Larry Kosmont on Value Capture: Zoning as Currency

Larry, you recently led a webinar focused on the convergence of post-COVID trends that represent a sea-change for local governments pursuing economic development strategies. Elaborate on what you suggest is a new paradigm for cities and counties: that housing is a growth driver rather than a loss leader for city balance sheets and the impact it has on economic development planning.

Two paradigms are actually going on. Housing is a growth driver because the demand on the real estate side is almost unending. For housing in California, I don't need to tell you that we're short 1.5-2.5 million units, depending on who's counting and who's keeping track, in every possible income category, whether it's affordable or workforce or market rate, and there's a lot of reasons for that.

What we have found in a post-COVID digital world is that the value of housing, particularly in California, is growing. Now, 40% of homes in Orange County and 32% in LA County are valued at over $1 million. With that high of a tax value, residential alone becomes an economic driver.

When you couple that with the post-COVID digital trend of people buying their goods online or elsewhere but seeking out services in person—the adjacency of retail and residential has become a premium in the valuation marketplace. This means that multi-use, mixed-use, side-by-side adjacencies, and service-based retail—things that drive trips per square foot, not sales per square foot—have added to the value of rooftops in the economic equation of economic development. That's trend number one.

Trend number two is that the state has doubled or even tripled down on climate action and resiliency, and thanks to Prop 4, both the feds and the state now have buckets of dollars—notwithstanding what the administration might decide to do with some of that money. None of that is going away.

All the alternative energy and infrastructure funded under the Inflation Reduction Act or the Infrastructure Investment & Jobs Act—it's essentially about infrastructure for climate action. In California, we've historically been infrastructure-poor, especially given the size of our economy and population. Now if you take the federal and state funding available for climate action along with the goal of building resilience against weather impacts, flood, and resource management—all of those natural occurrences in California—and you pivot your approach, you can see these climate resiliency and infrastructure funding programs as a source of capital and as an economic development investment driver.

Those are your two primary strategies. It's all about climate action and housing. If you're running a public agency in California that has any interest in promoting the local economy, it's going to be about those two initiatives. Demand and dollars; and specifically housing dollars because of the value and because people are staying home and using their homes as a place to shop, work, and play. The more rooftops you have in a community, the more likely you're able to keep local wallets and local spend in that community—people don't have to leave to buy.

For climate, there's a ton of money out there, and the state and the feds want us to adapt to a new world of energy utilization. The infrastructure required to do that needs to be paid for. Climate action/sustainability and housing… that’s really what economic development is about in California today, from my perspective.

Taking a step back, Larry: TPR has published several interviews with you over the years, and they've all been about the fiscal disincentives surrounding housing development for cities post-Prop 13. So, what has caused you to reconsider your long-held views?

What's changed is that despite all the post-Prop 13 discussions, which caused most city and county managers to view new residential as a net negative—in other words, "If I’ve got to put more density in, that means more services, and there's no accretive value,”— those same city & county managers have come to realize that's just not the way today’s world works.

Today’s consumer wants a place to live, play, and work—all in one community. The equation of evaluating housing as a fiscal benefit has shifted because housing is not just residential. It's the ability to keep that local spending in the community and leverage it to your local governments’ advantage.

Couple that with the rest of retail. Retail alone is no longer driven solely by a big box format. Retail was the king or queen of the parade because we had big boxes pumping out hundreds of dollars a square foot. The last time I looked, more and more of the big and mid-size retail boxes are becoming vacant and being repurposed or demolished.

The latter are being acquired to reconfigure into what? In many cases it’s multifamily housing.

If you look at Wall Street—Wall Street believes that shopping centers can be redeveloped into multifamily districts, and that's the savior of retail in the long run. It doesn’t mean that retail isn’t doing well. It just means that retail is adapting to the size it needs to be and so, there's not been a lot of new development; we’re absorbing and resetting existing space.

What it means is that we've got to find a different use for these retail boxes, whether it's infill industrial, or knocking them down and putting in residential–in many cases that may be the reuse  savior. The economic equation around residential has shifted. More importantly, city leaders and county leaders are starting to understand that they’re in an economy that sees residential as accretive.

Accepting, Larry, that the above is a winning argument for encouraging more infill housing density, it doesn’t explain how the new services that accrete from this housing paradigm shift are going to be funded.

Well, it does, in a way. In California, the dramatic increase in the value of residential per unit at every level—whether single-family or multifamily—the property tax has become sort of the favorite horse to ride on in terms of taxes. What you're seeing is property tax becoming a larger part of the general fund. That doesn’t diminish the importance of sales tax; it just changes and at some level, balances the equation.

We will never see a time when we can replace the big-box sales tax impact that Costco has or even a Target can have. But we’re also never going to see an economy that doesn’t need to ramp up its residential development to recapture as much local sales tax as possible—because at the end of the day, those rooftops matter. It’s where wallets live.

Given that Prop 13 and its progeny effectively limited what cities may raise from land and property tax, elaborate on how new revenue to fund the demand for more services is generated.

It only works because we've managed, in terms of the supply and demand equation, to have such an imbalance in those two, and that the property values have risen.

We're seeing housing that was once $400,000 hit $800,000 or even $1 million. That ramp-up in value, with the consumer level of demand—which hasn’t gone away despite the increase in value—has generated a level of local property tax upside. 

If you talk to most city managers today, they'll tell you that the growth in their general fund sources has been from property tax, not necessarily as much from sales tax unless they have some unique drivers in their community, and that has become the norm. I was a 26-year-old city manager when Prop 13 passed in 1978, and we all shifted to sales tax. I mean, it was like the dance stopped. They turned off the lights, and said, "Go home until you figure out a way to generate sales tax," right? This is what we did for about 35 years and by and large, we deployed redevelopment to install retail.

Then the Internet comes along, and Amazon says, "Yeah, but you don't need a store to generate the sale.” We’re finding a convergence of those two: consumer-based and consumer delivery systems, but the balance has changed.

Despite all of these, in a post-COVID world where people have realized they don’t have to necessarily go to the office every day or be in person to buy a service or good—the value of housing has gone up on the property tax roll. It’s that reset.

There’s no single silver bullet here. These ingredients have converged to underwrite a different solution for economic development that tends to have a bias toward housing as long as it is leveraged properly, meaning rooftops are coupled with services and uses that generate trips and as a result some sales tax.

You are clearly here asserting that cities should embrace greater housing density because their tax rolls grow when property values increase as a result of upzoning. This of course runs counter to what’s been sold by the State of California and YIMBY activists: that producing more housing will increase housing affordability. Casting Henry George land economics aside, how does the supply-side argument that more housing will depress costs actually work if there’s, as you put it, ‘almost unending’ demand for housing?

You know, it’s just too one-sided. Land as a commodity can’t easily achieve increased value unless and until the public sector attaches entitlements to it. Until you say, "The piece of property you own, which was zoned for agriculture, is now zoned at 40 dwelling units per acre," there's limited money or added value in your pocket.

On the other hand, if the cost of construction reaches a point where there's no real land residual value—because you have to put in underground parking, or because the new  building codes have expanded  energy-efficiency material requirements and that some parts and materials can't easily be acquired by developers—then you can have a ramp-up in delivery costs and a potential deduction in land residual value.

Those value-add risks or value deduct conditions can start to drive the density back. That's the interesting thing. In most cases in California, if you ask developers today, "Should I build 50 dwelling units per acre?"—which is, if you listen to the state, what you ought to do because that's where the density is statutorily moving to—or if you ask, "Should I build 20 units per acre in a townhouse configuration with surface parking? "They'll tell you all day long that in today’s economy, the latter pencils and is likely more accretive.

Density isn’t the sort of cocktail mix improver you might think it is. It's just situational. Overall, back to the YIMBY discussion, the value of land tends to be tied to the level of entitlements. However, the level of entitlements may not be deliverable in the marketplace depending on other cost and construction equations.

Speaking of cocktails, if you happened to be in a bar late at night drinking & being candid with the YIMBY-inspired leadership of the California State Senate, share what that off-the-record policy conversation would address?

I would say, look, showing them this graphic on my phone which lists the over 40 communities in California that have or are creating new tax increment (value capture) districts (Enhanced Infrastructure Financing Districts (EIFDs) and Climate Resilience Districts (CRDs) that you, the State, authorized to induce infrastructure and housing. Here’s the problem: You should and need to invest with them, but you haven’t so far; find a way to co-invest locally in those districts so you can accelerate the generation of tax increment from new private investment, and everyone can benefit.

These Districts benefit greatly from early startup funding, which motivates private investment in the lean years as tax increment builds. If you think you can just sit in Sacramento, prescribe density, and let people create a district, that’s just like what Marie Antoinette said, "Let them eat cake." You’re missing the point. If you don’t put your money, especially startup money, in the game, it won’t happen as quickly. 

What I would say to them is, look at what you have started. You’ve enabled and created a pathway for dozens of these specialized districts led by counties and cities, and they’re now talking to each other, in essence partnering, in a way they never have before. Why wouldn’t you invest in San Bernardino? Why wouldn’t you invest in Riverside? Why wouldn’t you invest in rural counties where you're trying to improve climate resilience conditions? By sitting back and watching, you’re just giving them a prescription and not following through on the treatment that’s what I would say.

What's your take on the need for value capture?

Well, I think it's a must-take. This is the second half of the lesson for city managers, the first half being state law and policy driving density and housing entitlements. Residential has to be a driver in the economic development equation. Will it be as good as a Costco? Not ever, but it's better than anything else you have. That’s sort of number one.

The second question is whether you can make density work in your community, and part of making density work—given that you don’t have Redevelopment anymore and have tight budgets—is to see if you can selectively put your density in places where you can trade the value of that density for the value of the opportunity. In other words can you derive value from the policy yoke that’s been placed on you by the state, which is to dole  density out based on the Regional Housing Needs Allocation (RHNA) formula and prescribe that density in an updated    housing element within three years of adopting RHNA. In many cases higher density can mean increased values, but it is often placed on properties where the owners don’t have the skills or resources to redevelop. The question becomes can you confer that density in a manner that can derive some value to the community.

What do I mean by that? If you have old retail corridors, and you give away your density in your housing element as part of your RHNA compliance—you may have given away the store. In many cases you might be able to capture the value of zoning. For example, don’t shift the zoning on an old retail center simply as a response to RHNA. To the extent you can meet RHNA requirements elsewhere, it may be more accretive to subsequently consider a zone change on that retail corridor, but in doing so, charge the developer for the upzoning. In other words, in a RHNA compliance world, where possible (say a deficient regional mall), it may be possible to use zoning as currency. And use the value created by trading the zoning via a development agreement, to generate negotiated developer contributions, and use those “zoning value capture funds” to invest in amenities and infrastructure to enable neighborhood improvements and amenities. It’s not a perfect solution, but on a situational basis it’s worth looking at zoning as a value capture mechanism. That’s the newest trick of the trade; induced by a combination of housing mandates and housing demand.

Expand on how state and local governments have & should approach approving greater density while also assuring more affordable housing. How could value capture play a material role in achieving both goals?

If the state and local governments ever got together to put together a strategy at the front end of this, they would have agreed to collaborate with the state saying, ‘you guys throw your density in places you need it and charge for it, so you can underwrite affordable housing,’ but we never did that. Instead, the State  came along, and said to local cities, ‘You’re going to increase density, or you fail your report card, and we’re going to check in nine years, and we will penalize you if you don’t produce.’

Value capture is about taking these specific opportunities—on a corridor, in an old shopping center, or in an area that wants to recycle into residential that you didn’t give away in your RHNA element or in your housing element modification—and turning around and adopting a policy that says, "I’ll give you the zoning, but you’re going to pay for it; and we are going to use that to reinvest in community amenities and affordable housing that makes your new housing even more valuable, and at some level supports our efforts to comply with state affordable mandates. We call that mechanism value capture zoning.  

 And by the way, if you are going to pursue a specific plan which intends to ramp up density for residential, don’t grant new housing density to specific parcels, potentially enriching owners with little skill or capacity or motivation to redevelop. Instead, pick the preferred area for that new housing density (e.g., the specific plan area) and grant the density to yourself, the city, by putting it in a pre-approved “density bank account”, also known as Development Opportunity Reserve. Then when an application for increased density comes along, you can authorize allocation of a portion of the density in the bank to the project by “trading density” deposited in the DOR in exchange for developer funds which can then be used for community amenities and/or improvements. In other words, zoning can be “currency” and as a such, a value capture mechanism, rather than a giveaway, which absent these mechanisms, is what specific plans have tended to do. We’re starting to evaluate and implement these value capture and density allocation DOR platforms in multiple communities in California.

Do you have any examples?

One good example is the city of Buellton. I like it as an example because it's a smaller middle to affluent suburban type city, like so many in California in that it faces funding hurdles for certain needed and desired community improvements.  The city has a primary commercial corridor, Avenue of Flags,  that needed amenities to boost the overall character, useability and viability of the boulevard, so they enabled residential development by increasing density and instead of giving it away, Buellton adopted a Development Opportunity Reserve, and they now have completed two development agreements where the developer either trades off and pays for the zoning or delivers an amenity that the city wants.

It could be benches, bathrooms, or street improvements, but it's a direct use of the development agreement process in a creative way, recognizing the zoning as a commodity that could be valued and traded to the community’s benefit. It’s a way to take a state mandate and make it work from an economic development perspective, as well as delivering housing.

Any other examples or trends you’d like to bring to our readers attention?

The newest kid in town, called Climate Resilience Districts (CRDs), are tax increment districts that enable a community to lay down a baseline of property tax value and then collect any increment in taxes, just like old Redevelopment, and put it to infrastructure. That infrastructure is primarily physical infrastructure that supports resilience and adaptation as related to climate and mobility conditions.

In the case of climate resiliency, it can be resource management, climate adaptation, weatherization, and a whole bunch of things that both rural and urban communities must deal with. I like CRDs particularly for rural counties and suburban cities because the climate money is available to them through the feds, and now through Prop 4. These rural counties and suburban cities have heavy infrastructure requirements, and CRDs can help generate funding for improvements by inducing private investment in return for using a portion of the new property value (CRDs do not impose a new tax –they capture the added value). Plus, CRDs can not only fund capital expenditures, but can also fund operations and maintenance, including the hiring of staff. This feature, in my view, makes CRDs the most autonomous of all the newly approved TIF districts in California.

Essentially, this enables a community to select areas where they believe growth will occur and match them with areas that need investment, which could be coterminous, and create these special districts—public financing authorities—under something called an Infrastructure Financing Plan, which doesn't require a vote like Prop 218, only has a protest vote, and allows for the use of the tax increment. It can also increase the eligibility of those areas for state funding. And the District does not impose a new tax.

Certain state funding sources recognize that if an Enhanced Infrastructure Financing District (EIFD) or CRD has been created by a city and/or county then a  higher level of eligibility for those funds may be available from state funding sources  such as  Affordable Housing & Sustainable Communities (AHSC), Infill Infrastructure Grants.  (IIG). Finally, unlike redevelopment, EIFDs have yielded eight “public-public partnerships,” wherein cities and counties have joined forces to jointly create the infrastructure  district and pursue grants and private investment.

For context Larry, at the age of 26, you began your professional career as City Manager of Bell Gardens, California. How did you get through the four decades of change that followed and both be productive and keep your mind clear?

Luckily, everything tends to change all the time. Constituencies change, the economy changes, and land values change. But what's happened in those 40 years is that local government has become both the key to local delivery of services and quality of life, but also, in a way, a lesser player because a lot of their control to command their future has been diluted by other events, whether it's the state stepping in on housing or industrial warehouse policy or the internet’s influence on local economy.

One thing hasn't changed – people want a good quality of life, safety for their families, and quality education. So, the very goal of local government hasn't changed, but the way to achieve local prosperity is always changing. As a city manager, the economy can shift on you; local politics will shift on you; tax structures shift and financing mechanisms come and go.

We had 50 years of Redevelopment, and when I grew up in this local government world at 26, we were halfway through the Redevelopment cycle. Now that’s long gone. It’s already been 13 years since the unraveling of Redevelopment, right? It was 2012, and so those are some major changes. The tools and circumstances are still changing, and nothing quite stays the same. Bottom line I find that to be effective as a local leader, you have to stay on the cutting edge of where the economy and constituent preferences are going, and where the legislation is trying to drive priorities to see how to best put it all in an implementation blender to see what you can make work on a local level.

With the 18th annual VerdeXchange Conference– which for the last two years has focused on how to deploy public infrastructure dollars from the Inflation Reduction Act (IRA), and Bipartisan Infrastructure Law (Infrastructure Investment & Jobs Act), etc—scheduled for the Spring 2025, April 6-9—elaborate more on how this new infrastructure funding ought to be invested to leverage local resources? 

When I look at the categories of the IRA and IIJA funding, it covers clean energy, roads, bridges, major projects, the power grid, passenger and freight rail, broadband, public transit, water infrastructure, airports, manufacturing, resiliency, ports, waterways, electric vehicles, and buses. This is a huge opportunity. What I’m thinking is that if you take these massive trends, like housing demand and changes in the way the economy buys and sells goods, and couple that with the categories of infrastructure that are being funded—$1.6 trillion over the next five years—that’s the core of your economic development plan.

You need to figure out how to get your community to take advantage of these funding opportunities and benefit from these programs. The money is coming from third-party sources like the state and federal government, as well as the newest voter-approved Prop 4 and other funding sources. It’s a significant amount, and last time I checked, how else does local government create money? Charging for zoning or creating the value-capture of private investment through these relatively new state authorized  special tax increment districts is an  entrepreneurial— and necessary—way to go.

Of course, developers have to pay a price, but in many cases, depending on the project, you can’t expect that they will get the financing necessary to build and generate significant levels of tax increment without underwriting their investment by  reinvesting a portion  of the economic value created by rezoning granted and tax increment their project generates. So value capture and reinvestment of TIF revenue is the best available economic development toolkit to achieve  local prosperity.

To close, both VerdeXchange and ULI have focused more and more on the management of localities’ curb space—sidewalks, curbs, and streets. Have you and Kosmont, in its advisory roles, been asked to address how cities and counties should best manage the street/curb relationship?

You know, it’s interesting because it’s one of the issues in every special district we’re looking at. How do you manage existing infrastructure—streets, curbs—and the uses adjacent to those? As a subset of that, in some cases, we’ve been able to use streets and curbs as collateral for lease revenue financing to make improvements in an area.

Our approach is, because Kosmont has three companies, one of which  registered with the SEC, we’ve tried to figure out how to take the financing value of owned public assets (land, buildings) and leverage it, not only for better use of the space, but also for improved  financial leverage, so that we can reinvest in that space or in public private real estate transaction. The post pandemic digital economy has created a new paradigm, with more shifts coming via AI. So today, economic development is about public sector entrepreneurialism, hence value capture and TIF, climate action, sustainability and housing. At Kosmont, that’s how we look at it.

 Thank you and we look forward to having you at Verdexchange 2025.