attorney, a couple liquor stores, an old-time barber shop, and a neighborhood-oriented restaurant. This is some of the most marginal commercial real estate in the entire region.
Here’s why all of this is important: The Old and Blighted block has a total value of $1.1 million. Add up the taxable value of each of those businesses and that is what you get. In comparison, the Shiny and New block, which has the same dimensions, same amount of public infrastructure, and same everything except for the development style, has a value of only $620,000.3
In terms of community wealth, the Old and Blighted block is 77% greater than the Shiny and New. The old block generates 77% more property tax than the new. Despite outward appearances, the Old and Blighted is far more financially productive, even though it costs the community the same to service.
The Old and Blighted block is the traditional development pattern – the way civilizations around the world built human habitats for thousands of years –
in its infant phase, after suffering nearly a century of neglect, and it still outperforms the stuff we are building today. And it’s not even close.
Not only is the Old and Blighted the financial winner, it outperforms in many other ways. Those 11 small businesses have 11 local owners. That’s 11 entrepreneurial people deeply vested in the community. I interviewed them all; collectively, they employ another six full-time equivalent positions. The Taco John’s franchise, which is headquartered two states away in Wyoming, would not tell me how many people they employed in their Brainerd location. Their application to the city indicated between 20 and 25, almost all of which are part-time employees.
Six of the small business owners in the Old and Blighted block indicated that they hire a local accountant, someone within the city limits. Two use local attorneys. Seven use one of the local printing shops. Six advertise in local publications. These are dollars passed around the community to employ my friends and neighbors. The Wyoming-based Taco John’s franchise would not indicate to me where they obtained similar services. I suspect they find it more efficient to source those services outside of Brainerd.
And all of this while the Taco John’s is still shiny and new. What happens when it ages, when the sign fades, the siding starts to show its age, and the parking lot has weeds growing up in the cracks? This very development suggests an answer.
The Taco John’s has a new building, but it was not a new franchise in Brainerd; it merely moved up the street three blocks to a new location. It left behind a building in disrepair on a site in a state of decline. After years sitting empty, that old site experienced a succession of failed businesses. The current iteration is a restaurant serving Asian cuisine. The site has been cleaned up, but few would call it thriving.
Why would the Taco John’s franchise choose to relocate three blocks instead of fixing up their old location? The answer is simple: tax subsidies. With the corridor labeled as blighted and designated for highway-oriented redevelopment, Taco John’s could receive subsidies – in this case, a 26-year Tax Increment Financing subsidy – to abandon their old site and redevelop the new. While the Taco John’s is paying 44% less taxes in its new location than the businesses on the Old and Blighted block, for nearly a generation it will get those taxes returned to them as part of the redevelopment agreement.
Let me summarize: In exchange for 26 years of tax relief, the community was able to get an out-of-town franchise restaurant to abandon their old building and move three blocks up the street where they tore down a block of buildings and replaced them with a development that is 44% less valuable than the development pattern of what was removed. By any financial measure, this is a bad investment, yet cities everywhere routinely do this exact kind of transaction.
Downtown versus the Edge
In my home region, the most valuable properties are along the highway corridor, a state highway that provides a bypass around the core of the city. The frontage roads along the highway provide access to the standard collection of big box stores, strip malls, and franchise restaurants. The most valuable of these is the 22.8-acre Mills Fleet Farm complex, a site that includes a double-sized big box store, an auto dealership, and a gas station.
Mills Fleet Farm was founded as a general store in downtown Brainerd. Their relocation to the highway corridor, and their expansion to big box locations across the Midwest, is a source of local pride. When Mills officials show up at a local council meeting, their concerns are given full attention. Sometimes more. With a site valued at $14.4 million, they are one of the largest single taxpayers in the region.
In contrast to the success along the highway bypass, downtown Brainerd struggles. In the four and a half decades I’ve been alive, no new buildings have been constructed in the core downtown. Plenty of buildings have come down, some voluntarily and others as a result of fire. These empty spaces are now used as parking lots. While great strides have been made in recent years, the downtown struggles with vacancies at the ground level. Most of the second and third stories are unused or should be, given their condition.
The nine square blocks of the core downtown constitute 17.4 acres. The 132 separate properties within the core have a combined tax value of $18.9 million.
In a farm field, productivity is measured in terms of output per acre. For example, the productivity of a wheat field is measured in bushels per acre. Land is the base resource of our cities, and financial productivity should be examined in this same way. What is the value per acre created by different development patterns? How productive are the neighborhoods we build?
Mills Fleet Farm receives the deference that comes with being a huge taxpayer, but their financial productivity – the value their development creates per acre utilized – is relatively low. The $14.4 million dollars of tax value spread out over 22.8 acres yields a financial productivity of just $630,000 per acre. They pay a lot of taxes, but they use a lot of land, all of which is served by expensive roads, pipes, and drainage systems.
The core downtown uses less acreage and yields a greater tax base. That’s impressive, but the financial productivity is truly astounding. The $18.9 million of the downtown on just 17.4 acres has a productivity of $1.1 million per acre. Even with decades of decline, disinvestment, and tax-base loss, the financial productivity of the downtown is 72% greater than the most successful site out on the highway bypass.
How much was spent getting the Mills Fleet Farm and the other sites along that corridor? The state of Minnesota, accessing federal dollars, spent hundreds of millions on the highway bypass. Millions more were spent on frontage roads, backage roads, pipes, pumps, water towers, and the like. This infrastructure now becomes the infinite obligation of various governments, regardless of any changes in the financial productivity in the adjacent private land.
How much did present-day generations spend building the wealth that has endured in the core downtown? The reality is: very little. That was wealth my great-great grandparents and their contemporaries built incrementally over time. They bequeathed it to us as an endowment of sorts, a base of such amazing financial productivity that we could continue to rely on it through times of prosperity as well as times of struggle. We’ve slowly milked it down, yet tremendous wealth remains.
Someday, Mills Fleet Farm will no longer be at their current location. It may be 5 months, 5 years, or 50 years, but at some point in the future, Mills Fleet Farm will relocate or simply close altogether. What becomes of this site when that happens? A look around the community, and others nearby, suggests an answer.
A rash of big box closings have left many similar sites vacant. In these cases, it’s not uncommon for the owners to request a reduction in their valuation, which they are entitled to, despite the anxiety it creates. The market value of commercial property is tied to revenue; for a vacant store, there is no revenue. Even where it is argued that the tax value should be based off the level of investment, a big box store – despite the size – is a marginal investment.
Construction costs for big boxes are generally less than $50 per square foot.4 For comparison, the National Association of Home Builders reports average construction costs of $85 per square foot for new, single-family homes.5 An office or retail building can be expected to cost between $100 and $150 per square foot.6 Corporations build big box stores because they are cheap, and that makes them easy to amortize in a short time frame and ultimately easy to abandon.
Where big box stores are reused instead of abandoned, the iteration after the big box tenant will generally be of lower intensity and lesser value. Warehousing, government buildings, and churches are all common. These uses pay fewer taxes, where they pay any at all. It is almost certain that Mills Fleet Farm, in its present state, is the peak of financial productivity for this site. It is likely to never be worth more and has a very good chance of ultimately being worth much less.
In contrast, what happens when one of the 132 properties in the downtown loses a tenant? What happens when a business owner retires? Or grows t
o need a larger space? Or must downsize to a smaller space?
What happens when the market shifts and there is too much retail space and not enough office space? Or too much office space and not enough residential?
In the core downtown, none of this change is a problem. Despite the ornamentation, the buildings are very simple boxes. If spaces are too big for the current market to utilize, internal walls can split them into smaller units. If more space is needed, internal walls can come down. There is an enormous amount of flexibility.
Buildings can easily shift from one use to another based on what is needed. I’ve seen some of these storefronts shift from retail, to a restaurant, back to retail, then to office space. There is an amazing amount of flexibility in this pattern, an ability to adapt as the market changes.
In the traditional development pattern found in my downtown, nobody needs to be able to predict the future. We don’t have to guess right to be successful; adaptability means there is no huge downside to being wrong. Out on the highway bypass, the lack of flexibility means there is tremendous downside to being wrong; entire sites will be abandoned, despite the public investment in place.
Out on the edge, we have a development pattern that is expensive to build, low in financial productivity, and is fragile, lacking the ability to adapt without massive infusions of additional capital. In the core of the city’s traditional neighborhoods, we have a development pattern that is built incrementally over time, with high financial productivity, and is strong, with the ability to adapt and change with market conditions.
There is a reason our ancestors, around the world, for thousands of years, built human habitat in this way. We were both playing an infinite game; the only difference is that they were aware of it.
Value per Acre
When I was consulting with cities as an engineer and a planner, I worked to make sense of the financial implications of individual projects. Engineers are trained to estimate costs, and so I was good at calculating how much expense the cities I worked for would incur in different development styles. I later taught myself how to calculate revenue streams so I could analyze the real return on investment for individual projects. What I was lacking was a way to expand these insights beyond the inferences that could be drawn from single projects and into a holistic examination of development patterns across an entire city.
Strong Towns Page 14