Real Estate Deal Unexpectedly Costs Taxpayers $5 Million

Monday, May 8, 2017, 8:19 am
By: 
Alice Dreger and Eliot Singer

The Avondale Square housing project wasn’t supposed to turn out like this. When it was conceived by City of East Lansing leaders in the early 2000s, the idea was that the homes to be built near Marble Elementary School wouldn’t cost local taxpayers anything much beyond having to give up the new property taxes to be generated by the project and funneled back into the development.

But as it has turned out, East Lansing taxpayers will ultimately shell out up to almost $200,000 per house in public subsidies for the project’s 26 privately-owned homes—or over $5 million. As the current City Council heard at a recent special budget work session, to pay for the substantial debt generated by the project, the City is having to divert hundreds of thousands of dollars a year—funds that could be going to other uses.

What went wrong? In short, when City leaders decided to enter this complex real estate development scheme to provide a type of housing they saw as needed in the City, those in charge didn’t anticipate all that might turn out differently than they planned.

They assumed the federal government would give them a grant rather than a loan. They didn’t think they’d have to pay so much for the private properties they had to buy up for the project. And they didn’t anticipate the real estate crash.

An odd twist of the tale is that the mayor under whom Avondale Square launched was Mark Meadows, the man who is now the Mayor of East Lansing again. Today, the situation is bleak enough that City Council found itself at its April 18 meeting darkly joking about how to get out of the financial problem that is Avondale Square.

At that meeting, Meadows asked City Planning Director Tim Dempsey if the City had pledged “full faith and credit” for the federal loan on the project.

“We used the Grove Street Parking Garage” as collateral for the credit, Dempsey replied. He said it was a debt-free City asset “at the time it was identified” for this use.

“They can have it,” Mayor Pro Tem Ruth Beier joked, referring to the garage’s current need for costly repairs.

“It could become part of the National Park Service,” Meadows rejoined.

The Council then went on to discuss what it is going to do if the Trump Administration cuts back on the annual federal grant the City has been using to pay back the federal loan—the Community Block Development Grant. If that happens, the City will be in even rougher shape than it is now with regard to Avondale Square.

The original plan versus what got built:

The Avondale Square project was intended to redevelop a long block of Virginia Avenue, near Marble Elementary School, from what were mostly student rental houses to single family homes. When originally conceived, around 2005—near the end of the housing bubble—there was a perceived lack of homes in East Lansing for young families.

The original plan called for 16 single-family detached homes and 14 townhouses. According to the 2009 plans: “Construction is anticipated to begin in late summer or early fall of 2007 and will continue until estimated completion in 2009.”

In fact, as the original plans fell apart, the City kept changing the plans, and the last houses have only just been completed—a delay that has cost the City substantial amounts of money. There are today 26 single-family homes (and no townhouses), of which 10 have been designated for income-qualified (lower-income) buyers.

The properties that cost more than anticipated:

For the project, the City had to buy up approximately 25 properties from private owners. (Three existing higher-quality houses on the street were left intact.) The City spent about $3.7 million buying the necessary properties.

Originally the land acquisition cost wasn’t expected to be so high. But landlords owning some of the needed properties figured out they could charge well above normal market value, because the City couldn’t make the project work without their land. The City opted against attempting to use eminent domain, and paid far more than originally hoped would be necessary.

The federal grant that turned out to be a loan:

The original conception of Avondale Square called for a federal housing grant from Housing and Urban Development (HUD). That didn’t come through, but City leaders decided to proceed anyway when HUD offered a Section 108 loan for $1.5 million. The total principal plus interest when the HUD loan is retired in 2026 will be about $2.3 million.

Taking a HUD loan rather than obtaining a HUD grant meant the City had to pledge funds from its annual federal Community Development Block Grant (CDBG) funds for the next 20 years at a cost of $75,000 plus interest, each year. Had the loan been a grant, those annual CDBG funds would have been and would now be going to some other structural improvements in the City, like street or sidewalk repairs. Avondale Square is by far the largest single expenditure in the City’s annual CDBG budget, which also pays for neighborhood improvements, child abuse prevention, domestic violence shelter, etc.

As a condition for the HUD loan, twelve of the planned 30 homes were reserved for income-qualified households, defined as 80% median family income for East Lansing-Lansing area. For the first several years, most of the houses built were not income-qualified. Eventually, ten income-qualified homes were built, and HUD agreed to the reduction in number of income-qualified units, since the total number of new homes was reduced from 30 to 26.

Other elements of the expenses and financing:

To build the project, the City also issued Bond Anticipation Notes for $2.5 million along with using various additional City funds, including property exchanges. Bond Anticipation Notes (BANs) provide temporary bond financing for three years. On them, the borrower (the City) pays interest only, with principal due at the end.

The City refinanced the BANS in 2010 with a $2.365 million bond on which it has been paying principal plus interest. At the April 18, 2017, meeting, the current City Council started talking about how to try to pay off the bonds and the HUD loan early, if possible, to try to avoid paying more out in interest than necessary. The interest on the borrowing for this project will inevitably reach into the millions of dollars.

Below: A newly-constructed Avondale Square house, currently for sale.

Up until now, the City has managed to pay for most of the principal and interest on the bonds by selling remaining plots in Avondale Square for redevelopment. All the plots have now been sold, and for years to come, the only revenue to pay for the bonds will be tax increment financing (TIF). Using TIF, the City is going to pull property taxes out of the area and redirect those funds to pay for the bonds. If this weren’t happening, those property taxes would be going to the City’s General Fund, like the property taxes of most East Lansing homeowners do.

Nevertheless, TIF revenue is expected to fall short of the amount needed by more than $100,000 annually for next few years, with large deficits until the bonds are paid off in 2035. That shortfall is being covered by the City’s general fund.

The total cost to the taxpayers:

When we combine the debt service deficit, the HUD loan, and miscellaneous costs associated with this project, the total cost comes to about $5.1 million. More precisely, for each of the 26 new houses constructed, the average cost in terms of public subsidy comes to $196,033.

Just to be clear, this isn’t what people who bought these houses paid to buy the houses. What they paid to purchase their homes is separate from the public subsidy of almost $200,000 per house, or $5.1 million spent to bring East Lansing 26 new owner-occupied houses, replacing existing mostly-rental housing, including for 10 income-qualified households.

As noted above, if, under the Trump Administration, CDBG funding is severely cut or eliminated, the City will be forced to repay the loan from general revenue. That means even more of the taxpayer burden will be focused locally than is currently the case.

Even if the federal government keeps funding CDBG, the fact is that this project has been so much more expensive than planned that it will continue to suffer a shortfall through 2035. And, now that the lots are all sold, the City will have to pull funds out of the general fund to make up the shortfall.

At the April 18 meeting of Council, Mayor Pro Tem Beier asked City staff, “Was this the original plan, to have this deficit?”

The answer was no. City leaders never expected this housing project to turn out this way.

The current City Council has been grappling with two other unexpectedly high-cost real estate deals signed by previous Councils. One involves properties purchased in 2009 on Evergreen Avenue for what was supposed to be the Center City 2 project. The recent deal with DRW/Convexity for the Park District redevelopment provides for about $7 million in captured taxes to be used to deal with that financial problem, where the properties are worth less than half what City leaders paid landlords for them.

The other involves the M.A.C. parking garage under the Marriott hotel downtown. There, thirty years ago, the City entered into a complex real estate arrangement to make possible the privately-owned hotel, office, and commercial space built above it. Paying to reconstruct that garage, which provides substantially discounted parking to the hotel, has recently unexpectedly led to a record-breaking 60 year TIF. That TIF is now set to divert another $4 million dollars that would have otherwise gone to the City's general fund.

 

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