Strong Towns Thinking about Return on Investment

A sample of original thinking from Chuck Marohn from his “The Barbell Strategy

 
The last three weeks we have delved deeply into the different mindsets for local governments to approach capital improvement projects. For a country that reflexively believes that investments in infrastructure are a catalyst for growth (build it and they will come), this is a very important conversation. Is there a way to invest limited dollars so that, over time, the pie expands and our capacities grow?
 
Our current approach is ad hoc, at best, where experts and their theories on what makes a good investment advise public officials on the best ways to throw around millions of dollars, a growing amount of which is borrowed. It takes money to make money. Will it work? Who knows. While this approach is comforting to those that want action, acquiescing to the human impulse for easy gain, we reject it wholesale. Local governments should not be in the businesses of risk.
 
This led me to define three core understandings for how risk and return are measured for local governments. While a radical departure from our current thinking, there is simple logic to the suppositions that:
 
    Local government investments need to generate a REAL rate of return, one where the government actually gets money back for the money it invests.

    The revenue a local government receives in an investment be capturable in amounts sufficient to actually fund the project.

    The revenue stream from a project is capable of sustaining the improvement over multiple life cycles/
 
Finally, for a local government to get out of the risk game and actually be prudent stewards with a long term vision for the public purse — as if their city itself were an endowment — then a new strategy is needed.

A Strong Towns approach combines the risk adverse mentality of a banker or accountant on nearly all of the city’s “portfolio” with a venture capital swagger on the tiny sliver that remains.
 
As I indicated last week, today I’m going to elaborate on what a guaranteed return (banker) project and an experimental (venture capital) project looks like. I apologize in advance to those of you that don’t like math but, if you can wade through it, I’ve kept it fairly simple (overly simple, especially if people really want to quibble with the numbers).

Guaranteed Return / Low Risk
 
For each of these three examples, I will assume (for the sake of round numbers) that 25% of the city’s budget is used for infrastructure maintenance, with the remaining amount going to the other functions of local government (police, fire, parks, elections, etc…) I’ll also assume (for the sake of simplicity) that the city’s revenue, outside of one time grants and fees for service, is from property tax.

New housing. Make it low risk.
 
Example #1: A developer is putting in a new housing subdivision and is requesting that the city take over the maintenance of the infrastructure. The long term cost (calculated through a full life cycle and replacement) for the infrastructure is $100,000 per year. The new development will generate $400,000 per year in new taxes when it is fully built out. The city signs an agreement to take over the maintenance of the infrastructure once the development is built out and the value reaches the target amount. Until that time, the infrastructure is privately owned by the developer and/or a housing association.
 
Example #2: A street in a city is in disrepair and a maintenance project is planned. In evaluating the project, it is discovered that new growth and a rise in property values along the street has doubled the revenue the city is getting from within the project area to $400,000 per year. An enhancement that would widen sidewalks, installed decorative lighting and make other improvements would add $50,000 per year to the long term costs of the project, bringing the total annual cost to $100,000 per year. The city goes ahead with the project with the knowledge that the tax base has grown a sufficient amount to cover the long term costs.
 
Example #3: A STROAD runs through the city, bisecting two neighborhoods in a way that artificially separates them. Development along the STROAD is not very productive, providing an annual revenue stream of only $400,000. The cost to maintain the STROAD alone is $600,000 per year, which does not include costs for policing, responding to accidents and other normal city costs. The city secures a grant from the federal and state governments to put the STROAD on a road diet, narrowing the overall surface, connecting the adjacent neighborhoods and improving the overall prospects for the corridor. As a result of the project, the annual cost to maintain the STROAD (now a street) decreases to $300,000, an amount now covered by the corridor’s revenue stream. The growth in value expected along the corridor — if it materializes — will only enhance the city’s already marginally-positive position.

(From the Strong Towns blog)