When is it okay to annex property?

With major cities like Memphis making headlines for their plans to de-annex city property – a.k.a. deliberately shrinking their city's footprint, and in this case, a smart move by some smart people – I was surprised to learn that Shreveport, Louisiana, is still playing the annexation game. Yes, this is the same Shreveport looking to do a retrograde 1960’s highway project through the middle of a majority-minority neighborhood. Yes, the same Shreveport that has over a billion dollars in outstanding “critical” infrastructure needs, an amount more than three times what they spent cumulatively on infrastructure over the past decade, with no notion of how to pay for it all.

What are they doing annexing more property?

Annexation – the act of bringing property outside of the city limits into the municipal boundaries – is rarely more than an economic sugar high for a city, one with long-term consequences that are nearly always negative. As my hometown of Brainerd, Minnesota has lost residents in our core downtown neighborhoods, we've managed to keep population levels steady since the 1940’s by growing the boundaries of the city many times over, annexing more land out on the periphery (which, by the way, is the most expensive to service) and scooping up some nominal tax dollars from the new residents. After the small initial windfall, there's really no other way of looking at it: it’s a bad trade.

For cities that are currently considering annexing property, the strategic goal (unless you are operating your city as a charity organization) must be to improve the prosperity of existing residents. If we agree on that, then there are three things to consider before acting.

Priorities for Spare Capacity

A common (incorrect) argument that city staff often put forth when they recommend annexations goes something like this: we already have a fire department, a police department, a library and parks….why not have more taxpayers sharing those costs? That’s good for everyone, after all.

There is some logic to this, but it’s overly simplistic in a dangerous way. The capacity of most municipal systems grows in plateaus. A fire department can serve a given area with the equipment they have on hand, but there is a limit to what they can do. At some point, all this land growth forces city services to increase their capacity up to another plateau (e.g. buy another truck and retain six more fire fighters).

Once that investment is made and the next plateau is reached, the city has capacity to spare. And cities – awash in sunk costs and now desperate for cash, since the bill is now coming due on the infrastructure for all that peripheral land– will then, inevitably, use that spare capacity to justify more growth. Travel across the country and you’ll see, practically everywhere, business parks with wide, thick streets and expensive sewer, water and storm systems full of storage sheds. Storage sheds! They don’t employ anyone, provide any significant tax base or make use of any of the massive public utility investment, so why are they there?

Simple: they pay the development fees. And an occupied lot is better than an empty one, at least in the eyes of public officials.

It's even simpler to illustrate in terms of a water tower. A tower has a certain amount of storage capacity. It can provide service to a finite mix of commercial and residential property. Go over that finite amount and you’ll need to build another complete water tower. You can’t build a quarter of a tower or half a tower; it’s all or nothing.

The capacity you have left in your water tower is your spare capacity. Here are the questions you should be asking yourself before you build another one: 

• How much space capacity does your water tower have?
• What is the projected timetable and cost for the next jump in capacity?
• Is this land annexation how you want to allocate that remaining capacity?
• Does this land annexation justify speeding up the timetable on your next jump in capacity?

That’s for your water tower. Now go through all the systems your city is managing—sewage treatment, water treatment, drainage, roadway congestion, police, fire fighting, elections, parks, libraries, etc…—and ask yourself the same questions. 

But of course, most cities don't do this. They just see that they have a little spare capacity, and they fire up the construction crews. 

Here’s the bottom line: If you don’t know your spare capacity—and from what I’ve seen from Shreveport, and most other American cities, there is little chance anyone does—then you have no right annexing any property.

All you are doing is giving away community wealth your existing taxpayers have created, and you’re doing it in the least strategic way possible. Figure out your spare capacity and then create priorities for how to utilize it. Only then you are ready for a mature conversation on annexation.

Return on Investment

When it comes to annexations, public officials often give a justification like this: The developer/property owners are going to pay all the costs before we annex, and so there is no cost to the city for us to grow. Therefore any tax revenue represents a positive gain for the city.

This is like buying a new car and claiming there is no cost for doing so because you’re only considering the time prior to making the first payment. I know that sounds ridiculous. It is.

First, stop and consider the obvious: Most American cities have huge backlogs in maintenance—and again, Shreveport's backlog is over a billion dollars—even before they annex a single square foot of additional land. And you don’t get a billion dollar backlog in maintenance because the way you are going about doing things is working so well. Something is really wrong; what is it? Why is the city you’ve built not generating enough wealth to maintain essential infrastructure—so much so that you're looking outside your city's boundaries to solve the problem?

Maintaining roads and streets is really expensive. So is providing police and fire protection. So are all the ongoing services a city provides. Will this new development generate enough revenue to pay its share of services, and then some?

And note that the “and then some” is really important to this discussion. Because, unless you are running your city as a charity, why are you pursuing investments that we think will only to break even at best? And more importantly, why are you obligating existing residents and business owners to provide services and membership into the city for that break-even-at-best development? That’s not a risk we need to take or one that even makes sense, unless it really makes us better off in some meaningful way.

One quick way to ballpark it and see if annexation is even worth exploring in detail is to look at our street maintenance costs. What is the cost to build the street out of town, and how long will it be until that street needs to be reconditioned? Let’s say it’s a half million dollars with an expected life of 25 years.

                $500,000 / 25 years = $20,000 / year

Now, ask yourself: what percentage of the tax revenue generated by the new development adjacent to this new street will need to go into annual street maintenance? Not the public works staff budget and not the interest on debt, but what it actually costs to go out and maintain the street, year after year. Let’s say it’s 5%.

Now you should be asking yourself: how much revenue do you need those new developments to generate to justify building this new street? 

                $20,000 / 0.05 = $400,000 per year.

If the property to be annexed isn’t bringing in $400,000 per year in year one—and the costs of maintenance tend to grow more than inflation—then it’s kind of silly to seriously dig into the much more expensive utility systems or public safety costs.

If it is close, then do the math and figure it out. My suggestion is that you should only annex if the guaranteed, non-speculative return on investment is 25% over cost. That not only gives you a buffer for future uncertainty but it meets that “and then some” requirement to justify the risk to current members of your incorporated municipality.

One last note here: Costs for providing services generally increase as you go outward from the core. While we’ve documented this trend in places like Lafayette, it’s also just intuitive. That land is further away from police and fire protection. It requires more pipes and pumps, roads and intersections, to reach and provide service to. When your city takes on an annexed property, you're adding expense despite the revenue remaining the same; a house on the edge served by a dozen sewage pumps will generally pay the same monthly bill as the house near the core that was built on high ground and requires no pumping, even though there is a huge disparity in cost.

Long Term Stability

Annexation proponents often point to the shiny and new development to be brought into the city and make an argument that it is somehow de-facto superior to the older and more dilapidated development within the city. The grass is always greener.

We at Strong Towns have shown over and over that the shiny and new doesn’t outperform the old and blighted, that poor neighborhoods are generally more financially productive and outperform newer ones. But there remains a powerful selective perception problem. Here’s how we overcome it.

Examine the neighborhoods in your community that were built around 1988. How are they performing? Are they maintaining a 9:1 improvement to land value ratio? Since they are less than a generation old, are they exceeding the median home value in your community?

If you are not able to answer all these questions positively, then you have some serious problems that annexation is not going to help you overcome. Why are your neighborhoods not keeping up? Why aren’t they continuing to flourish?

For most cities, the answer is that they weren’t designed to. Everything was built all at once to a finished state—not incrementally over time on a continuum of improvement—and so, three decades later, every house on the block goes into distress at the same time. They all need their roof replaced at the same time. Their siding needs new paint, the sidewalk needs fixing and the appliances all need to be replaced at the same time.

The entire neighborhood, in a predictable echo of the initial construction, needs critical and expensive maintenance all at the same time.

And since the neighborhood layout and design—let alone the local zoning ordinances or any neighborhood association—doesn’t anticipate any change in the neighborhood, there is no natural way for the neighborhood to renew itself. No investor is going to buy a declining single family home in a declining neighborhood of single family homes if the only thing they can do with it is make it into...another single family home.

At the exact time that the city’s long-term maintenance costs start to come due, the neighborhood finds itself in financial decline.

Is the area you are planning to annex going to be any different?

Why will this generation’s version of a new development perform any better than last generation’s? What has fundamentally changed that gives you confidence that this time won’t be like the last?

If you’re prepared to allocate your space capacity to a new addition to your city, and if you’re confident that it will provide a positive return on investment and then some, then take the extra step to make sure the new addition to your city is going to be financially stable for the coming generations.

Make sure the layout and design, as well as your regulatory approach, will give this neighborhood the flexibility to adapt to changing needs and market conditions so it can remain a productive place for generations to come.

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It’s hard to imagine a scenario where Shreveport could do an annexation that benefits the city, its residents and its businesses over the long term. That’s not saying it’s impossible, just unlikely.

A city of that size does not build up a billion-dollar backlog of critical maintenance by developing in a way that is flexible, adaptable and financially productive. There is a lot of work to be done before any annexation should even be considered.

And in that sense, the city of Memphis does provide a great example. Memphis used annexation for years to cover annual budget gaps, booking the revenue in the current year and the expenses in subsequent years. It was a horribly destructive practice for everyone involved.

Today, the leadership of Memphis is coming to grips with the impossible math problem they’ve created. Not only are they making incremental investments in core neighborhoods, they are shrinking the boundaries of the city—de-annexing property—to make Memphis stronger and more prosperous.

Shreveport, you can make this change too and put yourself on the path to becoming a strong town.

Top photo from Wikipedia.

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