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Unusual North of South deal leaves taxpayers vulnerable

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Proceeds from a refinancing of bonds that paid for road improvements to Lilly's Technology Center on Harding Street,
                              above, will provide a chunk of the funding for North of South. Proceeds from a refinancing of bonds that paid for road improvements near Lilly Technology Center will help fund North of South.(IBJ Photo/ Perry Reichanadter)

The $156 million North of South project is a complicated, risky and potentially transformative bet on downtown.

It’s also a no-brainer of a deal, at least for Buckingham Cos., the developer, and Eli Lilly and Co., which owns the 15 acres of surface parking lots set to be developed along South Street east of Delaware Street.

That’s because taxpayers—acting as the project’s bankers—are shouldering most of the risk in the no-bid deal, while the potential for a tangible profit rests squarely in private hands, a review of documents and interviews with people familiar with the project show.

Buckingham stands to cash in every step of the way, earning fees for all three of its divisions—development, construction and property management. And Lilly gains a new amenity for its corporate campus while cashing out of a 20-year-old arrangement with the city that required the company to make periodic payments on infrastructure bonds.

Financing for the North of South projectTaxpayers are putting up nearly every dollar used to build the apartment, hotel and retail project, chiefly by loaning $86 million raised from the sale of municipal bonds. All without the city’s landing any job commitments, charging the developer a spread above the city’s cost of capital as any banker would, or installing a mechanism for taxpayers to enjoy some upside if the deal succeeds.

The benefits to the city are a larger tax base, a plugged hole in the downtown streetscape, and a powerful employment driver for the corporate campuses that surround the property, city officials say. They point to a study showing an estimated five-year economic impact for North of South of $350 million, and a conservative loan-to-value ratio of about 70 percent that gives taxpayers a good shot at recouping most of their investment.

Devil in the details

Several developers who spoke with IBJ on condition of anonymity and are generally supportive of public-private deals said the North of South arrangement upends the traditional risk-reward calculation for land development. They say any developer would have jumped at the deal the privately held Buckingham achieved.

“All the developer has is upside!” one said. “The taxpayer has all the risk.”

A 90-page project agreement provides insight into some of the risks. City officials declined to share the project agreement until they finalized the details and the City-County Council approved the plans in mid-March.

Buckingham, which has its headquarters at Ninth and Meridian streets downtown, broke ground on the project last month.

A few details found in the agreement and other documents:

• A $15 million cash contribution credited to Lilly is more complicated than it appears on the surface. Because Lilly’s Technology Center did not generate enough in property taxes to service the debt on a package of infrastructure improvements the city approved in the late 1980s, Lilly had to cover the shortfalls. Now, the city is paying back the pharmaceutical giant, and Lilly is reinvesting the proceeds in North of South.

The city also gives credit to Lilly for contributing the 15-acre site on which North of South will be built, valuing the property at $15 million. For tax purposes, though, the current assessed value of the 12 parcels set for development is $2 million.

• Buckingham is credited with a $7 million equity contribution. But that’s not money it put up. Rather, the sum represents the project’s development fees, which the company agreed to waive.

The company will be paid separately, out of municipal bond proceeds, for the project’s architecture and engineering costs and for construction management. Once North of South is complete, Buckingham will earn more cash by managing parts of the property.

If the project revenue is insufficient to make debt payments, Buckingham will be on the hook for the first $6.9 million, backed by a personal guarantee from Buckingham CEO Brad Chambers.

Steps in the history of Lilly and the city dealings• Buckingham could start cashing in profits from the project by selling individual components before taxpayers are paid back in full.

The hotel, office and apartment phases each are assigned a “base release price” at which the bonds for that portion are considered satisfied. For instance, the release price for an office component starts at about $2.4 million (and falls as payments are made on the bonds).

If the developer can sell that portion, it can pocket any profit above the release price. A potential consequence of the arrangement is taxpayers could get stuck holding underperforming portions of the project while the developer cashes out of profitable ones.

Deron Kintner, executive director of the Indianapolis Bond Bank, said the city “increased the value” of various components to help guard against the risk.

“From Day One, when we started down this road, risk mitigation was of utmost importance to us,” he said.

• Taxpayers could be on the hook for building a multimillion-dollar parking structure for the adjacent WellPoint Inc. campus since the North of South project will remove some spaces and create more demand for existing ones.

The city is obligated to provide 2,000 free spaces to WellPoint as part of a 1997 agreement, expiring in 2012, that enticed the insurance giant to consolidate operations from the suburbs.

The North of South agreement suggests the city could pay Buckingham for use of some of the new spaces in the project or build a new garage at taxpayer expense. For reference, the North of South deal assigns a value of $12 million for its two parking garages and 800 total spaces.

Lilly is key

Lilly initially approached Buckingham in 2007 about putting together a redevelopment of the North of South properties.

The companies worked on the project for two years before approaching the city to request a $45 million subsidy to support it, Chambers said. City officials came back with an offer to act as a lender instead.

The decision came down to a philosophical question: Is it more prudent for the city to cap its exposure by investing a cash sum in a private development as it did with the JW Marriott and Conrad Indianapolis, or to put more money at risk for a chance to recover the full amount?

The city opted for the latter, giving Buckingham what amounts to a mortgage loan. Under the arrangement, after a two- to four-year period of construction and stabilization, the city will apply an estimated $2 million in property taxes and state income taxes on the North of South properties toward about $8 million in annual bond payments.

Buckingham will be responsible for paying the rest out of project revenue, Kintner said.

The city considered taking an equity stake but decided against clouding its role as lender, Kintner said. He said the city would have had to contribute more to the project to earn equity.

Chambers noted his company’s equity in the deal is merely theoretical until taxpayers are paid back.

“We’ve got significant motivation and skin in the game to work hard on this project, and have for three years now,” he said in an interview. “We’re going to work very hard to make this successful. At the end of the day, the project and its merits are solid.”

Chambers said a successful deal would be “very profitable” for Buckingham, but he would not provide a number.

Kintner said it doesn’t matter how much Buckingham profits on the deal as long as the city gets a new amenity and taxpayers are paid back. The project simply would not have worked if the developers had to tap private credit markets.

“Our goal was to protect the city’s interest and to see the project built and financed in a way that’s most advantageous to the city,” Kintner said. “Buckingham is no less at risk than other developers who have borrowed to put money in projects—they borrowed $97 million; there’s an inherent risk in that.”

Public and private?

The city sold about $98 million in bonds to finance the project and will kick in another $9 million for infrastructure improvements. Add in a $6 million state grant, and taxpayers are on the hook for about $113 million.

The bonds will generate $86 million for the project itself; the rest will cover fees and pre-paid interest for the time North of South is under construction.

City officials say the big public investment helped leverage $37 million in private contributions to the project by Lilly and Buckingham, though that figure includes the city’s payment to Lilly and the $7 million equity awarded to Buckingham in lieu of development fees.

The plans call for 320 apartments, a 157-room conference hotel, 40,000 square feet of retail or office space, and 800 parking spaces. An $18 million YMCA branch also is planned, but its financing is separate from the city-supported deal.

“These are amenities a lot of corporations move to the suburbs to chase,” said Scott Travis, Buckingham’s senior development executive.

But Melina Kennedy, the presumptive Democratic challenger to Republican Mayor Greg Ballard, was surprised the incentive package didn’t come with any job-creation commitments or an opportunity for taxpayers to earn some return alongside the developer if the project succeeds.

“Certainly, the actual development itself will be positive for downtown, but I believe some of the negotiating on the city’s behalf wasn’t as aggressive as it should have been to protect the taxpayers,” she said.

One protection the authors of the plan included was hiring locally based Keystone Construction Corp. as the city’s agent in the deal to watch over Buckingham. Regions Bank, meanwhile, is administering the loan on the city’s behalf.

“The city is acting as the bank on this project—taking on roughly the entire project in terms of risk financing,” Kennedy said. “If it fails, it will be on the city’s shoulders.”

The flip side is, if North of South succeeds, the city gains an asset that could attract more young professionals and make downtown more walkable, said former real estate broker and developer Gus Miller, who now works for a pension fund adviser.

He sees it as a prudent gamble to keep up the momentum that appeared in a recent study of U.S. Census data: Between 2000 and 2009, downtown Indianapolis saw an 83-percent rise in the number of college-educated residents ages 25 to 34.

And it helps when the risk involves a 27-year-old developer that manages more than 18,000 apartment units and has built 5,000 of its own. Buckingham also owns The Ambassador and Harness Factory Lofts apartment buildings downtown, and is developing The Avenue, a $25 million apartment and retail project along Indiana Avenue.

“We beat up people for pushing these kinds of things through,” Miller said of North of South. “You can build all kinds of sewers and roads, but at the end of the day, people like to live in communities. [The deal] is unorthodox, but we have to take risks to move forward as a community.”

Paying old debts

The North of South deal also settles a 20-year-old agreement between Lilly and the city that went expensively wrong for taxpayers.

City officials agreed in 1989 to vacate a portion of Kentucky Avenue and spend $36 million to widen surrounding roads to accommodate an expansion of the Lilly Technology Center.

The city sold bonds backed by property tax revenue on the property, but starting in 1997—thanks in part to a new round of abatements, Kintner said—the bond payments due exceeded the property tax payments, triggering an agreement for Lilly to cover the shortfall.

Lilly paid about $13 million toward the bond payments over the years, and would have been entitled to reimbursement from the city of the remaining balance after the original bonds were retired in 2020.

Instead, as part of North of South, the city opted to refinance the debt, paying off the remaining $15 million balance (including interest) owed to Lilly and forgiving the requirement that the company cover any shortfalls in bond payments. In exchange, Lilly agreed to reinvest the entire sum in North of South.

The upshot: Twenty years after building $36 million in road improvements, the city still owes $44 million. And it will continue making payments until 2024, unless a future mayor opts to refinance again.

Kintner doesn’t see a problem with taking 33 years to pay for road improvements since, he says, the point of municipal borrowing is to fund improvements with a long life.

In fact, Kintner said refinancing the bonds and paying Lilly now saves taxpayers $20 million. That’s because the city replaced bonds accruing interest at about 6 percent with new bonds at 3.5 percent.

Promises kept?

The 1989 agreement said Lilly was entitled to reimbursement only if it invested at least $168 million in improvements at its Technology Center along Harding Street. The company told the city in a March 1998 letter that its investments at the facility since Jan. 1, 1989, had totaled $357 million.

In 1999, the company announced a 10-year, $1 billion expansion in Indianapolis, a commitment Lilly spokesman Ed Sagebiel says the company also has met.

Yet during the North of South negotiations, Lilly was “doing cartwheels” to rid itself of its guarantee to cover bond payment shortfalls on the Harding Street project, Kintner said.

David Lewis, Lilly’s vice president of taxes, said the company hadn’t anticipated it would ever need to make the payments. He said “nothing comes to mind” on why the property taxes came up short of covering the bond payments.

“Assessed values used in the forecast and the ultimate values were different,” he said.

So did the city get enough in return for releasing Lilly from its obligation to backstop the bond payments?

“We negotiated with them for quite some time,” Kintner said. “Instead of a bonus to executives, they agreed to reinvest it into downtown.”

The payments between the city and Lilly seem murky to Christopher Steele, an economic development and site-selection consultant and president of Massachusetts-based CWS Consulting Group.

Steele applauds local governments that find creative ways to partner with developers after “sober reflection” to attain “broader public goals.”

But Steele, who reviewed the documents at IBJ’s request, described the agreements as “poorly negotiated.” He can’t quite understand how, if a company doesn’t pay enough property taxes to cover the bonds for its own infrastructure improvements, the city could wind up in arrears.

“There are very good and effective ways of structuring incentive and tax programs to build a strong and mutually reinforcing situation between company and community,” Steele said. “This is not one of them.”

He described the commitment that Lilly reinvest the proceeds in the North of South project as “trying to make a very bad deal better.”

Misplaced priorities?

Taxpayers are being fleeced, plain and simple, for a project that offers no clear benefit to the public, said Julia Vaughn, policy director for the government watchdog Common Cause Indiana.

If North of South really were such a certain success, the developers should have been willing to part with some of their own money to help finance it, she said.

“It really shows what the city’s priorities are,” Vaughn said. “We’re going to help out a private developer and one of the largest pharmaceutical companies in the world, yet we’ve got a second-rate public transport system, infrastructure is falling apart, neighborhoods have so many needs. But apparently the checkbook is open if you’re the right corporate citizen.”

The arrangement sounds like the deal between the city and the Indianapolis Colts that paved the way for Lucas Oil Stadium, said Gary Welsh, author of the cantankerous political blog Advance Indiana.

The city under former Mayor Bart Peterson credited the Colts with contributing about $100 million toward the stadium, but the claim was disingenuous at best: The team had simply agreed to waive the lease-termination fee on the RCA Dome in exchange for a state-of-the-art new stadium.

Welsh’s problem with deals like North of South is that they prevent property taxes collected downtown from going to anything other than new downtown projects, to the detriment of neighborhoods and schools.

“They always make those deals so complicated, deliberately so, to confuse people and make it seem like money is coming out of someone’s pocket that it really isn’t,” Welsh said.

But for Buckingham and Lilly, North of South makes perfect sense.

“It’s the deal of a lifetime,” said one local developer who would have bid on the project if given the opportunity. “I can’t imagine there would ever be anything like this again.”•

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  • here we go...
    ...AGAIN! Looks like another typical case of 'crony capitalism' at work where the 'capitalists' are happy to privatize any profits and socialize the losses....it's the Republican way. (really Freddy, are you REALLY surprised by what your 'fellow Republicans' would screw the taxpayers this way? it's what they do it's who they are
  • Bad Deal
    There is already a glut of housing downtown, which is one of the reasons this project couldn't get traction. Additionally, today's lending requires more equity than could be injected.

    Our City has no business being in the banking business for this type of project. Worse, if the decision is to do it then we should have gotten A LOT better return. If Buckingham went to the mez financing market they would have paid significantly higher rates and probably given up equity too.

    Our stupid politicians made a bad deal and are now adding to an emerging problem....excessive new housing in center township.

    Bad idea.....bad deal!
  • Golden Handcuffs
    88 is right.

    Instead of drawing the company closer to the community with capital investment or job obligations, Eli Lilly was given the keys to the treasury with no strings attached.

    Same with the $1 billion dollar agreement with the state and local government 10 years ago that a low level company spokesperson in this article says they fulfilled.

    Would love to see Eli Lilly executive Bart Peterson, Mayor Ballard, and Governor Daniels be put on the record regarding company compliance and government incentive clawbacks on that deal.
  • What Really Happened
    What does a company do as it rightsizes for a sale? Layoff staff, downsize their real estate footprint, and most important, get off guaranteeing notes and other debt obligations. The City just tee-d up their largest employer to be bought.

    I'm a big cheerleader for downtown, but this was wrong from the beginning; Thanks Cory for digging in on this. Keep following the smell ...
  • Public Grafting and Fleecing
    Travis, your juvenile outlook is incomprehensible with "public money". I have to agree with Wilbur. I want the chuck holes filled in my street out in the "burbs" as you say and further want Water Company proceeds used for maintaining a safe water system supply and not levered to politically payback cronies of the Mayor or this corrupt counsel. I do not need the Ballard Sign Propaganda entitled "Rebuild Indy" used as the shadow campaign mechanism by this incredibly inept Mayor and his grafters.

    Let the private capital markets dictate the real estate markets thru proper risk and investment assessment and not thru a circumvented process which essentially is public corruption.
    The city has engaged in public corruption by picking the winners and losers. That is what was done is the Soviet Union wherein the public officials take care of their cronies thru grafting. See where that got them.

    Pigs get fat and hogs get slaughtered. Travis you better look for another job outside the Mayors power base. Change is coming and soon to a neighborhood near you!
  • Risky
    First of all... It is nearly impossible to get support from banks. Even with a great credit history and long standing with a specific bank. Secondly, this may actually be a good investment for the city. It has not won any new large amounts of downtown office space for decades due to what the suburbs can supply for corporations. Now, Rolls Royce is supposedly moving in and I'm sure more will follow. This project has given downtown something that the burbs can not compete with and it will be interesting to see if it will be a success or failure. (and about the risk... some of you are forgetting that cities are businesses too)
    • INDIANAPOLIS IS NO BETTER THAN ANY BANANA REPUBLIC!
      What Buckingham's ledger gets a credit for $7 Million dollars of "Blue Sky" for a developer fee? Oh come on that is complete Horse Crap. Chambers signs a personal guarantee? How about he pledge REAL HARD ASSETS! Go BIG or STAY HOME Mr. Chambers but then again all the Mayor's buddy's are being taken care of. Did an Independent CPA FIRM SIGN OFF ON Mr. Chambers Personal Financial Statement? How does the mechanics of enforcing the PERSONAL GUARANTEE work?

      LETS GET ONE THING CLEAR... I DO NOT APPRECIATE PAYING TAXES (TRANSALATION BEING EXTORTED)to fund private developers in NO BID PROJECTS. INDIANAPOLIS IS A BANANA REPUBLIC!!!
    • reply to Jerry
      I don't buy the theory that they could not get financing from the banks. If Lilly wanted to back this, they would get financing tomorrow. But businesses will always ask for more, and they figured they can get more from the current local government. I am not sure what Bart's role was in this deal, now that he works for Lilly, but he knows the system inside out...
    • So?
      This is exactly like what Carmel's Mayor did with their PAC which doesn't get the kind of scrutiny that this project is getting. At least this project has the potential of economic development while Carmel's is nothing more than a palace for elitist entertainment.
    • But...
      Joe, if this project were "probably going to make money" as you suggest, don't you think the private sector would have agreed to finance it? They all turned Buckingham down.
    • my theory
      If something is too complicated to understand, than one should beware. And this financing deal is very complicated for a good reason. I agree that the project will probably make money, but my "probably" is not good enough reason to put taxpayers at great risk. Also, if they were actually more honest and not trying to confuse people (an average person would believe that L. & B. are contributing $22 in cash), I would be more supportive. But after the parking meter deal, I pretty much lost any trust in Ballard and his team.
    • While I love the project...
      I hate how we have gotten to this stage! Indianapolis has a horrible transit sustem at best - think of what $86 million would have done to getting a light rail line up and running!!! But no, we don't want to help lower and middle class residents - only those that can afford to visit here and then leave. I agree that if this project was such a slam-dunk, then Lily and Buckingham would have contributed money to this project!

      I bleive in this projcet and fully expect it to suceed since the additional apartments will be leased before the shovel hits the ground, but the priorities of this administration are totaly misplaced!
    • Just More Graft Like The ACS Parking, Pacer/CIB, and Veolia Water Deals
      It's not a public private partnership when the public takes all the risk and losses while the politically connected private firms get all the upside profit.

      It's called being a dormat, not a partner. Mayor Ballard's folks should be ashamed if not prosecuted for breach of fiduciary responsibility to taxpayers.

    • IBJ Rocks
      Stories like these are why I pay for a IBJ subscription.

      No other news organization can compare on business news. The Indy Star business reporters are clueless (except Ted Evanoff) and Inside Indiana Business is too busy running press releases covering issues not related to business.

      Keep up the good work.
    • Ballard's Administration is Immoral
      Thanks for writing this article. I am the activist that led the Indiana Tea Parties in 2007 that helped to elected Ballard. We devoted our lives to his election for the entire summer of 2007.

      As it turns out he is not the man he promised would end country club politics. He abandoned us, promptly after the election, and went to work for Barnes & Thornburg's interests instead. The original people that worked so hard on a grass roots level to elect Ballard rightfully feel betrayed.
    • Council's Role
      City County councilors were warned repeatedly about the fact that the deal was one-sided and taxpayers were being fleeced. Yet they voted for it anyway. No one who voted for No-So should be returned to office. I find it embarassing that so many of my fellow Republicans were willing to screw over taxpayers to make a private developer wealthy.

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    1. The $104K to CRC would go toward debts service on $486M of existing debt they already have from other things outside this project. Keystone buys the bonds for 3.8M from CRC, and CRC in turn pays for the parking and site work, and some time later CRC buys them back (with interest) from the projected annual property tax revenue from the entire TIF district (est. $415K / yr. from just this property, plus more from all the other property in the TIF district), which in theory would be about a 10-year term, give-or-take. CRC is basically betting on the future, that property values will increase, driving up the tax revenue to the limit of the annual increase cap on commercial property (I think that's 3%). It should be noted that Keystone can't print money (unlike the Federal Treasury) so commercial property tax can only come from consumers, in this case the apartment renters and consumers of the goods and services offered by the ground floor retailers, and employees in the form of lower non-mandatory compensation items, such as bonuses, benefits, 401K match, etc.

    2. $3B would hurt Lilly's bottom line if there were no insurance or Indemnity Agreement, but there is no way that large an award will be upheld on appeal. What's surprising is that the trial judge refused to reduce it. She must have thought there was evidence of a flagrant, unconscionable coverup and wanted to send a message.

    3. As a self-employed individual, I always saw outrageous price increases every year in a health insurance plan with preexisting condition costs -- something most employed groups never had to worry about. With spouse, I saw ALL Indiana "free market answer" plans' premiums raise 25%-45% each year.

    4. It's not who you chose to build it's how they build it. Architects and engineers decide how and what to use to build. builders just do the work. Architects & engineers still think the tarp over the escalators out at airport will hold for third time when it snows, ice storms.

    5. http://www.abcactionnews.com/news/duke-energy-customers-angry-about-money-for-nothing

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