SMa.r.t. Column: Santa Monica’s Precarious Business Plan

As the City’s budget season gets underway, it is helpful to step back from the minutiae of an annual process and reflect on the emerging financial trends from City management decisions that will impact the residents for decades to come.  

Picking up the financial pieces from the receding Covid-19 crisis, the City is simultaneously making incremental unresearched decisions that will have long lasting, significant, and likely unintended consequences on services, city amenities, cost of living, and quality of life and housing affordability across all the neighborhoods. 

Until the 1990s, the City generally reflected the effects of organic development over the post war decades. City services and amenities were sized to a predictably growing population, supported by a stable commercial base that simultaneously generated city revenue, served the broad needs of the residents and provided significant local employment opportunities at all levels.

  1. Pivot to Tourist Destination 1990s

Starting in the late 1980s, the organic growth approach was replaced by a targeted industrial policy, no doubt driven by the desire to expand the city revenue base. A pivot to a high-end tourist destination business model was chosen. Since 1988, the city has doubled its hotel room capacity (currently around at 4,400), almost all being high-end. There appears to be another 5% (220 net) premium hotel room expansion plan in the current development pipeline. Transit occupancy taxes (TOT) generated $48.6 million in FY20, almost 7% of total City revenues and 19% of General Fund revenues. In FY19 (pre-Covid), TOT generated almost $60.8 million or 22% of General Fund revenues. 

Cost of Tourist Pivot

Unlike other business segments, tourism is reliant on high volumes of visitors in addition to employees. The cost to residents has been primarily in reductions to quality of life in the city from visitor densification and the implicit inflation of an increasingly upscale retail sector. This has also added strain on headcount-intensive services such as safety and sanitation. For example, sworn Police personnel per thousand residents has stayed constant at around 2.4 since 2001. Sworn Fire personnel has remained constant at roughly 1.2 per thousand residents. During this period, the number of hotel rooms has surged by an estimated 25%. Any additional hospitality sector expansion would occur amidst possible sworn police personnel staffing reductions. 

  1. Pivot to Housing 2020s

The upcoming budget is the first to reflect the new pivot to what could ultimately be a 20% (or more) city resident expansion in line with the proposed (and highly contestable) 8,895 state RHNA units, of which 6,168 are to be affordable. The high-level impacts include: 

  • Increasing city services (e.g., safety, sanitation and public works headcounts) and related pension liability increases commensurate with a population increase of approximately 20% 
  • Accelerated upgrades of the entire city infrastructure commensurate with densification of areas not engineered for proposed density increases 
    • The City has a 205‐mile water main system that has been on a 100-year replacement schedule by replacing two miles of water main per year at a current cost of $2.4 million per mile.
  • Expansion of affordable housing site acquisition assistance to affordable housing developers
  • Expansion of housing assistance programs 
  • Reduction of local revenue-generating diversity with the likely further concentration (and revenue risk) on the tourist strategy, which in turn increases demands on services.

Cost of Housing Pivot

The 03-30-2021 City Council discussion of the Housing Element was conducted without any information on the incremental direct costs related to infrastructure or services despite knowing of the proposed scale of the adopted RHNA housing expansion for over 15 months.  

The March 30 discission was also devoid of any revenue risk assessment related to this housing-preferenced strategy pivot. Specifically, there were no opportunity cost assessments related to the repurposing of commercial and parking spaces to residential. Staff noted that the preliminary plans call for conversion to residential of 1.5 million square feet of commercial space. This represents 3x the entire square footage of Santa Monica Place. In addition, Parking Structure 3 is under consideration for conversion to housing.

While the changing economic landscape is challenging traditional uses of commercial (and especially retail) space, there has been no discussion of incentives or initiatives to revitalize Santa Monica’s stricken commercial sectors. Broadly defined commercial-related taxes (i.e., Sales & Use, Business License, Parking) are the largest General Fund revenue component, generating $109.6 million in FY20 and represent almost 42% of General Fund revenues.

  1. Current City Structural Cost Starting Point

The City’s structural finance embarkation points for these housing and tourist-centric pivots include high staffing costs, towering pre-existing pension liabilities, unrealistic climate funding initiatives and increased exposure to volatility:

  • Staffing Costs: The City’s administrative staffing is generally much higher than comparable cities. While there have been reductions in some areas, the scale can be illustrated using the latest comparable data as of 06-30-2020:
    • SM city attorney’s office headcount is 2.7x Santa Barbara’s. 
    • SM’s population is 17% smaller than the City of Ventura but our planning staff headcount is 2.5x.
    • Administrative staff total 47% of total SM Police department headcount compared to 39% in SB and 26% in Culver City 
  • Pension Liabilities: The headcount-driven unfunded pension and retirement health care liability of $0.5 billion has increased from 46% of total city revenues in FY2011 to 75% in FY2020, despite a 20% increase in total city revenues during the period.
    • The approximate pension and health care liability per average household in the City during the period FY2011 to FY2020 has increased from $5,600 to $10,500 (+88%)
    • Downside liability estimates should CalPERS investment rates decline would approach $0.8 billion, which is the liability value the Fitch municipal bond rating agency uses.
  • Unrealistic Climate Funding Initiatives: A resolution to implement a ten-year $800 million Climate Action and Adaptation plan for city carbon neutrality by 2050 (or sooner) was adopted in the 05-28-2019 Council Meeting. The unfunded portion was estimated to reach up to $450 million, with anticipated funding from new grants, rates, public-private financing and/or tax measures.  Debt is also being used.
    • The green city administrative building cost twice the normal amount and required financing with additional interest costs. 
  • Increased Exposure to Volatility: The increasing infrastructure and services cost burdens will be more exposed to funding volatility (e.g., Covid-19) from concentration in hospitality and retail sectors: 
    • Combined Sales & Use and TOT taxes declined by $21.2 million (15.8%) in FY20 on a total General Fund decline of $18.9 million.
    • FY2021 Budget deferred Annual Water Main replacement program 30% to 50% until Water and Wastewater Funds recovers from COVID-19 impacts with catch up in (undefined) future years
  1. Residents’ Role in City Funding

Facing potentially compromised revenue growth prospects from sales and TOT taxes, along with increased costs from conversion of revenue-generating commercial parcels to cost-generating residential usage, the City’s revenue strategy is also migrating to a more resident-centric tax model.  

The upzoning accompanying various densification proposals, regardless of actual unit production outcomes, will increase land values. This will automatically increase property and transfer taxes on sale, further reducing overall future affordability. In FY20, property and transfer taxes totaled almost $75 million, or over 11% of total City revenues. Of this total, $67.8M (90.2%) was property tax. These combined taxes are the second largest source of General Fund revenues with a 29% share. Since FY2011 and under Prop 13, the property tax component experienced relative stable growth at a compound annual rate of over 7%. 

Pursuing administrative and housing-centric tax initiatives seems to be a strategic priority. In the 02-23-2021 City Council meeting, Staff was instructed to explore a vaguely defined “land value tax” concept that could raise revenues from increased upzoning valuations, potentially before properties are sold. While such a new tax may require voter approval, resident involvement in a significant part of this process has already been excluded. Upzoning is an administrative action and does not require voter approval. The related property tax receipt increases follow as a County administrative function. 

It is not difficult to imagine the scenario that these trends strongly suggest. The (perhaps) unintended consequences of City policies are very likely to exacerbate the very problem these policies are ostensibly designed to ameliorate: 

  • Housing and living costs will increase from upzoning, further bifurcating the city’s socio-economic demographics. 
  • Equity across the city will become ever harder to achieve, creating reinforcing cycles for increased City program expansion. 
  • The magnitude of accumulating city post-employment liabilities and infrastructure costs will increase and likely require resident tax increases as well as service and amenity reductions to mitigate cost increases, further denigrating residents’ quality of life. 
  • Ultimate resident debt payment responsibility is assumed in Fitch’s 03-23-2021 Santa Monica bond rating assessment when it notes that unfunded pension liabilities and other long term debt total approximately 15% of the City’s personal income base
  • Continued expansion of the hospitality sector will increase congestion and drive shops further upscale, further eroding resident quality of life, increasing underlying city inflation and driving more shopping out-of-town.
  1. Conclusions

The real issue is how such consequential pivots in City strategy, the latest being the housing pivot that has been contemplated for over 15 months, are now transitioning into execution mode in the complete absence of rigorous, thorough analysis, data and debate.  

While commitments are being made to address, for example, climate change, for which almost no city-specific data exists, impacts to the city’s future business model are being completely ignored despite the abundance of city-specific data and modelling capability.

These are fundamental pivots that, if enacted without a clear consideration of, and agreement on, future impacts, will ensure that Santa Monica’s economic future and quality of life will be permanently transformed in a way the current residents would not recognize today.  There will be no going back. And today’s residents may not want to go forward. 

Maybe that is, after all, the objective. 

By Marc L. Verville for SMa.r.t. (Santa Monica Architects for a Responsible Tomorrow)

Thane Roberts, Architect, Robert H. Taylor AIA; Ron Goldman FAIA, Architect; Dan Jansenson, Architect, Building and Fire-Life Safety Commission; Samuel Tolkin Architect; Mario Fonda-Bonardi, AIA, Planning Commissioner; Marc L. Verville M.B.A., CPA (inactive); Michael Jolly, AIRCRE