Tax Reform May Change Shape of Downtown Dreams
‘The first reaction to the tax changes was one of hysteria, the sky is falling. CPAs (certified public accountants) were running around like Chicken Little.’
Sanford Goodkin
Development adviser
The Gaslamp Quarter may experience a boomlet.
Small developers may find downtown a hard place to pitch a project.
And the redevelopment agency that has engineered many of the changes in the landscape of the center city will have to revamp the way it does business.
Those are some answers to the many questions about the future of downtown development raised by the tax reform bill now awaiting President Reagan’s signature.
Those closest to development downtown, where the fragile momentum of revitalization can ill afford new obstacles, say it may take a year or more before everyone picks their way through the fine print and nuances of the complex tax legislation.
Still, at least initially, what seems likely to occur downtown is this:
- The rules of municipal and government financing will undergo a dramatic change. The Centre City Development Corp., the agency in charge of downtown redevelopment, will find it more difficult and possibly more expensive to sell the bonds it uses to pay for the bulk of its redevelopment work, ranging from the buying of the land it turns over to developers to the putting in of sewers.
- Large companies and corporations doing development business downtown will be relatively unaffected. Smaller developers who typically rely on limited real estate partnerships to finance their projects are expected to be hurt the most because the tax bill curbs most of the tax benefits attracting limited investors in the first place.
- The historic Gaslamp Quarter is expected to benefit from a loophole that retains special tax credits of up to 25%, making the 16 1/2-block section a potential island of plenty in the new landscape carved by the tax bill. The downside, however, is that the Gaslamp has typically relied on small-scale developers, who rely on limited partnerships for funding.
- Decisions on construction of high-rise office buildings--where overbuilding has caused vacancies of about 20%--will more than likely involve less debt, more equity and real returns on investment rather than being driven by tax shelters and paper losses.
“The first reaction to the tax changes was one of hysteria, the sky is falling. CPAs (certified public accountants) were running around like Chicken Little,” said Sanford Goodkin, founder of the La Jolla-based Goodkin Group, which advises developers on market conditions and building design.
“My own feeling is that it’s simply going to get the tax (shelter)-driven wheeler-dealer out and the (profit) deal-driven deal back in,” Goodkin said. “Tax shelters created a whole industry of tax-driven investments that were interested in the icing on the cake but which led to overbuilding the market in every city I can think of.
“Tax reform is more good news than bad news. It is bad for those who have to service a severe negative cash flow in their projects.”
For CCDC, the bill strikes at the agency’s traditional method of raising money through tax-free, tax-allocation bonds. The bonds are paid off by money coming from higher property taxes caused by new construction and business in designated redevelopment zones.
“Our bread and butter has been the sale of tax allocation bonds,” said CCDC assistant vice president Pamela Hamilton.
Since 1984, CCDC has sold about $39-million worth of tax allocation bonds, which it has used for a variety of expenses, such as acquiring land, building the Lyceum Theater, various public works-type improvements and helping subsidize housing and commercial projects.
“It didn’t matter how we used the proceeds (from the sale of the bonds),” Hamilton said. Under the new bill, however, it does.
The bill places restrictions on how bond money can be spent to the extent that major projects such as Horton Plaza would be extremely difficult, if not impossible, to finance through tax-free bonds in the future, redevelopment officials say.
Essentially, the tax bill puts CCDC’s bond financing into three categories instead of one, a more cumbersome process just by definition.
Though CCDC will still have the ability to issue tax-free bonds to pay for public improvements such as constructing sewers and streets, moving utility lines and installing street lights, it will have to get state permission to sell tax-free bonds for purposes such as buying land or relocating businesses.
The state will be working under a maximum bond-issue limit set by the federal bill for all of California. The cap is roughly estimated at $1.6 billion for next year, based on a per capita allocation formula.
As a practical matter, this means formerly tax-free bonds are now contingent on San Diego “standing in line and competing with L.A., San Francisco and Quail Hollow,” Hamilton said.
The third category puts CCDC in the same status as a private borrower. CCDC could issue taxable bonds, in which case it, and the public, would be forced to pay higher interest rates, or it could seek out a bank and apply for a loan like a regular corporate borrower.
“Financing for use is a whole new ball game. As we look at it today, it’s going to cost us more money to service our bond debt,” Hamilton said. “There are still a lot of uncertainties about the (state bond) volume and who is going to get what.”
CCDC can afford to wait because all of its current and proposed major projects have already been financed through previous tax-free bond sales. Its first bond sale under the new tax bill probably won’t come until sometime next year.
In Gaslamp, the retention of tax credits for the next three years, ranging from 25% to 10%, is expected to spur development, according to businessmen and Gaslamp officials.
“This will make Gaslamp a better investment deal than anywhere else in the county,” said Dan Pearson, a Gaslamp developer who is a partner in the new Horton Grand hotel. In fact, Pearson said, without the 20% tax credit he used in building the $12 million hotel, such a project would have been impossible.
Larry Monserrate, executive director of the Gaslamp Quarter Council, as well as other Gaslamp officials, are praising Rep. Jim Lowery (R-San Diego) for pushing through the continuance of the historic tax credit for the Gaslamp.
“Given the higher land costs down here and the delay in the convention center, without these incentives it would be very difficult to make the (dollar) numbers work for projects in the Gaslamp,” Monserrate said.
Despite the good news on tax credits, some people are worried the Gaslamp will suffer from other aspects of tax reform, principally from the curbs on limited real estate partnerships that many small-scale developers who work in Gaslamp rely on.
“If we had lost them both (tax credits and limited partnership tax shelters), we’d have been in trouble,” Monserrate said.
The bill hits limited investment partnerships by preventing investors--usually the affluent--from deducting losses on the partnerships against other income. Deductions from partnerships already in operation will be phased out over five years.
Real estate partnership losses may only be used to offset profit income from similar real estate investments, but may not be deducted against money earned from their primary jobs. The bill also imposes stricter rules on depreciation and stretches out depreciation timetables.
“While important, I don’t think most (Gaslamp) people are as upset with the loss of depreciation,” Pearson said.
Even while the shakeout from the tax bill takes place, some downtown advocates believe development downtown will continue without too much of a hitch.
“It’s going to take some rethinking, no doubt about that. The old tools people have relied on aren’t going to be there,” said Peter Davis, president of the Commerce Bank and a member of the CCDC board of directors, who supports the bill.
“If people have a desire to be downtown, people will find a way to do it,” he said. “San Diego is not going to be a ghost town.”
