Council borrowing and the cycle of doom for a new suburb

The cycle of doom for a new suburb

Most greenfield development success stories come from release areas with concentrated ownership or development patterns. For example, Oran Park (GDC), Edmondson Park & Fairwater (Frasers), The Ponds (Landcom), Gledswood Hills (Sekisui) are all regarded as good examples of master planning and all of them were largely developed by one developer. 

Whereas greenfield areas with well publicised challenges commonly have fragmented land ownerships. Marsden Park, Austral and Leppington are examples that come to mind.

Enabling infrastructure, like roads and stormwater drainage systems, is needed to incentivise developers in greenfield areas with fragmented land ownership. In concentrated ownership release areas, works in kind that offset state and local contribution charges allow enabling infrastructure to be delivered earlier, and at a lesser cost, compared to fragmented areas where Council is the primary provider of new roads and drainage basins.

It may not come as a surprise then that Councils in NSW do not have a good record of providing enabling infrastructure in release areas with fragmented ownership.

But, why?

For starters, Councils have to acquire more land than they need because of lot division patterns and they have to pay more than they have budgeted because of the Just Terms Act. But I believe there is a more significant factor at play - which is saying something because the two reasons I mentioned are pretty significant.

A keen Council can develop a land acquisition strategy that targets parcels of land that are easier and less expensive to acquire. But you know what they cannot plan for? Not having any money.
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This is the point where I introduce you to (what I call) the cycle of doom for a new suburb.

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The cycle of doom of a new suburb

This ominously named diagram is designed to show the chicken & egg cycle that leads to pervasive infrastructure delivery issues in fragmented new release areas. 
 
Enabling infrastructure is required to make it easier for developers of all scales to develop their landholdings. In most cases, developer contributions are a Council’s only source for funding this enabling infrastructure. But when no development has occurred…no development contributions have been collected. 

At this point, a Council will need to borrow money to fund this enabling infrastructure.

Councils are not doing that. 

In our 2022 survey of Councils, 73% of the responders said they had not borrowed to fund enabling infrastructure.

But, why?

Let's get the easy explanations out of the way first. Many Councils are not aware of best practice in encouraging development, or simply do not have the risk appetite to follow through with best practice. Borrowing and spending millions can be daunting and the famously risk averse Council system does not take to it with enthusiasm. 
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However, I do not believe those are the main explanations and they are certainly not the subject of this article. 

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​The issues around Council Borrowing

The final report from Productivity Commission’s 2020 review of infrastructure contributions in NSW – the report that is now sitting collecting dust – made a fleeting mention of the issues around Council borrowing:

"Borrowing would have a negative effect on councils’ debt service ratios because revenue from infrastructure contributions is not counted as income when lenders determine a council’s borrowing capacity. Borrowing for infrastructure in contributions plans can therefore disproportionally reduce capacity to borrow for other projects."

The debt service cover ratio referenced above is calculated as follows:

The debt service cover ratio measures the availability of operating cash to service debt including interest, principal and lease payments. It must be greater than 2 for Tcorp to allow Councils to borrow from them.

The problem with the above calculation is as stated in the quote from the Productivity Commission’s report – development contributions income is not included in a Council’s operating result, but the cost of servicing a debt taken to provide enabling infrastructure in a contributions plan is included in the debt service cover ratio.

Presumably, development contributions income is not considered because the forecast income may not actually be collected if the planned development does not occur. Although I would like someone to point out a greenfield release area to me that saw less development than was forecast.   

While the debt service cover calculation may not always lead to a loan for enabling infrastructure being rejected, it will almost always jeopardise any other borrowings Council has planned. This is a significant deterrent for most Councils.

I know of two major Sydney Councils in the north west and south west growth regions that could not borrow specifically due to the debt service cover ratio considerations. These two instances alone would have led to a considerable amount of greenfield housing being sped up.

My anecdotal experience in discussing this matter with folk from Councils and the development industry tells me there is widespread agreement for allowing development contributions income to be included in the debt service cover ratio, specifically for infrastructure related borrowings.  

While it is true that the forecast income from a contributions plan may not eventuate, the delayed delivery of enabling infrastructure will have a strong role in ensuring it actually does not eventuate.
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With all of this in mind, it seems like an absolute no brainer that the debt service cover ratio calculations are changed by TCorp to include development contributions income. It is a simple change that could directly result in earlier delivery of a lot of greenfield housing.  

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Impact on the housing market​

A lot of of the measures that would make a meaningful impact in improving housing supply are complicated and difficult to implement. Not this one. This is a no brainer.
Now, I am not going to try and tell you fixing issues with Council borrowing will solve the housing crisis. I will not even try to tell you that increasing housing supply will solve the housing crisis.

Sydney is a world class metropolitan and it will always be more expensive than third world cities like Brisbane (I jest).

However, that is not to say that there is absolutely nothing to be done to improve the housing situation. Even as NSW Government's priorities change to 'building up, not out', well planned and delivered greenfield housing remains an important part of the housing sector.

If you too are fascinated by challenges related to infrastructure funding, please reach out for a chat because not enough people want to talk to me about it.
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Suyash Pareek
Director,
NXS Planning
[email protected]