Special Tax Districts for Development Are a Ticking Fiscal Time Bomb

The coronavirus-induced economic downturn is expected to take a colossal toll on local government budgets. The fiscal impact is especially going to hit those cities that are heavily reliant on one badly-disrupted industry or source of tax revenue (watch out, retail sales tax!) as well as those already deeply indebted and laden with unfunded maintenance liabilities from years of overbuilding infrastructure—as so many of our places have under the growth paradigm of the Suburban Experiment.

But in many U.S. metro areas, there's another fiscal ticking time bomb out there, other than city halls themselves. I'm referring to the special tax districts so often used to finance suburban expansion. Most people are a lot less aware of these, but they've gotten into big trouble in past recessions, and they're worth watching this time as well.

There are all sorts of special taxing districts in every state for such things as schools, hospitals, water authorities, but I'm referring to city-like entities set up by the developers of master-planned subdivisions specifically to fund the infrastructure and initial services for those subdivisions. In my state of Florida they're called Community Development Districts (CDDs), the term I will use here for convenience. In Colorado, they're Metro districts. Many other states have some equivalent.

Unlike a simple homeowners' association, a CDD has the governmental power to levy property taxes and issue municipal bonds. Without a CDD, a private developer must borrow money to build the streets, sidewalks, pipes, landscaping features and so forth for a new subdivision, and then recoup the costs by bundling them into the up-front price of the homes. A CDD can borrow money at lower cost because it issues bonds like a city would, and it then pays off the bonds by levying property taxes on the new development over 20 to 40 years, spreading the costs of new infrastructure over a long time and making it appear comparatively cheaper up front.

But you've got to actually build and sell the homes to reap the taxes. If a subdivision goes unfinished, lots go unsold, or property values tank, a CDD can quickly find itself unable to pay back bondholders. This is why in the Great Recession, these went bad in huge numbers. Florida was the epicenter: at the worst point, an astonishing 73 percent of Florida CDDs were in default. For residents, this meant finding your dream house marooned in a subdivision left half-finished, its opulent promises unmet. Stories like this one from the Tampa Bay Times were common around 2012 and 2013: 

Their "American nightmare,'' as Albert puts it, is the subdivision, River Bend, where they live. It has become a place where weeds have overtaken sidewalks and broken light poles dot the streets. A pool sits empty; the clubhouse remains half built.

"I can't adequately describe the feeling of driving by a builder's sign that clearly advertised your model for less than half of what you paid," Albert Davis recalled about watching his subdivision collapse. 

Few Checks on Reckless Suburban Overbuilding 

CDDs encourage reckless suburban overbuilding during boom times, because they make it possible to finance infrastructure at breathtaking scales. Without them, developers might be forced to proceed more cautiously and incrementally. But with them, you can lay out your grand vision for 20,000 homes on 16 square miles over 20 years, get it approved by the local authorities and get to building, racing the clock of the real-estate cycle. (Or, say, a global pandemic that causes demand for new homes to tank.)

In the worst-case scenarios, such as have occurred in Florida, the endgame is massive expanses of partially-built suburban landscapes with deeply insolvent governments. (Note that not all of the struggling places profiled in the linked articles had CDDs, which are a newer invention; the point is that CDDs are a tool to facilitate the outward expansion of suburbia at similarly mammoth scales.) 

Even aside from such spectacular flame-outs, CDD-like entities are known for corruption and unaccountability. There's a good chance that the state to watch this time is not Florida, but Colorado. 

A Denver Post exposé from December on metro districts is an absolutely stunning read. It describes how Colorado's metro districts have issued over $19 billion in debt, out of $1.2 trillion they are authorized to issue, in what has "virtually become the exclusive mechanism by which all new development occurs in Colorado today."

The process by which metro districts set budgets, issue bonds and establish tax rates is theoretically democratic, but in practice, these districts are accountable to the land owners—and in a newly-formed and mostly-unbuilt subdivision, most of the land at that point remains in the hands of the developer or people closely connected to the developer. The result is that metro districts function as proxies for the developers, and in some cases this leads to naked self-dealing:

For example, the developer-controlled Big Dry Creek Metropolitan District in Adams County in 2017 issued a pair of senior bonds totaling $11 million at about 6% interest to cover the costs of building its infrastructure. They were primarily sold to institutional investors and are to be paid over 30 years.

The district also issued junior bonds for $1.8 million at 9% interest, also for infrastructure costs.

The buyer of those junior bonds will see a $1.8 million investment become a $22 million payday, according to bond documents. That’s because no payments are scheduled to be made to its investors for at least 20 years, effectively ballooning the interest rate to 29.5%.

The junior-bond investor: Lennar Colorado, the builder of Big Dry Creek and its main subdivision known as Orchard Farms.

Of the five members of the district’s board of directors to approve the bonds and sale to the investor, two worked for Lennar and two others for the developer, TCIRATO LLC, according to conflict of interest statements filed with the Colorado secretary of state.

.... The Post found dozens of similar examples across the state, with developers buying a district’s tax-free junior bonds—essentially loaning themselves money at huge returns on the backs of future homeowners who buy into the development.

You should read the entire Denver Post piece.

Keeping the Growth Ponzi Scheme Going

A decade of low interest rates has left the U.S. awash in cheap credit with few high-returning investment vehicles. Because of this, development districts have been able to find buyers for the comparatively risky (and thus high-returning) bonds they issue, thus allowing the financing of development projects that make little sense on the underlying merits. 

In an August 2019 article titled ”’It’s Just Dirt’: Anything Goes in Today’s Muni Bond Market,” Bloomberg News described one such subdivision: 

Last month, a risky, new deal hit the municipal-bond market. It came from a small borrower in Colorado that was looking to finance the construction of 1,200 luxury homes in the foothills of the Rocky Mountains.

It was an odd time for such a project. Denver’s decade-long housing boom was beginning to show signs of cooling and, moreover, rival developers had already raised record sums to turn vast tracts of land into new communities. “There’s no houses to see,” said Nicholas Foley, a municipal-bond fund manager at Segall Bryant & Hamill in Denver. “It’s just dirt.”

No matter. The buy orders poured in anyway and, in the end, about $20 million worth of bonds had been sold for yields as low as 4.75% on 30-year maturities—similar to the rates that investors once only reserved for relatively risk-free market behemoths like California or New York.

The moral hazard here is intense. Investors looking for a vehicle to park their cash can bankroll grandiose development plans out of proportion to a place's actual local demand for homes. For a local government desperate for revenue itself, these special development districts give the seductive appearance of "free" growth. The developer builds all the infrastructure, incorporating its costs into the special district / CDD, and the city reaps the regular ad valorem property taxes for schools, police, fire, and other services.

When it goes bad, though, the local government is not truly off the hook. It bears a risk too. If a CDD defaults, but people are already living in the subdivisions it comprises, those people won't be abandoned—"Oh well, shouldn't have bought in that community." Someone will be expected to keep the streets paved and the streetlights on and the water flowing and the sewers intact. And as we've seen in annexation (read: suburban bailout) wars around the country, that someone is likely to be the local government.

Siloing off the costs of new development—"making growth pay for itself" in the framing so often used to justify these special development districts—does not actually solve the problem that the fundamental pattern of development does not pay for itself. If the public expense of maintaining infrastructure and services to a spread-out place is out of whack with the wealth that place is producing, someone is going to get burned.

Denton, Texas recently approved a special taxing district for a large suburban expansion during the coronavirus pandemic. The city manager's defense of the project (in response, I might add, to the principled objections of Strong Towns member Eric Pruett of Stronger Denton) is an object lesson in hubris:

City Manager Todd Hileman told council members that the city’s analysis of the project—which could take 40 years to bring 15,000 new homes and businesses to the west side—factored in the possibility of recession. 

Hileman said none of the agreements require the city’s current taxpayers to front money for public infrastructure for the developments to get off the ground.... Over the life of the project, the city expects more than $860 million in net benefits from the subdivisions, primarily because the homes built there would have higher valuations than current average home value.

And if they don't? If property values fall over 40 years? (Quick, check in on the subdivisions built in your area in 1980: how many are among your city's wealthiest neighborhoods today?)

And if all 15,000 aren't built?  

But don’t worry, “We factored in the possibility of recession.” Oh, okay. All good, then.

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