Income Tax Plan Could Negatively Impact Development Deals

Friday, October 6, 2017, 8:06 am
By: 
Alice Dreger

If East Lansing voters approve a pair of tax proposals on the November 7 ballot, the resultant fall in City property taxes could have serious implications for various development deals. One side effect could be that the City is stuck with millions of dollars in unexpected debt—debt that has been scheduled to be paid through property taxes on private commercial development.

City Council and staff have been asked by ELi reporters a number of times to work up what kinds of figures we are looking at if a major property tax reduction happens and, as a result, various tax increment financing (TIF) plans don’t pan out as had been expected. Receiving no response, at this time ELi cannot provide exact figures, but today we explain the issue using three examples of potential impact.

Background on the paired tax proposals:

The City is facing serious financial problems, so City Council is looking for ways to increase revenue. They have put on November’s ballot a pair of tax proposals meant to net about $5 million in new revenue per year for the City. These are (1) a City income tax pinned at 1.0% for residents and 0.5% for non-residents, and (2) an approximately 5 mill decrease in City property taxes, taking the millage rate from about 17 to about 12.

The idea behind this pairing is to shift the new-tax burden mostly to non-residents who work in the City—mostly people working at MSU. This arises from the perception that MSU has been costing the City much more in emergency services (and related retirement costs) than it pays in. The paired proposal plan also arises from the political calculation that home-owning East Lansing voters, especially retirees, may be willing to pass these tax proposals if it means their own net tax liability won’t go up too much, if at all.

The property tax reduction will go into effect only if the income tax proposal passes. If the property tax reduction does go into effect, by law it must drop the property taxes to be paid on every tax-paying parcel in the City. That includes all commercial development.

And that means it will have a big impact on every tax increment financing (TIF) plan in the City, some of which are designed to have private developers pay off City debt. If now that money isn’t coming in to pay that debt, the City is going to have millions of dollars in debt it has to find a new way to pay off.

Background on how TIF works:

Tax-increment financing (TIF) is a scheme meant to enable development that theoretically otherwise wouldn’t happen. It allows some local governments to create plans to capture new taxes generated by redevelopment to pay for pre-determined “eligible expenses” of a redevelopment project.

For example, a TIF plan can be set up so that—after a redevelopment project is complete and the land is generating substantially more taxes than the property did previously—the captured taxes are used to reimburse a developer for environmental clean-up related to the project. TIF can also be used to reimburse cities for public infrastructure costs related to a redevelopment.

When a TIF plan is set out, it is set out under certain assumptions, including that the millage rates of capturable taxes will remain stable over the life of the TIF plan. That allows the City and developers to calculate how much capturable taxes will likely be available over the course of a TIF deal.

If the City’s property tax rate drops by about 30% after the November elections, from 17 mills to 12, TIF plans all over the City are going to be thrown into unexpected states. For some TIF plans that have wiggle room built in, it won’t matter. But for those that are close to maxed-out in terms of the amount of taxes captured for eligible development costs, whomever is set to be reimbursed could be stuck with unexpected debt. In some cases, that’s the City.

Example #1—the M.A.C. Parking Garage:

The City’s very first TIF plan was made about 30 years ago for University Place, the development that includes the downtown Marriott Hotel, M.A.C. garage (under the hotel), and retail and office space in the complex. East Lansing worked up a 30-year TIF plan for that project to help pay for the parking garage needed for the project.

That TIF meant that the owners of the private properties in the complex were essentially paying off the expenses of the garage construction through property taxes generated by the redevelopment. (Otherwise that tax money would have been going into the City’s general fund, being used for other needs.)

Just as that TIF plan was running out, the City determined that the underground M.A.C. garage was in such bad condition it needed a major renovation. Council decided to renew the TIF plan there for another 30 years to pay to fix the garage.

Those repairs were recently completed at a cost of about $4 million. The City took out bonds to borrow the money that is due to be paid back through the renewed TIF.

By my calculation, based on the TIF plan as passed by Council in December 2014, if after November 7 the City property tax millage rate drops by about 30%, from 17 to 12, the University Place TIF plan is going to come up short by about a million dollars.

The City is still going to owe that $1 million on the bonds for the parking garage. But now the owners of the commercial properties at University Place aren’t going to be paying about $1 million in property taxes that the City expected to pay back the bonds.

Who will pay that $1 million? Well, the City will have to come up with some other source.

University Place is not the only TIF plan that is paying back the City through private commercial development tax dollars, so it is not the only plan where the City may have to find some other way to take on unexpected debt caused by a property tax reduction. Again, without the City providing the numbers, we don’t have a clear picture of the likely impact on the City’s bottom line.

When City staff and Council have said the paired tax proposals will net about $5 million a year, they don’t seem to be taking into account debt that might be effectively generated by property tax reductions leading to problems with TIF plans meant to reimburse the City.

Example #2—the Park District:

Plans for the Park District redevelopment were recently withdrawn, but the owners/developers of the private properties in the area, DRW/Convexity, are expected to come back soon with a new plan. When they do, we can expect that they’ll present a new TIF plan designed in cooperation with the City, and we can expect that the City is hoping that TIF plan will be a way to deal with a lot of City expense and debt.

Back when the previous owner of the private properties in the Park District, Scott Chappelle, was planning to redevelop the area as City Center II, East Lansing’s Downtown Development Authority (DDA) bought up a bunch of privately-owned properties in the area to help the project. Eager to support the City Center II plan, the DDA paid millions more than these properties were worth.

The DDA is now saddled with about $7 million in debt that is coming due on those Evergreen Avenue properties—properties worth at most probably about $3 million in total. (The DDA’s debt is ultimately East Lansing taxpayers’ problem.)

City Council had been planning to use a $19.6 million TIF plan for the Park District to pay off that debt and also to pay for large amounts of public infrastructure upgrades in the area, including to streets, sewers, and water mains. In fact, of the $19.6 million, only $2.5 million was going to pay the developers back for their own expenses—the rest was going to consist of the owners of the private properties in the Park District redevelopment paying for City and DDA debt and expenses, totaling about $17 million.

When the Park District plan failed, Mayor Mark Meadows acknowledged “there is no Plan B” for the Evergreen Avenue properties debt. Meadows and the rest of Council, City staff, and the DDA are hoping a new project will still come with a TIF to pay off that debt.

But, when DRW/Convexity comes back with a new redevelopment plan, if the City millage rate has dropped about 30% because the tax proposals have passed, there’s going to be millions of dollars a year less available in capturable taxes over the life of a potential TIF plan. That’s potentially going to mean that debt and expenses that would have been paid by private commercial property owners is now going to have to be paid some other way. In other words, the Evergreen Avenue debt may not be solvable this way. Then the City will be stuck finding money to solve it some other way.

Another issue could be this: With the property tax rate dropping dramatically, there simply might not be enough capturable taxes to do the project the developer and the City might want at the Park District. So the property tax reduction, if it happens, seems likely to impact what can be built.

Example #3—Center City District:

The Center City District TIF plan looks different from the two examples above because of how the City has set up that project to protect taxpayers from unpredictability—and to shift that financial unpredictability on to the developer and bond investors.

The Center City District TIF plan calls for 100% capture of eligible taxes for the full 30 years. That means that, for 30 years, all the City taxes (and a lot of other local taxes) paid on the private land in the redevelopment will go to the TIF plan reimbursement, not to the City’s general fund. The total expected has been about $58 million over the 30-year life of the TIF plan.

What is the Center City District TIF plan reimbursing? Basically, the plan is reimbursing the developer for the cost of building the new parking garage and other public infrastructure for the City. It’s covering the City’s costs. Under the Master Development Agreement, the developer has agreed to take on all these costs—even if things turn out more expensive than planned.

To pay the developer back for (at least most of) the costs and interest, East Lansing is having its Brownfield Redevelopment Authority (BRA) issue non-recourse revenue bonds in the amount of about $31 million. The developer will essentially borrow the construction money to build public infrastructure using the bonds, and the TIF revenue will be used to pay back bond investors for principal and interest, up to the $58 million total.

But what happens if the City property tax rate plunges 30%? By my calculation, the Center City District TIF then produces at least $6 million less than has been expected. (Again, I’m hoping the City will run the actual numbers and tell us.) That drops the amount investors can count on getting from the revenue rather dramatically.

This may be one reason the developer is anxious to have the BRA issue the bonds right now rather than after the project is built, as originally planned—because right now it looks to potential investors like there’s close to enough expected tax revenue to potentially pay back the bond investors, based on the current tax rate. After November 7, it may become patently clear to all that there’s not enough tax revenue in that project to pay back the principal and interest on the bonds from the taxes. (The developer is hoping the BRA will vote to issue the bonds at its noontime meeting today.)

Because the bonds are “non-recourse,” if the tax revenue does come up short to pay back the bond investors, the City won’t be on the hook as it is with the M.A.C. garage and the Evergreen Avenue debt. In fact, the way this has been structured, the developer and potentially any bond investors have to take a pretty serious financial risks. The City has tried hard to insulate itself from risk, but the fact is that this is a private-public high-risk partnership, easily as complicated as City Center II was.

Why might some developers not want property taxes to fall?

When developers set up TIF plans, one thing they don’t expect is for property tax millage rates to plummet. It rarely happens.

And, when it happens, it isn’t always a problem for developers with TIFs. If the TIF pays back the City and not the developer, then the developer is probably perfectly happy to pay less tax and leave the City hanging.

What if the developer is set to be reimbursed for her or his own expenses through a TIF? Well, if a developer continues to own a property and the tax rates on the property fall, then that isn’t really a problem for such a developer. They were basically going to be reimbursing themselves via the TIF for what were eligible expenses under the plan—so it’s a zero-sum game.

But imagine a developer builds under a TIF plan and then sells the property to a new owner. Now, when the tax rate plummets, the developer loses. That’s because the new owner is paying much less in taxes, which means less TIF capture to pay back the original developer for the eligible expenses the developer had laid out.

So in cases where developers have developed using TIF that reimburses them, and they have sold their properties, they probably are dreading seeing the property tax rate fall.

All this may be one reason some business people are against the paired tax proposals—they may not want the property taxes to fall because they count on TIF to make money or get reimbursed in some cases.

All this also explains why lawyers for the Center City District developers recently asked the City to promise it wouldn’t allow a new owner to ask for a reassessment that might lead to the property assessment being lowered there. Here’s what’s up:

The lead Center City District developer, Mark Bell of Harbor Bay Real Estate, has said the developers are planning to continue to own the private properties after development. But odds are pretty good they’ll sell—that’s what often happens with these big projects—and if they do, and the property taxes fall because of reassessment, Bell and his partners will be out some amount of TIF reimbursement if they’ve essentially invested in the bond. (The City did not make any such promise not to allow reassessment; by law, it can’t.)

Now, with Center City District, on top of the potential for (1) reassessment lowering the taxable value of the private properties or (2) a market crash in the next 30 years lowering the property value, there’s (3) the possibility that the City property tax rate will fall dramatically. That’s a whole lot of financial risk and unpredictability for the Center City District developer. None of these risks is calculated into the best-case-scenario public talk of $58 million in capturable taxes.

And if Center City District developers don’t yet have their full financing plan together—and it appears they don’t yet—it could throw a wrench in the whole plan if potential lenders and investors are paying enough attention to know what’s on the ballot in East Lansing this November 7.