More on Takoma Junction

The analysis I summarized in the previous blog post generated numerous responses from the public, the City, and the developer.  One central theme of the responses has been skepticism over my contention that the City is subsidizing the developer, NDC. What follows are my further comments on the debate for the Takoma Park City Council:

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Is Takoma Park Subsidizing NDC?

My preliminary answer was “yes.”  Compared to the lease given to the Takoma Park Co-Op, NDC was getting roughly $4.8 million of subsidized rent in the first 50 years ($1.8 million if a 5% discount rate were applied).

The City is adamant that no subsidy is occurring.  In its most recent “Questions and Answers” on the project (5 April 2018), the city insists: “The City of Takoma Park is NOT providing a subsidy to NDC.  The City of Takoma Park has NOT deeply discounted the lease rate for the property.”

I consider this a good sign, because it suggests that the City and I are on the same page about first principles:  This is a project that should not be subsidized.  As I said in my original paper and elaborate below, it will generate ordinary benefits that almost any redevelopment project on the property would, and therefore does not warrant special municipal financing.

Where we disagree is whether a subsidy is occurring. My argument was that the best data point we have for what the market value of a lease should be is what the Co-op is paying for its portion of the property.  Given that the Co-op is currently paying $21,800 for a fifth of an acre, the implied lease rate for the entire lot is $158,000 per year. A simple spread sheet (download here) comparing NDC’s actual payments with this implied market rate, shows that over 50 years NDC is underpaying $4.8 million ($1.8 million if the payments are discounted).

Keith Kozloff, a resident with some background in economics, dismisses this argument: “When trying to price a house for sale, real estate agents look for ‘comps’, that is, dwellings with the same number of bedrooms, etc.  The rent paid by the Co-op is not a comp.”  The problem with Kozloff’s argument, as I pointed out to him in private correspondence, is that there is no reasonable comp in the area. The City owns no other pieces of undeveloped land remotely approximating the size and location of Takoma Junction.  Given that, the best indicator of property value is what one real-world business—the Co-op—actually is paying for its portion of the property.

But if you’re skeptical, let’s undertake another calculation.  The City says now that the appraised value of the property in 2018 is $2.2 million.  What would an appropriate annual lease be for a generic $2.2 million piece of property in our region?   As a renter, Zillow says the property I live in nearby Silver Spring (2203 Quinton Road) has an estimated value of $543,392 and estimated monthly rent of $2,550.  A year of rent is $30,600 or about 5.6% of the valuation.  If we apply this standard to Takoma Junction, the fair market lease rate should be $123,000 per year.

There’s a difference, of course.  My lease is just for a few years, not 99 years.  Shouldn’t a 99-year lease lower the rent?  In fact, economists say just the opposite.  A 99-year lease is effectively ownership and should command a higher lease rate.  As real estate guru Kundan Bhaduri explains, “[I]n order to gain access to the 99-year lease period, you pay a lease premium up front to the freeholder [the landlord].  This is to compensate the freeholder for the ‘loss’ arising from not having his freehold property back for the next 99 years.  This premium is calculated based on the current freehold value of the property, what ground rent the landlord might earn over the next 99 years, and potentially what capital growth the property might see over the next 99 years.”[1]

I won’t speculate on what the “capital growth” of the Takoma Junction project could be over the next 99 years, except to note that my subsidy calculation assumes that the current market valuation of $158,000 stays constant over the next century.  In other words, my calculation significantly understates the likely capital improvement and the likely size of the subsidy.

The City’s explanation – “the initial lease rate of $10,000 is within the range of market rents in the DC region based on the assessed value of the property” – defies logic and the evidence.

After a long, barely comprehensible discussion of subsidies, Keith Kozloff’s missive to the City Council suggests that because NDC will be doing more with the land than the Co-op, it deserves a lower rate.  That also seems to be the logic of the City, as well as one Council Member with whom I’ve spoken:  NDC deserves a lower rate to compensate it for the investment its making in the property.

This, however, is the textbook definition of a subsidy.  The City is lowering market lease rate of its property to induce construction and development.

But Isn’t the Subsidy Worth It?

In its recent “Questions and Answers,” the City provides a long list of benefits that the Takoma Junction will provide.

Some are exaggerated.  Sure, the project will stimulate some commercial activity, but it also may drive out the district’s anchor tenant, the Co-op.  It will add a tiny number of offices and retail establishments.  As I noted, even if the Plan fully realizes all the benefits NDC claims, it will expand the City’s job base by 2.3% and its tax base by 0.8%. If the Co-op goes out of business and other businesses shut down because of rising rents, these gains will evaporate.

The claim that these new businesses will be “locally owned” is wishful thinking, as I pointed out previously.  The vague terms of NDC’s agreement with the City still allow national chains to be tenants.

Ditto for the small amount of public space provided, which is still under negotiation.

The other benefits – better aesthetics, stormwater management, environmental cleanup, etc. –would be generated by any responsible tenant of the land.

Some have misread my previous analysis as suggesting that the project carries no benefits.  What I said—and still maintain—is that the benefits are real but unextraordinary.  And certainly not worthy of a $5 million subsidy.

But What About the Tax Benefits?

If the City were being dispassionate about this project, it might acknowledge that NDC’s original claim of generating $200,000 of taxes per year was inflated by at least a third. Instead, the City and NDC won’t admit to the simplest of errors.

Take personal property taxes.  I pointed out that NDC’s suggestion that the project would generate $57,838 in personal property taxes each year could not possibly be true.  Why would a project expanding jobs by 2% increase the City’s personal property tax base by 17%?  To provide a sense of this mistake, I suggested that the City consider what the average contribution of the tax is per local employee, which would lead to a more reasonable prediction that NDC’s tenants would pay $7,580 per year.

The City takes me to task for suggesting that the personal tax is legally based on the number of employees —something I never wrote.  What I did write, and maintain, is that there’s no evidence that NDC’s project would generate eight times more tax dollars than other businesses in the City.

The Bottom Line

As I suggested previously, the City would be smart to rewrite its development agreement with NDC to include five provisions:

  • Insist that NDC provide more event space, so that the City can draw some public benefit from the project.
  • Charge a price for use of public land commensurate with what you are charging the Co-op.
  • Require that all NDC tenants be locally owned businesses or locally controlled nonprofits (and not franchises of national chains).[2]
  • Place reasonable rent restrictions on NDC, to prevent the project from raising commercial rents in the City.
  • Ensure that the Co-op parking and loading needs are fully met during and after construction.

While I applaud the City for striving not to subsidize NDC, I encourage you to be honest about the subsidy you seem committed to providing.  The hallmark of good government is transparency about government spending.

If you continue to insist that the market rate for leasing the property over the next ten years is $20,000 – instead of the $158,000 implied by the Co-op’s lease and other evidence – let me add a sixth recommendation.  Give the Co-op tax breaks over the next decade equivalent to what you apparently have overcharged it over the past two decades.  If NDC can lease the property over a decade at the same rate that the Co-op paid for one-seventh of the property, basic fairness suggests that the Co-op should receive several hundred thousand dollars in rebates from the City.

 

NOTES

[1] 5 August 2016, https://www.quora.com/How-does-99-year-lease-work .

[2] Some readers were uncomfortable with my recommendation that NDC only lease to companies owned by Takoma Park residents.  If that’s the case, then simply put explicit language in agreement that NDC is prohibited from leasing to national chains.

 

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10 Comments to “More on Takoma Junction”
  • Karen Elrich
    April 16, 2018 - Reply

    Great piece. Captures my thoughts and feelings on this issue. I use this to show to folks to give them an understanding of the broader issues of this development.
    Thanks Michael

  • Susanne Lowen
    April 16, 2018 - Reply

    The City of Takoma Park should accept that it’s subsiding NDC and, if they think it is justified, then defend the subsidy based on the benefits. If they would simply acknowledge the obvious, which Michael convincingly argues in this analysis, diminishes the City’s credibility. One is led to question whether they beholden to the developer in some way…why are they so determined to defend the NDC development plan when it doesn’t make sense on so many levels: economics, safety, local business, diversity/equity? Chiming in to thank Michael Shuman for lifting the veil on the economics behind the Junction development!

  • David Greenberg
    April 18, 2018 - Reply

    Michael- You mentioned that you do not live in Takoma Park. Are you being compensated by any third parties for your analysis regarding the Junction?

    • Michael Shuman
      April 19, 2018 - Reply

      No.

  • Tony Camilli
    April 18, 2018 - Reply

    Michael,

    Interesting analysis and I agree that the City is giving a subsidy in this development. but you missed the forest for the trees. The subsidy given by Takoma Park is to the Coop itself in the form of a 99-year monopoly from competition. Certainly an economist would agree that the Coop’s protection from competition is worth quite a bit, right?

    If you disagree, then please explain how you would value the Coop’s exclusive right to sell us overpriced groceries at the Junction for 99 years.

    • Michael Shuman
      April 19, 2018 - Reply

      I’m unaware of any City measure that proscribes other grocery stores in or near Takoma Park from setting up shop, so the Coop’s presence can hardly be deemed exclusive. If you find the groceries there overpriced (especially after taking into account annual dividends), then simply don’t shop there.

      • Tony Camilli
        April 24, 2018 - Reply

        Michael,

        Have you read the development agreement? Paragraph 4 states: “NDC will not lease any portion of the Project to another food co-operative (meaning
        a food distribution outlet organized as a co-operative) or grocery store (meaning a retail grocer or supermarket selling a large variety of food and household items,”

        So yes another grocery store can technically be built elsewhere in Takoma Park, but where else does a sizeable plot of land exist in the heart of the city to do so? Nowhere, especially since most of the center of TP cannot be changed due to the historic district (another failure in economic policy).

        So, I would appreciate it if you show your work as to how you might change your valuations of NDC’s subsidy to reflect its limited ability to contract with whatever tenant is wants to bring to the Junction.

        Here’s the link to the development agreement: https://documents.takomaparkmd.gov/initiatives/project-directory/Takoma-Junction/20160801-Development-Agreement-Executed-OCR.pdf

        • Michael Shuman
          April 24, 2018 - Reply

          Tony, context is important here. If the City Council believed that the Takoma Junction Redevelopment Project would put the Coop out of business, there wouldn’t be a single vote in support of it. Everyone understands that if the City is the gain net benefits from the Plan, every effort should be made to ensure that the Coop is not adversely effected.

          In that context, a non-compete clause in the development agreement is not only a no-brainer–it was absolutely essential to the Plan being approved.

          How does that effect the subsidy? Generally, the more conditions that the City puts on the development agreement, the more in subsidies that the developer will probably demand to proceed. But in this case, I also think NDC realized at the outset that leasing to competitor grocery store is off limits. Unless NDC had a secret plan to destroy the Coop (which I think is absurd), this condition had very little impact on the lease price.

  • Rick Weiss
    April 22, 2018 - Reply

    I appreciate this analysis. With the city thus (and repeatedly) notified of, and inadequately responsive to, its errors (at best) or its obfuscation (at worst), it should make it easier for plaintiffs once the lawsuits get launched.

    • Michael Shuman
      April 22, 2018 - Reply

      Absolutely. And it also might IMPEDE the City’s legal action if, for example, it complains about renting to a national chain retailer (which the City, incorrectly, believes is forbidden under the terms of the agreement).

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