Dubious Deal

The city's TIRZ policy is increasingly controversial: On July 20, 1,200 people protested a proposed TIRZ for the Memorial City area.

If developer Greg Baxter never gets a dime of the $10 million in public money he needs to carry out his City Park project along White Oak Bayou, it won't be because city officials didn't try.

Last December, City Council agreed to commit future property tax revenues from Baxter's planned development — an apartment complex and a shopping center — to finance public improvements, including the extension of East T.C. Jester Boulevard through the near-north Houston site.

But a few months later, it was learned that Baxter had misrepresented to city planning officials the environmental condition of his land, a former oil and gas field. Then county commissioners notified Baxter that they weren't interested in subsidizing his venture with $2.4 million of future county property taxes.

On April 21, Houston planning director Bob Litke sent a memo to Mayor Lee Brown, recommending that City Council withdraw its support and "allow this development to get built, if at all, through normal private sector processes."

Litke told Brown that state and federal regulators had determined that Baxter's environmental testing of the site was flawed. He also advised the mayor that without the county's participation there wouldn't be enough money to pay for the renovation of a neighborhood baseball park that Baxter had promised area residents.

"[I]t would be difficult to justify reducing the project costs by eliminating the park improvements in the plan to make the numbers work," Litke wrote to Brown.

Less than two weeks later, though, Litke reversed field again. In another memo to Brown, Litke said the developer and "various" Baxter consultants satisfied him that the site was environmentally safe. Litke also said Baxter had reworked his financial plan to accommodate all the promised public improvements without the county's participation.

None of this, however, appears to be true. At the time, Baxter still hadn't provided additional soil samples requested by the federal Environmental Protection Agency. And Baxter's new financing plan seemed to work, not because the developer found additional funding, but because his consultants arbitrarily increased their estimates of how the redevelopment would affect the taxable value of the land.

Here's how they did it: When City Councilmembers originally approved Baxter's project, they agreed to create a tax-increment reinvestment zone, or TIRZ. Property taxes collected above the current amount would go not to the city, the county and Houston Independent School District, but to a special fund for 20 years. The City Park "redevelopment authority," a nonprofit corporation whose board members are appointed by City Council, would sell tax-exempt revenue bonds to generate some $5.5 million for public improvements within the zone.

Baxter would use that funding to help develop the land, which, according to his financial consultant's estimates, would raise its taxable value from $1.5 million to $31.5 million by 2002. By 2018, that additional $30 million in value would generate about $9.9 million in new property tax revenues, which would be used by the redevelopment authority to pay off the bonds. After that, the property goes back on the tax books, and the city, county and school district begin reaping the revenue benefits of the City Park development.

When Harris County declined to divert future property tax increases, that created a shortfall that would make it impossible to cover the bond debt. The most immediate solution was to revise the property value estimates, which is exactly what Baxter's financial consultants did. For no other apparent reason, they raised the projected value of the City Park redevelopment from $31.5 million to $35.3 million and extended the life of the zone from 20 to 30 years. That more than covered (on paper, anyway) the $2.4 million Baxter wouldn't be receiving from Harris County.

Mayor Lee Brown agreed to delay a vote on the project until next week, to give councilmembers more time to study Baxter's latest figures.

However, Baxter's financial sleight of hand appears to be paying off. Litke has recommended that Council approve the City Park plan.

Brown's postponement of action on City Park was a rare pause in the torrent of TIRZ activity on Council's agenda in the past six weeks. Since June, the Brown administration has created five new tax-increment zones and nearly tripled the size of another. More than half of the 17 TIRZs created by the city since 1990 have been approved in the last 12 months, and three more will be considered by the end of the summer, a pace that has some elected officials suddenly worried that the city may be abusing tax-increment reinvestment.

While the long-term benefit to taxpayers can only be guessed at, the city's TIRZ policy has spawned a thriving cottage industry among a small circle of land planners, public-finance lawyers and bond attorneys. Armed with an intimate knowledge of the state TIRZ law, a complex statute that lends itself to broad interpretation, these consultants have become a direct conduit between the city's real estate developers and its elected officials.  

Lately the connection has seemed particularly tawdry. Last month, for example, City Council approved a TIRZ for Metro National Corporation, which owns the Memorial City Mall. At a heated public meeting that drew 1,200 opponents of the TIRZ, one astute individual presented a blow-up of recently filed campaign reports: In the previous two weeks, Mayor Lee Brown had received more than $30,000 from Metro National executives and the consultants who prepared the corporation's TIRZ proposal. A half-dozen councilmembers had also received contributions from Metro National and its consultants.

The following day, despite the dissent of a few councilmembers, the Memorial City TIRZ was approved, as were zones requested by the Uptown Houston Improvement District, which represents Galleria-area property owners, and the Upper Kirby District Association.

The city's sudden urge to subsidize new development in those bustling commercial corridors has angered County Commissioner Steve Radack, who has asked county attorneys to have Texas Attorney General John Cornyn clarify the Tax Increment Financing Act, which authorizes the creation of a TIRZ.

In a letter to Cornyn, first assistant county attorney Michael Stafford pointed out that the Texas Constitution restricts TIRZ projects to "unproductive, underdeveloped or blighted" areas of the city, but that the precise definition of what constitutes such an area is "conspicuously absent" from the state law.

Indeed, the inconsistency has created a loophole that the Brown administration has, as Councilmember Rob Todd put it recently, "driven a mall through." Michael Stevens, an advisor to former mayor Bob Lanier, who exercised a decidedly more judicious TIRZ policy, says "a number" of the tax-increment zones created by Brown don't seem to fit the criteria of state law.

"Once you do that, you are taking away tax revenues rather than giving the city the option of spending it on the other things the city needs to spend money on," says Stevens, who negotiated most of the subsidies given to private developers during the Lanier administration. "The problem is that ten years from now, if you didn't do the TIRZ and the area continued to grow, you would have that revenue to do whatever the city deemed appropriate."

If there ever was a time in Houston's history when real estate developers didn't need a subsidy before getting out of bed in the morning, it's now: Interest rates are low, the job market is solid, and the stock market is at an all-time high. That has combined to generate some of the highest real estate values in Houston's history.

Moreover, few people would argue that taxpayer-funded projects such as the Rice Hotel renovation and the downtown baseball stadium haven't provided plenty of incentive for private development. Yet the Brown administration has nearly doubled — to almost $2 billion — the amount of future property tax revenues that could be diverted away from city, county and HISD coffers to TIRZ projects in the next 30 years. If all proposed zones are passed by Council in the coming weeks, more than 6 percent of the city's taxable land will be inside a tax-increment reinvestment zone.

Under the state Tax Increment Financing Act, no more than 15 percent of a city's land can be inside a TIRZ. But Brown's aggressive use of tax-increment reinvestment suggests some city officials may see that figure as a goal rather than a cap.

Do TIRZs work? That's hard to say, especially in Houston, where most of the zones haven't been in existence long enough to produce much additional property values. Tim Wooten, of the property tax division of the state comptroller's office, says no one knows if tax-increment reinvestment works. While stressing that he is not taking a position on the issue, Wooten says elected officials should demand some analysis of the costs and benefits of a TIRZ before setting policy.

"If I was a decision maker," Wooten says, "and I could participate in these or not participate, I would commission a cost-benefit analysis to show: Will the taxes I'm forgoing in the near term at least be offset — it really should be more than offset — by the enhanced taxes I'm going to receive, long-term? If such is not the case, I would be a little crazy to get into one of these deals."

To be sure, the economics of tax-increment reinvestment are daunting. They are also, of course, based on speculation. The only certainty is that any number of factors could precipitate a downturn in the economy that could have a serious effect on a TIRZ project's finances. After all, TIRZs are typically set up for 30 years. In the past three decades, Houston has experienced three significant economic slumps, the latest of which the city is still dealing with to some degree.  

Predicting the long-term value of a tax-increment zone, or any other piece of real estate for that matter, is risky, says Jim Robinson, chief of the Harris County Appraisal District.

"We wish it was possible, but we have difficulty doing projections five years out," Robinson says. "When you get down to it, even trying to predict what values are going to be beyond next year, it gets a little like using a Ouija board."

Yet if there's one thing all TIRZ financing plans have in common, it is that they are almost absurdly optimistic. They all assume property values will rise and remain high for the next 30 years, resulting in more than enough new tax revenues to pay the project costs. There are no alternative scenarios.

Most plans back into their financial projections by first deciding how much money is needed, then adjusting the estimated new value to be generated by the redevelopment project accordingly. One common tactic is known as "front-end loading," cramming most of the projected increases in taxable value into the first few years of the 30-year financing plan.

An example is a recent revision of the Gulfgate Mall TIRZ. Last month the Brown administration expanded the zone to include additional property surrounding the mall that is currently valued at roughly $12 million. According to the developer, Ed Wulfe, more than $45 million in additional value will be created on that property by the year 2004, resulting in an annual increment of nearly $700,000. By 2027, the redevelopment is estimated to produce $20.5 million in additional tax revenues, all of which will be pledged to pay off bonds sold to fund the public improvements.

The trouble is, Wulfe's projections assume not only that the redevelopment will create enormous new value in a down-at-the-heels part of town, but that the project will come off without a hitch. If that's true, one question that needs to be asked is, If there is no downside to TIRZ projects, why are subsidies needed to carry them out?

The answer, it seems, is because developers say they cannot afford it otherwise. That's because the city has long neglected the basics — streets, sewers and utilities — which now need extensive repair and upgrade. Another problem was the city's failure to implement a development code until the 1980s, which encouraged shortsighted development that has made it difficult to launch new projects.

"You can say, 'Why don't the developers pay for it?' But the reality is they can't," says Robert Randolph, a municipal-finance lawyer with Vinson & Elkins. "The money is not there to pay for it, and whether the fault lies in local government not requiring developers to plan the streets at the time an area was developed, the problem is there now, and there's no way to fix it."

Tax-increment reinvestment was among the tools used by former mayor Bob Lanier to reverse the 25-year trend of Houston losing residents and businesses to other parts of the county.

Lanier resisted creating TIRZs until a group of landowners from Midtown, 800 acres of abandoned buildings and vacant lots between downtown and the medical center, approached him with a plan in 1994. Today, it's difficult to deny the transformation going on in Midtown. Four large apartment complexes, totaling more than 1,800 units, and two retail centers are under construction. Dozens of town homes are planned, or already under way, in the eastern part of the TIRZ, as is plenty of commercial construction throughout the zone.

It's difficult to predict whether this boom would have occurred on its own. Certainly there was no evidence that anyone was anxious to tear into Midtown before Lanier turned it into a TIRZ. That, in time, might have changed: Metro and the city had already planned $50 million worth of streets, storm sewers, water lines, bus shelters, landscaping and sidewalks.

No doubt the TIRZ accelerated the public works, and with most of the heavy lifting being done by Metro and the city, the Midtown TIRZ could focus on specific amenities for developers. According to city records, the TIRZ is paying for landscaping and irrigation, pedestrian lighting, trees, fencing and brick sidewalks. The TIRZ has also picked up the tab on hundreds of thousands of dollars in impact fees. While these could, in some sense, be considered "public improvements," they also make the complexes more marketable, and therefore more profitable, for the developers.

But that's part of the "synergy" that makes tax-increment reinvestment so wonderful, says Charles LeBlanc, executive director for the Midtown Redevelopment Authority, the nonprofit corporation that oversees the TIRZ.  

"This zone has been very proud of its accomplishments," LeBlanc says. "The proof is in the pudding. We're exceeding expectations."

The apparent success in Midtown might be the shining light of the city's use of tax-increment reinvestment, but some of the zone's corporate behavior is, at times, a little shadowy.

Until last March, the Midtown Redevelopment Authority was chaired by Doug Williams, the deputy special assistant for housing and inner-city revitalization under Lanier. Since Brown has been mayor, Williams has had a consulting arrangement with the quasi-public Houston Housing Finance Corporation. Though he's paid with public funds, Williams is not considered a city employee.

That distinction became important to Williams when he hired on as a paid consultant to Columbus Realty and Camden Property Trust, both of which had development agreements with the Midtown Redevelopment Authority. While that might appear to pose a conflict of interest, Charles LeBlanc says Williams didn't advise the developers on their Midtown projects, nor did he participate in any board discussions involving their development agreements.

"Mr. Williams would leave the room — completely," LeBlanc says. "Most of the time, I don't even think he attended the meetings if they were on the agenda."

Likewise, LeBlanc insists it was made "very clear" to the Midtown board that its legal counsel, Robert Randolph, the V&E municipal-finance attorney, owned an interest in land inside the TIRZ, including a parcel that was sold to an apartment developer in 1997.

None of these potential conflicts were reported to councilmembers. That's not surprising: Once a TIRZ is formed and a redevelopment board chosen, the only responsibility left to councilmembers is to approve TIRZ budgets every year. While most councilmembers say they don't have a problem with the arrangement, maybe they're just used to it. Some elected officials aren't convinced it is good public policy, though.

"It takes government money out of the hands of the government and puts it into the hands of these boards. I have real problem with that," says County Commissioner Steve Radack, who has found much to dislike with the city's TIRZ policy. "When elected officials send authority somewhere else, where that board is not answerable to the public through the voting system, then I think you're asking for trouble."

Indeed, redevelopment boards are subject to very little oversight and are free to dole out management and development contracts without first taking bids. Moreover, thanks to a recent change in the state TIRZ law, redevelopment authority board members aren't public officials and therefore aren't accountable to taxpayers.

Not surprisingly, perhaps, the chapter of the state law that governs redevelopment authorities was authored by Robert Randolph, who, as it happens, provides contract legal services to more than half of the city's 17 existing TIRZs. According to state ethics commission records, he also lobbies the state Legislature on behalf of a half-dozen tax-increment zones.

State Representative Garnett Coleman, whose inner-city district includes the Midtown and Market Square TIRZs, says Randolph has written many of the tax-increment reinvestment-related bills the legislator has sponsored.

"Robert Randolph is a genius," Coleman says, "and his genius has worked very well to really create some good opportunities at a time when there were no opportunities."

With Coleman's enthusiastic support, Randolph has helped shape the TIRZ law to address a wide range of problems far beyond its original intent to redevelop "unproductive, underdeveloped or blighted" urban areas. In particular, the Brown administration has taken aim at so-called major activity centers such as the Galleria and Memorial City. The theory is that by subsidizing new streets and other public improvements, TIRZs will spawn new office buildings and retail shopping outlets.

"If the city wants to maintain places like the Galleria and Memorial City as healthy and viable," Randolph says, "they have to put the streets in. There's not going to be anyone else to do it."

It's a little ironic that Randolph is now trying to protect the city's tax base by encouraging taxpayer-funded redevelopment of shopping malls. In 1995, Randolph and his V&E partner, Joe B. Allen, lobbied the Lanier administration to cut "industrial district" contracts with four petrochemical companies rather than annex their land, a deal that cost the city $30 million in property tax revenue.

During the last legislative session, while Randolph was writing amendments to the state law, Allen was lobbying for Enron. Among his interests was creation of a management district for east downtown, including land that Enron was in the process of purchasing. Last month, City Council approved that land for the East Down-town TIRZ. Plans for the zone include $15 million in street and infrastructure improvements east of Enron Field.  

In a letter to city officials urging approval of the TIRZ, Enron vice president Stephen Barth wrote that the zone was "essential in supporting our effort to attract high-end developers to this area."

One of those potential "high-end developers" is the Mills Corporation, which has been negotiating with Enron to develop an open-air retail project east of Enron Field. Mills is the developer of the Katy Mills megamall, which, according to Randolph and other TIRZ supporters, will be a serious threat to the Galleria and Memorial City Mall when it opens in the fall.

It should be noted, however, that the city sold the taxing rights to 408 acres of its extraterritorial jurisdiction to the city of Katy less than two years ago so Mills would have the land to build its mall. It was an unusual transaction, and not only because the city let the land go for a measly $1.25 million. The Mills lobbyist was none other than Randolph's partner, Joe B. Allen, who convinced City Council not to seek future sales tax revenue generated by Katy Mills as part of the land sale.

Randolph isn't the only hired gun touting the widespread use of tax-increment reinvestment. Two of the most visible players are Patricia Knudson and David Hawes, former city employees who have each formed a business that shops tax-increment reinvestment to wealthy property owners who want to carry out large-scale construction projects. Knudson and Hawes specialize in identifying tracts of land that might be eligible for a TIRZ then preparing project plans that include a certain amount of public improvements.

The plans are then presented to the city planning department for evaluation before going to City Council. Since the city created its first TIRZ in 1990, Council has yet to reject any of the the planning department's recommendations. That's good for Knudson and Hawes: Invariably, once a redevelopment authority board is appointed, their familiarity with the project plan makes them logical candidates to manage the day-to-day operation of the TIRZ. Depending on the size of the zone and the scope of the redevelopment planned, they earn fees ranging from $5,000 to $10,000 a month for their services.

Knudson actually wrote the city's first TIRZ policy, back in 1989, when she was director of the planning department. She never saw it carried out, though, at least not as a city employee. In October 1990, Knudson resigned after admitting to then-mayor Kathy Whitmire that she had accepted money from a city contractor.

She immediately formed her own business managing special taxing districts, including tax-increment zones and public-improvement districts. One of her first clients was Robert Silvers, who had approached the planning department with a redevelopment proposal while Knudson was still director. The Lamar Terrace TIRZ was approved by City Council in December 1990, two months after Knudson resigned from the city.

In 1993, Silvers sued Knudson, Fulbright & Jaworski lawyer Charles Williams and urban planner Peter Brown for breach of contract. He claimed that delays caused by the consultants had damaged the project's viability and drained its budget. The case never made it to trial, and, according to sources familiar with the outcome, was settled recently for about $2 million.

Neither Silvers nor Knudson would comment on the suit, though Knudson did acknowledge that she paid a portion of the settlement.

When Lee Brown became mayor in January 1998, he vowed that there wasn't anything he wouldn't do for Houston's neighborhoods. These days that promise is ringing hollow among the residents of subdivisions that border two tax-increment zones, City Park and Memorial City.

Their opposition to the proposed projects is understandable: The City Park site includes acres of open space that serve as a neighborhood park. As well, the planned apartment complex and grocery would eliminate the natural buffer between their homes and flood-prone White Oak Bayou. Residents who live near the Memorial City Mall fear that the $1 billion in private development anticipated by the mall's owner, Metro National, will create even more traffic in their congested neighborhoods.

Civic group presidents in both areas suggest privately that they may take legal action to halt the TIRZ projects from moving forward.

In fact, a lawsuit may already be having an negative impact on the Gulfgate Mall TIRZ.

In March 1999, Husein Ali, a 34-year-old native of Bombay, sued Houston Gulfgate, Inc. The joint venture was formed by developer Ed Wulfe and the Houston Housing Finance Corporation to redevelop Gulfgate Shopping City into a 550,000-square-foot "power center." In December 1997, City Council created a TIRZ to finance $6.5 million in public improvements to the area.

Earlier in 1997, Ali signed a five-year lease for 1,000 square feet in the Gulfgate mall and spent $150,000 transforming it from a clothing store to a cookie shop.  

It was a risk. Gulfgate Shopping City was 43 years old and had long been in decline. Still, Ali says, the mall continued to draw customers, and besides, there was no cookie store. Even after such major tenants as Dillard's and Service Merchandise moved out, Ali was doing all right with his dough — making about $4,000 a month in sales, he says.

But that changed last January. Without warning, Wulfe terminated the leases of about 30 tenants, effectively shutting the mall down and decimating Ali's customer base. Wulfe says the tenants' spaces had to be vacated because of required asbestos-removal work.

Ali, who is married and has a three-year-old daughter, says he called Wulfe Management Co., the mall's leasing agent, and asked to negotiate a lease buyout. The offer was refused.

By March, traffic at the mall was so dismal that Ali was down to selling about $50 worth of cookies a day. He had to close his store.

Wulfe all but admits he knew Ali's business would fail and that, in fact, he was counting on it. He says the company would have paid him off had it needed to end his lease. That might appear to be the best thing for Ali. Not so, says the developer.

"Rather than having to face x-number of years left on his lease, which was his legal obligation, we're doing him a favor by letting him out of his obligation," Wulfe says.

A court will now decide what was legally right. Ali sued Wulfe, Houston Gulfgate Partners and the Gulfgate Redevelopment Authority, the city-created nonprofit that oversees the TIRZ.

Ali isn't asking for much — just the $150,000 he invested in build-out costs and equipment.

"When I first came to this country, I was worked 100 hours a week, easy, the first seven to eight years," says Ali, who has a small jewelry shop in Northwest Mall. "I think I took three or four days off the whole time. But that's how it is: When you leave your own country for another, you just can't sit around."

Wulfe's attorneys have asked the court to dismiss Ali's lawsuit. A hearing has been set for September. In the meantime, Ali's attorney has attached an order against Gulfgate mall, meaning any judgment rendered against Wulfe and Houston Gulfgate Partners would be enforceable against the property.

That legal action could impact a $40 million construction loan Houston Gulfgate is seeking. It could also hold up a $5 million loan that the Gulfgate Redevelopment Authority needs to purchase the mall from Gulfgate Partners.

And Wulfe admits he's having trouble marketing the mall. Since purchasing the property almost 18 months ago, he has yet to secure a major anchor tenant. Until he does, what exactly he will do to the Gulfgate mall is up in the air.

"Everything is driven by anchor tenants," Wulfe says. "That determines what happens in terms of what we build, what we demolish or whatever."

Wulfe's track record shows earlier successes. In 1993, he bought the Meyerland Mall from the Resolution Trust Corporation, which took over the assets held by failed savings-and-loan associations. Wulfe tore down some of the mall and redeveloped it into a thriving shopping center. Perhaps because he was using his own money, Wulfe didn't terminate any leases, nor did he buy anyone out to make room for the renovation. A few years ago, he sold Meyerland, reportedly for $80 million.

Wulfe says that "ultimately" the Gulfgate redevelopment will happen as well. Until then, the city has upped the taxpayers' stake in the deal. Last month, Council approved a 185-acre expansion to the TIRZ to help redevelopment of blighted commercial properties adjacent to the mall. According to Wulfe's revised project plan, the additional $4.6 million in public improvements planned for the expansion will protect the public's original $14 million investment.

"By and large, the thing that was most frightening was the neighborhood, which was really in very bad condition, blighted, run-down," Wulfe says. "The demographics show the average income is very low, low to moderate. We need to lift up the entire area."

If the project works, it's a pretty good deal for Ed Wulfe. According to his TIRZ development agreement, Wulfe will lease the mall for $1 a year for 50 years, receive a $500,000 development fee and, as "exclusive" leasing agent, will command a fee of $4 per square foot. He'll also be paid an $8,000 monthly "management" fee.

As for Husein Ali, he's making ends meet with his jewelry business while his court case continues. He says it'll be a while before he recovers from the Gulfgate cookie-store fiasco.  

"My wife wanted to buy a house," says Ali, "but I put all of our money into the cookie store. I was there day and night for a month to build that store. It's bigger than money to me."

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