To Be or Not To Be: An Investment Banker
There is a reason investment bankers have private jets and drive Range Rovers–they make good investments, and make a lot of money off those great investments.
Investment bankers, whether they are investing in companies or real estate, conduct meticulous due diligence and financial analysis before investing their dollars, in order to determine what type of returns an investment is going to make. Why? Because they can either make a ton of money or lose a ton of money. And here lies the big dirty secret on how to incentivize sound investment analysis.
To Be or Not To Be: A Government Official
So why is it that city governments who (similar to investment bankers), are spending hundreds of millions of dollars on large infrastructure and public-private development projects, do not do the same type of rigorous analysis? The simple answer is they aren’t incentivized by a big financial payout for a wise investment. However, the answer is more nuanced. Perhaps governments don’t have the capacity or the skill to conduct this same level of analysis, but more likely, decision-makers typically care more about wielding political power than about whether or not a deal is going to be a sound investment (i.e. Councilmen care more about re-election than whether a 30-year project is going to be a high-yield investment).
Media Ignorance is not Bliss
Enter the media. When government officials drop $200 million in infrastructure here, and $600 million in tax abatements there, the media picks up on it, and happily criticizes individuals and motivations, yet might not understand the “terms” they so easily toss around. This misunderstanding however is not their fault, as the government officials often have left them without enough information, and most certainly without a meticulous cost-benefit analysis explaining the rationale for their “investment” or expenditure.
What is a Government Investment?
Economic Development 101 tells us that in the absence of sound market fundamentals (demand > supply; value > cost), real estate developers will not build projects in neighborhoods where their numbers don’t pencil out (like our investment bankers above, they like to make a profit). The government can play a role in incentivizing development in neighborhoods that need private investment by providing a plethora of tax breaks or infrastructure investments. However, this sentence may make sense to you the reader, but to the average Joe reading the Philadelphia Inquirer, and even, the average Metro writer of the New York Times, this sentence can be gibberish, and they could both use a primer on what “tax breaks” even are. Simply, if risk is too high for a developer to invest in a site or neighborhood, and numbers don’t pencil out, cities can reduce the cost to developers (which in turn increases the property value) by reducing the property taxes paid to the city, which is called a “Real Estate Tax Abatement”.
Hudson Yards, good or bad?
Upon its grand opening this past spring, there was a flurry of media criticism on the “tax breaks” the Hudson Yards project has received to date. The bulk of subsidies to build Hudson Yards came in the form of tax abatements and (TIF-like) bond financing. Neither one of these incentives are the same as a cash subsidy that might draw from other pools of city money, which is what much of the media criticized. In fact, New York City was able to fund some $3.6B in subway improvements and a new park without having to draw on any taxpayer money meant for sanitation or street repair.
Additionally, developers get a break on future real estate taxes for 20 years and in return, the entire City gains a whole new neighborhood that will produce significant tax revenue for generations to come.
The basis of public-private development is “but for”: but for public subsidies, Hudson Yards couldn’t have been built, because no investor would have risked it. Surely, the developers will eventually reap profits, but so will the City–billions of dollars–from economic activity in an area that was a no-man’s land until 2019.
In yet another NYC example, the press had a field day with the Amazon deal that NYC Mayor de Blasio and Governor Cuomo struck to lure the mega-corporation to Queens, NYC. After much heated debate in the press over how egregious the “tax breaks” were, the City and State offered to Amazon and Amazon actually pulled out of the deal, as they were hesitant to move in to a place where they were not going to be welcomed with open arms. Never was there presented to the media or the general public, a detailed cost-benefit analysis that the City or State conducted to justify the tax breaks with future economic development and future taxes. And it’s questionable whether this level of analysis even existed.
What if city government officials entering into public-private partnerships with developers, or investing in large infrastructure projects, or providing corporate relocation incentives, had to present their “investment” to an “Investment Committee” like, bankers do? This would require a detailed analysis of the cost of the project/investment, as well as the benefits a project or investment would make. This may include increased tax base from real estate, sales, and even mortgage recording tax as well as temporary and permanent job creation. In addition to the direct tax benefits of new development, there are indirect and induced benefits. The problem with some of these benefits is they are hard to quantify. This may include increased property values surrounding a new development, as well as an increased “happiness factor” for people experiencing an upgraded public transit station, or a new park, or just having great retail to walk beside on a street. However, smart people (like those at Econsult Solutions) have figured out how to conduct these economic impact analyses, in order to quantify and present the benefits of a large costly project. A sound cost-benefit analysis of a large public investment would go a long way to garner constituent support as well as give the media actual data to discuss, rather than mere conjecture.
Secondly, governments would do well if they also analyzed investments after making them. Just like a good investment banker who continually follows their investments, city governments should also be tracking their investments after they are completed. To spend $200 million on a new sports stadium may seem like good political move, but more important to the public is to be able to quantify five years later that the new sports stadium is generating billions of dollars in additional tax revenue for the City. This is a data point people need to hear. So why isn’t this done more often? Perhaps, again, city government officials don’t have the capacity or skill to manage a retroactive analysis, or politicians have too many current policy objectives to spend time reviewing other politician’s decisions. It would be wise, however, at the time an investment is made, for city governments to outsource this to a third-party to report over time. A third party would be a-political, impartial, and would provide the proper analysis to justify decisions like incentivizing Amazon’s relocation, spending money upgrading public transit, building stadiums, rezoning neighborhoods, creating city-wide tax abatements, etc. Enough of this media criticism of governments, let’s make our governments behave more like investment bankers.
Cori Packard Beasley is a senior advisor at ESI. Cori is a Clinical Assistant Professor at the NYU Schack Institute of Real Estate and a Lecturer at the University of Pennsylvania and brings experience in both government and private development in her teaching, which is focused on public-private development and post-catastrophe revitalization.