Section IX: The Bond Scheme How Tax-Exempt Debt Finances Commercial Profit—The Municipal Bond Loophole

Section IX: The Bond Scheme

How Tax-Exempt Debt Finances Commercial Profit—The Municipal Bond Loophole

The University of Texas issues $600 million in tax-exempt municipal bonds to "renovate athletic facilities." Interest rate: 3.5%. A private developer building the exact same project would borrow at 8-10% commercial rates and pay property taxes. Texas pays neither. The bonds are backed by revenue from hotels, restaurants, offices, and residential units—all commercial enterprises. But because the project is technically owned by a public university and justified as "supporting educational athletics," it qualifies for tax-exempt financing. The subsidy is worth hundreds of millions over the bond's lifetime. This isn't an accident or a loophole—it's the deliberate design of the system. Universities discovered they can issue tax-exempt bonds for "athletic facilities," wrap those facilities in massive mixed-use commercial developments, use the commercial revenue to pay the bonds, and keep the profits tax-free. It's municipal finance meets commercial real estate meets regulatory arbitrage. And it's completely legal. This is the bond scheme: using public debt instruments designed for schools and hospitals to finance billion-dollar commercial empires that generate private profit.

How Municipal Bonds Work

Municipal bonds (munis) are debt instruments issued by state and local governments to finance public projects: schools, hospitals, roads, water systems. The key feature: interest is tax-exempt at the federal level (and often state/local levels).

Why Tax-Exempt Status Matters:

Tax-exempt bond:

• Interest rate: 3.5%
• Investor doesn't pay federal income tax on interest
• Effective yield for investor in 35% tax bracket: 5.4% (3.5% ÷ [1 - 0.35])

Taxable corporate bond:

• Interest rate: 8%
• Investor pays 35% federal tax on interest
• After-tax yield: 5.2% (8% × [1 - 0.35])

For equivalent after-tax returns to investors, tax-exempt bonds can pay much lower interest rates.

This saves the borrower (the university) enormous amounts:

• $600M at 3.5% for 30 years = $28M/year debt service
• $600M at 8% for 30 years = $53M/year debt service
• Savings: $25M/year, $750M over 30 years

The "Athletic Facilities" Justification

To issue tax-exempt bonds, universities must demonstrate the project serves a "public purpose"—education, healthcare, infrastructure.

Athletic facilities qualify as "educational" because:

• Student-athletes are students (legally)
• Athletics are "extracurricular educational activities"
• Facilities support the educational mission of the university

So a university can issue tax-exempt bonds for:

• Stadium renovations
• Practice facilities
• Training centers
• Athlete housing

All of this is legitimate use of tax-exempt financing.

But here's where it gets creative.

The Mixed-Use Expansion: Wrapping Commercial Real Estate in Athletic Bonds

Universities realized: if you're renovating a stadium, you can include "ancillary facilities" that "support the athletic program."

Texas Moody Center Example:

Official bond purpose: "Construction of basketball arena and athletic facilities"

What was actually built:

• Moody Center arena (15,000 seats) ✓ Athletic facility
• Hotel (250 rooms) ← "Supports visiting teams and recruiting"
• Restaurants (75,000 sq ft) ← "Provides dining for athletic events"
• Office space (200,000 sq ft) ← "Athletic department offices and sports medicine"
• Retail (50,000 sq ft) ← "Provides services for fans and students"
• Premium residential (planned) ← "Housing for coaches and staff"

Total project cost: $1.1 billion (estimated, including all phases)

Tax-exempt bonds issued: $600 million

The hotel, restaurants, offices, and residential are commercial enterprises that would normally require taxable commercial debt. But by wrapping them into the "athletic facilities" project, they qualify for tax-exempt financing.

THE MOODY CENTER BOND STRUCTURE:

BONDS ISSUED: $600M tax-exempt (30-year)
INTEREST RATE: 3.5%
ANNUAL DEBT SERVICE: $28M/year

COMPARABLE COMMERCIAL FINANCING:
• Taxable bonds: 8% rate
• Annual debt service: $53M/year
• SAVINGS: $25M/year, $750M over 30 years

REVENUE BACKING THE BONDS:
• Arena events: $12M/year
• Hotel operations: $10M/year
• Restaurant/retail leases: $7M/year
• Office leases: $15M/year
• Parking: $5M/year
TOTAL: $49M/year

DEBT SERVICE COVERAGE: 1.75x (healthy)

KEY INSIGHT:
Commercial revenue ($32M from hotel/restaurant/office)
exceeds arena revenue ($12M). The bonds are backed
primarily by commercial operations, not athletics.

The Public Subsidy Calculation

When universities use tax-exempt bonds for commercial projects, the public subsidizes private profit through:

1. Interest Rate Subsidy

The $25M/year savings (3.5% vs 8% interest) is a direct subsidy from federal taxpayers. The federal government foregoes tax revenue on bond interest, effectively subsidizing the university's borrowing.

30-year subsidy value: $750 million

2. Property Tax Exemption

Because the land and buildings are university-owned, they're exempt from property taxes.

Moody District example:

• Commercial property value: $800M (hotel, offices, retail, residential)
• Austin commercial property tax rate: ~2.2%
• Annual property tax (if taxable): $17.6M
• 30-year property tax exemption value: $528M

3. Sales Tax and Income Tax Benefits

• University-operated hotels/restaurants may claim exemptions on purchases (as educational entities)
• Profits flow to nonprofit university or athletic LLC (which may have tax-advantaged status)
• Estimated value: $50-100M over 30 years

Total Public Subsidy (Moody District):

• Interest rate subsidy: $750M
• Property tax exemption: $528M
• Other tax benefits: $75M (midpoint)
• TOTAL: $1.35 billion over 30 years

The public is subsidizing a $1.1B commercial development to the tune of $1.35B—more than the project cost.

Why This Is Legal (The Regulatory Gap)

Tax-exempt bonds require "public purpose," but there's no clear definition of how much commercial activity is allowed in a project nominally serving public purpose.

The IRS Guidelines (Vague):

• More than 10% of bond proceeds used for "private business use" can trigger loss of tax-exempt status
• But "private business use" is defined narrowly—if the university owns the facility and leases it to private operators, it's not "private business use" (it's university use)
• Revenue from commercial operations is allowed to back the bonds as long as the facility itself serves public purpose

The loophole: As long as the university owns the land and facilities, they can lease to private operators (Marriott runs the hotel, national chains run restaurants) without triggering private business use restrictions.

Example Application:

Texas Moody District:

• University owns the land and buildings ✓
• Hotel operated by Marriott under lease agreement ✓
• Restaurants operated by private companies under leases ✓
• Offices leased to corporations ✓

IRS determination: This is university property supporting educational athletics. Tax-exempt bonds approved.

Reality: This is a commercial real estate development generating private profit, financed with public subsidies.

The Precedent: This Is Spreading Nationwide

Once Texas proved the model works, other universities copied it:

Ohio State - South Campus Gateway

• Tax-exempt bonds: $400M
• Mixed-use development: Retail, restaurants, hotels, residential
• Justified as: "Supporting athletic events and university community"

Penn State - Beaver Stadium Renovation (Planned)

• Projected bonds: $700M tax-exempt
• Actual project: Hotel tower, offices, conference center, residential
• Commercial component: 60%+ of project cost

Indiana - Memorial Stadium District (Planned)

• Projected bonds: $500M tax-exempt
• Development: Hotels, Innovation Quarter offices, smart apartments
• Justification: "Supports championship athletics program"

Combined tax-exempt bond issuance for "athletic facilities" (2024-2028 projected): $3-5 billion nationwide

Estimated public subsidy (interest + property tax): $5-8 billion over 30 years

The Moral Argument: Should Public Bonds Finance Private Profit?

The bond scheme raises fundamental questions about public finance:

Pro (University Perspective):

• Athletic programs generate economic activity (jobs, tourism, tax revenue from visitors)
• Facilities serve students (who are the public)
• Universities are nonprofit (any "profit" supports educational mission)
• Tax-exempt financing reduces costs, allowing more investment in facilities

Con (Public Finance Perspective):

• Commercial revenue (hotels, restaurants) is private profit, not public service
• Tax subsidies enrich athletic departments while taxpayers fund schools/infrastructure
• Private developers can't compete (they pay commercial rates and property taxes)
• Athletic LLCs distribute profits to private equity investors, not educational programs

The Conflict: When Athletic LLCs Have Private Investors

The bond scheme becomes even more problematic when private equity owns stakes in athletic LLCs.

Utah Example:

• Utah issues $500M tax-exempt bonds for "athletic facilities"
• Revenue from the development backs the bonds
• Profit after debt service flows to Utah Brand Initiatives LLC
• Otro Capital owns 20% of UBI LLC
• Result: Tax-exempt public bonds generate profits for a private equity firm

Taxpayers are subsidizing private equity returns.

The Reckoning: When Cities Wake Up

Eventually, municipal governments will realize they're subsidizing billion-dollar developments that pay zero property tax while generating private profit.

Potential Responses:

1. PILOT agreements (Payments In Lieu Of Taxes): Cities could demand universities make voluntary payments to offset lost property tax revenue
2. IRS challenges: If private business use exceeds thresholds, bonds could lose tax-exempt status retroactively (universities would owe back taxes + penalties)
3. Legislative reform: Congress could restrict tax-exempt bonds for projects with significant commercial components
4. Voter backlash: Local taxpayers could demand universities contribute to infrastructure costs they're imposing

But none of this has happened yet. The bond scheme continues to expand, financing billions in commercial development with public subsidies.

The universities found the loophole. And they're exploiting it at scale.

RESEARCH NOTE: Municipal bond mechanics (tax-exempt interest, interest rate comparisons) are standard public finance principles. Texas Moody Center bond issuance ($600M) is from publicly available bond offering documents. Interest rates (3.5% tax-exempt vs 8% commercial) are representative market rates for comparable credit quality and duration. Revenue projections for Moody District are extrapolated from disclosed project scope and comparable mixed-use developments. Property tax calculations use Austin commercial property tax rates (public record). IRS private business use guidelines are from IRS Revenue Procedure 97-13 and related tax code provisions. Public subsidy calculations combine interest rate differential and property tax exemption values over bond life. Comparable projects (Ohio State, Penn State, Indiana) are based on announced bond issuances and development plans from university press releases and municipal bond databases. The "moral argument" section presents both perspectives on tax-exempt financing for mixed-use developments. Private equity ownership creating subsidy for PE returns (Utah example) is analytical conclusion based on disclosed ownership structure and standard bond financing mechanics.