Tuesday, March 07, 2017

An Alternative to 'Synthetic' Local Economies

An Alternative to 'Synthetic' Local Economies

by Jason Arp
reprinted with permission from Indiana Policy Review

Government-run economic development entities are having a difficult time replicating the real thing.

News stories from around Indiana point to problems related to creating what I call synthetic economies: The Muncie building commissioner is charged with wire fraud, theft and money-laundering; a Marion tax district lost $2.5 million on a failed hotel project; Crawfordsville and Montgomery County defunded their economic development corporations; the Angola Herald-Republican filed a public access complaint against the Steuben County Economic Development Commission.

And these hiccups aren’t confined to Indiana. The Florida House recently voted to eliminate Enterprise Florida, its equivalent to our Indiana Economic Development Corporation.

Despite myriad variations and convoluted machinations, the problems of supply, demand and price in free exchange cannot be solved by a system of bureaucratic agencies trading in other people’s money. These systems are rife with the complacency and nonchalance of those who have none of their own capital at stake as gatekeepers, bookkeepers and paymasters.

The weakness of the government-funded economic development model is laid bare by its own example. In my city in the last three years, we have seen three progressively more egregious public-private "partnerships" in our downtown.

In even the least preposterous of these the government-funded portion of the transaction is about a third. It was the first of the Regional Cities-funded projects (despite being unmentioned in the application to the state). Its total cost at the time the city granted it $4.1 million was about $46 million (factoring in the portion of a parking garage that our city deeded over).

The developer put in $5 million of equity capital and borrowed more than $16 million, according to the information that City Council had at the time it considered the project. That means the balance (a full $24 million) came from a mix of governmental sources. The story for the other two projects is similar, but the percentage from truly private sources of capital is even lower.

The problem with all these programs is the tremendous waste of money. For instance, apartments that will rent for between $900 and $1,200 a month are being constructed for between $220,000 to $250,000 a unit. Compare that with apartments in roughly the same price range at the Riley Towers in Indianapolis, assessed at $60,000 a unit, or at the Three Rivers Apartments in downtown Fort Wayne assessed at $25,000 a unit.

Finally, the new subsidized buildings include commercial space that is being built for $280 a square foot when high-quality office space is available for sale throughout the city (southwest, northeast or even downtown) for $75 to $125 a square foot.

No one in their right mind would construct such projects with their own money at these prices. In fact, a quick scan of commercial real estate prices in my city finds plenty of properties available that would yield unleveraged investors anywhere from 5 percent to 8 percent, given current occupancy trends.

There is an alternative. Those who really “believe” in downtown development should form a REIT (Real Estate Investment Trust), which pays no federal income tax itself, distributing 90 percent of taxable income to investors. The ownership must be dispersed across at least 100 investors with no five holding more than 50 percent of the shares, a requirement that would seem doable considering the number of wealthy boosters of downtown renovation.

Such an entirely private solution allows them to pursue their vision without forcing the rest of us to abandon our own.

Jason Arp, a financial consultant and member of the Indiana Policy Review Foundation, represents the 4th District on the Fort Wayne City Council. A version of this essay was published by the Fort Wayne Journal Gazette.

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