Other People's Money
Pensioners lose big on Broadway Village.
From the August, 2010 issue
This was the year that tenants were supposed to be settling into the Broadway Village at Lower Town.
But instead of the shiny new condos, retail, and office space promised by the developer, Broadway Village is 6.4 acres of unmowed field ringed by a chain link fence.
The plan to turn an abandoned supermarket and a few neighboring buildings into a virtual new downtown was always audacious. But Broadway Village's real daring was its financial engineering. East Lansing-based Strathmore Development Company planned to build it all with other people's money.
Strathmore's appetite for public funding was a subject of considerable debate in Ann Arbor. The city ultimately decided not to issue bonds to help pay for the project, but the company's website boasts that Broadway Village "received one of the largest economic incentive packages from the State of Michigan in State history totaling over $75,000,000."
Even that understates the commitment of public funds, which eventually approached $100 million. The Michigan Economic Development Corporation (MEDC) boasted that Broadway Village would create 582 new jobs, and in January 2008 Gov. Jennifer Granholm came to Ann Arbor to celebrate its "groundbreaking."
By then, Strathmore had demolished the existing buildings on the site, including a former Kroger store, a bank, a pita shop, a car wash, and a dry cleaner, blamed for pollution leaching to the river. Strathmore moved some other tenants, including a pottery studio, a party store, and an Asian market, to a small strip mall across the street.
But construction never started. And despite approval of millions of dollars in brownfield cleanup funding, the pollution continues to spread.
Strathmore planned to pay for much of the project's cost from money Broadway Village otherwise would have paid in property taxes. Since it was never built, that's now moot. But the state still lost money on the project: the State of Michigan Retirement System (SMRS), which manages pensions for 565,000 Michigan public school employees, state workers, state police, and judges, made a $20 million equity investment.
SMRS won't say how much it lost on Broadway Village. But based on the city's estimate of the market value of the vacant lot, the state's pensioners are out at least $12 million.
Strathmore founder Scott Chappelle is a Michigan State grad with a law degree from Cooley Law School. He's also a CPA. His wife, Laura, also a lawyer, served as deputy legal counsel to former Gov. John Engler, who appointed her to the state public service commission in 2001. Both Chappelles have been active in the Republican Party.
Strathmore's brownfield application for Broadway Village went through quickly. The state program is designed to promote redevelopment of existing urban areas, including contaminated sites. The environmental cleanup was expected to cost about $4 million, says Brett Lenart, who administers the Washtenaw County Brownfield Redevelopment Program. Strathmore undertook some preliminary work to address contamination from the old dry cleaners, but it had only marginal benefit, says city environmental coordinator Matt Naud.
And most of the brownfield money had nothing to do with environmental problems. Strathmore's plan called for public funding of tens of millions in infrastructure work.
"That includes things like street lighting, streetscape, expenses that do add value to a real-estate development but aren't recoverable if you sell the project later on," Lenart says. In Broadway Village's case, by far the biggest brownfield investment, $27 million, was intended for a 640-space parking structure.
Throughout Broadway Village's lengthy history, it was always conceived as an enormous project, with half a dozen three-to-six-story buildings containing more than three-quarters of a million square feet of floor space. But exactly how big it would be, and what it would cost, was hard to pin down. Over the years the estimated price tag ranged from $125 million to $210 million. Not surprisingly, the main stumbling block in the negotiations between the city and the developers was how much new tax revenue the project would bring in to repay the proposed bonds.
While changes made to plans along the way account for variations, the developers "can't really predict costs," says Lenart. "Neither can the assessors."
Precise or not, it was a June 2007 adjustment to the projected value of the project that helped boost state support to the point where it appeared the financing finally would come together.
The Washtenaw County Brownfield Redevelopment Authority initially approved $40 million for the project in 2003. The following year, the state raised that to $66 million. Then, in mid-2007, the board of the Michigan Economic Growth Authority--which works with MEDC--added $30 million more, bringing the total to $96 million. Taking advantage of a provision added to the brownfield program after the original Broadway Village application, the additional money could be used to pay interest on borrowing for eligible work.
Yet even with the state willing to cover interest costs, Strathmore wasn't able to get the project financed before the financial crisis hit.
Strathmore lost a future payday when the project stalled. But the biggest loser was the state pension fund.
SMRS has invested in commercial real estate for thirty years, says state treasury spokesman Caleb Buhs, and in general that experience has been positive. Real-estate investments allowed for diversification and, in a ten-year period ending this past December, earned an annual total return that exceeded investments in stocks, says Buhs.
But, Buhs says, SMRS has marked down the value of its Broadway Village investment and taken an unrealized loss based on what it believes to be the land's current market value.
Although taxpayers are on the hook for pension liabilities, the amount of that markdown--based on an estimate of the current value by SMRS's investment manager, Seattle-based Kennedy Associates--is confidential, Buhs says, citing the state's interest in maximizing the price should the property be sold.
In fact, setting a value is difficult. Though Strathmore spent $11.4 million for the property, city assessor David Petrak now values it at $7.6 million, or $27 a square foot. Even that may be high: transactions involving roughly comparable properties suggest a sale price today could be much lower.
For example, the former Michigan Inn on Jackson sold for $2.2 million in the spring of 2008. Although the deal for that 4.5-acre property may have included other considerations (like paying off creditors), the recorded sale price comes to $11.22 a square foot.
More recently, a vacant 7.2-acre parcel on Washtenaw Avenue at Huron Parkway sold for $3 million, or $9.56 a square foot. The property, across from Barnes and Noble and Whole Foods, was sold by Comerica Bank after going into foreclosure.
At that price per foot, the Broadway Village property would be worth less than $3 million. And even at that price, the Washtenaw Avenue land is only a deal if the new owners can get tenants quickly, says Ann Arbor's Jeff Hauptman, a commercial real estate broker.
"With as much surplus space as we have on the market, there's no reason to build unless you have a user who wants a particular location."
Even if the property could be sold today for Petrak's estimated value, the SMRS would lose $12.4 million. That's because the state's entire $20 million investment has been spent. It appears that the pension fund--not Strathmore--paid to buy and clear the Broadway Village site.
Asked what stake Strathmore had in the project, Chappelle objects to the question. When pressed, he acknowledges that the company itself was not an investor in Broadway Village. Instead, Strathmore acted as a "fee-based developer," raising all the capital from other parties.
Developers working entirely with "OPM"--other people's money--are the new norm, says Ann Arbor developer Ed Shaffran. Where "older, traditional developers" assume some risk by putting in their own capital, that's rare today, says Shaffran, who puts himself in that small traditional camp.
Fee-based developers raise virtually all the project's equity from other investors. Typically they'll put together a prospectus that details the services they will provide--sales, pulling together financing, and perhaps construction, for example--and what the fee will be. In most situations, a developer will plan on a fee that's 6 to 10 percent of the project's total cost, Shaffran says.
"I don't know Chappelle, and I have nothing negative to say," Shaffran adds. "But it's a very different way of operating."
At one point, Lower Town Project LLC had been behind in paying property taxes on the Broadway Village site. Those payments are now up to date, says county treasurer Catherine McClary. Liens and lawsuits involving payments to contractors have also been resolved.
That said, Strathmore today is more apt to be discussed for its troubles than its accomplishments.
In southwest Florida, where the company maintains an office, a shopping center renovation project in Bonita Springs stalled, and the building was eventually sold at a loss.
Closer to home, Strathmore has been under scrutiny in East Lansing, where delays and financial trouble have tarnished a public-private partnership with that city. The planned City Center II was to be a $112 million mixed-use project. However, Strathmore has had trouble securing financing and has faced criticism for overdue taxes.
In a situation reminiscent of the company's ultimately unsuccessful bid to have Ann Arbor issue bonds to support Broadway Village, Strathmore acquired key properties for the City Center II project and then approached East Lansing officials about forming a partnership, says planning director Tim Dempsey. East Lansing's Downtown Development Authority subsequently acquired additional property for the project.
"I think they just took on too much," says Kevin Polzin, business editor at the Lansing State Journal. (A Strathmore project in Petoskey has also been subject to lawsuits, liens, and controversy.) East Lansing mayor Victor Loomis says the developer "owes the East Lansing City Council a detailed financing plan."
Broadway Village is past that point. The project "did make sense, at least on paper at some point," says Shaffran. "Before 2006, it probably would have happened."
But today, economic conditions in Michigan will need to continue to improve "for some time" to warrant construction, says treasury spokesman Buhs.
The Broadway Village site isn't being marketed for sale. However, the investment manager, Kennedy Associates, would review any unsolicited offers, Buhs says. In the event of a sale, the pension system would get the proceeds.
Chappelle, once enthusiastic about issuing press releases that touted the project, would now rather not talk about Broadway Village. Asked if the project might be scaled down or developed incrementally, he says only, "We're still working on it." Asked if all or part of the property might be sold, he responds, "the credit markets continue to be challenging."
Buhs is more definite: Kennedy will evaluate the economic viability of any proposed development plan.
[Originally published in August, 2010.]
On August 31, 2010, John Hilton wrote:
This Calls & letters item appeared in the September, 2010 Ann Arbor Observer:
To the Observer:
Sending another view of the "Broadway Village" lot. This is not meant to trivialize the depletion of state pension funds or any other social, aesthetic or economic issue.
This field: Recently an impervious parking lot with a few weeds sprouting through cracks. Then dry, seemingly barren earth. Now "weeds." Plowed up last summer, replanted with wildflowers: Very nice. But the weeds return and dominate. I watch them. They are fabulous in their vitality and diversity of form. They attract birds, insect pollinators and human creativity. They slowly transform the soil into something life-supporting. Many have medicinal value. Every day, something new: scatters of flowers, fountains of green and gold in shapes wilder than imagination. A rich potential ground for the study of how rapidly life regenerates and each part interacts with every other. Like to see a healthy economy in action? Watch this field.
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