SCA Urban Investment Theme #1: Are Smart Cities Smart Investments?

Smart CitiesIn coming weeks, our blog will be looking at Smart Cities Advisors’ 2014 urban investment themes in emerging and developing markets. SCA is all about urban impact investment and social enterprise in developing countries – still an early concept, still developing, but urgent, inevitable and promising. Our 2014 urban investment themes relate to our mission to advance inclusive, sustainable and commercially viable models of affordable housing and urban regeneration in emerging and developing markets.

Our first look is at “smart cities,” which conjures images of gleaming towers, driverless cars, green walls, solar trash compactors, the ultimate live-work-play location and much more. It also calls to mind big corporate players working with cities to implement large scale programs, as with Rio de Janeiro’s partnership with IBM. Critically, though, these projects are still mostly about hardware and software and not yet about residents and communities. Critically for investors, “smart cities” are not yet being designed for inclusion.

How well do these realities square with investing in emerging markets cities? Today’s post focuses on this theme, which will be a regular focus in 2014.

How Smart Are “Smart Cities” In The Developing World? Masdar, Songdo, Tianjin… all large-scale smart city experiments many years in the making and recently making strides towards populating and becoming operational. This interview with Anthony Townshend in The Atlantic Cities about his recently published book Smart Cities highlights the ups and downs, the business drivers and the contradictions behind this urban phenomenon.

Now follow this thread to Africa where this story – “Konza, Hope City threats to urban poor” – about new ecocities being planned to absorb some of Africa’s explosive urban growth  summed up concerns about the feasibility and reality of the impact of these projects. The real estate play in these new developments may be understandable given the appeal of cheap land, massive urban migration, a dearth of urban office and residential supply, difficulty of developing and financing projects in emerging urban centers and lack of governance and planning structures.

Needed: business models, long-term capital and cross-stakeholder partnerships.  Still, history shows these projects aren’t one-way tickets to riches (see Lavasa’s challenges in India and Tatu City’s snarl-up in Kenya as examples). A feasible business and investment model for these ambitious new cities has yet to be birthed in the emerging markets where promoters are so enthusiastic to built them. Why is this?

There is as yet no established tradition of working across stakeholders to build these complex projects. Acquiring land, building infrastructure, fusing local and international know-how, assembling the right financing structures and putting together key partnerships between private, public and community are all more challenging in emerging markets. Globalization means that projects can (and usually must) bring in international capital (like Renaissance Capital in Kenya and Equity International in Mexico), but that capital wants to earn risk-adjusted returns appropriate to frontier markets, i.e. very high. A high-end target audience needs high-end design. Local expertise has blossomed in more developed markets like India and Brazil, but other countries need international design and architecture consultants as well. These are simple examples. From planning to construction to marketing, emerging markets will be importing capital and expertise at high cost, and project execution entails extremely high risk.

These competencies are in early stages of development in emerging markets. A consortium of dedicated, experienced partners with an appetite for long gestation development projects can usually address these issues and often do in progressive projects in North America and Europe.

The business rationale for inclusive and sustainable projects. Smart cities projects in emerging markets also lay bare the imperative to integrate human and environmental issues in the earliest stages of a project. When villages and agricultural land are converted into newly planned communities for upper income residents, the cost of legal challenges are often not figured into the true costs of the project. Certain challenges – a sensitive habitat, water scarcity, local inhabitants – can be at least partially transformed into assets – a nature preserve, ready labor force and local food production. Sustainable design and planning has much to offer here.

A major constraint has been failure to analyze prospects for uptake, especially given the sparse services that these developments offer at the outset (see Angola’s ghost cities). Populating these communities often takes longer than expected. These projects lack good transport options to nearby city centers (because there are no residents), requiring long car or bus trips, nor are these places well-served in early stages by businesses and services, like markets, health care and schools.

People-centered urban business models. “Smart cities” are extremely costly to plan and construct, so the ideal residents – at least in early days – that smart cities developers envisage are well-heeled, formally employed and able to afford some creature comforts. Where and how are the teachers, policemen, housekeepers, waiters and drivers – the people that keep our communities moving forward – going to live? Silence on that one in most of these projects. Yet, to the contrary, the few private ventures that have succeeded in delivering truly affordable, inclusive housing tend to sell projects out quickly, albeit at thinner margins.

In countries where the vast majority of demand is concentrated in lower and lower middle income segments, developments aimed at current or future demand from more affluent residents can find themselves struggling to win over people living closer to jobs, services and social life nearer to city centers. Affordability for a wide range of residents is rarely factored in, nor is accessibility by workers most likely to service these new places. These projects are rarely inclusive or sustainable, let alone economically viable over a time frame that most investors would consider compelling.

Smart from the bottom up. So, how smart are these projects really? The “smart cities” business model is still in development. They require long-term investments, complex negotiations and partnerships and a massive risk appetite. The high costs of implementing poorly have been borne by countless entrepreneurial visionaries and their investors. If smart cities started with people not technology, sustainability before systems, they might be no less complicated over the lifetime of the project but more successful. As an example, housing for working people, both rental and for purchase, combined with financing partnerships might generate shorter-horizon interim returns for investors.

At this early stage of the “smart cities” trajectory, African cities that aspire to develop these urban satellites can learn from experience with master-planned communities and align those models to their own commercial, financial, socioeconomic, demographic and environmental realities.

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