New Hanover County could save $24 million on Project Grace. The deal could also self-destruct
The current proposal for Project Grace, New Hanover County’s plan to redevelop the downtown library block, will cost taxpayers $90 million over 20 years in lease payments to the Zimmer Development Company. But by its own calculations, the county could save $24 million if it borrowed the money at the current low interest rates and built the project itself.
The county is in a bind. Zimmer has said it will only participate if the project is a lease deal, and will walk away if the county directly funds construction. However, the state has already nixed a nearly-identical lease-to-own deal for the County’s government center redevelopment, and will likely do the same for Project Grace.
The deal appears to be in serious trouble unless Zimmer changes its mind -- or the county invokes an obscure state statute to avoid state oversight.
The issue comes down to interest
On paper, the construction costs of a new Cape Fear Museum and downtown public library -- the county’s part of the deal -- are about $56 million dollars. But neither the county or Zimmer Development Company has that kind of cash on hand, and so one of the parties will have to borrow. That means paying interest.
In the memorandum of understanding (MOU) being considered for a vote on Monday by county commissioners, Zimmer Development Company would shoulder that financing burden, and the county would pay roughly $4.5 million in annual lease installments for 20 years, owning the property at the end. That $90 million includes the cost of construction, the cost of interest on a loan that Zimmer would have to take out and pay back over two decades, and presumably some additional profit for the private developer.
Exactly how much interest Zimmer would pay -- and how much they would profit solely from the financing -- isn’t clear, but the original proposal for the government center redevelopment plan offers a useful analogy.
The government center deal
The construction costs of the public part of the government center were estimated at around $49 million. The initial proposal, a lease-to-own deal very similar to the current MOU for Project Grace, put the final public cost at a little over $80 million. According to the county, this included around 4.5% financing costs paid to a private developer.
After county commissioners approved the deal, the Local Government Commission (LGC) -- part of the Office of the State Treasurer -- told the county to scrap the financing arrangement in favor of paying for the project itself, which would save taxpayers roughly $20-25 million over twenty years.
Commissioners later approved the new deal, paying for the project through a limited obligation bond instead of re-paying the private developer. As part of that deal, the county re-negotiated what the developer would pay for private land, slashing the cost by around $2 million. This, in effect, was to help compensate the developer for profit it would have made if it was handling the finances. As County Manager Chris Coudriet said earlier this year, “So, part of it is recognizing that the developer still needs to make some degree of money on the deal. And what they were going to make in the lease agreement is no longer an option.”
When it comes to Project Grace, it appears a similar adjustment isn’t workable. According to Coudriet, "[t]he developer is only interested in proceeding if this is a lease-to-own arrangement."
Coudriet confirmed that Zimmer, which offered the initial MOU agreement, wrote the lease-to-own clauses. He also confirmed that the county made it “very clear that a similar yet not identical deal” -- that is, the government center -- “was not acceptable to the LGC.”
New Hanover County already knows how much it could save
Further, County Chief Financial Officer Lisa Wurtzbacher confirmed the County has already run the numbers comparing the lease-to-own costs versus the self-financed, borrow-and-build costs.
“I had our underwriter run what the debt service would look like for the museum and library based on the costs they gave us. The total debt service based on those rates for a project cost of $56.7M were estimated at $66.2M. The lease cost over the 20 years that is being proposed based on the estimated costs is $90.1M. This is a difference of $23.9M. This doesn’t take into account any tax revenues we may receive from any private investments that result from this project. This also takes into account a historically low interest rate (the lowest we’ve ever seen). I imagine that 2 to 3 years from now, the interest rates would not be this low, but to know what that might possibly be is difficult,” Wurtzbacher wrote in an email.
Wurtzbacher alludes to the fact that, without a private partner, the county could still build a new museum and library complex, but potentially without private development of the block -- and thus without the additional revenue from property tax. The benefit of spurring private development is a common argument used in favor of public-private partnerships, including by the City of Wilmington in the Riverplace project, and the county in the government center project.
The additional tax revenue Wurtbacher notes would be from the private side of the development, which isn't laid out in the current MOU. It remains uncertain if Zimmer would buy county land or lease it. It’s worth noting that, while Zimmer’s plans will likely generate considerable property tax, that additional revenue would not close the considerable gap between the costs of self-financing and a privately financed county project. (By way of example, the annual tax revenue for the county from a project on the scale of Riverplace would be around $250,000 -- not a negligible amount, but only a fraction of the added cost of bringing Zimmer into the deal).
Likewise, as Wurtzbacher stated interest rates do fluctuate, but there are two caveats:
One: While interest rates for the county are at a historic low (around 1.5%), even if they doubled the county would still save money self-financing over paying Zimmer closer to 5%. And, while the county suggested that the recent decrease in interest rates was the rationale for the new funding structure for the government center, they haven’t recently been high enough to make private financing the less expensive choice. According to State Treasurer Dale Falwell, the bond rate isn’t expected to change dramatically in the future, “So the fact is, is that we would fully anticipate based on the credit history of New Hanover County, that they would be able to issue those bonds somewhere in the 1.5% range. And we don't expect that to change by the time those bonds come out the oven.”
Two: Even if bond rates do go up, it would likely still be cheaper for the county to borrow than for a private developer to finance the deal. The county’s bond rate and private financing rates aren’t unrelated factors -- market forces that affect one are likely to affect the other. Asked if, for example, the county’s bond rate could jump up to 5% Folwell said, “anything can happen, but if for some unusual reason that that were to happen, then that 5% wouldn't be 5% anymore. The developer would be demanding more also.”
Folwell didn’t comment directly on Project Grace’s financing because the county hasn’t officially shared it with the LGC yet. And, while the LGC often acts as a final fiduciary check on public-private partnerships, Folwell said there’s nothing stopping local governments from asking for guidance earlier in the project. He also noted his office hopes future changes to the law will make the LGC part of earlier planning on public-private deals.
“There are so many instances where we are brought in in the eighth and ninth inning. And where, for example, in the New Hanover government complex case, if we would have been brought in in the first inning, we could have shown them ways to save that $25 million right up front. So as I said earlier, we don't need a law to tell us what's right and what's wrong. And then our minds doors and hearts open, remain open to helping New Hanover County or the City of Wilmington or any of the other local entities across North Carolina, trying to figure out what's right.”
The ‘carve-out statute’
With a vote on the MOU scheduled for Monday, March 15, it seems unlikely that the LGC will have a chance to review the deal before it’s signed. Once it does, the county can’t walk away without paying up to $800,000 to compensate Zimmer for planning costs it’s already accrued -- unless the LGC reviews the deal and finds, as it did with the government center, that the county could save significant taxpayer money by self-financing.
And, while Project Grace is not an identical project to the government center, the financing structure is very similar. Thus, it’s very likely that the LGC’s verdict on Project Grace’s financing will be the same: better to use a low-interest bond rate and save the taxpayers $24 million.
So, if Zimmer will only move forward with the lease-to-own option, and the LGC is all but certain to reject that option as fiscally irresponsible, is the deal dead on its feet?
The only way forward, it seems, is if for some reason the LGC does not review the deal, which brings up the most confusing part of the MOU, the reference to Session Law 2017-86 -- which staff at the LGC and county have referred to as the ‘carve out statute.’
According to State Senator Michael Lee, who served on the conference committee for the bill, New Hanover County requested that representatives work on the law -- which started as House Bill 397 and passed with nearly-unanimous bipartisan support -- to give them authority to enter into downtown development agreements. [Note: Lee is also coincidentally helping to represent Zimmer in negotiations with the county.] The language was tacked onto an unrelated bill and specifically exempts the Project Grace property from parts of state law covering public-private partnerships.
“The property was owned by the County on January 1, 2017, in the central business district of the City of Wilmington, described as follows: That block bordered by Grace Street, 3rd Street, Chestnut Street, and 2nd Street...The project shall not be subject to Article 8 of Chapter 143 of the General Statutes if funds other than county funds constitute at least twenty‑five percent (25%) of the total cost of the construction and renovation of the public and private facilities included in the project," the bill reads in part.
According to Chris Coudriet, the general threshold for private investment to grant the county additional authority would be 50% -- which Project Grace wouldn’t satisfy. With the change to 25%, Project Grace would qualify.
So, what does exemption mean? The short answer is -- many things. But one notable point is that, under the statute, the lease with the Zimmers would not be subject to LGC scrutiny.
Article 8 of Chapter 143 is long (over 25,000 words, and roughly 50 pages as a Word document). There are requirements for reporting costs to the state, for the involvement of minority businesses, and a provision that “If a capital lease or operating lease is entered into by a unit of local government as defined in G.S. 159-7, that capital lease or operating lease is subject to approval by the local government commission.”
So while the law appears to exempt Project Grace from LGC oversight, the MOU specifically invokes LGC approval. And it’s unclear how the paradoxical legal language of the MOU would work out if challenged -- if the County ignored LGC guidance.
The county maintains that the project is subject to LGC approval. According to a spokesperson, "this agreement cannot bypass LGC consideration. Capital leases are treated as debt on the county’s books, and leases of $500,000 or more, and more than 5 years in duration (this would be a 20 year lease) require LGC approval. And it is part of the MOU that LGC approval is a condition of final advancement."
[Note: The requirements cited by the county are the same ones cited by the statute -- Article 8, 143-128.1C(k)(1) -- from which the county is exempted by Session Law 2017-86.]
Asked about this conflicting language, Treasurer Folwell said he didn’t see it as contradictory.
“Well, actually, that makes it very, very clear. And that is that you don't always need a lawyer to tell you what's right and what's wrong," Folwell said.
Several companies expressed interest in Project Grace after it was announced in 2017, but Zimmer was the only company to submit a full development proposal. So, scrapping the agreement with the developer would likely mean a return to the drawing board for the county. It is, however, possible that the county could reach an alternative agreement with Zimmer, as it did with the government center developer.
County commissioners will likely discuss Project Grace -- and the MOU, specifically -- during their agenda review meeting on Thursday afternoon at 4 p.m. If the item remains as a hearing and vote on the agenda, commissioners will consider that Monday morning at 9 a.m.