Speaker 1In order for a MUD to sell a $10 million bond issue, it has got to demonstrate that it has at least $100 million worth of taxable value on the ground today to support the issuance of that debt. And so we're not issuing bonds based upon projections. We're not issuing bonds based upon a promise to build. We can only issue bonds by state law based upon value on the ground today. Hey, what's going on, everybody?
Speaker 2Welcome back to the Land Development Podcast. I am your host, Ryan Glick. I'm excited today to be joined by Howard Cohen, who is the managing partner at Schwartz, Page, and Harding. Howard, thanks for joining me. Thank you for having me. Well, I'm going to set the stage here really quick for everybody before we get into our topic and we get into your background. So about a month ago, we had an episode on the show where we dug into some high-level topics related to MUDs and special districts. And today, we're going to get a little bit deeper into those topics and maybe a little more technical in the forming of these special districts and the MUDs and everything, and also the infrastructure reimbursement. And so this is going to be, it's not going to be the same as that other episode. We're going to get, again, more into some of the details there. But before we get into that, I did want to start, as we always do, by getting into your background and how you got into the industry. So could you walk us through your path getting into land development and into public finance on the legal side?
Speaker 1I'd be happy to. So by trade, I'm a lawyer, and I spent the better part of five or six years as a young lawyer, mostly practicing general real estate law. I've been in the business for a long time. I've been always very interested in real estate, not necessarily land development, but my early practice consisted of real estate closings, whether they be commercial or other types of industrial developments. And then just through folks I know, and in fact, one of my current partners, kind of introduced me to the mud world. And, you know, as a real estate practitioner, I really didn't know a lot about mud. Every now and then it got brought up in a transaction, but I think like a lot of real estate practitioners, they just, they know enough to know what it is and maybe some issues around it, but I didn't really know anything about it, but kind of got brought over here in the late nineties. And this is where I've been ever since. And so my practice now consists of representing landowners and special districts of all, all sorts. Muds are one part of it. And so I've been in the business for a long time. And since it's a cradle to the grave representation from the beginning to the end, there is very nuanced practice. There's a lot to it and there's a lot to know about it. And there's a lot of misunderstandings out there about muds, what they do, what they don't do and how they operate. So that's, that's more or less my background, my firm. All we do is special district work. We've got more than 20 lawyers here and that is our specialty.
Speaker 2Well, I do want to ask on the, since you've been working on the, on the, on the, on the I think it has maybe not so much change, but
Speaker 1again, to have, I think a clear understanding of muds and the role that they play in land development, especially in the Houston area. It is somewhat geographically differentiated throughout the state, but especially in the Houston area, it is an absolute. Integral part of how Houston has developed and likely will continue to develop in the future. Some of it has to do with politics, local politics, and then some of it has to do with availability of water supply in the Houston area versus some areas that may be in North Texas or Central Texas or even West Texas. But yeah, it's changed really from the standpoint of just really understanding how integrated it is in the development business.
Speaker 2So we have listeners, you know, throughout the state of Texas, we have listeners around the country, of course, as well. So for those who are not in the state of Texas, maybe they don't have this concept of special districts and they may be curious how something like this even gets started in a state. Is there anything you can speak to on that? As far as if there is somebody out there in a state where this isn't even a thing, but if, if they did implement something like this, maybe it could help them get more of these projects to pencil and more development growth. Any thoughts on that?
Speaker 1There are some similar districts in, in other states, similar tools, if you will, California, Colorado, Florida, and other states have, it's an alphabet soup game, acronyms for everything. But the unique thing about Texas, and it is very unique, is the regulatory environment here. Right. The MUDs here are highly regulated. They are not allowed to do what we call air land financing. That is spend the money and hope it develops. You have to have a proven track record in order to do a MUD financing. And so in other states, there've been a lot of trouble that comes with ups and downs of the market. In Texas, we did have some trouble in the eighties. We got that fixed and we've been through several cycles. Since then, and it has produced a very reliable, stable bond market, which really is all hinged on, on the regulatory environment here in Texas, which again is very unique from, from other states. We have had a lot of inquiries from other states. And in fact, other countries that look at Texas as a model for how this should work. That includes places like Australia. Which we recently met with a delegation then wanting to solve housing crisis in that country. And so, you know, they look at Texas as a good working example and it is very true.
Speaker 2Well, let's dig into the concept of forming a MUD. So say I'm, I'm a developer and I have a piece of land that I'm putting under contract that needs a MUD. What, what happens next?
Speaker 1You have the basis of the facts, right? A developer will usually contract. They'll come to us and want to prepare their land for development and we look at a MUD as an entitlement to that property. A MUD can be created through one of two ways. One way is an administrative process. The Texas Commission on Environmental Quality is a state agency that is empowered by statute to create MUDs. That process entails an application. That application is, I mean, it's not a two page form. That you fill out. It is legally technical and an engineering study that has to be provided. But in essence, a landowner can create a MUD upon land that they own. Not land anybody else owns, but the land that they own. That application takes from the beginning to the end. It takes about 12 months and the beginning being the time that the landowner says go. About a 12 month process. The process is. Relatively certain. It's gotten less certain in the modern context. But if you comply with the rules and your application meets the legal requirements, it should be approved. There is public hearing process that goes along with it. But again, about a 12 month process that includes a petition from the landowner, a financial feasibility study, an engineering report, some maps and other things. But that gets. Packaged up and processed through that state agency. The other way is through a special act of the legislature. And of course, in our state, they're not a full time legislature. They meet for about five months every two years. And so the timing of that has to be right. That is a little bit more of a streamlined process, but a little more risky as well, simply because not everything that happens is going to be done in a timely manner. But I think there's going to be a lot of uncertainty in terms of what happens in Austin, you know, that there is no certainty there in terms of being able to actually pass that special act. And so those are the two ways that they're created. There are other types of districts, not muds, but other types of districts that can be created through the action of the county, not muds specifically, but other other types, but basically two ways.
Speaker 2So you kind of led right into what I was going to ask next. But before we do that, I shouldn't have made the assumption that everybody who's listening in. Right now, listened to that other episode. So I guess the first first thing I'll have you do for us is tell us what mud stands for. Number one, because people might not even know what what is a mud. So could you tell us what that stands for? Sure. It stands for a municipal utility district.
Speaker 1And it is one of many types of districts that we have in the state. And the purpose of a mud really is to be able to. have a governmental entity and it is a true governmental entity that is responsible for constructing, financing, and ultimately operating the water, sewer, and drainage that will serve a very defined geographical area. They also can operate and construct roads as well as recreational facilities. So those are kind of the five types of facilities that you normally and typically see a mud responsible for. But it is a mechanism to ultimately have utilities owned by a governmental entity as opposed to private entity. And there are some areas in the state that are operated and served by private entities, which is a different model that, you know, major differences there. And we can talk about that if you like as well.
Speaker 2So you had said before that there are other special districts that can be created besides MUDS as, you know, MUDS is one of them. But for those other ones, you just, I guess you just listed out, I think, the five different things of where MUDS are typically used. And I would assume that any other scenario would then be a look to other types of special districts for other use cases. Like what are some example of use cases where you might use a different special district?
Speaker 1Yeah. There are some other types of districts that are similar to MUDS and may be used in lieu of a MUD. You know, in North Texas, I think they historically preferred freshwater supply districts, which I think is a good example of that. And I think that's a good example of that. Which is very similar, but not exactly the same as a MUD. But really, it really centers around what is the purpose and what is the need that you're trying to fill? A MUD is kind of basic utilities. You may have a LID or a Levy Improvement District that is designed to build and operate levy systems in Fort Bend County, has a lot of LIDs. Water Control and Improvement Districts are generally used for that. dealing with drainage only. You have other specialized districts such as navigation districts. But really, you're looking at what is the need and what is the problem that you're trying to solve.
Speaker 2Well, let's look at the funding mechanism for this then next. So let's say that a MUD is created. How does the developer then, you know, fund the infrastructure and, you know, eventually get reimbursed if that's how it works?
Speaker 1Yes, it is how it works. And this is one thing that is fairly unique, I think, to Texas and what I call the Texas MUD model. And the reason why, as I described earlier, it is so safe and stable is, you know, land development is a risky business. There are cycles that change. And when the market moves one way or the other, it can be really good or really bad. But the MUD model, in essence, keeps the risk of and the success of development where it should be. And that is on the developer. It doesn't transfer that risk to either the state or to the bond buying public. There is some risk there. But generally, the risk of a successful district is on the developer. So the financing in a typical MUD is the developer pays for everything. They pay for the creation of a MUD. They pay for the operations of the MUD in the early days. They pay for the construction of all the facilities that the MUD is going to operate. They build those facilities. They have to be built based upon approved plans and specifications. And by approved plans, they have to be approved by the state. They have to be approved by the county. If you're in a city extraterritorial jurisdiction, you got to get the approval of the city. So all the regulatory approvals have to be had. And the MUD has to approve them. And if they're built in accordance with approved plans and specifications, and if the value, the vertical improvements, the taxable value that is ultimately kind of the goal, if the value is sufficient then to support the issuance of bonds, then and only then will the MUD reimburse the developer. Its cost not cost plus profit. It's a reimbursement system. It's cost of those improvements. And the MUD is the one that owns and operates those improvements, which, you know, puts it in the hands of an elected board of the residents that live in that MUD.
Speaker 2This episode of the Land Development Podcast is brought to you by First Continental. For more than 30 years, First Continental has been a trusted financing partner for many of the most important businesses in the United States. And we're of the nation's leading home builders and developers, providing non-recourse lot acquisition and development loans in over 40 markets throughout the South, Southeast, and Mountain West. During periods of changing market cycles, First Continental has proven to be a consistent and dependable lending partner, one that stays committed instead of retreating when conditions shift. Unlike many private lenders and banks, they offer genuinely non-recourse loans, free of hidden provisions that could trigger personal guarantees. Structure ensures true alignment and shared success in delivering new home communities. From application to payoff, the process is straightforward, efficient, and designed to keep projects moving forward. Whether working with publicly traded or privately owned production builders, First Continental brings experience, clarity, and flexibility to every deal. To learn more about how they can support your next community, visit firstcontinental.com. All right, let's get back to the show. Can we talk about the issuing of the bonds? I'm not entirely sure how that all works and everything. Is that something where the developer is paid out over time or at the time, you know, as the bond is actually, you know, purchased by the people or how does that process work?
Speaker 1Yeah. So building of infrastructure is non-inexpensive. It is a significant undertaking both in terms of the dollar investment and actually getting it, in the ground and physically implemented. For a developer to do that, they have to have the experience and the financial wherewithal to do it. And the agreement, if you will, and there is an agreement with the developer that basically says, and I'll put this not in legal terms, but if, as, and when you build it, and if you build it in accordance with the contract, then if and only if we're able to pay you. We'll pay you. So that, that's the basic agreement with the developer. Now you may say, well, that's not a, that's not a very solid promise, but it is. The developer understands what they have to achieve. And so at a certain point in time where you've got all the infrastructure in the ground and vertical improvements have started to be developed and the value of those vertical improvements have been developed, then you have to go out and create a tax base. Then there is a market that exists for mud bonds, Texas mud bonds, and it's a very, very well regarded market. And the district is able to go out to the bond buying public and say, we will sell these bonds to you. The security for those bonds are the mud taxes that the businesses and the residents will pay. on their vertical improvements. And, and those taxes are then levied and collected by the mud and promised that that is the security for the bonds. And so that market is very well recognized in a startup development. It might not be what we call rated paper. And by rating, there are groups like Standard and Poor's or Moody's that will provide rating to certain districts based upon their finances and history. But in the early days, probably not. And then again, as it matures, you might get a rating or you might get municipal bond insurance, which guarantees the payment of those bonds. In essence, it is, it is a promise to pay the developer or repay the developer for the infrastructure that they have built. And that infrastructure is then owned by the public to serve the public and the people who live in the district. And it may be beyond the scope of your question, but I want to relay a very important point. You know, when a person buys a home, they're obviously buying an interest in land. And they're buying the structure on the land. And the cost of that house is not just the land and the house on it, but the cost of it is also the infrastructure that was put there to serve that house. And so one of the reasons why you're talking about the infrastructure is because it's not just the land and the house on it, but the cost of it is also the infrastructure that was put there to serve that house. cost in the initial home price or that infrastructure cost can be paid out over a period of time through a tax, and not only are they getting the benefit of deferring to that cost, but they're not going to pay the entirety of that cost because that cost typically, you know, you live in a home, I don't know, 10 years, let's say, you'll pay that share of the cost, but the second homeowner will also pay a share of that cost. But it also allows that infrastructure cost to be financed at a tax-exempt rate. These mud bonds are tax-exempt, which means the cost of borrowing is lower, and so ultimately it goes to reduce the cost of housing, and that is a really important point.
Speaker 2Yeah, I was going to ask you on that a couple of things I wrote down here as you were talking through that and describing it. One thing, and you may have already said this, but I just want to make sure I understand it. When are the bonds issued? Does the project have to be completed before bonds are issued, or at what stage are the bonds actually issued?
Speaker 1Yeah, so the bonds are issued in tranches over time, and they're issued at a point where there is demonstrated taxable value there in an amount sufficient to support the bond. So in order to develop an area, let's say that there's $100 million of infrastructure cost. The developer will be reimbursed in tranches, and perhaps we can just take that number and divide it by 10, and the district may sell an initial bond issue for $10 million. This is an oversimplification, but in order for a mud to sell a $10 million bond issue, it has got to demonstrate that it has at least $100 million worth of taxable value on the ground today to support the issue. And that is really a distinguishable factor. So it's issued in tranches over time as the development proceeds, but only based upon what's on the ground.
Speaker 2So does that mean that if you're a developer, that's not going to be able to issue bonds that's not doing vertical construction? You're selling the empty lots to builders. Do the builders have to have completed construction to the point where they've been sold to generate enough taxable revenue for that bond to be issued? Or I'm just trying to figure out, if you're a developer that's not doing the vertical construction, are you kind of at the mercy of the builders getting stuff done before you can prove that you have that taxable revenue in place?
Speaker 1You are, and that's why it's incumbent. It's incumbent upon the developer to have those relationships with quality builders who they know are going to perform, who have a track record of performing. The value of a house, even constructed in a builder's hand, is typically less than it is in a resident's hand because you have some different appraisal valuations. One is an inventory value. The other one is true retail value. And so, yes, the developer really. And it's all on the developer's back. And so they're going to be reliant upon a good contractor. They're going to be reliant upon good quality builders that they know that if they take down, i.e. buy 100 lots, that they're going to build on those 100 lots. And they have a marketing program that can sell those 100 lots to homeowners. And if the market slows down and home sales are light or the builder has problems, the developer is at risk of not being paid back that money or at least not being paid as soon as they expect it.
Speaker 2So if, you know, going back to something you said earlier in the conversation, if a project is delayed, gets delayed, you know, significantly, or let's say a project just never gets completed, you know, which I'm sure happens, in those scenarios when that happens is, you know, I guess. What does that look like to the developer? What does that look like if they've already issued bonds and the rest of the project never gets completed? I would assume that the bond's not going to get issued unless there is some taxable revenue. So those should be a wash, hopefully, and there's not anything lost to the bondholder.
Speaker 1Yeah, the existing bonds that are outstanding, again, were based upon value in the ground. So those bonds have been sold and are fully supported. If there's no additional value, the bond program stalls or stops until that value is created. There are rules that the Texas Commission on Environmental Quality has that basically says a district cannot sell bonds if they cannot demonstrate based upon a no-growth basis, that is, not one more house is put on the ground. That the tax rate will not exceed certain thresholds amount. And so there are what we call feasibility rules that have to be complied with. Otherwise, the bond program stops and the developer is left holding this receivable, if you will, for some period of time, perhaps many years.
Speaker 2So let's say that a development is completed and bonds have all been issued. The developer's been fully reimbursed and everything's basically done. The mud lives on. How does the funding of the mud continue after the developer is out of the picture?
Speaker 1Great, great question. So every mud has a life cycle. And that life cycle begins, obviously, upon creation. You have a development phase. And then you have a phase. Where development is over. And what the tax rate for your average mud looks like is they begin very high. I say very high. A high tax rate at the beginning because you're in the stages of development. Value is being created. Costs and construction are also increasing. But as those facilities get constructed and as the value creates, you see this slow, steady decline of the tax rate over a period of time. Once the infrastructure is paid for, then you go into a maintenance mode. And the mud operates and maintains a system with a fairly nominal tax rate. Obviously, they have other revenues like water and sewer revenue that helps them operate and maintain that system. And so at some point, it will revolutionize. And you have to travel out to fairly low nominal rate. And the folks that are, quote, unquote, in control of the mud are your neighbors, board members that literally are your neighbors. And if you've got a complaint about the mud or the quality of water or level of drainage, go right down the street and complain to your neighbors. So it's a very localized system of governance. Perhaps the most localized system of governance. But it used to be that the model was originally designed to have cities like the city of Houston swallow up these muds once they're fully developed. Over time, that has become, after the Kingwood annexation, which was kind of a very distasteful episode in the late 90s, where the city of Houston annexed Kingwood, kind of adverse to a lot of the residents that live out in Kingwood. Under today's law, cities can't just involuntarily annex an area. They've got to have buy-in from the general public. And so whereas the muds of yesterday were really designed to go away at a certain point, today, we might. We may be seeing a world where they're kind of left in perpetuity to operate those systems. And we'll kind of see how all that works out.
Speaker 2Do you have different special districts that overlap a certain area? Like, could you have a mud and then also one of these other districts or multiple districts in the same spot? And then secondarily to that, is it a different board that manages each of those then?
Speaker 1Yes. Yes, you do have overlap. If you have an overlapping district, it's not uncommon. Most of the master-planned communities, and by master-planned, I would tell you communities that are several thousand acres, will have a number of muds, perhaps an overlapping levee improvement district or an overlapping water control and improvement district. Those are somewhat similar in nature in that they're drainage functions only. Some areas. and counties have countywide drainage districts, which are a little different different as well. But yes, you do have overlapping districts and they each have an independent board that operates independent from each other, but working with each other for the community as a
Speaker 2whole. So you mentioned that some large projects will have multiple MUDs within that project. Is there a certain maximum size that they like to try to keep the MUDs to before they would say like this single MUD for this entire thing, or it's like, no, you have to have two here because of the size of it?
Speaker 1There's no legal limitation either on the smaller end or the larger end. There are practical limitations on the smaller end. Obviously you've got to have enough bandwidth there to create enough value to support the improvements that are necessary to serve that MUD. And generally I would tell you, and there's exceptions to every rule, but generally MUDs are the ones that are going to have the most value. So you don't have to have a lot of 200 acres is kind of the minimum if you're going to have standalone facilities that serve that mud. On the larger side, it really is about how big can it be? It can be, I think, Clear Lake City Water Authority is the largest mud type entity, and that's 16,000, 17,000 acres. That's very large. You wouldn't see that done in the modern day and age. The woodlands community, which is about 30 plus thousand acres, is comprised of about a dozen muds and an overlapping management district, which really is responsible for a lot of the city type functions that you might see in the woodlands. And that's town center improvement district. That's an overlapping district. But generally speaking, on the larger side, I would tell you, you know, 700, 800 acres in a single mud is, from a practical standpoint, you can have larger, but may get a little unmanageable.
Speaker 2Well, I think looking at the time here, be good to shift into the last segment, which is the lightning round. So I've got five questions for you. First one, what is the biggest mistake developers make when forming a mud? Not doing it soon enough.
Speaker 1And by that, I mean, whether it be a developer or a landowner, as I explained in the first few minutes, the creation of a mud upon a piece of land is an entitlement. It is a way to serve the ultimate development of that land. And the sooner you can do that, the better off you are, because that mud is in existence and will be, if you're farming that way, you're going to get a lot of land. Your family might want to sell that land to a developer. That timeline may be somewhat out there and you think, well, I don't need it now. But I think not doing it soon enough and not understanding that it can be political. It can be time consuming. It's never as easy or as quick as one might think. And but you have to spend a little bit of money to get it done. But I think that is the critical mistake. It's not doing it soon enough.
Speaker 2All right. Second one. What is one question every developer should ask about special districts before buying a piece of land?
Speaker 1How do they work? And how do I get paid? I think really the basics of how these districts work, they need to understand it. They need to know what the expectation is of them. And they need to know what to expect in terms of repayment schedule. Many developers are sophisticated. Many developers might be sophisticated in a certain type of development or development in a certain geographic area where they don't have a lot of experience with muds. And I think just having a sit down with a professional who does understand it is a very critical item.
Speaker 2All right. Third one. What do you think is the biggest challenge facing muds and other special districts over the next 20 years?
Speaker 1So I think right now. We live in a time where we have experienced tremendous growth in the state of Texas. And that growth has been prompted by leadership in the state. A call, if you will, to come to Texas. We're open for business. We want your business. We want your folks. And we have been tremendously successful. Right now, I think there is a big pushback against growth. And so. I think the biggest threat that we have is a lack of understanding that muds are a way to accommodate the growth that we've experienced and that I think we will continue to experience. If we do something that undermines the mud model, I think what we're going to have is a different type of growth. We're going to have growth, but it is not going to be the good quality growth that we've experienced. And. I think it will be very bad for the state.
Speaker 2All right. Mixing it up with these last two here. So fourth one. What's the best piece of advice you've ever received in your career?
Speaker 1Be the first one in the office and be the last to leave.
Speaker 2All right. All right. Last one. If you weren't an attorney. What other career path do you think you would have gone on?
Speaker 1Doing something with my hands, either working on, you know, something mechanical or building something. I love what I do. So it's hard for me to really imagine. Doing anything else. But at some point, we all have to find a different hobby. But right now, my work is my hobby.
Speaker 2There you go. All right. Well, Howard, that is all for the episode. What's the best way for people listening in to, you know, connect with you and learn more about your company?
Speaker 1Well, I'm not a big social media person. I think my goal in life is for someone to Google me and not not find anything at all. But our firm does have a website and feel free to call me with any further questions. I'm always happy to talk about mud. Problem may be to get me off the phone, not necessarily on the phone.
Speaker 2All right. Well, if you guys look in the description for this episode, you will see a link there to the show notes page. And on the show notes page will be a link to the website. Howard, thanks again for hopping on here and sharing your knowledge and everything about muds and special districts. I learned a lot here, a lot of detail that we've never gotten into before on the show. So I really do appreciate you taking the time to do this.
Speaker 1My pleasure. All right.
Speaker 2Guys, that's all for this episode. If you're not already subscribed, please click that button. We'd love to have you back for the next one. Otherwise, we will see you all back here next week. Have a great day.
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