Structuring Urban Redevelopment Projects: Moving Participants Up the Learning Curve

Journal of Real Estate Research, The, Oct-Dec 2003 by Malizia, Emil E

Abstract Urban redevelopment projects implemented through public-private partnerships are the preferred way to revitalize inner-city areas. As the numbers of participants increase and deal structures become more complex, participants need more detailed knowledge of one another's motivations and behaviors to achieve feasible redevelopment projects. This research describes the expectations and behaviors of private sources of debt and equity, especially their financial return requirements, and the actions public participants can take to reduce project risks. With this knowledge, lead public and private participants should be able to forge economically viable projects that generate greater public benefits while reducing the risks of urban redevelopment.

Introduction

For many years, metropolitan economic activity has been decentralizing, and central cities and inner-ring suburbs have lost employment and population relatively and often absolutely. Central city decline is associated with a host of social, economic and political problems. In response, public policy has favored the physical renewal and economic revitalization of inner-city areas. Urban redevelopment projects have been the favored vehicles for inner-city revitalization.

For the past several decades, mobilizing public-private partnerships has been the preferred approach to implement urban redevelopment. Local governments, community-based organizations, foundations, neighborhood groups and other community advocates represent the public. Real estate developers and investors, commercial bankers, and tenants or their brokers represent the private sector. The focus of these efforts has been finding ways to lower risks or increase returns to private participants in order to attract investment capital to redevelopment projects.

To secure private capital, the public participants have primarily sought ways to attract commercial lenders and other private sources of debt capital by lowering their financial risk. Since the late 1970s, the gap financing model has evolved to lower financial risk through subordinated financing, fixed and below-market interest rates, flexible repayment schedules, and guarantees or other forms of credit enhancement provided by socially-oriented lenders (Meeker, 1996; and Malizia, 1997). Less attention has been devoted to risk reduction intended to attract private equity capital. Although private and community-based real estate developers can provide some equity, they are rarely willing or able to fund the equity position fully. Furthermore, public policy has changed dramatically since the mid 1980s. Depreciation schedules, loss provisions, income tax rates and capital gains treatment have reduced significantly the tax-shelter benefits of real estate ownership. Tax credits for low-income housing, historic preservation and the New Markets initiative rely on the tax code to attract private equity to socially beneficial projects. In most instances, however, socially beneficial urban redevelopment projects must be both economically viable and financially feasible if private equity and debt are to be secured on reasonable terms.

The other major change since the 1980s has been greater project complexity. Urban redevelopment projects now involve more actors on both the public and private side. In many cities, the lead role of representing the community has shifted from the public sector to the non-profit sector, a change that has paralleled the growing importance of non-governmental organizations (NGOs) in international development. Community-based organizations, in particular, community development corporations (CDCs), have become the champions of public-private redevelopment projects. Community developers and planners participate on behalf of local elected officials that represent the public at large. Many CDCs bring local, regional or national foundations to the table with program-related investments, thereby broadening the base of available financial support. On the private side, real estate developers, local investors and commercial banks still participate as project leaders and as sources of equity and debt. However, they are often joined or replaced by other private actors that include commercial bank CDCs, specialized real estate investment trusts (REITs) and major tenants that assume an ownership position in the project. The simple deal structure involving private developer/owner, private lender and public source of financing has become much less common than deal structures that involve twice that many actors or even more.

As the group of participants grows larger and moves beyond the familiar ground of tax-credit housing or historic projects and becomes involved in more complex commercial ventures, it needs to move up the learning curve. Participants especially need more detailed knowledge of the current motivations and behaviors of private lenders and equity investors interested in commercial redevelopment projects (Porter, 1995; Carr, 1999; and Williams, 1999). With this knowledge, lead participants should be able to forge partnerships that generate greater public benefits while reducing the risks of urban redevelopment.