CRITICS AND CHAMPIONS

Public Money For
Private Gain:

NEW FINANCE MODELS FOR THE NEXT

GENERATION OF RETAIL REAL ESTATE

 

by Keith Alan Deutsch and Sam Earle

 

As E.S.P. staffers burrow through mounds of information seeking a story about an interesting entertainment or specialty retail real estate development, we stumble across the same financial process again and again.  It is what is euphemistically called “public contribution” to a private-enterprise project. Often the public money is in the form of tax relief, but public money also appears in the form of an outright cash payment toward the capital costs of design, development and construction of the project.

 

Frequently this public money is to be repaid to the contributing government body from taxes through what is known as Tax Increment Financing (TIF).  Tax Increment Financing means that a portion of future taxes is dedicated to repaying this public debt.

 

One criticism of Tax Increment Financing of concern to some retailers is that publicly subsidized mega-malls often

cannibalize existing retail centers.  And when the public subsidies run out, these subsidized projects may not survive a crash in the local retail market themselves.

 

A favorite line of economic critics of Tax Increment Financing goes like this: when the subsidized construction ­ rather than pure market forces ­ was the primary reason for the project in the first place, doom and economic collapse must follow.  This doesn’t mean the nay-sayers are right.  But they’ve come up with a powerful phrase to carry home their point.  They call this kind of public financing for private gain “corporate welfare.”  And though the critics may be wrong about predictions of doom, they have an easy time finding examples of what they complain is a dangerous trend that runs counter to the traditional capitalist safeguards of pure market forces.

 

For example, in Norfolk, Virginia, the city forked over $100 million of the $300-million cost to develop MacArthur Center, an upscale retail mall anchored by Nordstroms, but built in the heart of a blue-collar downtown. Similar deals are cropping up all over, such as West County Center in St. Louis, Missouri, which is getting $30 million in taxpayer money to build a $300-million Nordstroms-anchored mall; Power & Light District in Kansas City, Missouri, getting $176 million in public funding towards the $453-million total cost; Fashion Square Mall in Scottsdale, Arizona, $29 million toward a $100-million mall; Northeast Mall in Fort Worth, Texas, receiving $80 million on a $260-million project. The examples go on, and they seem to be growing.

 

Professional sports stadiums are another major arena for what’s been called  “corporate welfare” by a growing number of anti-subsidy groups.  These activist critics are known by a variety of names, such as Grassroots Against Government-Mandated Entertainment (GAGME), or Citizens Opposed to Stadium Tax (COST). One of a number of books dedicated to the anti-subsidy movement, authored by Joanna Cagan and Neil Demause, is entitled “Field of Schemes, How the Great Stadium Swindle Turns Public Money into Private Profit.”

 

Yet publicly-subsidized stadium projects of all types are in the works with self-interested municipalities all across the nation:  Anaheim, California; Baltimore, Maryland; Birmingham, Alabama; Boston, Massachusetts; Chicago, Illinois; Cincinnati and Cleveland, Ohio; Denver, Colorado; Detroit, Michigan; Houston, Texas; Miami, Florida; Milwaukee, Wisconsin; Minneapolis, Minnesota; New York City; North Carolina; Philadelphia and Pittsburgh, Pennsylvania; San Diego, California; and Seattle, Washington.

 

The most prominent arguments against public funding for stadium projects are: stadiums never pay for themselves and remain a public tax burden; and professional sports franchises are wealthy enough to provide their own financing. 

 

But these “across the board” arguments are meaningless unless analyzed within the specific context of each city location--and they may be beside the point.  See “Sport Stadiums Go Retail--Maybe” in the April 1999 issue of E.S.P. Magazine.  It certainly is not clear when each specific project is analyzed that sport franchises and private developers can afford to finance  these enormous public undertakings. 

 

As the April 1999 exclusive E.S.P. feature revealed, this new generation of sports stadiums often is being packaged with retail projects in an effort to provide a source of extra cash for the private developers and franchisers to pay the interest on the public tax money that TIF and related public finance models demand. Shoppers, rather than tax-payers, ultimately will carry the financing burden in this new and untried but very popular model.

 

Such is the case in San Francisco, where voters narrowly approved $100 million for a new $325-million stadium for the 49ers, to be known as Candlestick Mills, featuring a $200- million Mills Corporation mall as part of the stadium deal.  This deal is said to be in jeopardy since the cost of the stadium was pegged $200 million higher than original estimates, though Mills Corp. spokesmen insist the project will continue.

 

These cooperative efforts between local government and private developers listed above, no matter how rocky the cooperation, not only serve private interests--these municipal governments are betting that stadium and entertainment infrastructures that support big time sport franchises will add luster, excitement, and commerce to their cities. 

 

And the quality of life in something as complex as a city community benefits in ways that mere dollar assessments cannot tally when successful sport franchises revitalize the inner spirit of the place.

 

Downtown redevelopment incentives, subsidies, government partnerships, whatever the new public funding models are called, are also often viewed as a good and necessary counterbalance to the half-century phenomenon of urban flight and suburban sprawl.

 

Historian Tom Hanchett, in an article that can be found on the internet (under his name) at http://www.longterm.mslaw.edu/longterm42.htm., was puzzled by the suburban shopping center boom, why it started when it started, what drove it. The first one was built in 1922 outside Kansas City, he said, but then virtually nothing happened for more than 30 years. Then came the 1950s. Boom. Kapow. Bam. They’re everywhere. Why?

 

“The explanation is quite unexpected,” Hanchett writes, “...a change in tax laws. By accident the federal government began subsidizing new shopping center construction. In 1954, Congress passed a change in the tax law, something called ‘accelerated depreciation.’ Republicans controlled the Presidency and both houses of Congress and very much wanted to use government to help business. There was a small recession on and they wanted to get people to invest in manufacturing, so they offered a tax break intended to spur factory construction. It turned out because of a quirk in the language that the law applied not just to factories but to any ‘income-producing’ building.”

 

Depreciation of commercial buildings had been around as long as the income tax code. But Hanchett notes that  “in 1954, Congress greatly accelerated that depreciation timetable, so that you could take twice as big a tax break in the early years. But nothing said you actually had to use the money for renovating the building, so it became tax-free income. The acceleration clause was so powerful that on paper it could look like you were losing money on your building for years even though the building’s value was going up. In fact, you could claim losses even in excess of the amount of profit you were making on the building, and you could apply those losses to other kinds of income. You could use them as a ‘tax shelter.’

 

“So in the mid-50s, commercial real estate became a tax shelter ­ you built in order to get these paper losses and shelter other kinds of income. Accelerated depreciation produced an unintended boom in ALL types of commercial construction, especially in suburbia. You could only get the full write-off on new construction, not renovation of an existing structure. And depreciation applied only to buildings and not to land. So you wanted to spend very little for land and a great deal on the building so you could get the biggest tax break. And where was land cheapest and new construction easiest? The math pushed developers towards the edge of town.

 

“The central point of my research, I’d say, is the discovery that U.S. shopping centers did not supplant downtowns purely because ‘the public demanded them.’ ”

 

Hanchett spends quite a few words on the social effects of all this suburbanization, how it helped kill the old city downtowns and waterfronts and created suburban sprawl communities that have been tagged “edge city.”

 

“The edge city phenomenon became unmistakable after 1981,” Hanchett points out, “when the Reagan Congress changed the depreciation structure to allow write-off of a building not in 40 years, but in 15 years. From 1981 to 1986, when that break was repealed, America saw tremendous overbuilding. The tax incentive was such that in Texas, for instance, they start talking about ‘see-through’ office buildings, where developers built purely to get the tax break ­ they’d earn money even if the space never rented.”

 

Critics fear that the new public financing statutes that allow Tax Increment Financing and  “revenue bonds” sold by state or municipal authorities, like a sports authority or a port authority, will spawn terrible public burdens and inefficiencies just like the old 15-year depreciation law did for so many decades. 

 

But even critics of the new financing paradigms agree that billions of dollars in private capital are being invested in exciting new kinds of commercial real estate projects.

 

Champions of the new funding models--municipal redevelopment agencies and governments, major entertainment and retail real estate developers, planners, designers, architects, and retailers--do acknowledge that the vast majority of big projects have substantial taxpayer financing; but  they view this phenomenon as a good thing for the cities, the larger public who travel to the new destinations, and to the future of the local economy.