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A Big Step

The city needed help fulfilling its downtown dream. So it asked Wall Street to take over. Is this a deal everyone can win?


“I’m a recovering lawyer, so if I talk too much, let me know,” Powell says, cracking a smile. “We had to sell this based on a profit motive. If the city were doing it, it would be subject to a lot of political agendas.”

Powell, an investment banker with Legg Mason, is describing the deal — and the resulting quasi-governmental body — that allowed all this to happen: the Broad Street Community Development Authority.

He sings its praises. Through the Broad Street CDA, the city could sell $66.7 million in municipal bonds — and get a big return. The money raised by selling the bonds will help transform a 10-block area of Broad, Grace and Marshall streets that most see as Richmond’s albatross. Old buildings will be knocked down. Parking will go up. Streetscapes will be revived and utilities will be expanded to accommodate the new plans for downtown. The city is getting millions of dollars in much-needed public improvements to go along with its shiny new convention center.

But the biggest payoff, he says — the cherry on top — is that the deal bears very little risk for the city. Instead, that’s shouldered by big, institutional investors who are paying for the bonds with private dollars. In exchange for a 7.6 percent return on their money, they’re footing the bill for the public improvements. Their payoff comes from fees generated by downtown parking and special taxes on property owners within the 10-block district downtown.

It seems that everybody wins: The city gets improvements. The private investors get money. But the deal is by no means a free ride.

Despite popular belief, the city is indeed bearing costs. The details are buried in the paperwork of the deal: Richmond must pay for $6.36 million in utility improvements, another $800,000 annually in appropriations and at least another $398,000 a year in parking revenue from a former city-owned parking garage that it handed over to the CDA. What’s more, Richmond is risking up to $3 million a year if the fees generated to pay off the bonds fall short.

All told, some $66.7 million in improvements will cost a total of $176 million during the next 30 years.

Aside from the costs, however, the deal represents a fundamental shift in how the city plans to rebuild its inner core in the years to come. Strapped with debt that leaves little room for big-ticket projects, Richmond increasingly must consider creative financing arrangements to make public improvements.

In the case of the CDA, that means allowing outside investors to take on the debt — and paying them handsomely for it. Richmond has, in essence, shifted a traditionally public function to the private sector. And that’s raising new kinds of public policy issues: Who’s in charge? Who’s taking on the risks? And who will reap the rewards?

“It comes down to accountability, risk and cost,” says John Accordino, a professor of urban studies at Virginia Commonwealth University. “Where’s the accountability of the contract and execution of what’s being agreed to? Will there be vigilant oversight as to how this gets done?”

In the past, if Richmond wanted to physically improve a section of the city, it would typically pay for the project in one of two ways. It could try to secure federal or state grants to offset the costs. Or it could go to the market and issue what are known as general obligation bonds, like those used to build the $160 million Richmond Convention Center. With the convention center, the city, along with Chesterfield and Henrico counties, agreed to pay off the debt by increasing hotel taxes.

With either choice — government funding or municipal bonds — Richmond bears the responsibility for paying the debt, overseeing the contracts for construction and monitoring the project as it moves along.

The Broad Street CDA represents a new, third choice. And this path changes everything. A board appointed by City Council to run the CDA — rather than the city itself — holds the debt and oversees the project. The CDA isn’t subject to some government-mandated requirements — such as public bids. And most importantly, the debt isn’t on the city’s books.

In this scenario, new players emerge. In this case it’s Chicago-based investor Gary A. Beller, the master developer contracted by the CDA to manage the work and spend the bond proceeds. Beller and his company, ECI Development Services, receive an overall fee, 5 percent of the total project cost, plus additional subfees and other money worked into the deal.

Suddenly, there’s a power shift.

“Basically, you’re trying to use private interest for a public purpose,” Accordino says. These kinds of public-private deals can be a good combination, he says; they work best when localities act as “shrewd businessmen” and aggressively push for the best deal. “If the city goes about it shrewdly, there’s no reason this can’t work.”

If it doesn’t work? There is potential for abuse that could wind up costing the city millions. The city’s goal is to protect the interest of taxpayers. Private investors are working to fatten their wallets. And in this case, Beller reports to the investors.

“This is the investors money,” he says. “We have a responsibility to manage this process on behalf of the investors and they expect us to do so.”

How shrewdly the city negotiated the project is open to debate. To weigh the deal, you have to go back to early 2000, when the city was starting a courtship with Beller.

In those days, momentum was growing to build a new downtown. The centerpiece was a 700,000-square-foot convention center, and construction had kicked into high gear. To support visions of bigger conventions and city sidewalks teeming with people, the city needed more hotel rooms — at least 200 more, consultants told officials. Richmond Renaissance, a public-private economic development group made up of local political, community and business leaders, began working with the city to create more hotel rooms.

But the city didn’t want to pay.

So Renaissance and city officials focused on ways to expand the Richmond Marriott by adding a second tower. They conducted a search for private developers who might be interested in taking on the project. They settled on Beller, an associate of Chicago real-estate magnate Sam Zell.

“Gary had already been in town sniffing around and actually made a proposal to us,” recalls John Bates, a business attorney with McGuireWoods who helped with the search. Beller had a resume full of experience in commercial real estate and had served as president of Equity Hotel Properties Inc., a company owned by Zell. In September 2001, Beller announced he would add a tower to the Marriott and build an upscale hotel across the street in the vacant Miller & Rhoads — and it would cost the city nothing.

“Isn’t this a heck of a deal?” Bates recalls thinking. “We’ve gotten our 500 rooms without any subsidy.”

The city had struck gold. Most cities across the country, many of them building their own new convention centers, were being forced to help pay for their new hotels. Typically, Bates says, the city picks up at least half the tab.

But the project shifted in a new direction in December 2001. Reeling from the aftermath of Sept. 11, the previous owners of the Richmond Marriott filed for bankruptcy. James A. Procaccianti, a businessman from Cranston, R.I., slipped in and outbid Beller, prying the hotel from bankruptcy court.

That left Beller with Miller & Rhoads. “He outbid me,” Beller says of Procaccianti. “He valued the property more than I did, obviously.”

So Procaccianti began work on the Marriott — so far he’s spent more than $10 million on improvements. And Beller is moving forward with Miller & Rhoads, he says.

While the city officials worked to get the high-profile projects on track — the convention center, the new and expanded hotels, the plan to make Thalhimers a performing-arts centerpiece — officials still needed to find money for the supporting public improvements.

Beller had an idea: Outsource the project by forming the Broad Street Community Development Authority. Community development authorities had become popular tools for funding public improvements in suburban retail projects. With the blessing of the locality, the CDA is given the authority to issue municipal bonds that pay for improvements to accommodate the project. Taxes generated by the new development pay off the bonds.

The technique isn’t typically used in urban settings. But Beller popped the question: Why not? With the help of Legg Mason and Powell, who had vast experience in setting up CDAs across the state, city officials decided to give it shot.

It wasn’t easy going at first.

The city formed the Community Development Authority in August 2002, and put together its first bond proposal to sell $95 million in bonds.

Investors didn’t bite, says Powell, for a couple of reasons: It was too costly because it included construction expenses for two new parking decks. Projections were too high considering the blighted state of downtown. And a sour economy — especially with war looming in Iraq – made the investment too risky.

So Powell and Beller tried again. In May 2003 they put together a more conservative bond package. They lowered projections, took out the parking garages and tried to reduce the risk. Potential investors seemed happier. But there was one thing missing: support from the city.

Investors generally feel more comfortable when localities share some risk by backing bonds — like co-signing for a loan.

But that wasn’t an option for Richmond. The city couldn’t afford to take on any more debt, explains Andrew Rountree, Richmond’s finance director. To maintain good standing with bond-rating agencies, the city sets a limit for itself: Bond debt can’t exceed 10 percent of its total budget. (For the most recent fiscal year, the city’s debt is about 9 percent of the $514 million budget.)

As an alternative, potential investors urged the city to agree to consider backing the debt through a “moral obligation.” The city agreed. Although the deal is not legally binding, the city promised that it would consider paying half of the annual debt payments — as much as $3 million of the $6 million — if the CDA can’t afford to make the payments. The city’s pledge would keep the debt off its books and give investors the security they wanted.

But if the city ever decided to turn its back on the debt, experts says, Richmond would lose credibility in the bond market and find it difficult to issue similar bonds in the future.

“I was none-too pleased about the city providing a moral obligation,” says Councilman Bill Pantele, who also chairs City Council’s economic development committee. “But on balance, looking at what we were getting, it seemed that those benefits clearly outweighed the contingent risk that we might have to provide some support for this.”

In late May 2003, the bonds sold.

Did the city get the best bang for its buck? Some wonder about the bond’s interest rate, how much money the city is giving up and what will happen if the CDA defaults.

Industry observers say the 7.6 percent interest rate on the bonds is much too high, and that with more prudence Legg Mason could have negotiated a better rate. After all, investors are taking on little risk. And according to an analysis of the bond proposal, investors are benefiting from a variety of existing, stable revenue streams:

ú There will be a $1 ticket surcharge at the Coliseum — or at a minimum, $400,000 from the Coliseum’s budget. The Carpenter Center has agreed to do the same, with a minimum of $150,000 a year.

ú The city will pay $250,000 a year to the CDA for the right to use 250 parking spaces for up to 20 special events a year. That comes to $50 per space per event.

ú As an annual fee, the Marriott Hotel and the future Miller & Rhoads hotel have agreed to pay $2.50 per rented room night, or a minimum of $256,788 a year for the Marriott and $124,173 for Miller & Rhoads.

ú Landowners in the downtown district will pay a flat real-estate fee of between 29 cents and 35 cents per square foot annually, which comes to $121,137.

ú $2.3 million in parking revenue from those parking decks that are currently operating — the decks at Seventh and Marshall and Fifth and Marshall — based on net revenue projected for 2004, assuming no increase in demand.

That’s $3.47 million — not including the money that the Miller & Rhoads hotel and the future parking lots are expected to generate. Add that to the city’s agreement to pay $3 million and the bond payments are more than covered.

So where’s the risk — and why is the interest rate so high at 7.6 percent?

The city should have gotten a better deal, says a local public finance banker who reviewed the CDA’s bond prospectus and spoke on the condition of anonymity. “Basically,” the person says, “the investors named their rate.”

If the city had considered morally backing all of the debt, the banker says, the CDA likely would have lowered its rate considerably, to around 6 percent or less, which would have reduced annual payments on the bonds by about $1 million.

William Harrell, deputy city manager and member of the CDA board, says that wasn’t an option. The city couldn’t afford to take on any more debt, he says. Harrell acknowledges that a lower interest rate could have been achieved through other kinds of funding, but that would have required the city to take on too much responsibility for the debt. “The city has competing resource needs: neighborhood structures, schools, all sorts of major funding interests,” he says. “We wanted to identify a strategy that would utilize private investment and preserve the city’s capital for other capital needs.”

Regardless, the local banker says the CDA didn’t explore its options thoroughly. In the original $94 million bond proposal, first floated late last year without city backing, Legg Mason projected an average 7 percent interest for the bonds. In the less-risky $66 million bond issue with city backing, the final interest rate increased to an average 7.6 percent. Meanwhile, across the board, interest rates in the municipal bond market were trending downward during the same period.

“They paid more money and have more risk than what they were told they were going to get,” the banker says. “Once the deal got done, they got the worst of all worlds: higher costs and contingent moral obligation. I think the city was sold a bill of goods.”

Officials in the economic development office say such a characterization is unfair. Because the CDA’s bonds are unrated, they were riskier and more susceptible to fluctuations in the economy — particularly the war in Iraq. The traditional municipal bond market is decidedly more stable.

Legg Mason’s Powell defends the interest rate too.

“When we finally got to market, the war in Iraq had made it very difficult,” he says. “I think the interest rate is the best rate we could have gotten.” Powell says they could have gotten a better interest rate if they had waited for the market to improve, but time was running out and they needed to hold the project together.

“It was a balancing act,” Powell says. “We brought together many, many property owners. We brought in investors of the Marriott hotel. We were able to keep the project from falling apart despite a lot of different political agendas.”

And there was no guarantee, says Powell, that the CDA’s master developer, Beller, would wait around for the city to get its act together.

Would another banking firm have approached the deal differently? That’s hard to tell, because insiders say proposals from other firms weren’t considered. Sources say that even Davenport & Co., which serves as the city’s financial adviser, wasn’t allowed to make a counter proposal.

James Trout, co-manager of Davenport’s public finance department, says he doesn’t know how the project was put together and wouldn’t comment on whether Davenport attempted to make a proposal for the CDA bonds. “I know that the transaction occurred,” he says. “I had no involvement.”

Harrell says neither the city, nor the CDA board, was heavily involved in securing an underwriter for the deal. Beller is the one who picked Legg Mason, he says, and that was his right.

Other investment bankers could have teamed up with developers and offered their own proposals when the original search for a downtown developer started years ago, says John Woodward, the city’s economic development director. All the complaining is sour grapes, he says. Legg Mason spent more than two years putting together the CDA, he says, and it had the expertise to make it work.

“You don’t sit back and say I’m going to pick an apple from this team and an orange from this team,” he says. Other investment firms “could have teamed up with a developer, and they didn’t.”

Even the most skeptical don’t foresee Richmond going bankrupt if it ends up paying back the CDA’s loan. And there is plenty of evidence to suggest the revenues generated by parking, along with the special real-estate assessment, will be sufficient to cover the debt even if the economy worsens.

The only way the city might get stuck holding the bag, says Edwin Gaskin, deputy director of economic development for the city, is if parking revenues don’t grow. That would mean the convention center had failed — and that’s a bigger problem than the CDA, he says. “That’s an almost apocalyptic scenario for downtown,” he says.

And, he adds, there are plenty of options for paying off the debt before the city would have to dip into its coffers. Plus, Gaskin counters, the city has saved $2.2 million a year by tearing down the 6th Street Marketplace and phasing out an expensive parking contract with the Richmond Marriott.

Every month, Beller and his local manager, Michael T. Laing, update the CDA board on its progress. The meetings are typically held at the Greater Richmond Chamber of Commerce office on Franklin Street in a drab conference room. The board members sit behind a small, rectangular card table, while Laing and Beller, and whoever else has business with the CDA that month, form a half-circle in plastic chairs.

Sometimes the meetings are contentious. Two weeks ago, the board chastised Laing and Beller for the first major cost overrun. Last week’s demolition of 6th Street Marketplace, it turned out, would cost about $800,000, or roughly twice as much as originally expected. The board wasn’t happy and demanded answers.

“How did we miss it by so much?” questioned Tim Watkins, the board’s chairman.

Beller and Laing reassured the board it was simple underestimation — it was a host of things, they say. It’s all part of the process. “Somewhere along the line we’ll be on the right side of this,” he said. “Sometimes we’ll be on the wrong side.”

Watkins and the other board members are probing, and they aren’t afraid to demand detailed explanations about how the money is being spent. At times, Watkins seems to play devil’s advocate purposefully.

“If I have to kick a little butt to get it done, so be it,” he says.

Whether or not the CDA becomes the city’s economic savior will largely be determined in this boardroom. In essence, the city hopes it can privatize some critical downtown development initiatives without taking on any more debt. Perhaps the money for a new baseball diamond in Shockoe Bottom could be raised this way. There is talk of starting another authority to beautify Jackson Ward.

The key, says Lynne B. Sagalyn, professor of planning and real estate development at Columbia University, is in the oversight.

“You have to ask what is the city’s interest in making sure that it’s getting what it’s contracting for,” Sagalyn says. “Where is the set of procedures of reports that assure the public interest is deliverable on the contracts?”

Rachel Weber, an assistant professor of urban planning at the University of Illinois at Chicago, says the idea of the quasi-governmental entities issuing bonds is rapidly gaining in popularity. But these CDAs change the rules. They aren’t subject to the same kinds of government and public scrutiny.

“It does sort of take the project out of the public sphere and the public scrutiny,” she says. “When you are kind of shifting responsibility, oftentimes they are not subject to the same kinds of rules. You’re kind of making up the rules as you go along.”

The authority officials say it’s covered. William Harrell, the deputy city manager, sits on the board and Woodward and Gaskin are ex-officio board members. The proof, however, will come two years from now — when improvements are scheduled to be complete and Beller is knee-deep in hotel construction.

And, of course, when the convention center is expected to begin churning out thousands of weekly visitors. S

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