Part 3: Matters that the five local authorities have raised

Using development contributions and financial contributions to fund local authorities’ growth-related assets

In this Part, we discuss some of the practical matters that the five local authorities have raised with us. We have grouped these matters into:

Although those matters warrant consideration, we do not make any specific recommendations about them. Where appropriate, we have included the five local authorities’ views to explain and/or illustrate the matter.

Forecasting growth, and calculating capital expenditure to meet additional demand

Ability to forecast growth is important

Economic and population growth drives the need for new capital expenditure to meet that growth. It is essential for local authorities to have good growth forecasting models because they are the basis for forecasting future revenue (rates, growth charges), finance costs (debt, debt servicing), and capital expenditure required to meet the additional demand and asset renewals. The five local authorities emphasise the importance of asset management plans. An asset management plan is a plan for managing a local authority’s infrastructure and other assets to deliver agreed levels of service, and also reflects assumptions on growth.

In preparing their financial strategies for their 2012-22 long-term plans, local authorities had to state the factors they expected to have a significant effect on them during the 10-year period of the plan. Those statements had to include expected population changes, the use of land in the district or region, and the capital and operating costs of providing for those changes. Those financial strategy requirements mean that local authorities have to consider likely growth in their districts and regions, consider land availability and use, and set out likely costs. Tauranga City Council states in its Development Contributions Policy that:

Under the SmartGrowth Strategy, Tauranga City has to accommodate approximately 70% of the anticipated sub-regional household growth plus significant business development, for the next 50 years. This growth will be accommodated through a mix of greenfield (approximately 70%) and intensification (approximately 30%).15

The five local authorities told us that it is essential that their planning policies align with their funding policies. Tasman District Council assesses the specific growth capacity of each of its settlements and the areas within them. The Council carries out this exercise every two years, ahead of preparing the long-term plan, for residential development, and considers commercial development needs every three years. The Council said that current population forecasts for its district show that the number of people in each household is lower than previously expected, and there is an increase in the number of holiday homes. For each settlement, the Council forecasts the number of expected household units and the infrastructure investment required.

Marlborough District Council said that, for the Marlborough area, directly projecting dwelling numbers produced plausible estimates. Logarithmic trends were fitted to census dwelling counts for 1991, 1996, 2001, and 2006, and subsequently extrapolated to 2051.16

Marlborough District Council noted that current forecasts indicate that its population will continue to increase and will peak around 2045. However, the forecasts show variability in the future growth profile between settlements and may result in the Council holding back on investing in new infrastructure in some settlements. The Council said that:

Accurate growth projections are a fundamental component of any development contributions policy. They help determine the extent of capital works required to service growth as well as the demand over which the resulting costs should be spread. Unfortunately, however, growth projections are often difficult to generate with any reasonable degree of accuracy.17

Marlborough District Council is also seeing an emerging trend of a reduced number of people in each household.

Across the five local authorities, there are differences in the methods used to forecast growth in residential and non-residential18 developments. For residential developments, several methods are available. All seek to project the number of households (dwellings). One method is to project population to convert to households using average household size. Another is to extrapolate building consent trends. Yet another is to extrapolate the number of dwellings directly.

The calculation of the “total cost of capital expenditure”

In calculating the maximum development contribution for a community facility or an activity or group of activities for which a separate development contribution is to be required, a local authority must first:

(a) identify the total cost of the capital expenditure that the local authority expects to incur in respect of the community facility, or activity or group of activities, to meet increased demand resulting from growth within the district, or part of the district, as the case may be; and

(b) identify the share of that expenditure attributable to each unit of demand, using the units of demand for the community facility or for separate activities or groups of activities, as the case may be, by which the impact of growth has been assessed.19

We found that the practice differs between local authorities in the calculation of the “total cost of capital expenditure”. Some local authorities have included debt-servicing costs within the total cost of capital, because those costs form part of the total cost of providing the infrastructure. Other local authorities have excluded debt-servicing costs from their total cost of capital expenditure calculation.

Community facilities, and particularly network infrastructure, typically take a long time to plan and build. Often a local authority will not have the funds to pay for this infrastructure up-front and will borrow to initially pay for the asset. This means that a local authority will incur the associated debt-servicing costs (interest). This debt-servicing charge will need to be funded. Because the debt is for growth-related assets, some local authorities fund it through development contributions as part of the capital expenditure costs.

Some of the five local authorities have in their development contributions policy, an allowance for price changes to recognise higher construction costs where assets are built later. This is because in practice, costs generally escalate, particularly the price of construction materials. For example, Tasman District Council’s policy provides that “the value of the development contribution shall be adjusted on 1 July each calendar year using the annual change in the Construction Cost Index”. Marlborough District Council also adjusts its development contributions annually by the Producers Price Index.

There are complexities with managing levels of service and cost

For cost-effectiveness, local authorities aim to design and build network infrastructure, provide reserves, and provide community infrastructure that can service that area, catchment, or type of development at its maximum occupancy. For example, network infrastructure will most likely be designed to meet peak periods of demand, taking into account an influx of temporary visitors to the area.

Local authorities also take into account that the facilities need to meet environmental, health, and safety standards. Tasman District Council said that new assets must comply with the Council’s engineering standards and be consistent with the service levels reflected in its asset management plans.

The five local authorities said that there can be inconsistencies between developments in their districts, and this reflects the service levels of their communities. In general, local authorities consider the minimum legislative compliance standards that they need to meet – for example, New Zealand Drinking Water Standards (NZDWS). However, service levels may differ between areas in the district. Using the NZDWS as an illustration, the service standards can legally be lower in an area that services a smaller population than in an area that services a larger population. At the same time, a local authority needs to take community views into account. A new community may want higher standards of service than existing communities in the district. This can mean that, to provide the desired higher service levels, infrastructure required to service the new community may cost more than is required to meet current legislative standards.

It is also important to recognise that local authorities receive assets from developers in the form of “vested assets”.20

Although local authorities effectively receive these assets at no cost, they become responsible for the future operating costs.

Overall, local authorities have to balance a number of matters when it comes to designing and building their growth-related assets, these affect the calculation of growth charges. As illustrated, local authorities have to consider how, when, where, and what assets should be built, as well as managing expectations about the levels of service to be provided, how the assets will be funded, and future maintenance of the assets.

Apportioning the capital costs relating to growth is not straightforward

A development contribution must be used for, or towards, the capital expenditure of the reserve, network infrastructure, or community infrastructure for which the contribution was required, but must not be used for the maintenance of the reserve, network infrastructure, or community infrastructure.

The five local authorities look at each project to consider what portion is growth-related and calculate the growth charges based on that percentage. However, even this approach has its challenges.

Some of the five local authorities said that, in reality, no growth-related project is 100% attributable to growth. This is because some element of the expenditure will improve existing levels of service. For example, growth may trigger an increase in the size and standard of an existing piece of road. Because growth does not occur all at once, the new capacity on the road is a service-level improvement for existing users. However, one local authority commented that the service-level improvement is only temporary and is not required by the existing users, who should therefore not contribute towards funding the cost for the improved service level.

Other local authorities have a different view. For example, Tauranga City Council has many projects in its development contributions policy that are 100% attributable to growth. Likewise, Western Bay of Plenty District Council has many projects that are 100% attributable to growth, particularly greenfield developments.

In many instances, installing new growth-related infrastructure can also bring forward repairs and maintenance. For example, a local authority might carry out renewal work on road assets while installing new wastewater pipes to meet growth. This type of opportunity for efficiency can cause an acceleration of maintenance or renewal work. But it can also cause difficulties in the allocation of costs and create short-term cost pressure from a financial management perspective.

Different approaches in calculating development contribution charges

Local authorities that wish to charge development contributions must have a development contributions policy. The policy must contain a schedule of the development contributions payable in the district or parts of it. It must also explain and justify the way each development contribution is calculated and the significant assumptions underlying the calculations.

Clause 2 of Schedule 13 of the Local Government Act states:

For the purpose of determining in accordance with section 203(2) the maximum development contribution that may be required for a particular development or type of development, a territorial authority must demonstrate in its methodology that it has attributed units of demand to particular developments or types of development on a consistent and equitable basis.

The five local authorities have taken different approaches in terms of whether the development contribution or financial contribution is to fund growth-related assets on a catchment or defined area of growth basis and/or a district-wide basis. The five local authorities have said that the approach they have individually adopted best reflects their district planning and financing strategies, and the geography and catchments of their district.

Marlborough District Council calculates its charges based on each catchment area and each activity on the expected scale and timing of capital works required to service growth.

Tasman District Council applies development contributions on a district-wide basis for transportation, water supply, wastewater, and stormwater. Growth charges are charged only to those service connection areas that benefit from the service. The Council’s rationale is that this is more appropriate for a geographically large and relatively dispersed population. This approach means that there is a subsidy for the smaller development areas.

Tauranga City Council charges a city-wide development contribution for assets that service growth across the whole city. The Council also charges a local development contribution for assets that service growth in particular catchments.

Western Bay of Plenty District Council charges financial contributions based on catchments for network capital expenditure with district-wide charges for transportation, recreation, and ecological protection.

Challenges with preparing the financial forecasts in the long-term plan

Projections and growth beyond the 10-year long-term plan time frame

A local authority’s long-term plan is required to cover a period of at least 10-years. There is currently a mix of approaches to including or not including growth-related projects beyond the 10-year time frame in long-term plans. Some local authorities have included only growth-related projects that fit within the 10-year time frame in their long-term plans, and the development contribution charges are calculated based on only those projects.

Other local authorities have included growth-related projects that are within the 10-year time frame as well as projects beyond the 10 years into their development contributions calculations. This is because network infrastructure can take many years to plan and build. For example, development of individual catchments (that is, new suburbs) will generally take more than 10 years from when development commences to when it is substantially completed. The local authority and its community would benefit from knowing in advance the assets planned to cater for growth and for the district, and also how they are going to be funded and financed.

Non-residential development charges

Growth charges on non-residential development

The development contributions regime enables local authorities to recover the growth-related costs of network infrastructure, reserves, and community facilities as a result of growth.

There is debate in the local government sector about whether local authorities should charge for growth-related costs arising from non-residential development, specifically in relation to reserves and community infrastructure. One view is that, if additional jobs are created from non-residential development, then the growth-related costs of reserves and community facilities/infrastructure can be recovered from development charges for new residential development. Another view is that non-residential development creates a need for new infrastructure and therefore should share in funding the costs of those assets.

Marlborough District Council’s development contributions policy on non-residential activities states:

Non-residential subdivisions will attract development contributions on each additional allotment created. If the intended land use is known at the time of subdivision, development contributions will be based on (i) each lot’s planning gross floor area and (ii) the intended land use.21

The Council includes a table that shows the factors used to convert non-residential demands to HEUs. The Council states that “unless a separate assessment shows demand is created for the activities of reserves or community infrastructure, development contributions for non-residential activities are not charged for these activities”. This means that the Council charges non-residential subdivisions for growth-related costs on network infrastructure, including roading, water supply, wastewater, and stormwater.

Tasman District Council states in its development contribution policy:

Where there is a subdivision for a non-residential land use or non-residential building development, an assessment will be carried out to determine an appropriate unit of demand. This will be based on a comparison between the demand for network infrastructure generated by the non-residential development and the assumptions made in calculating the household unit of demand or such other criteria as may be relevant.

Similar to Marlborough District Council, Tasman District Council may charge non-residential developers to fund growth-related costs on network infrastructure where the services are available. Tasman District Council also charges financial contributions to fund reserves or community infrastructure where the building cost is greater than $50,000. Western Bay of Plenty District Council does not charge financial contributions for recreation on commercial and industrial development.

Approaches to funding reserves

The approach to funding reserves is different from the approach to funding network and community infrastructure

The development contributions for reserves must not exceed the greater of:

  • 7.5% of the value of the additional allotments created by a subdivision; and
  • the value equivalent of 20 square metres of land for each additional household unit created by the development.22

The development contributions for network and community infrastructure must not exceed the amounts calculated using the methodology set out in Schedule 13 of the Local Government Act. Typically, the development of city-wide reserves – for example, sports fields and open spaces – is a strategic planning issue with defined service standards. Applying the rules on funding for reserves based on a percentage calculation means that a local authority might not receive the same amount of funding through development contributions to cover the capital cost of such reserves. On the other hand, an increase in land value may result in more development contributions for reserves being receivable when calculated on a percentage basis.

Refunds or return of land if development does not take place

We found that high-growth local authorities might have significant accumulated contributions previously collected to be applied towards future growth-related assets in their balance sheets. This is because, with the economic downturn, the pace of development has slowed compared to forecasts and those changes have a significant effect on when (and where) development should take place. The growth-related projects will typically have a ‘trigger point’ before it is economically viable for the project to commence. This means that, in many instances, the development of the growth-related assets is deferred and some may not even take place.

Contributions of money or land for reserves must be used within 10 years after the local authority receives that contribution. This applies only to development contributions, not to financial contributions. If the contributions are not used for the specified reserve purpose as intended, then the local authority must refund the money or return the land acquired for the reserve purpose to the person who paid the development contribution or contributed the land. Some of the five local authorities have said that the process is not as simple as it may seem. This is because it can be difficult to identify the person who paid the development contribution if the subdivided reserve land has changed ownership several times. This dilemma also applies with having to refund amounts paid towards network or community infrastructure for which a development contribution was required but the infrastructure development does not proceed as expected.

Financial management

Local authorities need to carefully manage their finances

One of the drivers of new assets is not necessarily timing, but what is affordable and can be funded.

Some of the five local authorities said that they apply a 10:20:30 financial management guideline, although this ratio varies between local authorities. This means, as shown in Figure 10, that local authorities typically incur capital expenditure over 10 years for any given project. A local authority will typically borrow and repay the debt over 20 years. Then, the local authority typically takes 30 years to recover the total capital expenditure costs from development contributions (or other revenue sources).

Figure 10
Growth-related expenditure, debt financing, and funding

Figure 10 - Growth-related expenditure, debt financing, and funding.

Other local authorities have a different approach. For example, Tauranga City Council tries to align debt repayments with the time it takes to recover the total costs of capital expenditure. This is because the Council uses development contributions to recover the capital expenditure cost, debt repayment, and debt servicing costs.

Tauranga City Council said that it can be a challenge trying to balance its books for some developments. For example, the Council’s Southern pipeline asset is built to cater for growth for the next 50 years. However, the Council anticipates that it will take 50 years to recover the cost of the asset, including any debt-servicing costs. The Council would borrow to pay for the asset initially. This means that the cost of capital (debt-servicing costs) for projects such as this one could exceed the actual infrastructure construction costs. This reflects the need for lead infrastructure investments and a long debt-repayment period funded through development contributions.

In addition, Tauranga City Council is always looking at how to manage its balance sheet risk including managing its debt levels. One of the Council’s strategies is to take an incremental and just-in-time approach to development (for example, by proceeding with infrastructural development for the Wairakei catchment where the infrastructure costs between $3 million and $5 million and could service 1000 properties, rather than committing to the development for that whole community area all at once).

For many local authorities, including the five local authorities, growth charges such as development and financial contributions are useful funding tools for recovering the cost of growth-related assets. Although local authorities have other revenue sources, some local authorities regard them as less suitable for capital cost recovery of demand-driven expenditure. For example, targeted rates could be used, but the rate of recovery is slower than using a growth charge. If debt is used to initially finance the asset, then repayment of the debt from targeted rates would take longer and debt-servicing costs would be higher.

Using debt to finance infrastructure is not new in the local government sector. The spreading of debt repayment and debt servicing over time reflects local authorities’ view of intergenerational equity. Western Bay of Plenty District Council said that it:

… uses loan funding to spread the cost of infrastructure between current and future ratepayers. By borrowing to pay for assets with a long life, for example 25-50 years, we can recover the cost from ratepayers over the life of the asset. In this way the cost is allocated fairly between current and future ratepayers.23

Misalignment between development and/or financial contributions being due and cash flows

The five local authorities have noted payment of development contributions could be better aligned with developer cash flows (sale of land and house packages).

Typically, for subdivision consent, an applicant is notified of the requirement to pay a development contribution at the time the consent is granted. However, the development contribution is not payable until the subdivision (or stage thereof) is completed – marked by issue of the section 224(c) certificate (the subdivision completion certificate) under the Resource Management Act. At this stage, a developer is likely to have titled sections that can be sold. The developer would usually have made a number of pre-sales in order to obtain debt finance.

The above also holds true for building consents. An applicant is notified when a building consent is granted. Typically, however, payment is not required until the code compliance certificate is granted under the Building Act 2004 (that is, when the building is completed). Tauranga City Council is an exception, as it charges when the building consent is granted.

Sanctions for non-payment of development contributions include withholding a Resource Management Act completion certificate or Building Act code compliance certificate until payment is made. However, a local authority told us that a building consent applicant is not necessarily concerned with getting the relevant certificate until they want to sell the building. This means that applicants can delay paying the development contribution.

With service connections, a local authority may withhold the physical service connection to a local authority utility service until the development contribution is paid.

A local authority is able to register the development contribution as a charge owing under the Statutory Land Charges Registration Act 1928. However, some local authorities have said that this is ineffective because there are no sanctions for non-payment at the due time. Marlborough District Council, in its development contributions policy, allows developers to apply for a postponement of development contribution payments. This is provided that the GST component is paid immediately and the remaining amount outstanding is registered as a charge under the Statutory Land Charges Registration Act against the title at the developer’s cost. Postponement has a maximum time limit of five years or the period until the property changes ownership.

Local authorities take care to balance their books – between consideration of developer cash-flows and also their own finances. Delays in obtaining development contribution income could result in a local authority carrying higher debt and debt-servicing costs. The local authority would then need to consider how to fund the additional debt-servicing costs.

Other matters

Transition period when there are changes to the growth funding approach

Three of the five local authorities have adopted a development contributions policy, but the other two local authorities continue to apply their financial contributions policy and do not use development contributions.

One issue for all five local authorities is the need to phase in charges over time, particularly if there are significant changes to the funding approach. For example, where a local authority moves from using a financial contributions approach to a development contributions approach to fund growth-related assets, a transition period would be desirable to provide certainty for all concerned. Such a change might also affect the administrative effort of local authorities who have to work with developers in applying different policies under both the previous and new approaches. The phasing in of changes over a transition period allows developers time to adjust with paying growth charges under one regime to another. A local authority may include a remission or discounting arrangement in its policies to assist with the change.

Timaru District Council considered adopting a development contributions policy during the preparation of its 2012-22 long-term plan but decided not to. Although the Council has not yet changed its funding approach, the Council did think that, in managing a transition, it would be preferable to have a clean cut-off and apply the new approach on only new projects, and projects that have been undertaken in the last five years that still have debt owing. This would separate, for example, the debt that might have been incurred for projects under the previous approach. This is because there is great complexity involved in calculating cumulative collections.

Western Bay of Plenty District Council continues to apply its financial contributions policy for the effects of new or intensified development. The Council said that it has a mature approach and works closely with developers to provide them with certainty over funding charges. The Council said that it receives periodic rushes of applications ahead of the release of new plan changes. Because financial contributions are payable when the Council adopts the plan change after public consultation rather than when the plan change is notified, this allows developers and the market to assimilate the new or revised charges.

When Marlborough District Council adopted a development contributions policy to fund growth-related assets, the Council also introduced a remissions policy to smooth the transition from the previous financial contributions funding approach.

15: Tauranga City Council, Development Contributions Policy, page 7.

16: Marlborough District Council, 2012-22 long-term plan, Financial/Development Contributions Policies, page 245.

17: Marlborough District Council, 2012-22 long-term plan, Financial/Development Contributions Policies, page 245.

18: “non-residential” is not defined in the Local Government Act. Tauranga City Council in its development contribution policy has defined non-residential activity to mean any activity that is not defined in its policy as a dwelling unit, household unit, or residential activity. It includes, but is not limited to, a business activity, a low-demand business activity, or a community organisation.

19: Schedule 13 of the Local Government Act 2002.

20: Vested assets are assets that are transferred to a local authority at nominal or zero cost. Typically, they might result from a situation where a developer has installed assets when developing a site and, after completion, the developer passes them to the local authority. The fair value of these assets has to be determined and is then recognised as revenue in the year of transfer. The assets are then integrated into the local authority’s asset information system so that they can be appropriately managed.

21: Marlborough District Council, 2012-22 Long-term Plan, Financial/Development Contributions Policies, pages 250-251.

22: Section 203(1) of the Local Government Act 2002.

23: Western Bay of Plenty District Council, 2012-22 Long-term Plan, chapter 2, page 34.

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