Redevelopment Agencies Facing Default

JAN. 23, 2012

By CHRISS STREET

Public officials are scrambling to deal with the California Supreme Court’s decision in California Redevelopment Agency vs. Matosantos. It upheld the elimination of the RDAs last year by Gov. Jerry Brown and the California Legislature.

The Legislation canceled the RDAs’ tax increment-financing, which served as their piggy-bank under the Community Redevelopment Law for the past 65 years.  The California Legislature and its crony capitalist allies will desperately try to resurrect new tax and economic incentives to reclaim their ability to interfere in the California real estate markets.

But barring any last minute emergency legislation, many redevelopment agencies will go into financial distress and be forced to hammer-sale huge amounts of depressed California real estate to avoid default.

Redevelopment agencies incurred debt to finance “improvements” to properties held by private developers.  The primary source of financing has been tax-allocation bonds that pledge all tax increment increases in assessed valuation property tax by the redevelopment districts as source of payment for tax-free municipal bonds issued to finance privately owned projects.  But districts also incurred substantial unsecured advances from local cities and counties as start-up capital.

Risk Factors

Given the speculative nature of real estate development, prospectuses for municipal redevelopment bonds are loaded with risk factors, including a possible decline in the value of real estate, the failure of the project to generate increased tax increment and changes in California state law.  Given that local cities and counties generally dominate and control the redevelopment districts, those entities may also have substantial liability regarding the activities of the districts.

Unfortunately, all three risk factors identified in the prospectuses have now occurred. According to Seth Merewitz, municipal & redevelopment law partner at Best Best & Krieger:

“If redevelopment is not reinstated in some fashion by the legislature, then the successor agencies will be charged with meeting enforceable obligations entered into by the redevelopment agency as well as performing many other wind down functions. Moreover, the successor agencies will begin the process of selling off all of the commercial, industrial, residential and even vacant land assets currently held by redevelopment agencies across California.  This inventory of property for sale throughout the state will present vast opportunities for investors to pick up real estate assets and trigger future economic development or add more real estate inventory to a flooded and depressed market.”

Many redevelopment districts fantasize they can enter into Public-Private Partnerships to maintain projects.  The concept is that the skills and assets of the public and private sectors can be shared to deliver facilities for the use of the general public.

Unfortunately, crony developers usually acquired properties in redevelopment districts with little in down payments. And the developers rely on the districts to sell unsecured tax-free bonds at interest rates of 4 percent to 5 percent to finance 100 percent of property improvements.  If the projects succeeded, the developer gained huge profits and the bondholders would be paid in full. But if the project failed, the developer could simply walk away and turn the properties over to their secured lender, leaving the bondholders at huge risk.

No Deals

Once upon a time, bank lenders were willing to take huge risks in financing development “deals,” but those days are over!  The few banks still willing to provide commercial development financing usually demand the property owner have 55 percent equity or more and charge interest rates of 12 percent, with 3 percent to 5 percent in fees.

According to the office of state Controller John Chiang, the Supreme Court’s decision will generate $1 billion in additional taxes in the next budget year, and increasing amounts in subsequent years.  Redevelopment agencies around the state averaged leverage of $1 in tax increment revenue into $18 of total indebtedness.

Redevelopment agencies have $31 billion of bond debt and another $9 billion owed directly to sponsoring cities and counties.  Consequently, with the loss of $1 billion in property tax revenue, the state-wide leverage of redevelopment agencies just doubled.

The panic of default is already beginning to build for many redevelopment agencies.  Their local city and county sponsors are probably trying to bribe developers to rescue “orphaned projects” with expedited permit processing, pre-entitled land and major increases in density.

But with bond payments due every six months, hammer-sale property liquidations may soon begin.