June 30, 1995 - From the June, 1995 issue

The Dilemma of Redevelopment: CRA’s Strapped for Funds in 90’s

The CRA has less money to give to developers during a time when they need more of it. Allan Kotin, from Sedway, Kotin, Mouchly Group, details the ironic dilemma that CRA is in as compared to the past decades.

For more than 20 years, redevelopment agencies in the state of California have been a primary source of major seed capital and financing for new housing and the redevelopment of aging downtown and deteriorating neighborhoods. The late 1970s and 1980s saw an unprecedented explosion of new office buildings and shopping centers throughout much of California. More recently, redevelopment agency financing has played a crucial role in affordable housing as other funding sources have dried up.

The last four years have, however, marked a significant change. The position of redevelopment agencies as a consistently liquid “target” as a source of funds in city governments, otherwise plagued with deficits, has combined with several other factors to weaken and almost destroy the ability of many agencies to continue to fund redevelopment, except for affordable housing.

At a time when the true role of redevelopment has been expanded to include badly needed economic development through much of California, and particularly Southern California, it is ironic that many redevelopment agencies now find themselves strapped. Many transactions now suffer from a situation in which a sum of money which is probably barely enough to provide the badly needed assistance for new development, is often too much for the redevelopment agency to fund. This compounds a problem in which developers actually need more money than they did in the past, because they don't have the assurance of strong markets and rising property values to "bail them out." It is this ironic contradiction—that developers need more precisely when agencies have less to give—that California finds itself in today. 

The major factor in the net contraction of tax increment for California redevelopment agencies as a whole is the reallocation of redevelopment funds to state schools and cities to help balance their budgets. Although it is perhaps most obvious in Los Angeles, most cities in financial trouble are now looking to the redevelopment agencies to fund the infrastructure services and sometimes the operating services within the redevelopment project areas. These are funds formerly provided by the cities' general funds.

Historically, the tax increment collected by virtually every California redevelopment agency rose over time for three reasons: new development; rising values for existing development reflected in sales and exchanges; and the automatic 25% increase to reflect the minimum level of inflation. For much of California, all three of these sources have disappeared and, except for limited amounts of low-value, high-volume retailing and affordable housing, there has been very little development in California for the past five years. 

In addition, the premise of rising values has given way to an almost automatic assumption of falling values. Those properties that have traded in the last few years have usually done so at values significantly less than their initial construction values. Many of the properties that have traded were built in the 1980s boom and financed on extended construction loans or standing loans, and did not have more traditional long-term financing.

The proliferation of five-year "bullet" loans during much of the 80s and the early 90s has created a situation in which lack of replacement financing is triggering sales at a loss realized either by the original owners or the lenders who take over the properties in foreclosure. The long pattern of liquidation selling by the Resolution Trust Corporation after the savings & loan debacle has, however, not fully ended. While the RTC portfolios arc largely disposed of, lenders are facing a steady succession of office properties—as well as some retail and residential properties—returning to them by virtue of high initial costs, overleverage and declining rents. 

To take just one example of the type of transaction that historically would have bad little trouble but is now almost infeasible, consider a major new retailing project proposed in Riverside in the Casa Blanca project area. This project area reflects the classical elements of blight and deterioration and it genuinely needs new development. In this situation, the developers and Home Depot, as a major tenant were in a position to accept deferred and performance-based assistance. This is to say they did not need front money, but rather needed a commitment to retire a certain amount of stipulated "excess costs" or fees over a period of operation as a function of the amount of property tax increment and sales tax that they generated. The local redevelopment agency was in a situation with a declining tax increment and a large amount of debt secured by that increment. The situation was such that there were virtually no funds, other than the 80% of the increment generated by the project itself, to sustain such benefit.

Three years ago, the largest, most ambitious, and arguably most exciting redevelopment project in Los Angeles since California Plaza, was also undermined by a general absence of adequate funds. The project in question was the Promenade, to be built by Melvin Simon Associates in Hollywood at the intersection of Hollywood and Highland Boulevards. The development would have been an ambitious mixed-use project incorporating a museum, an extensive entertainment complex, specialty retailing, hotels, and eventually office space. 

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As the market declined, it became obvious that the amount of assistance would increase dramatically from approximately $18 million to well over $40 million. At the same time, the resources available to the redevelopment agency were substantially reduced. 

As a matter of policy in the city and as a matter of recent changes to the redevelopment law (AB 1290), sales tax in Los Angeles bas never and cannot now be used as a supporting element for redevelopment projects. 

Even so, it appeared that the only way to make the Promenade work without impoverishing the redevelopment agency was to tap other city revenues (e.g. property taxes and parking meter revenues), as well as city-supported assessment district funding. Ultimately, the City Council concluded this was not an appropriate allocation of resources. 

The almost complete absence of recent projects in downtown Los Angeles as well as the very limited volume of new projects elsewhere reflects both the scarcity of funds and the increasing assistance requirements of developers. What are the solutions to this problem? Except for the passage of time, there is no clear one-shot solution. There are, however, a series of principles which can make deals work or at least can help proposers and agencies to establish quickly that deals cannot work, and thereby save a lot of time, effort, money and political ill will.

The first and most critical of these principles is that, except for housing and certain projects based solely in social policy with no prospect for payback, there can be no projects in which the assistance format is not performance-based. Unless the land is already owned by a public agency and its costs have been fully absorbed by prior bond issues or other public funds, virtually any new project will have to be self-funding over time. What does this imply? First of all, it implies that the developer puts up the front money. If there is a need for a subsidy, that subsidy must be reflected in money recovered from the public sector over time and not from a front-end commitment.

Ideally, the project should also be self-contained, in that all the money recovered by the developer should reflect money created by the project. This is very difficult in this era of restricted use of sales tax revenues. It still holds promise, however, for hotels and other projects which have a clear spill-over or indirect benefit on other property values and activities. Finally, and somewhat ironically, the most critical issue is to be sure that the development is adequately funded. The level of public assistance can no longer be a simple fixed number in which the developer may be reasonably expected to absorb additional increases or adverse market effects. Some flexibility and commitment to maintain a feasible project must be part of the public pattern, even if it means that fewer projects are done. One of the hardest lessons to learn is that in this era of scarce resources, no project at all is clearly a better alternative than a failed project, since there is so little public support money available.

At the same time that public sources are so depleted, those responsible for administering the public side must be careful not to be trapped by developer optimism. "Down side" analysis is the key, and the critical question is not whether the developers is asking for too much, but rather whether they are asking for enough.

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