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Redevelopment May Survive, But Will It Be Stronger?

The new rules of redevelopment if the courts agree are now clear: You're dead, but you can buy your way back to life. That's probably enough to keep most redevelopment agencies in business. But is it enough for cities to continue to do redevelopment deals?

That's not clear, though redevelopment agencies have gotten accustomed to doing deals with less and less money over the years. Also not clear is whether this is the end-game on redevelopment or the first step in an effort to truly reform redevelopment a possibility that seemed far more likely in January than it does now.

Even though a lot of rhetoric about the past six months has focused on whether redevelopment is effective, the redevelopment deal in the budget was just about money. Agencies can stay in business if they fork over a big chunk of their tax-increment funding, but there's nothing in the budget deal that reforms how they do business. 

So, moving forward, there are two questions about redevelopment:

First, now that the budget has passed, will there be some kind of effort to reform redevelopment?

Second, can the remaining redevelopment power be combined with other financing mechanisms to put successful deals together especially in a down economy where real estate seems to be terminally in the tank? Or must redevelopment be combined with other financing mechanisms to make deals go?

Back in January, there was a lot of talk about redevelopment reform. Brown's proposal to eliminate redevelopment was couched partly in budget terms, but also in terms of redevelopment's overall effectiveness. In his budget press conference in January, Brown spent more time on redevelopment than any other topic; and he promised to devise a replacement tool if tax-increment financing went away. There was some talk, for example, of permitting cities to issue economic development bonds with 55% voter approval, though nothing came of it.

A ferocious back-and-forth went on all spring, with anti-redevelopment folks claiming it was a gravy train for fat-cat developers and pro-redevelopment folks delivering anecdote after anecdote about redevelopment's benefits. The fat-cat developers stayed on the sidelines in this debate, and the pro-con gradually degenerated to partisan politics, with urban Democrats speaking out against redevelopment and suburban Republicans defending it.

Lost in the shuffle of this debate was the question of whether redevelopment should be or could be reformed. There was some talk about tightening up blight findings yet again and a number of other ideas were floated making it easier to create blightless tax-increment financing districts, for example, but creating a state allocation system and stronger state oversight in response. These were mostly non-starters for two reasons: First, the real reason redevelopment was on the table in Sacramento was money, not effectiveness; and, second, the only thing that sets the redevelopment establishment on fire more than taking away the money is the possibility of more state oversight.

Yet, in the end, redevelopment reform is ultimately about more state oversight. Tax-increment financing is far easier for local governments to use in California than in any other state and it will remain so even if the two-bill strategy goes into effect. In most states, access to tax-increment financing is strictly controlled by the state, which uses that control to ensure that TIF is used for specific purposes. Washington, for example, recently adopted a law giving access to tax-increment financing to cities that participate in the Seattle region's transfer of development rights program. 

So it would seem that any meaningful redevelopment reform would have to begin with narrowing the purpose of redevelopment and giving the state more oversight power.  This is not likely to sit well with local governments, who would probably much rather take more of a hit on the blight finding than surrender any actual power to the state. On the other hand, it's not clear how much clout the locals will have on redevelopment if they are engaged in firestorm litigation with the state over the budget. Nor is it clear that the state will have much interest in real reform if the budget is resolved.

Which leads us to the second question: Will there be enough money left in redevelopment to do the real estate deals that redevelopment agencies have traditionally done?

The answer to this question is probably no, but it's worth noting that in the past the answer has always been yes even though prospects were dim. After Proposition 13 passed in 1978, for example, most experts predicted the end of redevelopment, because the property tax rate and hence the tax increment was cut by more than half. Cities soon figured out, however, that under Proposition 13, redevelopment was one of the few ways to wrestle property tax revenue unilaterally away from other agencies. So redevelopment was back in business.

Most agencies will probably decide it's worth it to stay in business, even though they will probably be getting less than half the tax-increment revenue they received only a few years ago. Especially in a lousy market, however, this situation will put pressure on cities and agencies to find other ways to fill the financial gap. The problem here is that the options are limited. 

In general, in order to subsidize a real estate deal without outside funding, there are only three options: 

1. Redirect some of the tax revenue from the project back into the deal, which is what tax-increment financing does.

2. Create additional revenue streams from the project's developers and tenants by creating something like an assessment district, which of course raises costs and changes the dynamics of the deal.

3. Give developers something of non-monetary value to the city, such as reduced parking ratios or increased square footage.

With property tax increment flows down, you can expect that more cities will turn to sales tax rebates an equivalent tool to make deals work. Sales tax rebates, of course, will only work for retail deals or other deals that involve businesses engaged in taxable transactions. Retail's on the way back, but retail chains are very reluctant to pull the trigger on new stores. So cities focus on other businesses that generate taxable transactions such as companies that manufacture large pieces of equipment that are sold to other businesses at high prices in taxable transactions.

Among the options for additional revenue streams are things like assessment districts, parking districts, business improvement districts, and so forth. Cities are also likely to move toward these financing tools as well, though there are some problems. First, many assessment districts require an election under Proposition 218 and approval is by no means certain. Second, by adding to the overall cost of development in a lousy market, such districts may raise money for infrastructure but may make it harder to do actual deals. The trend toward BIDs will continue, though BIDs tend to focus on operational funds for, say, a downtown, rather than capital cost of infrastructure or writing down land.

The last option would be to manipulate regulations to give developers something of value to them that doesn't cost the city anything. And there are two ways to do this. The first is to simply give these regulatory breaks away in order to induce private development. The second is to, in essence, sell those breaks, through something like a transfer of development rights system, in order to raise money for infrastructure or land write-downs.

Reducing parking ratios is a very powerful inducement for developers, especially in urban areas where the cost of structured parking is extremely high. In the current market, this option is probably more powerful than increased density, which increases revenue but also increases cost. At the same time, most developers will balk at reducing parking too much, since they must still deal with market demand for at least some parking on-site.

The TDR alternative essentially permits a developer to build larger buildings by purchasing development rights for other property owners who have ample zoning. If the seller of the development rights is a public agency, this could potentially raise money for infrastructure or land writedowns. Seattle has done this a lot since the city has limited access to tax-increment financing and Los Angeles has done it a few times with the Transfer of Floor Area Ratio (TFAR) program. L.A. Planning Director Michael Lo Grande has state L.A. is likely to do more TFAR deals in the future if redevelopment is eliminated or restructured.

Big-R Redevelopment has been curtailed and could still die maybe a slow deal. But small-r redevelopment will continue, as cities and developers look under every possible rock to find ways to do deals.