Making the Southwest Waterfront Bond Financing Act the Best Deal for the District of Columbia: Four Changes Could Potentially Save DC Millions

On July 1, the DC Council will hold its first vote (known as the “first reading”) on a bill to provide up to $198 million in District financial support to the Southwest Waterfront development project, a major component of efforts to re-shape the Anacostia Waterfront. The proposal also involves $95 million in District-owned land, bringing the total subsidy to nearly $300 million, one of the largest economic development subsidies in city history. In several ways, however, the design of the financing plan could make this project far more costly to the District than necessary.

There are a number of steps the Council can take when it considers this bill to reduce the impact on the city’s finances. The cumulative impact of these changes could be savings of $50 million and possibly far more. While it is important to find savings in any program or project undertaken by the city, it is especially important in this case because the Chief Financial Officer has indicated that the District has only a limited amount of new bonding authority for economic development projects, because of our already-high debt. If the city issues $198 million in debt for this project, it would have only $100 million in remaining debt capacity for such projects. Savings found in the Southwest Waterfront project would make it easier to fund other economic development projects.

Four steps the District can take to limit the costs of the Southwest Waterfront project are as follows:

  • Regain control of the land as cheaply as possible. The District owns the land but has issued long-term leases for it. The current plan to regain control of the land could be up to $46 million higher than if the city were to reclaim the land under the terms of the existing leases.
  • Use tax-exempt bonds – including general obligation bonds – to the fullest extent. The city’s subsidy will primarily fund infrastructure improvements – such as streets, sidewalks, and parks. These kinds of projects can be funded with tax-exempt general obligation bonds (GO bonds), the least expensive bonds for the city. Yet the current plan would finance none of the project with GO bonds and instead would use a mix of tax-exempt and taxable bonds that could have higher interest rates or other associated costs. Requiring the project to be financed as much as possible with GO bonds could save millions.
  • Require the CFO to conduct a “gap analysis” of the project to determine the amount needed to make the project feasible. As noted, the DC subsidy would cover infrastructure costs, yet it is not typical for local governments to pay for all infrastructure improvements in such projects. Instead, developers often pay some or all of these costs. The Southwest Waterfront financing legislation could be modified to limit the size of the DC subsidy to the amount needed to make the project financially feasible – with a cap of $198 million – rather than covering all infrastructure costs. The subsidy needed could be determined in an analysis by the CFO, but the current bill does not require such an analysis. It should.
  • Use only newly generated tax revenues from the site to fund the project. Most DC development projects tie the size of the subsidy to the amount of new tax revenues that the final project will generate. In the case of the Southwest Waterfront project, the financing plan would use all of these new revenues plus require a $4 million annual contribution from the city’s general fund.

Modifying the Southwest Waterfront financing legislation to reflect these changes would demonstrate the District’s commitment to this project while also ensuring that the project is fiscally responsible. Some may argue that these changes would add new steps that would slow the project, yet many other elements of the project have yet to be completed, including the land disposition, so it is unlikely that these changes would harm this multi-year development project. The legislation also could be modified to provide subsidies in stages, so that the first stage could proceed while other issues are resolved.

These issues are discussed in more detail below.

Regaining Control of the Land as Cheaply as Possible

The District does not control the land that will be used for the Southwest Waterfront project, and it will have to pay to do so. But the method it chooses to take control of the land would affect the costs significantly.

The land is owned by the District but currently being used by private entities under long-term (99 year) leases. Those leases include terms that allow the District to reclaim the land. Rather than pursue this option, the District plans to allow the developer of the new project to negotiate lease buy-backs from each leaseholder. This process gives greater deference to the existing leaseholder but it also is likely to result in costs that are $46 million higher than if the land were re-claimed under terms the leaseholders had originally agreed to, according to the CFO.

Given the substantial additional costs associated with negotiating the terminations of the lease, it would make sense for the District to regain control under the existing lease terms.

Using Tax Exempt Bonds to the Fullest Extent

The District subsidy for the Southwest Waterfront will cover infrastructure costs, which the city could finance using general obligation bonds, which are tax-exempt and the cheapest way of borrowing funds. Yet the proposed legislation would finance the project under two economic development programs – Tax Increment Financing (TIF) and Payment in Lieu of tax (PILOT) – that tend to have higher costs. Rather than pursuing this approach, the city should use general obligation bonds as much as possible.

Under the TIF and PILOT programs, some of the bonds could be taxable, with higher interest rates than tax-exempt bonds, and the District would be subject to certain financing expenses that are not present for GO bonds. For example, the CFO has indicated that the District would have to set aside up to $20 million in reserves if it uses TIF/PILOT financing, which it would not have to do if it used general obligation bonds.

For these reasons, the financing plan for the Southwest Waterfront project would be improved by requiring the city to use GO bonds to the fullest extent. While the District currently is working to develop a package that relies heavily on tax-exempt bonds, there is no requirement to do so, and as noted the current plans do not envision using GO bonds. The legislation could require the Deputy Mayor for Planning and Economic Development to offer an explanation if it chooses to use other types of bonds, and to identify the added costs associated with using non-GO bonds.

Utilizing general obligation bonds when possible for economic development projects is a recommendation from the CFO that was included in a letter to Mayor Fenty and the DC Council in June 2007.[1] If economic development projects are funded with general obligation bonds, it is possible that they would have to be included in the District’s six-year capital budget adopted each year, since GO bonds currently are tied to the capital budget. (Because the bonds would be repaid with taxes generated by each project, adding them to the capital budget should not affect the ability of the city to fund other projects in the capital budget.) The capital budget for FY 2009-FY 2014 has been approved already, which means the Southwest Waterfront project would have to be added either in a supplemental budget or included in the FY 2010-2015 capital plan that will be adopted next spring.

Requiring the CFO to Do a “Gap” Analysis

For any DC economic development project, the size of any subsidy from the District should be based on analysis that the developer would be unlikely to undertake the project without assistance from the city. For projects under DC’s existing Tax Increment Financing Law, the CFO is required to conduct such an analysis, but that is not how the subsidy for the Southwest Waterfront project has been set. The legislation would be strengthened if it were modified to require such an analysis.

Instead, the proposed $198 million subsidy for the Southwest Waterfront is based on the expected infrastructure costs for the project. Yet it is not typical for local governments to cover all infrastructure costs. Developers often are asked to pay for some or all of such costs.

Like other economic development projects, it would be advisable to modify the bill for the Southwest Waterfront Project to require an analysis by the CFO of the level of subsidy needed to make the project viable – that is, the amount needed to allow a developer to achieve a reasonable return – rather than to base the subsidy on the full infrastructure costs. This could help the District limit the costs of this project to the District.

Using Only Newly Generated Tax Revenues from the Project to Back the Subsidy

Most economic development projects in the District are designed so that the taxes generated by the completed project will cover the annual costs of repaying the bonds issued for the project, so that the project does not require tapping into the District’s general fund. Yet the structure of the Southwest Waterfront project would use $4 million in existing taxes being generated from the site of the project. The CFO has indicated that this cost must be built into DC’s budget.

Taking Steps to Make the Southwest Waterfront Project More Fiscally Beneficial to the District Should Not Affect the Project’s Progress

The intent of the Southwest Waterfront financing legislation is to make a clear commitment to this massive project from the District. Some may argue that the changes to the legislation proposed in this analysis would weaken the city’s commitment and thus affect the project’s future. But this is unlikely to be the case, for several reasons. Most important, the legislation still would authorize up to $198 million in financing for the project. It would require further analysis before the full District subsidy could be provided, but it would not deny any funding – unless the CFO determined that funding at that level is not needed to make the project viable.

Moreover, the Southwest Waterfront project is a multi-year development project that is still at a relatively early stage. Even if the bill is approved, the District will not provide any subsidy until several additional steps are taken. This means that there is a window of time to incorporate the modifications to the legislation proposed here.

  • The project is at a preliminary stage, and critical information is unknown: According to the CFO, several critical tasks in the development have not been completed, including rezoning, master planning, and permitting, and there are no final plans yet. This means that the full costs of the project and the full subsidy needs are unclear.
  • The developer has not lined up private financing commitments. While the District contemplates a nearly $300 million contribution, the developer has not yet secured funding from private investors to provide equity for the project, nor received commitments from financial institutions to lend money for the project.
  • It is not clear whether the District will be able to cover the subsidy costs.. Because the full scope of the project has not been determined, it is not clear how much it will generate in new taxes. This means that the CFO cannot determine whether the taxes will be sufficient to cover the cost of repaying debt issued for this project. The Office of the Deputy Mayor for Planning and Economic Development has indicated that it believes the project’s tax revenues will cover the bond repayment costs, but this has not been confirmed by the CFO, which must make the final financial determination.

The Southwest Waterfront Project Would Bring DC Close to Its Debt Limit

The agencies that rate municipal bonds utilize a number of financial measures and standards when setting each city or state’s bond rating. One set of standards are based on the level of the jurisdiction’s debt.

Based on these standards, the District’s CFO has recommended that the District set a goal of limiting debt so that debt payments are no more than 10 percent of its budget, and that debt payments should never be allowed to exceed 12 percent.

The District is now at a point where debt payments exceed 10 percent of the general fund budget and are close to the 12 percent recommended cap. To remain within the cap, the CFO recommended last year that the District issue no more than $1.5 billion in debt for economic development projects.

The Southwest Waterfront project would bring the city’s economic development debt to within $100 million of that cap, according to the CFO. If the costs of the project rise – if, for example, the cost to take control of the land increases -the project could place DC even closer to this cap. This means that approving the Southwest Waterfront Project would limit the District’s capacity to fund other economic development projects.

This suggests that the District should take steps to limit the costs of the Southwest Waterfront project, and that it should assess other economic development needs it may face in the near future before it approves this project.

[1] Letter from CFO Gandhi to Mayor Fenty and the DC Council, June 20, 2007, “Debt Burden and Borrowing Constraints” and accompanying “Background and Analysis” document.