Revenue Sharing at Battery Park City

For Urban Land 

Portions of two of New York City's most troubled neighborhoods are looking a

bit better today, with nearly 4,500 residents now living in clean, safe

homes, supported by a wide range of community and educational support

services. While these improvements were the result of a new municipal

housing initiative that is repairing large tracts of abandoned buildings,

the story here is about how New York financed the work--through the success

of another development project 12 miles downriver.

On the southern tip of Manhattan, adjacent to the towers of Wall Street,

lies a 92-acre landfill that has been the site of some of the city's hottest

real estate activity. Battery Park City (BPC) has been transformed from a

near bankrupt venture into one of the country's most remarkable new

developments, combining a major financial and retail center; an extensive

network of low-, mid-, and high-rise housing; schools; a network of parks

connected by a riverside promenade; and a dramatic winter garden that

welcomes visitors from lower Manhattan.

A significant detail of the overall plan that has not received much

attention is the imaginative way local and state officials have been able to

transform profits generated by BPC's development into renovated housing in

New York's poorest neighborhoods.

A Long Read to Success

Success can belie history, suggesting a lineage of well-conceived plans when

in fact a very uncertain path was tread. As Brendan Gill noted in The New

Yorker in 1990, that was indeed the case with Battery Park City.

It stands today as if it couldn't possibly have failed. The fact is,

however, that it teetered on the brink of failure not once but several

times. Seeking to prosper, it was often obliged to alter its nature, and yet

in order to preserve its legitimacy, it had to appear fundamentally

unchanged.

Building Battery Park City was above all a matter of timing. It took 30

years for essential forces-a balanced urban design scheme, an openness to

political compromise, and most important, market demand-to align themselves

for this undertaking.

Initial plans for a new complex in lower Manhattan were conceived in the

1950s by David Rockefeller, then vice chair of Chase Manhattan Bank and

organizer of the Downtown-Lower Manhattan Association. Rockefeller and the

association were very much concerned by the movement of the city's

commercial market to midtown after the end of World War II. Though host to

Wall Street, downtown was losing its claim as the city's preeminent office

market primarily due to a lack of developable land.

The first plan, devised by the city's Marine and Aviation Department, sought

to develop residential towers above a new marine terminal just north of

Battery Park. Developers, however, could not be sold on this mixed use.

In 1966, Governor Nelson Rockefeller revived essentially the same

residential/industrial scheme in a Corbusian-inspired setting. Its goal:

creation of a truly model city. The plan envisioned a mixed income,

multiracial neighborhood, incorporating a variety of community services and

jobs in the marine terminal. Again, the market was not interested.

Toward the end of the 1960s, approval was given for the construction of the

World Trade Center. The tremendous volume of earth that had to be moved

could provide an inexpensive means of initially filling in the proposed site

of Battery Park City-if a plan were in effect. In 1969, the state approved

the project's first official master development plan and created the Battery

Park City Authority (BPCA) to execute it. BPCA issued a $200 million New

York State moral obligation bond and used the proceeds to finance the

demolition of old piers, complete the landfill, and prepare the initial

infrastructure.

The futuristic 1969 master plan fell victim to a deep recession that glutted

the office and residential markets, virtually eliminating developer interest

in the project. Compounding this problem was the megastructure plan itself,

which prevented the project from being built in phases by separate

developers, even when market conditions improved.

A 1975 plan addressed this phasing problem by breaking the site into

developable clusters. It grouped residential structures around controlled

spaces in response to increasing public concern for security. Toward the end

of the decade, construction began on the 1,712-unit Gateway Plaza. It was to

be the only phase of this plan to be built.

What stymied this latest plan? By the late 1970s, New York City was on the

verge of bankruptcy. Investment in the city had slowed dramatically and

completely stopped in unproven locations. Rumors were suggesting that the

financial district's anchors-the stock exchanges-were on their way to New

Jersey. That the city could induce residents, shoppers, tourists, and elite

commercial tenants to venture to the other side of the collapsing West Side

Highway into an unimaginatively conceived network of superblocks was simply

not going to happen.

Battery Park City was facing an even bigger problem: the $200 million of

outstanding bonds was beginning to mature. Already fiscally extended in its

efforts to keep the city out of bankruptcy, the state could ill afford to

bail out a failing project whose prospects were not only mired by three

competing levels of bureaucracy-the city, state, and BPCA -but also by the

lack of a revenue stream.

In hopes of streamlining the development process and jump-starting the

project, the city decided to divest itself of control of the land beneath

Battery Park City. A 1979 memorandum of understanding between local and

state officials directed the New York State Urban Development Corporation

(UDC) to condemn the entire site and transfer landownership to the BPCA. In

return, the state loaned the authority tens of millions of dollars to meet

its debt service requirements.

As it turned out, divestiture was a shrewd move by the city, costing it

minimal influence and returning significant financial benefits. The city

relinquished direct control of the project, but was assured that excess

ground lease revenues would flow back to its coffers. And when all BPCA debt

was amortized, the land would revert to the city.

At this time, Richard Kahan, a former head of the UDC and the Convention

Center Development Corporation, became president of BPCA. He hired

Cooper/Eckstut to prepare a more traditional design that would extend the

Manhattan street plan into Battery Park City and ensure the application of

prewar architectural principles to all new building.

The 1979 master plan also shifted BPC's commercial core to the middle of the

site adjacent to the World Trade Center and its transit complex while

permitting individual parcels to be developed independent of one another.

These changes, along with a reviving office market, set the stage for

development of the 6 million-square-foot World Financial Center. In 1980, 30

developers submitted proposals. In 198 1, the winner, Olympia & York, began

signing lease agreements with prime tenants: Merrill Lynch, American

Express, Dow Jones, and Oppenheimer.

With construction of BPC's commercial core underway, Gateway Plaza

completed, and-per the 1979 plan-subsidized units no longer required in new

housing, developers began actively to plan the second phase of the South

End's residential development. These blocks, known as Rector Place, would

host ten new buildings containing 2,200 units, nearly all of which would be

condominiums.

But recently elected Governor Mario Cuomo felt something was lacking. The

massive state-assisted development was serving an increasingly limited

populace. Cuomo brought in Sandy Frucher to head the BPCA and to find a way

to imbue Battery Park City-in the governor's words-"with a soul."

Planners devised three key strategies toward this end. One, Battery Park

City would offer public walks and open spaces that would be destinations in

themselves, landscaped and maintained by funds derived from on-site leases.

Two, BPCA would subsidize the development of several public institutions,

including a Holocaust museum, Stuyvesant High School, and an aquarium (the

latter was later shelved).

But the strategy that was most closely allied with the governor's wishes was

the creation of a financial conduit that would channel excess revenue to

city neighborhoods desperately in need of improved housing. This plan would

counter the 1979 master plan's elimination of low income housing in Battery

Park City. The authority and the governor argued that using excess revenue

to stabilize and support existing low-income communities was preferable to

introducing a token number of poor residents into a residential district

that required high rents and apartment prices in order to justify

construction. Further, luxury development would generate a continuous flow

of cash that, in the long run, could assist more people than could the

creation of a limited number of low-income housing units in Battery Park

City.

Leveraging Battery Park City

In 1979, when the city relinquished its role in planning Battery Park City,

it was difficult to imagine when the development would be able to service

all of its debt, much less realize a profit. However, it did not take long

before the BPCA was generating excess revenue.

The BPCA generates a profit in part the same way any property owner does,

through the leasing of land. Annual ground rents paid by building owners

help cover BPCA's primary expenses: interest and principal payments on the

debt that is financing infrastructure improvements, wages, and

administrative and other general costs.

Ground rents provide about 20 percent of BPCA revenues. But BPCA also enjoys

what amounts to a taxing authority. Since New York City cannot levy real

estate taxes on development on land that is controlled by the state, BPCA

has been empowered by the state to collect a payment in lieu of real estate

taxes-PILOT-which now provides 75 percent of BPCA's total revenues.

Revenue remaining after deducting expenses and costs of capital improvements

goes into an excess revenue fund against which new debt can be issued. After

this subordinate debt has been serviced, the remaining funds are channeled

back to the city.

By the mid-1980s, the World Financial Center, Gateway Plaza, and the new

residential blocks under construction at Rector Place were effectively

supporting all of BPCA's debt. The state felt the authority's cash flow

could be leveraged a bit more. In 1986, BPCA was authorized to

support-through revenue generated by rents and taxes on leases signed before

January 1, 1986-up to $400 million of new debt for the rehabilitation of

low-income housing. The bonds would be issued by the Housing New York

Corporation (HNYC), a subsidiary of the New York City Housing Development

Corporation (HDC).

HNYC went to the credit market in 1987, raising $210 million. Because the

bonds were revenue rather than general obligation bonds, HNYC was required

to set aside nearly 30 percent of the issue for a debt service reserve fund

and three years of capitalized interest. With $67 million dedicated to

service the debt, only $143 million was left for housing improvements.

An "A" rating from Moody's ("AAA" on $44 million of the issue that was

insured) helped promote the sale of the bonds at interest rates that kept

the cost of borrowing relatively low. Moody's was encouraged not only by the

vibrancy of the commercial and residential neighborhoods rising in Battery

Park City, but also by the strong upward trend of BPCA's bottom line (see

Figure 1).

It indeed seemed that after two decades of planning, false starts, and

fiscal uncertainty, Battery Park City was finally up and running on its own.

Echoing this optimism was Cushman & Wakefield's 1987 pro forma cash flow

study that estimated future ground rent and PILOT payments pledged to

support BPCA debt. Every time it goes to the credit market, the authority is

required to generate these estimates to ensure that pledged annual revenues

are at least 125 percent of all annual debt service payments. While the 1987

bond issue (considered along with all other outstanding debts) was able to

satisfy this coverage test, the revenue estimates-prepared in prosperous

times-proved high.

Cushman & Wakefield, along with local officials, appeared unmindful of real

estate's mercurial nature. The firm anticipated annual revenue growth

exceeding 4 percent, based on steady growth in ground rents, assessed

values, and PILOTs.

But a month after the HNYC bonds were issued, the stock market crashed. New

York's real estate market began losing its muscle, and within a year, signs

of recession were all around. By 1990, Private construction starts in

Battery Park City ceased. After nearly a decade of soaring office and

residential prices, sales and rental prices even in the city's most

desirable neighborhoods began to decline. Cushman & Wakefield's projections

were now in question, and so was the authority's ability to issue new debt.

For the next five years, commercial and residential building in Battery Park

City remained in abeyance. Prime development sites sat vacant as credit

remained tight and investors waited nervously for someone else to start

building again before committing more capital. But the recession did not

significantly affect BPCA's financial position for several basic reasons.

The authority had over leveraged its cash flow and had not taken on any new

debt after private development halted. Ground rents and PILOTs from existing

development adequately covered all debt service.

And even though the recession caused property assessments and taxes to

decrease, PILOT revenues actually grew due to the gradual phaseout of the

World Financial Center's ten-year tax abatement program.

In its first year, the World Financial Center's first 2 million square feet

paid 25 percent of its PILOT, and this share was increased 7.5 percentage

points a year until it reached 100 percent. The other 4 million square feet

paid 50 percent of its PILOT in the first year, a level that was increased

by 5 percentage points a year up to 100 percent. According to Robert

Serpico, BPCA vice president of finance and treasurer, while overall

assessments declined annually during the recession by 6 percent in the World

Financial Center and by 8 to 9 percent in residential buildings, PILOT

revenues continued to increase. Net pledged revenues continued to exceed

debt service by more than 25 percent, enabling BPCA to meet its interest and

principal payments. 

The 1993 Refunding

By the end of 1992, BPCA had raised $934 million through various bond

resolutions, backed by an intricate flow of funds. This amount represented

nearly three-quarters of total debt the authority had been authorized to

issue. As of September 1992, $893 million remained outstanding. 

Taking advantage of extraordinarily low interest rates, BPCA went back to

the credit market in 1993 to refund all of its outstanding bonds, and in the

process, consolidated a complex debt schedule. It raised $872 million,

supported by all ground leases. (Previous bonds were supported by subleases

signed before January 1986.) The package included a $259 million issue that

refinanced the HNYC's bonds, reducing long "term bond" interest rates from

9.5 per cent to 5.5 percent. The new issue's less restrictive debt service

requirements eliminated the need for a capitalized interest account.

Starting with $21 million that was on the corporation's books, HNYC

deposited $241 million in escrow that will prepay the 987 bonds as soon as

they can be called. A $19 million debt service reserve account, amounting to

less than 8 percent of the total issue, will cover initial interest payments

on the new issue. Subsequent payments will be drawn from BPCA's excess

revenue fund. Moody's gave the refunding an "A" rating. 

According to Serpico, the total refunding will generate annual savings of

$13 million over the previous debt service schedule-a present value savings

of $70 million for BPCA. Because the HNYC bonds were financed at higher

interest rates than the major part of the authority's other debt, annual

debt service savings alone on the $200 million balance of the 1987 issue is

$7.5 million-a net present value savings of $33 million. Thus, half of

BPCA's debt service windfall is related to the financing of low-cost

housing. However, HNYC has not been authorized to issue any new debt.

While refunding has further strengthened BPCAâs already sound fiscal

position, theoretically enabling it to pursue its low-income housing agenda,

BPCA has decided instead to support three new on-site developments-a new

home for the New York Mercantile Exchange (NYMEX), fall-sized family

apartments, and the New York Holocaust Memorial and Museum.

After threatening to leave the city, NYMEX cajoled state and local officials

to subsidize its new facility on a prime waterfront site. The exchange will

realize savings of nearly $60 million through abatements and credits, over

half of which involve reductions in ground rents and PILOT payments. But

NYMEX's biggest coup was the assurance that $100 million of BPCA taxable

bonds would be available to finance construction. BPCA pledged its excess

revenue to support the bonds in the event of default. But even if not a dime

of the authority's money is spent on the project , it will be unable to

raise additional debt against this committed portion of excess revenue.

The same limitations will apply to $40 million of BPCA bonds that will

finance part of the construction of a 200-unit family apartment building in

Battery Park City's north end. In exchange for this assistance, the

developer will offer 30 percent of the building's apartments at below-market

rates. These 60 units have justified the use of the authority's excess

revenue to build where the private market could easily have done so. It

might have been more efficient to have used rent subsidies. A covenant,

however, currently restricts the use of rent subsidies in Battery Park City

that otherwise might have gone to New York City.

Plans for the Holocaust Memorial in Battery Park City have been

longstanding. When realized, the memorial will become an important landmark

for all of New York. But it was to have been financed by an adjacent

residential development and private money. Now BPCA is contributing 10

million toward construction. Should this financing have come from BPCA when

the authority hasn't been able to meet half its obligations for housing the

city's homeless and needy?

As it turns out, however, BPCA has figured out a creative way, via the 1993

refunding, to help the city amortize some general obligation bonds whose

proceeds were used to finance a housing program that HNYC had intended to

support. This arrangement is so substantial that BPCA will arguably have met

its initial $400 million capital commitment to low-income housing.

Support for Housing in New York

The Housing New York Program has been the city's primary housing policy for

nearly a decade. Its goal: to rehabilitate and construct more than a quarter

of a million units for New York's lower-income households and homeless in

neighborhoods where there has been extensive housing abandonment. HNYC was

created to finance part of the $5.1 billion effort, channeling proceeds from

its bond issues directly into housing improvements. In supporting these

bonds, BPCA is playing a key role in the Housing New York Program. In fact,

nearly one-third of BPCA's authorized indebtedness is committed to the HNYC.

Eight years after the initial 1987 H~,NC offering, however, only $142.5

million of the total $400 million earmarked for the housing program has been

spent. (Battery Park City was expected to generate an additional $600

million in general housing assistance. But a loophole in the agreement that

makes use of these funds contingent on the city's fiscal stability leaves

uncertain how much of this will ever be used directly for housing.)

A key strategy of the Housing New York Program was initially addressed

through the city's Construction Management Program (CM), which focused on

the rehabilitation of vacant city-owned apartment buildings. By contracting

private construction managers to super-vise renovation of clusters of

adjacent buildings, the city sought to improve large sections of several

communities at reasonable cost.

While renovating certain structures was more costly than new construction,

CM's policy of universal rehabilitation created more units per building

because new buildings cannot achieve the densities of structures built

before the zoning code reduced floor/area ratios.

Proceeds from the HNYC's 1987 bond issue helped finance the first two sites

of the CM program. In Harlem, the Frederick Samuel Apartments comprises 46

rehabilitated buildings. Tishman Construction was the construction manager.

Largely completed by the end of 1992, the project produced 727 units, 24

commercial spaces, recreational spaces, and a two-story community/day care

facility. The city's Housing Authority owns and operates the development.

The New Settlement Apartments in the south Bronx involved much larger

buildings. Work was supervised by Lehrer McGovern Bovis, Inc. The 14

rehabilitated buildings contain 893 dwelling units, residential support

services, and an early childhood center. The complex is owned and operated

by the Crenulated Company, a nonprofit corporation.

With the Harlem project costing $130 million and the Bronx project $103.4

million, the per-unit cost-$144,000-was more than double the $65,000 target

price. As a result, the city had to kick in more than $90 million to finish

the work. (The city and Tishman Construction ended up in a lawsuit, with

Tishman claiming the city failed to recognize the true costs of gut

rehabilitation; the city claiming Tishman ran up expenses.)

Why did costs go out of sight? Two big things went wrong. Because the city

retained ownership of the parcels throughout rehabilitation, the

construction managers were forced to abide by a controversial labor

regulation, the Wicks Law, which requires subcontracting each phase of work.

The second major reason development costs soared was that the expected

economies of scale did not materialize. Packaging 600 to 900 units in a

single job limits the bidding, for all practical purposes, to large

contractors. While very large jobs can reduce the unit cost of materials,

small contractors can employ substantially cheaper nonunion labor primary

construction expense. Gary Slowman, director of HPD's Permanent Housing for

Homeless Families, finds that a limit of several hundred units per job

allows participation of smaller contractors who can do the work for less.

The city has learned from these mistakes. The Vacant Cluster program, a

successor to CM, designates smaller sites with fewer buildings, thus

enabling smaller contractors to bid on the work. After plans are approved

but before work is started, the city transfers ownership of targeted

buildings to a nonprofit corporation that will manage the completed project.

The Wicks Law, therefore, does not apply. Construction costs for Vacant

Cluster also benefited from timing. Its initial work was contracted out in

the early 1990s, during the heart of the recession, when job bids fell by as

much as 20 percent in a year. Toward the end of 1993, the Vacant Cluster

program had renovated 2,128 apartments in 68 buildings on four sites in the

Bronx. Its average gross unit cost was under $80,000, 45 percent less than

CM-rehabilitated apartments.

The $167 million for the Vacant Cluster rehab projects was to have come from

HNYC bonds. But to expedite the work, the city used expense and capital

budget monies, including proceeds from general obligation bonds (GOs). BPCA,

it was believed, would eventually be able to reimburse the city. Budget

officials figured if the economy rebounded, additional excess revenue would

be generated at Battery Park City and new HNYC bonds would be issued. If the

economy declined, interest rates would continue to fall and the authority

would be able to generate money through re-funding its sizable debt.

Martin Siroko, HDC legal counsel, speculates that if BPCA's excess revenue

were used to secure GOs rather than HNYC bonds, more of the money raised

could go toward housing. This is because HNYC bonds require a larger debt

service reserve.

As it turned out, BPCA channeled nearly all of its savings from the 1993

refinancing to the city to amortize the costs of the Vacant Cluster program

and to repay the $90.5 million that the city had raised to help complete

rehabilitation of the original two CM sites. This $257.5 million commitment,

along with the $142.5 million from the 1987 HNYC bond issue, equals the

amount of BPCA excess revenues that had been earmarked for low-income

housing.

Does this mean that the authority has met its original housing obligations?

State and local officials will eventually have to decide the matter. An

argument that would require the authority to back additional housing bonds

is that the city is not permitted to use BPCA monies for housing projects

that have already been financed. Abe Greenstein, president of HNYC,

observes, "Whether or not this $2 5 7.5 million transfer means the authority

has met its initial $400 million legislative directive, it's clear that $400

million of capital improvements for low income housing is attributable to

Battery Park City's cash flow."

The Future Flow of Excess Revenue

A headline on the front page of the December 27, 1987, edition of the New

York Times announced, "New York Reaches Accord on Housing." The first

paragraph read, "Battery Park City plans to contribute $1 billion to develop

housing in New York City, $600 million more than originally agreed to. That

means the development is to finance one-quarter of Mayor Koch's 10-year plan

to build low- and middle-income housing."

Between 1987 and 1993, BPCA transferred nearly $175 million to New York

City's general fund as part of the city's cut of ground lease revenues. The

authority's excess revenue exceeded $110 million. Debt service on HNYC bonds

totaled $18 million.

Who ultimately decides where the excess revenue goes? The authority can

influence the decision by making recommendations to the city and state. Then

the politicking begins, and whoever is owed more favors or, at a particular

time, has a greater vested interest in a related project, tends to win out.

Though the authority and the state developed Battery Park City, the

principles of home rule have enabled New York City to retain a heavy hand in

all decisions pertaining to the use of excess revenue.

The only way a dedicated stream of revenue from BPCA to HNYC could have been

assured was if, first, the mayor and city council agreed to relinquish

control of these funds, and then, both state assembly and senate passed

legislation to that effect. As this was not done, neither the authority nor

New York City are legally bound to follow former Governor Cuomo's directive

to channel additional funds into low-income housing. This issue begs the

question of whether there should be more binding linkage between a specific

intent of a state-assisted project and the ultimate disposition of revenue

it generates.

As the city continues to struggle financially, local politicians are

preventing BPCA's excess revenue from supporting low-cost housing. The early

commitment to help those households that were excluded in the final Battery

Park City master plan has faltered. And this was never more evident than in

1990, when a $70 million HNYC bond issue was prevented from going to market

by a $223 million BPCA issue that was used to balance the city's budget. 

With the economy reviving and the city's real estate market picking up, BPCA

is returning to the credit market, but not to finance low-income housing (or

the city's deficit). New bonds supported by BPCA's excess revenue will

subsidize jobs, luxury apartments, and a museum in Battery Park City. The

windfall from the 1993 refunding was a fortuitous contribution to the city's

housing program. But BPCA's commitment to low-income housing is behind

schedule. Officials at HPD, the Office of Management and Budget, and the New

York Housing Development Corporation can give no estimate when new monies

will be raised to help those who are desperately in need of decent shelter.

And BPCA's official line on its housing commitment and a possible date for a

new bond issue is cryptically terse: "Battery Park City is absolutely

committed to the Housing New York Program." 

Former president of the Battery Park City Authority, Sandy Frucher, recently

recalled one of the proudest moments of his life during the 1987 dedication

of the World Financial Center:

Standing in the rotunda, I was surrounded by businessmen, politicians, and

advocates for the poor whose interests were all tied together in the success

of Battery Park City. We had set into motion a new kind of capitalism that

generated wealth, then recycled it to those who needed it most. But

priorities have changed, and I fear that when the economy returns, both

developers and government officials will have forgotten what was

accomplished.

The BPCA seems to have been on the verge of defining a new kind of

capitalism that enlarged the loop in which "profits" from private

development could flow. But now, eight years after the initial financial

commitment to low-income housing, one may well wonder whether the transfer

was truly a commitment to social equity or a political exception that has no

real chance of delivering continuous assistance to New York's neediest.