Mass construction projects are going up with the help of tax-exempt bonds

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by Rob Walker

Many large commercial projects are getting built in Virginia with a little help from the local government.

Localities and developers are partnering on projects by creating an independent community development authority (CDA) with the ability to issue tax-exempt bonds for public infrastructure.

The financing model is being used increasingly on some of Virginia’s largest and most high-profile projects. And today’s volatile financial markets aren’t likely to slow the trend, say real estate experts. In fact, some localities are looking to CDAs to get potentially lucrative developments — hurt by the fallout from the subprime mortgage crisis — back on track.

Interest is so strong that the International Council of Shopping Centers, in conjunction with Blacksburg and cities in Hampton Roads, recently sponsored programs to explain how CDAs can be used as an incentive for development.  The program’s tagline: “Weapons of Mass Construction: CDA in Virginia.”

“What we’re talking about here is construction for the masses,” explains Kenneth E. Powell, who came up with the tagline. Powell, who has been involved in many of the CDA bonds issued in Virginia, is managing director for public finance for the Richmond office of Stone and Youngberg LLC, a San Francisco-based firm that specializes in financial services for local governments. By law CDA bonds can be applied only to infrastructure that will be used by the public — things such as water and sewer lines, roads, parking lots and traffic lights — and for projects that will be owned by a public entity upon their completion.

Yet, mass construction is a fitting term for another reason: many of these public-private developments are massive. New Kent Vineyards, a $1.5 billion residential/commercial/resort development in New Kent County, won nearly $86 million in CDA funding for water and sewer infrastructure.

Nearly $93 million in CDA bonds is a key driver in the transformation of Hampton’s 33-year-old Coliseum Mall into the 500,000-square-foot Peninsula Town Center. “This is an extremely creative way to develop a site that has value and potential,” says Kathy Grook, senior development manager for economic development in Hampton.

Typically, developers welcome CDAs. They can significantly lower upfront costs by providing funds for expensive infrastructure. Localities like them, too, because a CDA helps attract projects that, over the long term, may expand a jurisdiction’s tax base.

Chesterfield County approved the creation of a CDA last summer to help pay for road improvements at the Watkins Center, an 800-acre light-industrial and office park expected to generate as much as $11 million in annual taxes when completed.

Counties, towns or cities may create a CDA when petitioned by owners of at least 51 percent of the land in a contiguous area. CDAs raise money by issuing bonds that usually are repaid by assessments on properties within the CDA.

Usually such assessments are paid by property owners, sales charges, tax increment financing (TIF) or a combination of these sources. With a TIF, the increase in revenues
over an established baseline (usually the revenue the locality gets from the district before development begins) goes to pay the bonds.

For instance, say a parcel generates $1 million in various revenues for a county. Then a CDA is created, and development boosts the revenue stream to $3 million. The county would continue to get the $1 million while the added $2 million would go to pay the bonds. Once the bonds were paid off, the entire $3 million would go to the county. In Virginia, the city of Virginia Beach is using tax increment financing to help pay for public infrastructure for the new $500 million, 17-block Town Center, a new central business district for the resort city. 

An advantage for tax-conscious local governments is that the developer bears the ultimate risk for repayment, not the locality. The real estate is the CDA’s collateral.

Henrico County a leader

Henrico County has become something of a leader on CDAs, using bonds to seed three large projects in recent years: Short Pump Town Center, an outdoor lifestyle center; The Shops at White Oak Village, another mixed-used, outdoor lifestyle center; and Reynolds Crossing, a 63-acre mixed-use office park on Broad Street. (See graphic on page 57 for more information on bond issuances.)

“For local governments, they’re in vogue,” says Henrico County Manager Virgil R. Hazelett, “but we look at them very critically. What you do today is going to have an impact in 10 or 20 years, and we want that impact to be positive.”

Due diligence is a must before proceeding with CDAs, particularly in the current market. Both Henrico and Prince William counties have established guidelines. For example, residential development raises a red flag because it generally costs more in services than it returns in taxes and fees. Consequently, neither county will approve a CDA for residential development alone.

To be considered in Henrico, the projects must be large enough to increase the county’s tax base by at least $25 million. Plus, the term of the bonds must be relatively short — 10 to 15 years. 

From a developer’s perspective, CDAs allow investments on infrastructure at rates and for periods that a typical lender would be reluctant to offer, notes Paul Weinschenk, vice president of the Peterson Cos. in Fairfax. It relied on two CDA bond issuances of $7 million and $6.6 million for road improvements and infrastructure development at the Virginia Gateway in Prince William, a mixed-used development of high-end shopping, dining and offices space.

One issue that could harm the popularity of CDAs is concern that bond rating agencies might view them unfavorably. These ratings are key to a government’s capacity to borrow money, and the fear is that a bond could be viewed as a debt that could come back to bite if a developer went under or the value of real estate dropped dramatically — a scenario that has played out recently in some areas as a result of subprime lending. 

A recent check by Stone & Youngberg on the ratings of many Virginia localities that have issued CDAs did not reveal changes.  “I’m not concerned about that,” says Henrico’s Hazelett. “Caution is good,” advises Powell, but where [CDAs] are used judiciously, I don’t see any problem.”

The housing industry’s slump doesn’t seem to have curtailed the creation of CDAs but a continuing downturn may. That’s because fees expected to cover borrowing might be depressed if the overall economy sours or goes into a recession. 

John B. Levy, founder and president of the John B. Levy & Co. real estate investment-banking firm in Richmond, says there could be situations where bonds will come due and authorities won’t have the money to pay off debts on retail projects. “I wouldn’t be surprised to see a minor panic in some places,” he says.

In Richmond, the Broad Street Community Development Authority tried to prepare for that possibility, says Powell. “A mechanism was put in there, [giving the CDA the right to borrow as much as $3 million from the city of Richmond] because people were concerned there could be a gap,” he recalls.

Turns out that was a shrewd move, because this year parking fees expected by the CDA came up short. It will need to borrow $750,000 to $1 million from the city to make debt service payments, an advance Powell says will be paid back. Fees were down in part because two projects, a downtown performing arts center and a new hotel, haven’t opened yet. “Next year with the Miller & Rhoads Hilton coming on line, the Carpenter Center reopening and the federal courthouse opening, there shouldn’t be any problems,” says Powell.

Questions remain about the public role in assisting private development, with some CDAs prompting legal challenges. Yet, the trend appears here to stay.  “It’s something we’ll keep in the tool kit,” says Peterson’s Weinschenk. “We’ll use it again.’

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