Don't Give it Away

By Frank Gruber

October 17, 2011 -- Sunday a week ago, Los Angeles Times columnist Steve Lopez took the City of Los Angeles and several of its leaders, including Mayor Antonio Villaraigosa and Counsel Member Jan Perry, to task for subsidizing the move of the Gensler architectural firm from Santa Monica to a fancy three-story building on Flower Street in downtown Los Angeles. In addition to the usual gift Los Angeles gives to relocating businesses of a three-year tax holiday, city officials used $1 million of federal anti-poverty funds to fund tenant improvements that would ordinarily be paid by Gensler or its landlord, Thomas Properties Group.

Mr. Lopez concluded his column with a quote from Santa Monica City Manager Rod Gould, to the effect that the use of scarce public money to poach companies from one city in the region to another was risky and “a zero-sum game.”

The City of L.A. has been subsidizing big development in downtown Los Angeles for decades. Actually, forget decades: we’re now talking about generations. It’s useless to expect they’re going to stop, but what interests me is the contrast between their policies toward encouraging business development with the policies Santa Monica has followed for 30 years, and to figure out which policies have been more effective.

As William Fulton documented in the first chapter of his seminal book about Southern California, The Reluctant Metropolis, Santa Monica was the first city in the region to confront the Southern California “Growth Machine,” when 30 years ago it declared a moratorium on development and forced Welton Becket to negotiate public benefits before he could build what was then called Colorado Place.

Santa Monica followed that with a citywide down-zoning, and although it has approved much commercial development since Colorado Place, when dealing with private developers negotiations have always focused on balancing the amount of development against the benefits, often costly, that the City can extract from the development. This strategy has now been codified in the recent updates to the land use and circulation elements of the City’s general plan.

Last week I spoke to several people in the city, including city manager Gould and Andy Agle, director of the City’s Housing and Economic Development Department, and no one could remember Santa Monica ever giving a tax holiday to any business coming into Santa Monica.

Yet, according to articles in yesterday’s L.A. Times, Santa Monica has the lowest office vacancy rate -- 10 percent overall, 4 percent downtown -- in Los Angeles County, and the highest rents. The office vacancy rate in downtown L.A. is almost 20 percent. As anyone who follows Santa Monica land-use politics knows, developers are clamoring to build more offices in Santa Monica, despite the long planning approval process and demands for public benefits.

Contrast that to downtown L.A., where it seems that nothing gets built without subsidy. Take the L.A. Live development by Anschutz Entertainment Group (AEG). While it’s hard to sort all the goodies out, the trade magazine Building Trades News says AEG received $290 million in subsidies and tax breaks, in addition to the benefit of having the land for the project assembled by the City of L.A.’s redevelopment agency using eminent domain.

You’d think that for all the money it spent, L.A. would at least have got a district that could attract business on its own; but consider the subsidies it took to get Gensler to relocate to a building only few blocks from LA Live. No private developer has built an office tower in downtown L.A. for many years; in fact, offices in older buildings are being converted to apartments and condos.

Santa Monica has created a much better place to do business than Los Angeles, and I mean it when I say “has created.” Nothing was inevitable because of location. Beach or not, Westside wealth or not, 30 years ago, Santa Monica was a dump -- where the “debris hits the sea,” as the Dogtown skateboarders put it.

In the ’70s, the city’s biggest employer, Douglas Aircraft, had departed for Long Beach, Santa Monica’s formerly thriving downtown was dead, the Pier was so decrepit the City almost demolished it, Main Street was a skid row.

What happened was that 30 years ago a bunch of left-wingers took over and Santa Monica became a Mecca for business. Huh? And how did that happen?

The answer is that the left-wing leadership that rode rent control to power in Santa Monica concentrated on public services and making Santa Monica a good place to live, and good places to live are also good places to work. While L.A. used redevelopment money to directly subsidize massive office towers, which privatized the benefits and incidentally sucked development potential from the rest of downtown, Santa Monica has spent most of its capital on facilities that are open to the public or that benefit the public, such as parking structures, parks, libraries and affordable housing.

Santa Monica also down-zoned, which property owners opposed, but which had the effect of spreading the potential for development around to more properties at the same time that it reduced “supply.” Call it a paradox, because down-zoning is supposed to make land worth less, but this made development rights more valuable. More valuable development rights attract more investment, which in turn increases values again.

You don’t make anything more valuable by giving it away, which is what the City of L.A. is doing when it subsidizes oversized projects on favored developers’ properties, which means that the values of everyone else’s properties decline, discouraging investment.

Those subsidized skyscrapers in downtown L.A., such as the new Ritz/Carlton/Marriott Hotel monstrosity at L.A. Live, not only distort the economics of development, but they place massive infrastructure demands on small footprints. As a result, the streets around them turn into automobile-sewers, further reducing value, since nobody chooses to work in such an environment. The massive volume of the Ritz building should have been broken up into at least four smaller structures spread around the district.

In that case, maybe the real estate nearby would have been valuable enough that the owners of the property that Gensler is going to rent could have afforded to pay for the tenant improvements out of the rent they would be receiving from Gensler, and they wouldn’t have needed a subsidy.

* * *

Readers may wonder if the City of Santa Monica has now got into the business of subsidizing developers by agreeing, for no compensation, to give the developers of the “Village” at the Civic Center an option to extend their ground lease from 99 to 149 years (at market rates 99 years from now). (See story: Council Gives Village Developer a 149 Year Lease Option , October 13, 2011.)

There is no question that Council Member Bobby Shriver is right that an option has a value, and that the City could have negotiated for the developer, The Related Companies, to pay for it. But I would argue there are several reasons justifying the decision to give Related the option.

The primary one is that we’re not talking about an office tower, but a housing development, half of which is affordable housing, and that the market-rate housing is subsidizing the affordable. The City is taking the $19 million the developer is paying the City to build the market-rate housing and applying that to the cost of the affordable units. Not only that, but the City needs this development to get built now -- it literally needs the dirt that will be excavated from the site for the hills of the new Civic Center Park that will rise across the street.

There is another reason to give Related the option without consideration, which is that Related negotiated its deal with the City before the real estate crash in 2008. Since then Related has had to come back to the City to negotiate an extension of its rights, because financing dried up after 2008, but Related did not ask for an adjustment in terms to take into account the decline in real estate values. Indeed, to get the extension, Related had to give the City better terms on the City’s share of the profits from the market-rate units.

Essentially, the City and Related are partners in this important housing development, and sometimes with a partner you leave something on the table.