COVER STORY, OCTOBER 2007

GOING PRIVATE WITH PUBLIC PROJECTS
Public need means more opportunities for private firms.
Douglas A. Praw

Praw

The tension between public infrastructure needs and the ability for municipalities to pay for those needs should garner significant attention as the housing and subprime loan crises continues. In light of mounting foreclosures and a stalled housing market, federal, state, and local governments are estimating billions of dollars in shortfalls for public projects that would have otherwise originated from property taxes.

Recent events have proved that our public infrastructure system is barely holding on. This is evidenced by the August 1, 2007 bridge collapse in Minneapolis and the response to the tanker fire that caused the off-ramp collapse in Oakland on April 27, 2007. There is also a consensus that our nation’s public school system is dysfunctional. Both systems are financed in part through the federal budget and in part through state budgets. The budgets will continue to thin as tax revenue, including property tax revenue, dwindles. As can be expected, the savior for the infrastructure shortfalls will end up being the private sector.

We are already starting to see that private development is picking up the tab for many of the things that government would otherwise traditionally fund. In fact, we are seeing private entities taking the bull by the horns to finance brownfield cleanup, schools, and the use and expansion of public transit through a focus on transit-oriented development.

Brownfields

Private developers in this private urbanism trend are doing the job of our public agencies as it relates to brownfield redevelopment. In California, if developers choose to retain a brownfield property after the site has been remediated, they normally use a homeowners’ or property owners’ association annual levy to pay for operation, maintenance and monitoring (OM&M) of the site. The developer is traditionally required to use cash or a bond to pay for OM&M with the California Department of Toxic Substances Control (DTSC). Developers can effectively retain the property and increase the project’s annual cash flow by forming a community facilities district (CFD) under the Mello-Roos Community Facilities Act of 1982 (the Mello-Roos Act). The CFD would finance, among other things, the performance of OM&M activities through the levy of special taxes by the CFD on the subsequent property owners of the redeveloped brownfield site. Redevelopment agencies often want an advisory role over the ongoing OM&M of the brownfield site. To facilitate its role, the redevelopment agency can form a tax-exempt organization, to whom the developer conveys the project site upon initial remediation. The tax-exempt organization would be responsible for (i) the administration of the OM&M, (ii) renewal of environmental liability insurance, and (iii) enforcement of the covenants, conditions and restrictions protecting the brownfield site. Such services will be paid by the annual special taxes levied by the CFD, with a backup of homeowner or property owner assessments. Again, the funding comes from the landowners who pay the special taxes to the tax-exempt organization responsible for such activities. The public entities are effectively out of the equation and are not required or obligated to commit public funds to the maintenance of the brownfield.

Schools

Good schools can help to revitalize a neighborhood, and bad schools cause neighbors to leave a neighborhood. Developers have an incentive to include new schools within their developments and justify premiums associated with the residential units within the project if there are new schools or if homeowner’s children get preferential treatment for schooling. The schools are funded through a combination of development fees, residential property taxes, commercial sales taxes and state funding, but ultimately it is the homeowner or the developer that pays the price of the school facilities. Some developers are even taking the next step and creating model school communities in which full school districts are built to cater to the students within the development. The benefit to the developer is the increase in control over the design and location of the school, and the developer can build a structure that integrates well with the overall aesthetics of the surrounding development. The advantage to school districts may be that the developer provides the resources and handles much of the construction process. The developer also bears the costs and takes the risk that it would be repaid through a land-secured financing mechanism or other means, but developer built schools otherwise alleviate the school district’s burden and put less pressure on school districts with already tight budgets.

Transit-Oriented Development

Finally, while the residents of Los Angeles or other car-obsessed cities may not like leaving their cars at home, communities and businesses throughout the nation are encouraging folks to use mass transit. Transit-oriented development — or, in other words, development that is situated near or around access points for public transportation — is along with “green” the new buzzword. Unfortunately there are a number of transit-oriented developments either under construction or fully completed that are lacking the transit portion of the development. Private developers have taken the lead on constructing mixed-use development that expands pedestrian options and complements residential use with commercial use. However, bus systems, train systems or light rails are noticeably absent from the current development and in some cases decades behind. It is unclear at this stage whether private developers are willing to jump into the construction of public transportation. There are financing mechanisms that developers could leverage to make these public systems a reality.

Hopefully, the housing crises are more like a short-term batting slump. Even if it is prolonged, the push for the privatization of public services and infrastructure will continue as long as private development, albeit begrudgingly, pays the freight.

Douglas A. Praw is an associate for Goodwin Procter LLP in Los Angeles.


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