Developer Exactions and Impact Fees

Development impact fees are required contributions by the private sector to cover the cost of additional public infrastructure and services. Typically, governments levy these fees as a one-time, up-front charge, and receipt of payment is a precondition for public approval to develop land. Developer exactions could assume any of the following forms:

  • Dedication of land for public use, for example, a requirement that a project reserve a certain percentage of land in a new development for public space
  • Construction of public improvements, for example, a requirement that a developer construct a public road to connect the proposed development with the existing public road network
  • Funding, perhaps in the form of a negotiated amount and tied to a broader policy goal such as a contribution toward the cost of a new public day care or recreation center
  • Utility connection fees

The concept behind these fees is that development growth brings an increased need for public infrastructure and services, such as sewage capacity, fire protection, and public safety. The fees help protect the existing (tax-paying) local community from having to shoulder the additional cost of added public services by asking the developer and incoming users of new spaces to share such costs. Impact fees and developer exactions are of the same nature. Developer exactions oblige the developer to either build infrastructure or pay for infrastructure elements provided by public authorities. Impact fees cover the external infrastructure costs associated with new development when it brings increased demand for expansion in infrastructure capacity (such as for roads, water supply, public spaces, and so on).

A benefit of impact fees is that they reduce the economic burden on local jurisdictions that may not have sufficient capital funds to keep up with the infrastructure requirements of growth. One of the appealing characteristics of assessing an impact fee is that developers or end users pay the cost of system-wide infrastructure expansion needed to accommodate growth from the urban regeneration project. Another benefit is that up-front impact fees, that is, fees collected prior to or at the time development begins, enable the city to access capital earlier than if a city had to wait for incremental service charges, property tax revenue, or other tax revenue that might be generated by the new development. Further, these fees generally generate a net positive—or in the worst case, neutral—fiscal impact.

It should be noted, however, that the successful use of impact fees requires that a municipality possess a robust analytical framework for how to estimate the infrastructure cost implications of proposed development. Impact fees are most easily estimated for greenfield projects; for urban infill projects, however, estimating the incremental cost of a new development can prove challenging. Among the disadvantages of this financing tool, therefore, is that it can be technically cumbersome to estimate appropriate costs. Indeed, it requires a high level of technical savvy by a municipal team in order to set and negotiate an appropriate amount with the developer. A further drawback is that government discretion regarding assessment amounts can open the door to controversy and perceptions of corruption.

How are impact fees used? The usefulness of these fees as a significant source of financing large-scale transformative urban regeneration efforts depends on the market and regulatory context. In order for a city to tap impact fees as a meaningful source of financing for urban regeneration, a viable private sector developer must be interested in constructing a new or higher density development program. However, many urban regeneration initiatives are located in blighted areas where disinvestment has occurred and private investors have been loath to invest. Whereas an exaction may work as a capital-raising mechanism in an area in which market demand is sufficiently strong to entice a developer to invest, this tool will not be useful as a fundraising instrument for projects whose location or other characteristics (perhaps environmental contamination) make them financially infeasible or unattractive within public intervention.

With the exception of some robust real estate markets (for example, Hong Kong SAR, China), imposing an extra levy can at times have the effect of discouraging, rather than incentivizing, private sector investment. Such fees also do not necessarily take into account—or, better said, may not provide enough funds to achieve—broader policy goals that a municipality might want to effectuate, such as construction of a new park with superior public space design, or the introduction of additional units of low- and mixed-income housing.

Examples do exist of municipalities that have successfully negotiated payment of impact fees that cover more than the incremental infrastructure and property-related city services. The city of San Francisco, for example, has collected impact fees from downtown commercial developments to help pay for public transit improvements, affordable housing, and child care. However, San Francisco (like Hong Kong SAR, China and Manhattan) boasts one of the most robust and expensive real estate markets in the world. Furthermore, new development projects that would increase density or introduce higher-value land uses in central areas (for instance, conversions of former industrial property into residential units) can easily “afford” exactions. However, this tool is subject to the volatility of land markets in that the amount of exaction a project investor can afford to pay varies according to land value.