Larry Kosmont’s Land Use & Development Playbook For Value-Capture & Creating Currency For Local Community Development

Larry, what are you currently advising your city and county clients about how to successfully restructure their local economies in a digital “post-covid” world?

Larry Kosmont: The conversation we are having with our city councils, mayors, city managers, and community development directors is that the notion of private investment has changed because the attitude and perspective about what and how consumers want to buy and where and when and how they want to receive goods, has shifted. In a consumer-based economy, cities and counties have to take their lead from private sector investment because these local agencies are trying to capture and convert private sector investment to a tax and job base that produces an acceptable quality of life for their communities. To an extent, a city’s future economic prosperity is about value capture.

The private sector and the consumer are looking at value much differently today. That's why pure retail is no longer a real long-term solution in this marketplace because the consumer has already accepted a redefined notion of a store and demonstrated their preference for expedited delivery of goods. Cities and counties will need to restructure their zoning priorities to achieve prosperity based on these new consumer trends while preserving, expanding, and promoting quality of life locally. In my view cities must use both zoning and certain recently approved economic development tools like EIFD districts to capture value and create currency for local communities.

Elaborate on how that need to restructure zoning is impacting both current principles of economic development and private investment in housing.

Housing is not a loss leader anymore. As a city manager in my 20’s, we all solved for retail sales tax because Prop 13 changed the availability of local government revenues. In essence Prop 13 took the capacity from cities to unilaterally increase in property tax to solve budget deficits. Without property tax increase as an “at will” budget balancing tool, city managers were forced to go after sales tax.  For the forty plus years since Prop 13 economic developers and city managers have been chasing shopping centers and auto malls to make up for the loss of property tax revenue.

No surprise, retail exploded (so did traffic), and now comes a post covid digital world that is in the process of downsizing (or right sizing) retail.  In this new post COVID digital world consumer behavior is changing the way the economy moves along. We can no longer rely on big box retail and auto malls, and we definitely should no longer conclude that residential is not as important to the local economy as retail, particularly when people are living and working and playing in and around their household, commuting less and spending more locally.

Beyond the consumer driven residential upsurge, we have the State of California standing behind its housing policy bully pulpit; essentially forcing cities to stuff housing in every nook and cranny using the mandated Housing Element updates (due this year)  as the “stuffing apparatus”. In a nutshell, private investment, consumer preferences, and state policy are driving cities to induce residential. The behavior pattern of consumers living, working, and playing at home means that housing is no longer a loss leader. And retail is no longer the economic development point guard.  It’s a new world order.

Address the changing nature of retail in city economic development.

Retail is not just retail anymore. It seemed that just about every city in the 80’s and 90’s wanted Nordstrom; in the 90’s they wanted Costco. The mantra for many of us in the economic development business was “bring in a big box, and you'll bring prosperity”. It's not that way anymore. In a post-covid digital world Its more like, give me a big box and get ready for a vacancy or at least a massive remodel.

Retail today is no longer a standalone anchor; it needs to be coupled with other uses. At Kosmont we call it “blended use”. There's still viable retail that is primarily service, necessity, food or entertainment oriented.  Today if you rely on just retail to drive economic activity and tax revenue, you're likely going to have a half-full house unless you surround retail with a blend of uses, that includes more than just residential. Some of the blend will likely include delivery based industrial, medical uses, education, creative office with integrated outdoor space and on a more limited basis, hotels, and other specialized entertainment, eating and event-based trip generators. At Kosmont we say that it’s not only the sales per square foot that matters; it’s also the trips per square foot. For example, we have worked on blended use projects where the anchor tenant was a curated coffee shop because of the dedicated consistent trips it generates.

 And as for the hard good retailers that are surviving, to thrive they must be integrated with an internet storefront as well and must have a way to get goods to their customers so they can compete with Amazon and other large deliverers. So, while the store is not dead, it’s probably smaller, more of a showroom and must be coupled with a delivery service, which could be readapted anchor space in a shopping center (yes, there is a growing need for onsite distribution service for the retailers left in the center). It’s a new world order.

Elaborate on your third principle for Economic Development: industrial distribution

Industrial is critical to your local economy. This is not your father's industrial. These consumers are expecting to be able to buy most of their stuff online and get it quickly, or they want to go to a store to see it and then get it home quickly. Industrial has evolved into distribution, delivery, cold storage, even lab space and urban kitchen space. These are the elements of industrial that are now key for local zoning programs.

Retail can't just stand alone; industrial is a critical driver for local economies. When you look at today’s valuation charts, residential and industrial generally have the highest land residual value or lowest cap rate values. More frequently we are seeing developers who are willing to take the risk of buying a retail-zoned piece of property and converting it either into industrial or residential, or they're willing to buy an office-zoned piece of property and move it to industrial.

For local government, how do you capture that value and manage those uses in a way that not only delivers economic vitality, but keeps your community safe and achieves acceptable the traffic patterns?

Not easy issues to deal with. Cities will need to seriously consider shifting their views on allowable zoning permissions from the standpoint of permitted uses to hours of operation, flexible delivery, reduced parking, integrated outside space without parking requirements, as well as seek to enable a mix of formerly unacceptable uses in certain places, such as a distribution center in the middle of retail center coupled with medical uses with  mid to high density residential sprinkle throughout.

If cities ignore these trends without adjusting economic development priorities and land use zoning policies, then they will likely miss the upside of these investment trends and lose out on having their cities become destination centers as redefined. Welcome to a new world order.  

Do California’s local jurisdictions presently have the financing tools to capture economic value in a sustainable and equitable way?

The irony of what the state has done is what I call the housing bullet. Housing is the state’s legislative   priority, and state is pushing cities because cities have been slower to respond to housing demand and have approved fewer entitlements that would enable housing production at levels that the state desires and has declared as an urgent priority. It’s not rocket science; we are clearly short on housing unit units in all categories. It also simple to understand that in most locations, multifamily residential yields the highest residual land value and/or lowest cap rate yields.

By imposing onto cities, a mandated Housing Element plus required subsequent zoning updates in pursuit of RHNA; these policies essentially force cities to jam residential on every available lot. The State has essentially legislated away local leverage on a zoning basis to capture the higher value of residential zoning. But for these mandates’ cities could trade residential zoning for much needed local infrastructure and public amenities. Ironically much of the need for local infrastructure and new amenities is driven by the State’s unwavering push toward higher residential density in local communities. So, where we are now, is that due to the RHNA mandates, the ship has pretty much sailed on the ability for cities, on its currently residential zoned properties, to trade out more dense residential zoning for community benefit projects.  

Our current view is to respond to RHNA more strategically by, limiting Housing Element RHNA compliance mandates for increased density to existing residential zones.   And when possible, cities should not include commercial zones in this density jamming process. By leaving out retail and commercial zoned properties, cities could subsequently up zone those for blended use including medium to high density residential in exchange for developer paid and installed infrastructure improvements and public amenities. To us at Kosmont, residential zoning placed on a commercial site in today’s high residual value and/or low cap rate value world, is akin to printing money for a community.  

Certain cities that have not yet in their Housing Element dealt out residential zoning on their commercial corridors and ageing regional centers can still value capture by enabling higher density residential on commercial so long as the density is out of a reserve account and doled out in exchange for pre-approved community amenities and infrastructure. We call this Development Opportunity Reserve.  This is a way for cities and counties to value capture through zoning.

Larry, please share municipal examples of where value capture is happening.  

The notion of value capture, we call it Density Opportunity Reserve (DOR), is where you float up the density on commercial acreage and pre-approve this new density which is then placed in a density reserve account to be traded for the installation of pre-approved amenities, infrastructure, and other community enhancements. We are working with multiple suburban and urban communities up and down the state on installing this value capture mechanism.  For example, we are currently working with Buellton who adopted a DOR for their Avenue of the Flags area, as well as did El Monte for their downtown plan.

The way it works is straightforward.  Avoid adopting Specific Plans (SP) that confer newly approved residential density on specific parcels within an area of the city which merely increases the value to an owner that may be not motivated or skilled to redevelop the site. This newfound density typically delivered by a well-intentioned SP  also enables those owners to hike the price to a developer, thus making it economically challenging to accomplish a fundamental purpose of the Specific Plan which is to induce revitalization.

Instead, of the City giving residential value away, it can create the value and take control of it by placing the total new amount of desired residential density (say 1 square feet which is roughly 1350 new units) into a city-controlled density “bucket” or Density Opportunity Reserve (DOR),  which creates an immediate trading commodity for improvements a community needs or wants. In essence, DOR manufactures residential zoning and converts it to development currency. This is a more strategic and controlled approach which captures the value of increased residential density in the form of installed infrastructure and amenities paid by the developers who negotiate to take density from the pre – approved DOR bucket and build it. Other than the adoption of the DOR overlay mechanism, all of this can be accomplished by using a Development Agreement

Further, as part of DOR installation process, we work with our community at the front-end to identify what they would trade that new density for; whether it’s streetlights or a park and open space or traffic/circulation improvements or other. Whatever that list of pre-approved amenities or infrastructure is, it now becomes the bartering chip for the community with the developer who wants to buy a piece of property in an area that's now zoned commercial and has been designated for additional “approved but unassigned” residential density via adoption of the DOR.

The actual assignation by the City of that newly approved but unassigned density is where the trade for value of the density comes into play. The State and community get housing accelerating the achievement of RHNA, and the community gets fair value for the higher residential zoning it approved by acquiring improvements from the developer that seeks to take the density out of the reserve account and put it to use. And it avoids a frequent SP result whereby passive existing property owners use the new density directly assigned to their property via the SP, to raise the sale price on their property; these passive owners are no longer unjustly enriched.

DOR is simply a value capture mechanism that in this world of higher residential values can create currency for community to use as way to improve their community while accelerating its capacity to achieve RHNA benchmarks.

You’ve personally invested years trying to evolve and encourage local jurisdictions to adopt new financing mechanisms like Enhanced Infrastructure Financing Districts (EIFDs). What have been the adoption challenges?  

It's been a long haul since January 2015 when SB 628 was adopted; but EIFDs are really starting to accelerate. We have almost 40 EIFDs in formation with 5 now approved, 2 of which include counties as a tax increment partner with the initiating City.  And several counties including LA County and Madera County have initiated and approved their own County led EIFDs.

EIFDs are state authorized special districts that permit cities and counties to create multiple non-adjacent areas within a community and designate them as tax increment districts (TIF Districts). The EIFD is established for 45 years during which any new property taxes generated by private investment can be captured by the Districts governing body (Public Financing Authority) and reinvested into that area to further induce more private investment. Advantages of an EIFD include no encumbrance of existing city/county resources, can attract tax increment contributions from other taxing entities, increased priority for grant funding, ability to demonstrate commitment to multiple infrastructure (and/or affordable housing) projects to catalyze private sector development, capacity to fund maintenance, with no additional taxes to property owners / residents / businesses, and no voter election required.

While not complicated in concept, creation of an EIFD has some nuances to it. You must think like a public agency entrepreneur when you create an EIFD. The EIFD is not a redevelopment plan. It's a business plan for infrastructure, the purpose of which is enhance a community and to induce private investment. In a business plan, you typically seek equity partners. With EIFDs, cities seek other public agencies as tax increment partners. For example, an initiating city can ask the County to participate in exchange for projects to be completed by the EIFD that the county would desire. If both a City and County agree to throw in a share of their respective local property tax, then they both approve an Infrastructure Financing Plan (IFP) that serves as the EIFD’s funding plan for delivery of capital improvements. The reason that EIFDs can be effective for local communities is because creation of the EIFD sends a message to the private sector that their investment will create tax increment that is captured by the EIFD and reinvested into the area that the private sector is investing in.

The pitch to gain county participation is basically that “but for” throwing in some of the county property tax rate, there will be much slower growth in property tax as compared to the accelerated property tax revenues that can materialize because the private sector sees the advantage of public agency partners (city and county) investing in an EIFD area that is set up to enable co-investment with the private sector.  

Some cities now appear to be rushing to comply with RHNA and similar state mandates by incorporating into their housing elements all the housing mandated. When you then confront cities with a complex financing tool like an EIFD that requires entrepreneurial mindset, what’s the common response?

We consistently experience initial mind sets and questions such as, do these [EIFDs] really work? That has become and will get easier to get past now that we have multiple EIFDs up and running and many more that will be up and running in 2022.  

Another is, won't the county throw us out when we ask for their collaboration? We have enough examples now where local county city partnerships have blossomed though the EIFD process.  

Also, there is a misplaced negative conclusion that cities or counties are giving up their own general fund money to put it into a public financing authority that manages the EIFD and that impacts their general fund. We routinely counter that by financially demonstrating as part of a fiscal impact analysis (which is mandated by the EIFD statute), that the area will do much better over time once a district is formed. To buttress that conclusion by framing a ‘but for’ test when considering the EIFD as in: “but for redirecting the increment and motivating and receiving more private investment, you won't have a substantial amount of the new tax increment money to redirect”.

Finally, it’s important to recognize that these tools are somewhat layered in that there's no one tool that fits all. Instead, you need to put them together based on a value capture strategy. I don't know how city and county leaders can reconfigure local economies in a post-COVID digital world without figuring out how to value capture and create currency for themselves. That is precisely what tools like EIFDs, and Development Opportunity Reserve are all about.

Are your local clients interested in the State’s Surplus Land Act process?

Like anything else in public policy, I think the Surplus Land Act started out as one of those platforms wherein the state became increasing impatient with local government’s resistance to making housing a consistent priority. With the SLA requirement the State imposed a procedural mandate that prior to sale or lease of public owned property, any public agency that owns the land must first declare it as surplus and then invite proposals from affordable housing developers. The public agency owner must solicit proposals for 60 days by offering it a list of developers that have registered with the Housing and Community Development Department (can find the list on the HCD website), and if they receive a proposal, the public agency must negotiate in good faith for 90 days and at the end can accept or reject the proposed acquisition. Ultimately, even if all affordable housing proposals are rejected, there is a residual covenant placed on the property that if 10 or more housing units are put on that site, 15% must be affordable. 

It's a process that can become more of a distraction than a solution for affordable housing projects, because many these public agencies owned sites that are so burdened by development constraints such contamination or lack of service from infrastructure or encumbrances such as a civic center or other public facility uses that require public parking. As such many of these sites will likely never be viable for an affordable housing developer. On the other hand, because the state mandated the SLA process of disposal, it has caused many local communities to evaluate their assets and to determine what they need or should put on the market. While it’s not the most elegant solution to making property available, the SLA probably enables transactions to come to market on properties that may have otherwise just have sat there. 

Bottom line, the SLA process is workable if cities, counties, and other public agencies understand how to manage the process. But that means that public agencies first must know what they want to do on those properties. As we speak, our real estate brokerage team is working on dozens of public properties that will or have hit the market. All are required to comply with the Surplus Land Act prior to any sale or lease activity for the property. It’s a new world order.

Many in media and state government frame today’s housing policy challenges as follows: the cities have been slow and resistant to change and the state needs to step in and change the goalposts. Fair? What’s the downside of framing the challenge thusly?

To me the downside is that the whole approach to induced housing production is a bit off the mark. The governor has stated that the state legislature and he signed over 20 housing statutes in the last couple of years, maybe more. Some of them are about housing accountability to preserve the access of housing to all income and all ethnic groups, which is necessary. Some of them are about cramming density down local jurisdictions’ planning process. There are a host of statutes that relate to required density bonus programs which are geared to put a lot of units into play. By taking local control away through density bonus and CEQA streamlining, more and more developers will realize that currently there is an open invitation for developers to achieve density that would not likely be available through local approval processes.

Overall, the state is becoming very focused on the enforcement side, from RHNA to the Surplus Land Act to timely housing elements and imposed time frames on actual rezoning with financial penalties if these items are not accomplished.

I think the state has paid significantly less attention to programs on the financing and funding side that can help cities put up more housing. EIFDs are a good start. It would be more productive for the State to authorize funding to kickstart local tax increment districts. If a county and a city were willing to put together an EIFD that included housing and/or job development, why can't the state kick in some early money so that the EIFD has earlier resources to enable the tax increment levels to rise more quickly, and thus enabling t more housing production and infrastructure improvement sooner?

I would urge the state to take a serious look at their capacity to help the creation and the matriculation of these local infrastructure financing districts by using some state resources as a carrot to get them off and running in the early days when tax increment is just starting to build.  This is about setting the stage locally so private investment can have the security that localities will continue to invest in the district alongside with the private sector. The state needs public/ private cooperation to get housing done and that could be more productive than mandates and enforcement.

Lastly, looking forward, what might local economic development in California involve five to ten years from now?

A couple of observations. I think the private sector wants and will continue to ramp up on industrial distribution. I The private sector also wants to ramp up housing at any level. Cities should be trying to figure out how they can use both the federal money they are getting today in the form of covid relief resources, as well as some of the new financing tools to support sustainable growth in their communities.

The world of consumers that drive our economy are shifting how they want to live, how they want to entertain themselves, where they want to eat, and how much they want to go out. There's an incredible opportunity for communities in California to reformat themselves into what I call 15-minute communities, where people are willing to stay in their local community, travel less, and spend more money locally, if they are provided the amenities and quality of life that they can get more readily in an urban center.

The irony is that cities are presently convinced that housing is depletive to their budgets. Yet in a post covid digital world, wherein constituents are living and working and playing in their local community, residential can no longer be characterized as a loss leader, instead it’s an accretive component of an overall economic development strategy. One can argue that the retail that is left cannot survive without residential rooftops nearby.  The key is to capture local spend because in today’s reordered universe spend wants to be local.

The potential for California to fill in the gaps between large communities by enhancing and expanding the quality and capacity of local suburban communities is a terrific notion, not only for the quality of life, but for production of housing.  HCD may view utilization of its “housing enforcement units” as a necessity, but in my view, the better approach would be to engender and motivate local cooperation. One way is to invest state money locally and provide funding for EIFDs in their early formation years.  And the State should take the time to figure out how to enable cities to capture higher residual land value and motivate more density in underutilized and/or underperforming retail corridors and centers, rather than approving statutes that mandate zoning and automate density bonus laws. 

More state and local funding cooperation could be a start to an improved world order.