March 7, 2014 - From the March, 2014 issue

Economic Development in a Post-Redevelopment World

Larry Kosmont, CRE, is President and CEO of Kosmont Companies—a real estate, finance, and economic development advisory firm specializing in public-private partnerships. He has advised numerous municipalities, as well as serving in local government himself in the Southern California region. TPR talked with Kosmont about tools for creating economic development in California without redevelopment agencies, focusing on the potential impacts of publically owned properties and special districts in accomplishing redevelopment goals, as well as the challenges to such approaches.


Larry Kosmont

“There are 427 cities and successor agencies out there that have anywhere from one to two properties to over a hundred properties that could be put into a productive real estate transaction under the right circumstances, either on a discounted sale basis or on a co-venture basis.” -Larry Kosmont

Larry, why don’t you give an introduction on economic development in California in a post-redevelopment world? What are the public-private transactions, public investment tools, and infrastructure procurements that give the communities in the state a sense that we can stimulate the economy and its growth?

Larry Kosmont: In California, the most compelling tool for economic development, which was redevelopment tax increments, is no longer available. This has required cities and other public agencies to look at financing economic development transactions with an assemblage of different tools—tools that relate to planning and zoning, the adoption of special districts, the potential to use special financing authorities and dedicate specific taxes to a project, as well as the opportunity to use publicly owned properties in part or entirely as a contribution to a public-private or infrastructure transaction. In summary, we have 4 groups of tools to use as follows: public agency “owned” property, site specific tax revenues (SSTR) that can be leveraged in a variety of ways, special districts (for financing and services), and finally, land use/zoning policy to enhance and direct private investment.

How much do they satisfy the pent-up demand for tools to stimulate local economies?

I like to say that when we had tax increment and redevelopment, we had a power tool, and now that we don’t, we’re down to hand tools. It’s not like we can’t figure out how to do it. It just takes longer, it’s riskier, more complicated, and overall not quite as specifically effective. That’s how I’d draw the comparison. These tools we have to use today, despite being “hand tools,” enable a city, if creative and skilled, to accomplish economic development—both in terms of public infrastructure with the assistance to private sector investment, also known as direct public-private deals. 

You can do them. It’s just harder and risker, I believe.

Before we get to the new tools that are being proposed or should be proposed, summarize in order of importance and value the hand tools that are now available.

Right now, the most important tool in my mind is the publicly owned properties. Normally, I wouldn’t conclude that, but we have a unique circumstance in California wherein over 400 former redevelopment agencies have been terminated and are mandated to liquidate all property assets through a city-by-city sales program that will by and large get started in 2014. The former redevelopment agency assets that are left are the property assets. 

Because the state-imposed RDA dissolution plan has been going forward now for almost two years, we are at the point now where the cash has been distributed, the housing assets have been moved to housing successor agencies or housing authorities, and the debits and credits (who owes what to whom)—in the form of a final “true up” payment—have pretty much been resolved for a majority of these 427 dissolving agencies. 

What’s left to do based on the law of RDA dissolution, called AB 1484, is the Property Management Plan, which is the governing document that, once approved by the Department of Finance, allows these agencies to sell property. The requirement, other than some exceptions, is to sell. 

There are 427 cities and successor agencies out there that have anywhere from one to two properties to over a hundred properties that could be put into a productive real estate transaction under the right circumstances, either on a discounted sale basis or on a co-venture basis. Kosmont projects over 2,000 properties being available for sale and reuse at some level, and as a result of this unique state-imposed property liquidation program, serves now as a primary tool for economic development.

Let’s stop there for a second, Larry. Give us some examples of how those properties are being used to stimulate economic growth, or how they should be.

Many of these properties have been purchased over the years. The argument about them that’s probably proliferated on a Monday or Tuesday night with people screaming at the city council meeting have long come and gone. These are properties that were bought Downtown next to transit stations and near freeways. Others were put into the portfolio because they had remediation issues. These properties found their way into a public portfolio, and they were generally bought with the purpose of an exit strategy, which usually had to do with the revitalization of Downtown, or a freeway adjacent site, or a gateway site within in a community. 

Now, when the music stopped, it was very likely that there wasn’t a transaction in place due in great part to the intense real estate recession during the five years that preceded redevelopment dissolution. Fast forward, these properties must now be liquidated and are uniquely positioned to be put back into the economy, many of which are well-located in suburban and urban communities.

What’s being done with them, or what should be done with them?

They need to be re-zoned, for the most part, and they need to be redeveloped. In some cases, they still need to be cleaned up. The recent Gatto Act appears to transfer many of the Polanco Act remediation protection powers that were once accrued by a redevelopment agency and are now accrued by a city. Accordingly, some of these properties that do have remediation and have to be cleaned up next will now have the benefit of Polanco-type powers in the Gatto Act. It’s not exactly parallel to Polanco, and no one has used it yet, but that’s the intent. 

You asked the question, “What needs to be done?” They need to be repositioned. They’re required to be sold. Likely, they need to be rezoned. But, they are in a position both physically and policy-wise to be placed into the local economy so they can be redeveloped in a manner that will generate taxes and jobs. I would say to my redevelopment agency (now successor agency clients), “As bitter a pill as it has been to dissolve redevelopment, the properties that you now have to put on the market are a backdoor to economic development. Make sure that you select the opportunities and buyers, and accomplish the zoning in a way that results in the greatest residual benefit to the community.” That means using the other tools you have to enhance the development prospects for these properties.

Larry, given the Gatto Act, what incentives are in place in the absence of redevelopment for jurisdictions to press forward with this sale of these properties to generate economic development—as opposed to just seeking immediate revenue from a sale? 

Very good question. Now, we move to the other available economic development tools. What is available without tax increments is a combination of things. In many cases, this includes establishing a special district—such as a tourism district, a parking authority, or a property business improvement district. These districts all have slightly different ways of managing resources, assets, or properties as well as the ability to introduce funding sources to a project or area. For example, In the case of a tourism district, it’s possible to have a property-based election, raise more TOT (Transient Occupancy Tax), and then adopt a policy to reimburse future TOT back to specific deals. 

In Los Angeles, you’re seeing a similar approach being recommended by the CLA, which would pursue increasing and expanding hotel projects in Downtown or in other primary areas of the city by reimbursing TOT. 

Another way is to take future tax revenues (like sales tax, property tax or TOT) generated from a site-specific deal and use that increment on a reimbursement basis to a transaction that needs some kind of public assistance, and that’s being done. We call that SSTR—site-specific tax revenue. 

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You can place site-specific tax revenues into a project through a mix of different structures. At Kosmont, we have applied a lease-backed structure, a reimbursement agreement structure, or a development agreement structure on various client projects in different cities throughout California. Because we don’t have as clear a process as redevelopment provided, we have to beg, borrow, and steal from other frameworks in public law to be able to use site-specific revenue to get a reimbursement back to a public-private transaction. The combination of a district and SSTR, with a lease back or without, gives us the facility to re-invest in projects serving infrastructure, or projects directly, depending on the structure that’s used. That’s what’s going on right now in the place of tax increment financing that was available before redevelopment agencies were tossed into the trash pile.

Larry, narrate me into the backroom of the city manager and the council, with you as their consultant. Are incentives in place to use these land assets to generate economic development and jobs as opposed to just housing or retail? Are the financial and political incentives presently in place to generate economic development?

There are incentives, but they are obstructed in a couple of very key ways. The answer is that the tools are there, the policy frameworks are there, but it’s like having a tool kit and the one wrench we need is the one we don’t have. I’ll give you an example. You’re in the back room, David. You’re the mayor and I’m the advisor. I’d have to tell you, “David, I can’t tell you that someone wouldn’t challenge the use of this money, because economic development alone as a policy in California is not considered a public benefit. It’s not a public purpose. Unless you can find a way to loop a public purpose into a public-private transaction, you are exposed to a challenge from someone who says, ‘No, no, no—this is an abuse or a misspending of taxpayer dollars.’ There’s no valid policy basis in law to make that work, and so you’re subject to a challenge.” I’m trying to bring up the point that you can do it, the tools are there, but it’s just clumsier now. You have to go through a number of steps, make a number of findings, and complete a number of reports that hopefully will on a go-forward basis withstand a challenge, should there be a challenge, on a particular transaction.

Are you saying that laws and policies need to change? A review of California’s economy in the first quarter of 2014 will find: 1) unemployment’s the fifth-highest in the US with 1.6 million out of work; 2) state unemployment is very uneven from Marin to Imperial; 3) close to 25 percent of Californians live below the poverty line; 4) enterprise zones have terminated; 5) California remains a high-cost place and unfriendly to business, etc. Are these facts why you assert it is time for the state to act to replace redevelopment?” 

What needs to be understood is: As local economies go, the state goes, in my view. If they truly as legislative leaders would like a long-term healthy budget, it would make sense to enable local jurisdictions to invest in infrastructure and in public-private transactions that create both jobs and taxes. That way, the state doesn’t have the burden of having to induce jobs and new taxes, and even better, if local agencies are successful in generating jobs and taxes, the state would not likely have to ask its constituents to pay higher taxes to balance the state budget . In other words, no more Prop 30 type requests to increase sales and income taxes. 

If I were speaking to the leaders, I’d say, “You, the leadership of the state, are the greatest beneficiary of every job that’s created locally. You’re the agency that gets 100 percent of the income tax, and you get the majority share of every dollar of sales tax. Local cities get only one percent, while you get around five. Your ability and your willingness to redirect local taxes hinged on some policy framework that you’re comfortable with but that efficiently induces local production of jobs and taxes, will do two things: It will allow you to reduce stress on the state budget, because you make money when local cities make money; and, frankly, it will put California to work, avoiding a reason to go back in two or three years when Prop 30 revenues expire and say, ‘That wasn’t quite enough. Empty your pockets again, because we need some more.’” 

I don’t know that there’s an ear for that message, but to me it’s a very direct correlation. It’s very understandable. Why there isn’t more momentum to resolve things productively when it comes to economic development tools and tax increment policy is beyond my comprehension, because it’s pretty straightforward. 

Speaking about a deficiency of tools, you’ve spoken often about the loss of tools since 1977—Prop 13, Prop 62, Prop 218, the recession, and the doing away with redevelopment agencies. What’s the aggregate impact of the loss of these tools on getting to that agenda?

The impact has been rather prolific. With those losses and the inability of local government to raise their fees without going to a vote, local leaders have basically thrown up their hands and concluded, “Now that we’ve lost our primary economic development tool in the form of tax increment, all we really can do is raise our prices/taxes locally. And if we are going to raise taxes, unfortunately it is probably best to do it in a way that impacts business more than constituents, so we can avoid voter wrath.” Obviously, no mayor or councilmember will say this out loud, but, if you look at the last couple of elections, there have been almost 500 local elections with two thirds approving increases in local taxes. The majority of those increased taxes are utility taxes, business license taxes, and hotel taxes. 

You can see a pattern. They’re hitting businesses, they’re hitting tourists, they’re hitting commercial activity, and they’re leaving the local residents intact as much as they can. All of this makes California increasingly uncompetitive. The state goes to the voters and essentially asks, “Let’s raise sales tax and raise income tax on rich people.” The local leaders go to the ballot and essentially ask to raise taxes on businesses. 

That just drives California to continue being the most expensive and business unfriendly state in the union. As you know, I’ve been an author of the Kosmont/Rose Institute Cost of Doing Business Survey. The 2013 Tax Survey just came out, and guess what? California remains the king of the hill when it comes to charging business.

You raised an interesting point. In a few years, Prop 30 expires. What’s the thinking at the state level on the creation of tools that will allow us to generate the jobs and the tax revenues to replace Prop 30, keeping California on the track to growth and job creation?

So far, I’ve seen a false sense of direction coming from Sacramento. I see movement, but I don’t see it being as effective as it needs to be to turn the tide for California’s competitiveness with other states that are plucking many of our businesses and jobs. I don’t see any movement in Sacramento to use tax increment financing (TIF) without a local vote and without public agencies being able to either opt in or opt out of the tax increment area. I don’t see the elimination of those policies, which means there’s no real appetite for a competitive TIF piece of legislation. I’m seeing a little bit of progress in the amount of the percentage that you need for the vote. The governor has a proposal to take the local vote now required to create an Infrastructure Financing District (IFD) down to 55 percent from 66 percent. That’s some improvement, but not that meaningful because the other constraints are still there. 

I do see a movement toward expanding business tax credits. There was a big hullaballoo last year about eliminating enterprise zones and replacing it with three or four tax credits. But, when you look at those tax credits, they don’t do nearly what tax increment can do. It’s money reimbursed after the fact, so they don’t do much for start-ups or small and medium sized businesses who need help on the front end of a transaction due to high land and building costs, as well as paying for California’s expensive regulatory requirements.

That philosophy of tax credits versus tax direct project contributions or subsidies is prevalent right now. I think you’re going to see SB 1199 debated and possibly passed, which would introduce new state tax-based market tax credits in California. It appears to me that the policy is: No TIF, let’s focus on tax credits and we’ll go down the road on that basis. 

I foresee California remaining under this philosophy for at least the next term of this governor—we will remain one of three states without tax increment financing, we will remain one of the most expensive states to do business with, and as result California will stay uncompetitive in many cases for a lot of businesses.

If you were writing a speech on economic development in a gubernatorial campaign coming up, forgetting about whether it carries votes or not, what would you want in that speech?

We’re at a point in California where private investment is being directed to very narrow bands of opportunity—technology, information, and medical. But, there’s a much broader economy out there. If we want to make sure that California gets its fair share of components in our large national economy, then we need to revisit the economic development strategies we have. We need to enter into an immediate dialog with those sectors of the economy that are sneaking out the backdoor of California—taking their businesses elsewhere because they are not an information company or a digital technology company—and see what we can do to reinstate the policies that would forestall that, perhaps making us eminently competitive for all of those industries that we agree are ones we ought to keep and not lose to otherwise inferior choices. 

The ones that we’re going to let go, we’re going to let go. We made a decision in California to say goodbye to furniture manufacturing for a lot of environmental reasons. That was appropriate. But it’s not appropriate to let go of a good number of businesses that, by and large, were born in California, have grown here, and then are forced to spend their adult life in another state, because we have no way to nurture them. We need to figure out how to keep those businesses here, how to keep those jobs here, and how to keep those CEOs enticed to remaining and reinvesting in what they started here. After all, what is our future going to look like if we don’t get this right?

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© 2014 The Planning Report | David Abel, Publisher, ABL, Inc.