A better way to fund housing infrastructure

By Leith van Onselen

I have written previously that I think Australia should look to Texas to solve housing supply. This view is based on the fact that Texas’ house prices have remained relatively stable and affordable in the face of rapid population growth and very easy credit.

Today, Luke Malpass, research fellow at the New Zealand Initiative, has written a nice primer on Houston’s innovative approach to funding and providing housing-related infrastructure – the Municipal Utility District (MUD):

With Houston growing so quickly (its population increased from 2,400 in 1850 to 5 million today), especially since World War II, it has been necessary to house all the extra people moving in, at an affordable price. New and innovative ways to finance infrastructure and housing developments were needed. Enter the Municipal Utility District (MUD).

An MUD is statutory authority or water district that has a board of directors, and is responsible for providing water service to its residents who pay an ad valorem tax to finance it. Developments are typically around 400 to 500 acres (202 hectares), although some are much larger, up to 12,000 acres.

These developments are done in stages; typically after the first stage, when enough value has been created, the MUD can issue bonds against that value (typically 20 years) to finance the rest of the development. To recoup the investment, it can charge a tax of up to $1.50 per $100 of value in two parts: a debt servicing charge and an operational charge (to run the utility). For a house worth $300,000 this means $4,500 a year. However, over time as the debt is retired, this component reduces; for residents in some MUDs, the charge for services is as low as 17c per $100 of value: a utility tax rate of 0.17%. For the same house worth $300,000, this is $510 per year [UE: note typical starter homes in Houston cost around $150,000 only].

And because the residents essentially own the MUD, there is every incentive to keep prices down and service quality up.

This model has obvious advantages. First, the value of the infrastructure is not folded into the house cost and subsequently passed on at sale. Second, it means those who have built the infrastructure have also paid for it. Third, as developments grow, the MUD can decide its own future, whether it puts in public amenities such as parks and pools. Because there is no zoning, a great diversity of MUDs exist: from high-end master-planned communities to complete starter-home areas.

Regardless of your views about Texas, Houston’s MUD infrastructure financing system is a model worth considering for anyone concerned about the costs of growth in Australia.

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Comments

    • My understanding is that MUDs are set up by the developer, who deposits 30% of the infrastructure funds up front, as a guarantee. The MUD then issues bonds to complete the funding, with the debts repaid via property taxes (which we would call rates). Interest paid to bond holders is presumably tax-exempt, in which case there’s a partial subsidy.

      I don’t have a problem with this, per se. At least it means that property owners are paying for their own infrastructure, instead of loading up state and local governments with ridiculous debts, which is how it normally works in Texas.

      They tend to be quite small. Occasionally they go broke, but I haven’t been able to find any details about the exact circumstances of this. If they get into trouble, their only way out is to raise property taxes, which can be crippling for some owners. At least two have filed for Chapter 9 bankruptcy.

      One problem is that MUDs push risk onto home owners. There are circumstances in which the MUD can become insolvent, in which case property taxes/rates can get very high. If that pushes people out of the area, I can see a nasty feedback loop developing.

      • But Janet; (rather than add to the skinny sub-thread below); of course developments are going broke in places like NZ, where land is forced WAAAAAY up in price long before the developer actually gets to buy it, by the knowledge of whether or not planning permission is likely to be granted.

        It REALLY HELPS diminish the risk of bankruptcies in developments, when as in Texas the developers are mostly just buying farmland on offer on the farmland market, at farmland prices, which can be dozens of times cheaper per acre. PLUS the pooor b—–y developer in NZ or Aussie is having to hold the land, complete with finance costs, for far longer than his Texas counterpart.

      • Dale SmithMEMBER

        Good questions regarding the ‘What if’s regarding MUD’s. Best example on how they are managed in this part of the world is Body Corporates. But think of the successful professional ones rather than the failures. One of the biggest in Texas is Woodlands, about 60,000 residents if I remember rightly, with commercial etc, is a small city.

        But unlike Body Corporates, MUD’s are formed to help with the intitial development so it is a combo capital/operational development that the developer is tied into, so in my experience the balance between these two is better, making for a better priced product and lower overall running costs.

  1. Good post, very interesting.

    There might be some practical issues rolling out this kind of privatised infrastructure development/management plan (for example, how would this work in with the rest of the State or Federally funded and managed infrastructure?)

    As for keeping costs down and service levels up, I would have thought it was already front and centre on the govt’s agenda? …Privatising (or handing the keys over to an independent Board of directors) brings about problems of transparency and self-interest. There are a lot of advantages to having centralised control at a large scale (i.e., State or Federal level).

    Good to see other ideas being circulated though.

    • Often the independent corporation hands everything over to the existing local council anyway once everything is completed; the debt and the assets; this is by voluntary agreement.

      The important thing is for the genuine market freedom and the “competition” to exist in the first place, in supply of land, supply of infrastructure, and “development”. It works, and very well.

  2. An interesting idea, but I have been on a body corporate management committee and I’ve seen the absurd ideas and politics on display there.

    • That subdivision I mentioned above, Peter? Guess what the land went for? About 60% of the original asking price…and a lot of it is STILL sitting for sale by the new owners optimistically trying to extract their premium by suggesting its 10% off original price.

      • Thanks Janet – That Bank of Scotland Int is probably HBOS which owned Bankwest here, I don’t think the RBS was involved in this part of the world – could be wrong though.

        That land – was it sold to this new developer who is now marketing it for 10% less – is that the story?

      • Pretty much. The link gives a fuller picture. Bank owed $95m.( not sure what the original developer had already put in!) New owner paid something around $30m….but I’m sure there were other add-ons to that !

      • My point being re land can fall…not only did this subdivision go down, but you can imagine what is did, and still does, to the price of all other land in the wider vicinity, and this is in our 6th largest city!

      • OK fair enough. When I said the other day that land can’t fall I was looking at the broader picture. Individiual block prices or subdivisions can fall, but those who “manufacture” land will stop “manufacturing” if they can’t see a profit, which later creates an undersupply, which then pushes prices up.

        Land development is high risk because of the volatility. It’s difficult to get finance, and when they do it’s at high interest rates due to the risk and short term nature of the loan.

        For a smallish developer the outcome is either great success or dismal failure. It’s too much like roulette IMHO. The system protects the well capitalised developers and makes the small guys sacrificial lambs in a downturn. It’s always been so.

      • I take your point, Peter. But I’d still suggest that on broader scale land can ( and will 🙂 ) fall in price. The problems of insolvency in individual cases can also be reflected corporate or nation cases. Greece, for instance, ( yawn!) will probably end up selling its land for a significant discount for national economic reasons. I never expect Australasia to be The Mediterranean, but other ‘unique’ reasons will hit us. The biggest risk we face is the cost of our labour. Wages will adjust here, just as they will/have in the USA and The UK/Ireland…and when that happens….land/property prices will also adjust.

      • The biggest risk we face is the cost of our labour. Wages will adjust here, just as they will/have in the USA and The UK/Ireland…and when that happens….land/property prices will also adjust.

        Is the bubble in wages then?

      • Janet – labour costs tend to get adjusted by staff reductions, loss of overtime, bonus’s etc, not via wage reduction, or at least not on a mass scale.

        Contractors and subcontractors can lose income, but the man and woman on lower tier wages who hold their job are not greatly affected, except their spending patterns are altered through a loss of confidence in the future.

        Household incomes in the US fell during the recession due to less hours and unemployment, but they are rising now.

        These graphs might help –
        http://www.businessinsider.com/doug-short-us-household-incomes-a-44-year-perspective-2012-9

        The issue in the US is that real wage growth hasn’t kept up with GDP increases since 1970.

  3. Very interesting post. There must be a better way to fund Sydney’s infrastructure. Currently many of us pay through the nose and get little to no infrastructure.
    One council even charged an infrastructure levy on new blocks and then bet and lost the entire wad on some dodgy wall street concoction.

      • Kellyville. $400k for a tiny block, train promised, then eventually the 1-lane road was widened to 2-lanes.

      • Kellyville has water, sewerage, power, roads, gas mains, a public school, a high school, parks, a fire station, the north-west T-Way, the new Glenhaven Bridge, and a sports centre. How is that “little to no infrastructure”?

        Kellyville has about the same infrastructure as the rest of Sydney, much as you might protest. Actually, plenty of places have a lot less.

        If you’re just peeved that a promised rail project didn’t proceed, I’m afraid you’ll have to get in line behind the rest of the city.

      • If you’re just peeved that a promised rail project didn’t proceed

        In fact I don’t live there and wouldn’t.

        Why shouldn’t citizens be peeved when govt promises and does not deliver?

        Let me guess, you are a government planner, and Kellyville is your success story.

      • “Let me guess, you are a government planner, and Kellyville is your success story.”

        Good idea. Attack me, not what I say.

      • Just following your lead

        if you’re just peeved that a promised rail project didn’t proceed

      • I have first hand knowledge of a heavily intensified suburb for which the Council concerned has been milking developers for infrastructure fees, including for new stormwater capacity because of course there is a whole lot more impermeable surfaces in the suburb now; but they have not actually done the stormwater upgrade and angry incumbent residents are getting flooded when there is a good downpour, and are suing the Council.

        This is all the more sickening given that Councils are constraining “greenfields” growth on the grounds that it is “more efficient” to intensify.

        This is not true anyway. The truth is that the Councils have failed to fund maintenance and renewal, and are trying to find another revenue stream with which to do so. Therefore they force developers to do intensification instead of fringe developments, and milk them for fees allegedly to “increase capacity” in the very locations the Council said would “save public money” if intensification happened there.

        BTW Portland has been known to SUBSIDISE intensification, not hit it with fees. This is at least morally consistent with the arguments “for” intensification.

  4. I’d support anything than the current system. Especially something that’s proven to work. Doubt Macquarie St will do anything about it though.

  5. Would it be possible to develop a “pay per flush” system for the funding of sewerage infrastructure?

    • This is one of the basic reasons there is an infrastructure crisis. There is no connection between “use” and amount paid.

      “Free” roads end up congested; the demand for “free” water and drainage and sewerage services and often many other things as well, would require local taxes higher than everyone is prepared to actually pay, to fund their provision.

      Far smarter to charge for use, and let the market work out the best way for people to get their costs down. People might actually recycle, and collect rainwater, and compost waste, and things like that, if there was any incentive.

      Patrick Troy’s excellent “The Perils of Urban Consolidation” discusses these aspects among many other things.

      • People might actually recycle, and collect rainwater, and compost waste, and things like that, if there was any incentive.

        I’d just cross my legs and think of Warragamba.

  6. Is the MUD able to provide standalone water/sewage and power generation or is it required to interface with existing infrastructure?

    If a developer decides to build 20 miles out of the city who pays for the road/communications infrastructure or gov services?

    Regarding the comments about avoiding upfront costs for infrastructure – whats the difference between financing the development cost through an MUD and repaying it as a property tax as opposed to just adding the cost to the sale price and repaying it via a mortgage – considering there is no difference between interest charged??

    • I’m terrified that one crazy developer might build a unit tower 20 miles out of town, and then insist that government build a trainline right up to the tower.

      Better to have a blanket ban on development and it avoids all that disappointment.

    • There are some differences.

      E.g., MUDs can borrow at the municipal bond rate, which is around 2% these days. As I mentioned above, the interest paid is tax-exempt, so this is also subsidised to some extent. Either way, it’s lower than the mortgage rate.

    • “…..what’s the difference between financing the development cost through an MUD and repaying it as a property tax as opposed to just adding the cost to the sale price and repaying it via a mortgage – considering there is no difference between interest charged??….”

      Here’s the difference.

      If we pais for roads by socking $20,000 of road user charges into the price of every new car, what would this do to the prices of used cars?

      Guess what: everything you sock in to the price of new houses, filters into asking prices for the entire existing stock of houses.

      Every first home buyer then effectively pays the fee to every vendor of the house he buys wherever it is, and the amount is a windfall gain to the vendor.

      Nice wealth transfer scheme, but it would actually be fairer to sock every first home buyer a tax on buying their first home, at least the government would get this revenue and it could be spent on infrastructure, instead of comprising a wealth transfer between sectors of society.

      This would still be unfair on first home buyers, period, but it is odd that this unfairness would be obvious, but the unfairness of the status quo is not.

  7. I’m not sure that this would solve too many problems. It seems to me that the main effect is that cost of infrastructure is amortised over a long period rather than being capitalised upfront. Given that homeowners typically borrow to buy a house, that upfront cost is then amortised over the same period anyway. What’s the difference?

    What would be more useful is analysing whether this model had benefits in terms of lowering the overall cost of providing infrastructure. I’m not close enough to it but developers always complain about the high costs imposed by councils and monopoly suppliers for electricity, gas etc.

    On the face of it, it’s hard to see how the MUD model reduces these costs – indeed it adds another layer of administration and you possibly lose some scale benefits so I’d need to be convinced. Add to that the risks of bankruptcy, misappropriation of funds, governance etc referred to by Janet and PF above, and there’s potnetial for real harm.

    In any event, I think it’s all a bit secondary to the main gam: which is not that Australia has high house prices, it’s that we have artifically high land prices.

    • So we should pay for roads by socking $20,000 of road user charges into the price of every new car?

      What would this do to the prices of used cars?

      Guess what: everything you sock in to the price of new houses, filters into asking prices for the entire existing stock of houses.

      Every first home buyer then effectively pays the fee to every vendor of the house he buys wherever it is, and the amount is a windfall gain to the vendor.

      Nice wealth transfer scheme, but it would actually be fairer to sock every first home buyer a tax on buying their first home, at least the government would get this revenue and it could be spent on infrastructure, instead of comprising a wealth transfer between sectors of society.

      This would still be unfair on first home buyers, period, but it is odd that this unfairness would be obvious, but the unfairness of the status quo is not.

      • “So we should pay for roads by socking $20,000 of road user charges into the price of every new car”. What if that meant the petrol tax was removed? Not being argumentative, genuinely interested in your thoughts. For what’s it’s worth, I support the idea of MUDs. Our infrastructure providers are “like-it-or-lump-it” providers so you get really bad service and really bad value for money.

      • The reason to not lump a charge upfront, into something for which there is a significant “used” market upon which most of the population rely, is because of the wealth transfer effect.

        This wealth transfer effect would become “neutral” eventually, but when it is first introduced, the impact is significant on the as-yet-not-owners.

  8. Thought I’d join in…
    Disclosure: I have property interests in Austin, Texas.
    The market value of a “typical” residential block of land there is around $30K-$40K. Property taxes make it less favourable to land bank, as pointed out previously on this blog. The contrast to my home town of Sydney is truly staggering.
    Even after the property tax is taken into account, the *net* rent return on houses and multi-family properties is much higher in Texas – perhaps 3 times as high in percentage terms.
    Australia’s political and regulatory elite have become wealthy from property in Australia and their greed prevents them from making changes for the benefit of those who weren’t fortunate enough to get hold of property a couple of decades ago. I’m not sure what the catalyst for change will be – a true crisis or the eventual rise of political power of those who can’t afford to buy a home.

    • geoffw,
      Do us all a favour and stay around and keep posting. The comparison between Austin and Sydney could be very useful to us, and there is no substitute for local knowledge.

      • Absolutely, we have all these comments above asking “what if” this and “what if” that, went wrong with a MUD based development.

        But someone from Texas looking at OUR system, goes “W…..T……F”????????????

        I know a guy from Texas who has done just that.

    • geoffw. Thanks very much for commenting. The more comparisons that we can get between Australia’s dysfunctional system and places where planning seems to work the better.

      If you ever want to send info offline or want to write a guest post, please email me at the address above.

      Thanks again. Leith

      • Thanks Leith.
        I have been a long time reader of your posts, which are always very informative and well reasoned.

        If you or other readers would like to know more about property investing or Austin’s economy, I’d be happy to put something together. I would need some guidance on what would be of interest.

      • Thanks Geoff. I might fire off some questions (after thinking about it for a while). It is very useful having someone familiar with both Sydney (which arguably has Australia’s worst supply issues) and Texas (which, in my opinion, has well-functioning supply).

    • “I have property interests in Austin, Texas.
      The market value of a “typical” residential block of land there is around $30K-$40K”

      Nice. That’s what I paid when I bought (late 1990’s) – a block priced under $200k in the same area is now considered a bargain.

  9. Happy to do that! Thanks for the kind welcome.
    For anyone interested in Austin residential gross rental yields… they are about 12% on a modern duplex and about 11% on a modern house. They are self-financing. Yield is a bit higher on older dwellings, but higher maintenance would eat into the return. Both rents and values are rising a bit. Dallas and Houston are cheaper and the yield may be a little higher.
    Somewhat better than to Sydney.

  10. Dale SmithMEMBER

    I lived and worked in Austin Texas for three years in property development and I am very familiar with the use of MUD’s which we used a number of times in our developments.
    One of the first reasons they work in Texas, is that they are pro affordability development, which is a different mental attitude from being pro development. Councils have no issue with a developer wanting to supply a service if the council cannot or does not want to. A developer can chose to develop adjacent to council services or 20 miles out. It is his call as to what the market wants.
    Most importantly about MUD’s and the whole land development scenario in Texas is they make it easier to build at the rate of demand. By being able to purchase land at the rural land price, and then use STEP type systems (for waste water in particular as this is a large cost/environmental component of any development), developments can quickly be brought to the market to meet demand, and just as important, stopped if demand is not there. After all the land can still produce a rural return on investment while it awaits to be developed. And since in theory, anyone can develop their land, there is so much competition that if you do develop you need to be competitively priced.
    Developing at the rate of demand is an important concept to understand. Toyota, for example can supply any extra demand for a model within 5 days. Just because there is more demand, they don’t put the price up, as the price for the quality they supply is the reason for the demand in the first place. This means there is no waste, either of time or money, in the system. To the benefit of both parties.
    Developers in this part of the world are only capital developers ie once they have developed and sold they are out of there and do not care about the operational side. This tends to make them want to put in cheaper capital items that by default have high operational costs. Of course councils who only have to maintain the operational side without having to pay for the capital side try to make developers gold plate everything so they have minimal operating costs. This causes conflict between developers and councils from the start, the result being system massive time and cost increases for no extra value. Of course this conflict has been formalised as a ritual within the rules and regulations, being the polite people we are.
    Because MUD developers are responsible for both capital and operational costs then they tend to put in the best balance of the services required. Also the home purchaser who is also responsible for both the capital (when they purchase) and the operational (with the on-going costs) can see where the money they are spending is going, ie locally. They are not paying development levies or rates that are going into a general fund to be spent far and wide by council.
    Because MUD’s are developed to meet certain markets, you can have MUD developments for large mixed use towns, small 20 lifestyle MUD’s, MUD’s for up market gated communities, MUD’s for mobile home parks etc.
    Post’s here have asked about the financial success, or not, of MUD’s. MUD’s can be more hands on if small, or professionally managed like any city. Councils have the ability to annex any MUD as the city grows out and around it. Which they only do if they are well managed as they can earn the management fee which is a good source of revenue. Approx. half the growth of Houston over the last thirty years has been from annexing MUD developments.
    Better stop for now, but hopefully this has helped explain the benefits of MUD’s, but whether MUD’s work or not in this part of the world has nothing to do with the concept of MUD’s themselves, but whether we can make the mental shift that they will require.

  11. Thanks for the article Leith.

    My preference is for macroprudential tools to prevent house price bubbles but sice it appears that these are unlikely to ever be implemented and loose credit is probably now a permanently enrenched feature, something along the lines of MUD is something we should probably seriously consider.

    Though I think we should still assume that the idea will face stiff opposition from vested interests fearing the potential for downward pressure on house prices in general.

    • GunnamattaMEMBER

      ‘Though I think we should still assume that the idea will face stiff opposition from vested interests fearing the potential for downward pressure on house prices in general.’

      That is actually the crux of the issue for mine. Everyone from banks to developers to exist property owners will be against anything which pushes nominal prices lower. Its the reason I think that the AUD (over the longer term) will bear the brunt of any global adjustment of Australian real estate prices, but that is going to leave nominally high real estate prices a major factor domestically for a way into the future.

      • Exactly. This whole debacle is a long-term means of undermining economic growth, productivity, and societal boat-lifting, and the longer it is maintained the more players become hostages to it.

        It is a lot worse than “house prices” make it look, because the land per “home” shrinks over decades. When you disaggregate the cost of structures and the cost of development, the inflation in the raw land cost component is orders of magnitude higher than the inflation in “house prices”.

        The cost of the raw land might be well over 50% of the “value” of the nation’s total “housing” stock against which debt is secured.

        The UK is the classic example. It is not just that the vested interests and hostages to the racket stand to lose on “house price median multiples” falling from 6 plus to around 3 again. Because the raw land cost is inflated hundreds of times, reform to land supply could suddenly make quarter acre sections one fifth the price that one-sixteenth-of-an-acre “sections” have been.

        What do you think will happen to the prices of “homes” on pocket-handkerchief-size sections when suddenly a quarter acre section NEW family home is “affordable”? i.e. median multiple 3. All those pocket-handkerchief properties will not just revert to a median multiple 3 level, they will go way below that.

        The logical thing would be of course to tear half of them down, especially the disgraceful old unrenewed ones that now are the cause of a health crisis, and redevelop at lower densities according to true household demand.

        But the more that shrinkage of section sizes has “ameliorated” the land price increases, the greater the hole that the economy would have to claw out of if raw land prices reverted to what they should be.

        The moral of the story is, like the anti-smoking ads: “don’t start”. I often think my efforts out in this part of the world are becoming more and more of a waste of time, and I should move to the USA and fight to defend the affordable-city status quo that is worth defending, against the growth-containment ideologues.

      • Dale SmithMEMBER

        Yes, the mental shift I mentioned in my earlier post was referring to the mental state of self-interest. But as has been suggested, if prices were held steady then inflation and income increases over time would solve the problem. The issue is how do you engineer that, because the resistant to any change is so strong, do you need to counter that with an equally over the top response just to achieve the balance needed for a smoother transition?

      • NZ fluked exactly the right balance in the 1970’s:

        http://sra.co.nz/pdf/RealHousingChapterOne.pdf

        “…..after the spike in house price inflation in the early 1970s, during which the national average real house price increased 55%.

        From the peak in the national average real house price in the December quarter of 1974, the national average house price increased less than prices in general for the next five years. House prices didn’t fall over this period, but because prices in general increased significantly more, the real value or purchasing power of the average house fell 40%. The fact that inflation in general averaged close to 15% per annum over this period meant that the sins of the bubble in house prices between 1970 and 1974 could be washed
        away over the subsequent five years without requiring actual house prices to fall. This experience will have helped create the myth that house prices never fall much. But be in no doubt about the implication of the 40% fall in real house prices over the five years after December 1974. Anyone buying a house at the peak of the speculative bubble in 1974 and selling it five years later will have lost 40% in terms of the purchasing
        power or real value of the money they invested……”

        Rodney Dickens is a valuable analyst.

        By the way, the bubble from 1970 to 1974 was due to ridiculously generous subsidies of several different kinds, to house buyers. And although housing “supply” was a lot more elastic back then (there were no “urban planning schools” teaching anyone to obstruct growth), nevertheless it got swamped.