Urbanization is a defining trend of our time. In 1900, 13% of the world’s population lived in a city. By 2030, the urban population will have increased from today’s 3.5 billion to 5 billion, more than 50% of the global population.
A big challenge with urban growth is that it is expensive. In both developed and developing markets, central or state government bodies have financed most of urban infrastructure, which is also centrally planned and maintained, yet municipalities either lack the money or the capability to cover up-front costs of key infrastructure upgrades. Investors, on the other hand, face what Harvard Business School professor John Macomber calls a "bankable projects gap": in other words, urban infrastructure projects tend to offer uncertain revenues; there are disagreements over guarantees; and there are concerns about political risk.
And where a single assets’ standalone cash flows can be understood (e.g. toll road, power plant, apartment building), the investment value of typical multi-sector urban opportunities (mostly urban infrastructure projects resulting from the use of the mayor’s tools such as re-zoning, land re-use, or partnership in utilities or sanitation services) can be harder for financial valuation. How can urban assets yield returns more attractive to a range of private sector investors?
In the below, we collected a few case studies from around the world of current attempts at urban funding innovations. Each involve multiple stakeholders, often including municipalities, capital market participants, development banks, technology companies and venture capital. Each relies on a governance or financial innovation, and importantly offers up a municipal finance solution that aims to be revenue generating.
1. From tax incremental financing (TIF) to next generation municipal bonds for social investments
As municipalities are not commonly revenue-generating units, public financing for urban projects has been raised traditionally from tax revenue. Tax increment financing (TIF) is a public financing method that is used as a subsidy for redevelopment, infrastructure, and other community-improvement projects in many countries, including the United States. Through the use of TIF, municipalities typically divert future property tax revenue increases from a defined area or district toward an economic development project or public improvement project in the community. TIF subsidies are not appropriated directly from a city's budget, but the city incurs loss through foregone tax revenue. If the cost of basic services increases, with TIF in place, the result is a revenue shortfall that has to be paid from sources other than tax revenues of the TIF district to prevent service cuts.
The new financial product, the so-called 'pay for success bonds', or 'social impact bonds', could play a role in adding to the pool to finance urban services. Examples of such bonds include the Massachusetts Roca programme, aimed at avoiding criminal recidivism. The bond is created a risk-bearing financial arrangement between public, private, and non-profit organizations, and the state will repay the investors their principal, with a sliding scale of profit tied to degree of success. (The state is willing to do this because keeping people out of prison saves the state money.) If Roca is unsuccessful, the investors could lose some or all of their money. States (or cities) have issued social impact bonds for social, economic and environmental causes, and in many places underwriters have been large investment banks or in some cases state-level “municipal bond banks” (e.g. in the US and Canada), or national level “specialized lenders for regional and local governments” (e.g. in the Nordic states).
2. Developing world cities issuing on deepening local/international capital markets
In 2015, Dakar, the capital of Senegal, sought to issue municipal bonds on the local exchange, in a move that was set to open up the debt markets for the first time to cities in sub-Saharan Africa. This was to allow Dakar to incur long-term debt, something many other cities in the developing world don’t have. Previous borrowings from commercial banks and other parties gave Dakar experience before trying to float a bond. Dakar sought a confidential credit rating from Moody’s, which offered a management roadmap for what steps the city needed to take to become creditworthy. The improvement of the creditworthiness of the bond was compared to the city itself as a result of financial structuring that applied several credit enhancement measures, including a 50% partial risk guarantee from USAID. This urban finance innovation failed because the local authorities determined that the bond issue had gone before the Municipal Council to get clearance before the urban governance reforms had come into being.
3. Venture capital in urban technologies
Sidewalk Labs is a Google-backed company that manages the largest pool of capital in the world focused on urban innovation. In 2016, they launched free wifi kiosks across public areas in New York City, to access some municipal services and in effort to make the fastest public wifi in the world freely available, with the stated benefit of reducing their spend on data plans. This wifi network project would be delivered at no cost to taxpayers, and was set to generate more than $500 million in revenue to the city during the first 12 years. The idea for the kiosks has been to allow New York City to deliver city services and generate anonymized, aggregate data that can be used to manage the city more effectively. In this innovative urban technology project utilizing old telephone booths, the idea has been for revenues to be generated in large part from advertising.
4. Urban real estate finance
Urban real assets, including real estate, have recently benefited from what are called Pooled Finance Development Fund Schemes (PFDF). These ‘first-loss-like’ schemes, backed by corporate partners, enable Government authorities to provide credit enhancement facilities to Urban Local Bodies (ULBs) based on their credit worthiness. In result, ULBs can access further market borrowings through state-level pooled mechanism; and as such, can have further resources to improve urban infrastructure and ultimately attain the goal of self-sustainability.
Pooled finance projects have attracted larger corporate sponsors to municipal infrastructure projects, the Mexican company CEMEX being a market leader in partaking in a pavement construction model in Mexico where also local citizens can be shareholders of the investment project. Pooled finance investment plans also underpin the Colombian Metrovivenda project, where, in Bogota, the basic strategy is to acquire, through negotiated purchase of privately-owned open space in suburbs, to create large assemblages of improved infrastructure – planned and parcelled – to sell to experienced developers for construction of market rate housing which is affordable to varying levels of low-income families. The sale of parcels makes funds more readily available for investment in subsequent rounds of acquisition and development.
5. Distributed ledger technology (blockchain)-based land registration and payments platform
In Honduras and Ghana, municipal governments have collaborated with US and local software companies to address inefficiencies in land administration to build next generation, more transparent land registration, title, and payment management solutions. These platforms use blockchain technology to track assets, payments and administrative processes to bring accountability and trust into land investments. The citizen portal allows users to manage their properties and interact with the local real estate markets in real time. In many cases the first projects of these platform companies are to first digitise the land cadastre (asset identification), before the platform could become revenue generating.
Have you read?
How can we bridge the $1 trillion infrastructure gap?
How can we boost private investment in infrastructure?
6. Enterprise solutions for urban mass transportation
The public sector has historically been the key financier of urban transportation infrastructure, but new private sector-led models for financing “public” transportation are cropping up around the world.
Mexico City’s The Avenida Chapultepec project is an interesting example of innovating urban transport infrastructure financing. As detailed in the Forum's white paper, A Field Guide to the Future of Mobility, the project gives a 40-year concession to a private trust that will be in charge of developing and operating the Chapultepec Cultural Corridor. In this model, a private investor will provide the necessary resources to build and maintain the project, and will receive income directly from the services offered in the Corridor, including an expected ROI. Mexico City’s Government will also receive a small percentage of the yearly income. Chapultepec Avenue, in the heart of Mexico City, will evolve to become a three-level linear park, incorporating public and private transportation, pedestrian and retail areas.
Whilst no “one-size-fits-all”-solutions to major challenges with urban mass transportation including safety, quality and reduction of congestion exist, but notable latest developments include Uber’s offering of now both individual and group transportation solutions in cities. In San Francisco, Chariot offers a private network of bus rides for commuter routes, and is based on a crowdfunding model. In Mexico City, the public bus company Metrobus includes service operated by vehicles some of which are owned by the private company CISA which operated tech for toll collection. In Kansas City, Bridj offers a microtransit solution with hail-ride van service at low fares for the morning rush hours. And in Singapore, to reduce congestion and mitigate traffic, electronic road pricing has been introduced as a new method. All vehicles have device fixed inside that is then digitally read by a meter along the roadside. Cars are charged different amounts depending on location and time.
The six examples above are just a selection of innovative efforts at financing next generation urban assets, but as the examples demonstrate, both investor appetite and public interest in structuring financing for urban investments including in infrastructure exists, and can be explored further.