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Big profit margins for some TIF projects raise questions about taxpayer support
By JEFFREY SPIVAK and LYNN HORSLEYThe Kansas City Star
Kansas City had a problem: The dying Blue Ridge Mall was turning into an eyesore along Interstate 70, one of the gateways into the city.
A real estate developer had a solution: Demolish the mall and build a new, Wal-Mart-anchored shopping center with a little help from a city development incentive known as tax increment financing, or TIF.
It was such a “win-win” situation that the project passed the City Council unanimously. But some city leaders didn’t notice that the developer, MBS Mall Investor, could achieve an 18 percent profit margin, almost double the average shopping center deal in metropolitan Kansas City.
The developer says the company needed that rate of return because it was such a risky project. But City Councilwoman Deb Hermann, who voted for the project, said the rate was a surprise to her.
“That’s not good,” Hermann said. “If they can make an 18 percent return, they don’t need all that incentive.”
The Blue Ridge Mall is one in a long string of TIF projects that show Kansas City’s approval process is often driven by developers who get good deals while taxpayers’ interests aren’t always adequately protected.
Some say these deals are worth it. At Kansas City’s Economic Development Corp., the city agency overseeing the TIF Commission, officials justify high profit margins for some TIFs like the Blue Ridge Mall because those projects boost the city in ways that can’t be quantified.
“To have a crumbling, deteriorating mall, what does that say about Kansas City? It says things aren’t going very well in the city,” said Jeff Kaczmarek, the agency’s president. “You have to look at the overall benefit of doing a particular project at a particular time.”
Nevertheless, a growing band of independent consultants, city auditors and corporate watchdogs believe developers shouldn’t be getting such good deals. TIF, they say, is only supposed to provide tax money necessary to make a project feasible for private developers, not to inflate their profits at public expense.
But that’s happening. Indeed, The Kansas City Star, in a four-month examination of TIF, found the city’s lack of scrutiny and analysis of TIF deals could be costing taxpayers millions of dollars.
Consider: The Star found more than half of non-governmental TIF projects approved this decade included profit margins that significantly exceeded national and Kansas City averages. That means taxpayer subsidies were potentially more than they needed to be.
In addition, while TIF tax dollars typically pay for such things as streets and parking, Kansas City also has authorized public dollars for extra features within TIF projects — from a downtown Christmas lighting display to marble statues in the Briarcliff shopping center in the Northland.
Essentially, while TIF has done a lot of good around Kansas City — revitalizing downtown and creating shopping districts, among other things — even average citizens are becoming alarmed.
“We have been too generous with tax breaks,” said Joe Medley, a native Kansas Citian who is so concerned about TIFs that he helped form a grass-roots group called Citizens for Responsible Economic Development. “What they’ve turned into is a silver spoon for fat-cat developers.”
Even some well-known development attorneys question some of the TIF deals.
“I think there are deals done by the TIF Commission that were too rich for developers,” said Mike White, who wrote substantial parts of Missouri’s TIF law and was the TIF Commission’s first attorney in the 1980s.
But in Kansas City, TIF projects are viewed as risky, so they often need a higher rate of return to attract private financing, said Aaron March, another development lawyer.
“Nobody is going to land on a project that doesn’t have a reasonable return on it,” March said. “It’s more likely than not that people aren’t standing in line to do the project. If people aren’t standing in line, you might have to offer a higher rate of return to give them a reason to take on the risk.”
The city government is now working on a new policy to strengthen and tighten the city’s approval of TIFs. A task force’s recommendations are due Friday. The TIF Commission’s chairman, Blue Cross Blue Shield executive Peter Yelorda, declined to talk about TIFs before that policy is prepared. But the Economic Development Corp.’s Kaczmarek said his agency is on board with the TIF reform effort.
“I would agree we can improve the process,” Kaczmarek said. “These processes are like making sausage.”
Healthy profits
The process of getting a TIF starts with an application with reams of paperwork.
One part of the application is something called a “but for” test, or the case why the project would not proceed unless it received public money. This analysis forecasts the project’s internal rate of return, a measure of expected profitability from cash flows.
The Economic Development Corp. sometimes negotiates that rate of return with the developer, but by the time the project reaches the City Council, members often act as if they have only two choices: Take it or leave it.
Because the rate-of-return analysis is just a forecast, there’s no guarantee that a project will attain that level. So some city officials and developers maintain that high return rates are needed to attract capital for potentially risky development areas.
It’s not surprising, then, that investors are looking for stronger returns than, say, if they put their money into safer developments.
The question is: How much is enough?
The Star reviewed profitability rates for 20 TIF building projects approved this decade. Only four projects were forecasting below-average returns, such as 1.7 percent for H&R Block’s headquarters downtown because the company is occupying its own building instead of leasing it.
But The Star found that 11 projects, or more than half, exceeded average local returns by several percentage points or more.
“That was always an area that I was concerned about,” said Pam Mason, a former county clerk for Clay County who also served two stints on Kansas City’s TIF Commission, which recommends TIFs. “They may be a little higher on the rate of return than they ought to be.”
Consider: TIF financing will help provide the Aladdin Holiday Inn hotel downtown with an expected 15.5 percent internal rate of return — greater than the roughly 10 percent average return for Kansas City area hotel projects estimated by the Chicago-based Real Estate Research Corp.
Additionally, the redeveloper of the Griffith Building near the Jackson County Courthouse could see a return ranging from 14.7 percent up to 35.7 percent, depending on rents, compared with a 10.8 percent average return for office projects in Kansas City’s central business district.
Developers defend those rates.
Charles Swan, executive vice president of Wright Investment Properties, which owns the Aladdin, said the hotel needed significant renovation and his company needed a high enough rate of return to attract investors. He also said the property may not soon achieve that rate because the downtown entertainment district opening is delayed.
Likewise, Scott Seitter, an attorney who is part of the Griffith Building’s ownership group, said: “We’re nowhere near to getting what we hoped we’d get.”
Not many cities make rates of return public on TIF projects. But one city that considers them is Milwaukee. There, TIF review boards try to keep rates of return around private-sector market averages.
“If we’re doing our job at all, the rates of return shouldn’t be any different than a strictly private deal,” said Michael Daun, Milwaukee’s deputy comptroller, an independent financial office in that city. “I can’t characterize TIF in our city as being on the high side of returns generally.”
In Kansas City, Economic Development Corp. officials think the return rates are reasonable. That’s because the agency hires independent appraisers to analyze the rates, then accepts the appraisers’ findings.
“They use their best judgment, I’m sure,” said the Economic Development Corp.’s Kaczmarek.
But The Star found these analyses sometimes relied on benchmarks based on the developers’ own desired levels.
That’s what happened with the Blue Ridge Mall TIF. An appraiser justified the project’s 18 percent return by noting “it is still below the minimum 20 percent that most developers would be hoping to achieve,” according to the evaluation done for the Economic Development Corp.
The appraiser, Robert Miller, senior vice president of Chicago-based Applied Real Estate Analysis Inc., defended the comparison, explaining: “We use a lot of information in developing our conclusions. We don’t rely on any one index.”
Bernard Craig, president of mall redeveloper MBS Mall Investor, explained the challenges of remaking a mall justified a high profitability rate.
“That (rate) was submitted up and down to people at the city and the people selling the (construction) bonds to complete the project,” he said.
But TIF critics say such high profit rates suggest flaws in the city’s TIF approval process.
“This raises all kinds of questions about the integrity of the process, that it’s not looked at closely enough by independent groups and that citizens find out about this after it’s a done deal,” said Judy Ancel, director of the University of Missouri-Kansas City’s Institute for Labor Studies.
According to city officials and consultants, a project with a high expected profit should signal that a developer needs to put more private money into the deal and taxpayers should have to put in less.
“We need to have some sort of independent look at what is an appropriate (rate of return) for a project and not just accept whatever the TIF Commission and the developers tell us,” said Mayor Mark Funkhouser, who promised during his spring campaign to clamp down on TIF abuses.
Christmas lights
Developers also have worked Kansas City’s TIF process to their advantage by getting taxpayers to pay some unusual project costs.
With TIF, a developer builds a project and then gets reimbursed for certain costs the city approves.
Those costs are supposed to cover expenses needed to make a project financially viable, so they’re usually for improvements like road construction, parking garages or building rehab.
But The Star’s review of TIF budgets turned up some reimbursed costs that seemingly go beyond what’s needed to make a project work.
DST Systems Inc.’s TIF that built up the office market across downtown’s west end also included up to $50,000 a year for Christmas lighting displays on Barney Allis Plaza, or almost $1 million total. A DST official overseeing the TIF said the lighting qualifies as a neighborhood improvement under TIF guidelines.
Then there’s Briarcliff’s new shopping village up north, where public funds are paying about $1 million for a fountain and a marble cherub statue.
“They’re part of the whole package” of site work the city is reimbursing, said project manager Nathaniel Hagedorn.
All these kinds of costs are allowed under Missouri’s TIF law, which is considered lenient.
“They’re eligible costs under the state statute, although it has somewhat of a loose definition,” said Debbie Carter, who recently left as chief financial officer at the Economic Development Corp.
TIF critics, though, consider these to be abuses of the system.
“Christmas lights and statuary, that’s personal decorations for the developments,” said Jon Matthew, president of the local chapter of the corporate watchdog group Reclaim Democracy. “That’s not something public subsidies should be used for.”
One other way developers get good deals out of TIF: Projects tend to expand in size — and taxpayer cost — after the city’s initial approval. In the process, the developers gain millions of dollars more in city subsidies without much additional study.
“The level of analysis applied to many incentives diminishes as the potential cost to the city increases,” a consultant to the city, Overland Park-based Columbia Capital Management LLC, wrote in a report earlier this year.
Overall, the consultants and other observers view the TIF process as “developer-driven.”
Michael Duffy, a Legal Aid attorney and a member of another board that reviews tax incentives, thinks he knows why. “These boards right now hear 90 percent of the time only from people who want to promote development incentives, and therefore may not be getting a full picture of all the facts,” he said.
But Kay Barnes, the former mayor whose administration promoted the broad use of TIFs, strongly disagreed with that assessment. The city’s review of TIFs, she said, “is rigorous, it is thoughtful, and it always has the city’s best interests in mind. It is not developer-driven.”
Nevertheless, some believe Kansas City has reached a TIF-ing point, where TIF subsidies have gotten out of control and need to be reined in.
“It doesn’t appear that many of the deals have been obviously good deals for the city,” said Linwood Tauheed, a University of Missouri-Kansas City economics professor and vice chairman of the city’s economic incentives task force, which is recommending a new TIF policy.
“The city has been very attractive to developers because this is where you could make lots of money without having to compete very hard for it.”
After a mayoral election in which TIFs were a hot-button issue, a city task force is preparing recommendations on ways to strengthen Kansas City’s process for granting development incentives such as TIF. A growing chorus of analysts, academics and concerned citizens has several suggestions for improving the system. Some of them:
•Direct more TIFs to needier areas of the city.
The original intent of the tax incentive was to help developers fund deals in blighted and neglected parts of cities. That’s not happening much in Kansas City, and in fact just about every major development deal anywhere in the city gets TIF financing.
The city needs stricter guidelines on TIF eligibility, and TIFs outside designated target areas should have to meet higher standards.
•Penalize developers who don’t deliver on their promises.
The vast majority of TIF projects have not created as many jobs as predicted. That ends up reducing the TIF’s benefits to the city, but often the city has no recourse.
There is a contractual term known as a “clawback” that, in this case, would require a developer to pay back all or part of the tax incentives received if performance measures aren’t met. This has been included in some recent deals in Kansas City, but not always. It needs to be a standard and rigorous contract provision.
•Prepare a better analysis of a TIF project’s impact on existing businesses.
In some cases, particularly with retail projects, new TIFs have simply added new businesses at the expense of existing businesses, such as when a Home Depot opens and a neighborhood hardware store closes.
City reviews of TIF projects need to incorporate that kind of analysis, which in economics is called the “substitution effect.” This would give city officials a better understanding of, for instance, whether TIF’ed shopping centers are worth doing at all.
•Create an ombudsman position or taxpayers’ representative who reviews TIFs.
Neighborhood leaders, city policy analysts and even some past Economic Development Corp. board members have complained that bodies reviewing TIF projects hear predominantly from one side — the developer’s. As a result, TIF projects aren’t scrutinized as well as they could be.
One idea used in other cities, such as St. Louis: Have someone in City Hall as an objective and credible analyst of TIF projects. That person’s perspective can then be shared with review boards and the public, as well as help determine whether a project would occur without TIF.
•Scrutinize developers’ potential profits more fully.
Each TIF project includes an independent analysis of what’s called an internal rate of return, or profitability rate. However, that analysis often compares developers’ projected rates to national averages or even developers’ desires. As a result, some projects get approved with very high profitability rates, meaning they may not need as much TIF financing.
These analyses of project return rates should compare developers’ projections to Kansas City averages.
•Cap the percentage of city subsidy in a TIF deal.
Kansas City provides a higher level of TIF financing than many other big cities do. Some projects in Kansas City are more than 50 percent publicly funded.
Some limit should be put on this percentage, to hold down the city’s public commitment. For instance, two local suburbs limit TIF subsidies to 35 percent or less of a project’s total costs.