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Closing the Gap: Public/Private Financing Tools and Development Feasibility
Tony Q. Smith, S. B. Friedman & Company
May 22, 2012
Overview
1. TIF General Best Practices: “When, Why, and How Much?”
2. The “Capital Stack” and Problem-Solving in the Current Environment
3. Case Studies- Innovative Uses of TIF and Other Public/Private Development Finance Tools
Part 1: TIF General Best Practices: When, Why, and How Much?
Tax Increment Financing
Revenues diverted for TIF‐eligible
purposes (state law)
Revenues continue to flow to normal taxing bodies
Fund
Pledged to support bond debt
service
Pledged to developer note
Used tofund streetscapeimprovements
Within a defined geographic area…
Tax Increment Financing
After TIF Expiration: All tax base released to
normal taxing
jurisdictions
Why Assist a Project?
To Achieve Key Public Goals Enhance local tax base/ fiscal
balance Enhance employment base Affordable housing/ community
facilities Catalytic infrastructure Remediation Greater public benefit Amenity/character
When Should Government Assist?
Public infrastructure/ improvements
Extraordinary costs Proposed project is “above
market” or “non-market” Market not yet established (not yet
financeable) Desirable features that market
won’t fully “pay for” Publicly desired use is not the
highest and best economic use
Limited circumstances: incentive to attract or retain investment in a strategic area
Illinois
Property Assembly Site Preparation and Environmental Cleanup Building Rehab Public Infrastructure/Improvements Affordable Housing Construction Interest Costs Job Training Site Marketing and TIF Administrative/Professional Costs Payments to School and Library Districts to Offset
Increased Fiscal Burdens
How Much Help?
Primary Ways to Determine: Financing gap in order to achieve reasonable rates of return Amount readily explained by extraordinary costs Cost of providing true public improvements Incentive deal: incremental cost of locating at proposed site
Other Factors Often Considered (but not recommended as primary decision-making tool): Subsidy as % of Project Increment Subsidy as % of Project Cost (Public funds “leverage” private) $ Amount Per Job Attracted/Retained
The Gap Analysis/“But For” Approach
Evaluates how much assistance is needed to make the project financially feasible
Guards against over-subsidizing projects Demonstrates to other taxing districts that TIF is being
judiciously used Reduces the appearance of arbitrariness Helps articulate the case for (or against) TIF to elected
officials Helps define and clarify the problem TIF is trying to solve
(can improve deal structure for all parties)
Does This Term Mean? Public Side ROI: Comparing “Dollars Out” (cash out of
pocket, revenues foregone, etc) with “Dollars In” (new tax revenues) Can consider fiscal impacts on a gross or net basis Can consider job, economic output, and other non-financial impacts
The fatal flaw: Sometimes projects are feasible without any assistance or with less assistance- Public Side ROI Analysis does nothing to evaluate this
Conclusion: ROI Analysis is not a substitute for “but for”/gap analysis process; can be used to evaluate the costs/benefits, but not the appropriateness, of the subsidy
District Hypothetical 23-year TIF district Base taxable value of $5 million Constant school district tax rate of 3% Annual property value increase of 2.0% Potential redevelopment project of $40 million in taxable
value starting Year 3
Question: Is TIF needed to make the development occur? Is the School District better off with the TIF-funded redevelopment?
School District’s Perspective
Projection over 35 Years
Scenario 1: No TIF + No
Redevelopment
Scenario 2: No TIF;
Redevelopment Occurs Anyway
Scenario 3: TIF +
Redevelopment
Total Taxes Collected‐ on School District Portion of Tax Rate
$6.1 MM $55.6 MM $55.6 MM
School District Tax Revenues $6.1 MM $55.6 MM $27.8MM
Present Value of School District Future Revenues in Today’s Dollars(@ 4%)
$ 3.3 MM $26.5 MM $9.9 MM
and Policy Considerations
$-
$2
$4
$6
$8
$10
$12
$14
$16
TIF-Eligible Costs Financing Capacity ofProposed District
Demonstrated TIF Need toBecome Feasible ("but for"
test)
(in m
illions)
AppropriateLevel of TIF participation
Costs
Developer’s BudgetLand Acquisition $ 3,000,000 Site Prep $ 500,000 Private Underground Parking Garage $ 3,500,000
Other Construction Costs $12,000,000 Soft Costs $ 4,500,000 Developer Fee $ 1,000,000 TOTAL DEVELOPMENTCOSTS $24,500,000
$3MM more than parking typically delivered by private projects in local market; However, not TIF‐eligible under applicable state law
TIF‐eligible cost under applicable state law. However, acquisition cost was reasonable compared to other area projects
Problem: Financing gap/extraordinary cost caused by parking structure (non-TIF-eligible in this example)
Solution: TIF agreement reimburses TIF-eligible land acquisition cost even though land cost was not extraordinary
Challenge: Keeping this logic clear during the approval process
The TIF Application: Core Elements Quantify the cost of public
improvements included in project Identify and quantify the extraordinary
costs faced by the project Appraisal of the project site Market research to support revenue
estimates Projections of TIF revenues from project Substantiation of project costs Information on project financing terms Other supporting documents (site
control evidence, personal disclosures) Fee to cover cost of evaluating request
Acquisition and Site Improvement Does the acquisition cost need to be written down to achieve
the public redevelopment objective? Some sites so impaired that public $ are needed to bring it
back into the development market Are the site’s deficiencies reflected in the developer’s
acquisition cost? Is the acquisition cost reflective of true market value, or is the
TIF allowing the existing landowner to overcharge? If Developer purchased the property in a better market
climate, which should be recognized: actual cost or current true market value?
Carry costs for long-term ownership of land- generally inappropriate to recognize
and Entitlements Ideally, entitlements and financial assistance should be
negotiated in tandem or entitlements should come first
Bulk, density, parking, landscape, building materials, and other regulatory requirements can significantly impact project feasibility and financial returns
A less-dense project usually (but not always) means less financial feasibility/larger financing gap
Encourage: Articulating acceptable density and urban form requirements upfront and avoiding the uncertainty factor built into land values
ReviewOperating Rents/Sales Prices Absorption/Leaseup Operating Expenses Property Taxes
Capital Land Acquisition Sitework Construction Costs Soft Costs Developer Fee
Financing Debt Parameters Equity Parameters Other Special Tools
(e.g. tax credits)
Projections Revenue
Lease-Up/Pre-leasing Rents
Expenses Utilities Property Taxes Management Insurance Replacement Reserves
Sources IREM BOMA CoStar/comps
Financing Parameters for Review
Loan to Cost/Value Interest Rate Debt Coverage at Stabilization Amount and Source(s) of Equity Mezzanine Debt Tax Credits (e.g. NMTC, HTC) Tax Exempt Bonds % Preleased and Credit Quality of Tenants Developer Fee: Paid or Deferred?
Spreadsheet Example
Analysis SummarySources and Uses w/o TIF
SOURCES OF FUNDSConstruction Loan $ 14,516,174 Equity $ 5,466,208 TIF Assistance $ ‐TOTAL SOURCES $ 19,982,382
USES OF FUNDSLand $ 3,750,000 Environmental $ 2,500,000Other Site Costs $ 1,853,000 Hard Costs $ 8,692,812 Soft Costs $ 2,562,247 Developer Fee $ 624,322 TOTAL USES $ 19,982,382
10yr IRR on Cost 8.1%IRR on Equity 10.5%
Sources and Uses with TIF‐based grant
SOURCES OF FUNDSConstruction Loan $ 14,516,174 Equity $ 2,966,208 TIF Assistance $ 2,500,000TOTAL SOURCES $ 19,982,382
USES OF FUNDSLand $ 3,750,000 Environmental $ 2,500,000Other Site Costs $ 1,853,000 Hard Costs $ 8,692,812 Soft Costs $ 2,562,247 Developer Fee $ 624,322 TOTAL USES $ 19,982,382
10yr IRR on Cost 10.0%IRR on Equity 18.6%
Common Pro Forma/Negotiation Issues
Excessive land acquisition costs Flaws in development programming/design Overly conservative pro forma Underdeveloped concept/excessive contingencies Municipality must be prepared to walk away if the deal
truly doesn’t make sense
Underemphasized Component
Market Feasibility vs. Financial Feasibility (or “Financial assistance can’t create a market”)
Key supporting factor for quality TIF revenue projections
Helps municipality evaluate feasibility and risk
Improves the quality of the Gap Analysis (avoid “garbage in, garbage out”)
Retail Category Discount Department Store
Predicted Annual Sales- Gravity Model $59.0 millionProposed/Typical Store Size (SF) 190,000Sales/SF equivalent $311Benchmark Range (Median- Top 10%) $173-306
Part 2: The “Capital Stack” and Problem-Solving in the Current Environment
Current Development Environment
For-sale residential and multi-tenant retail hit particularly hard
Speculative products (except residential apartments) are generally un-financeable
Appraisals are unpredictable and unfavorable Less financing available per dollar of project cost Credit-worthiness, track record, pre-leasing are
Must-Haves
The Upshot… Fewer projects are getting done Many that do are requiring some form of public/private
financing Creativity is essential on both the public and private sides
Municipal Focus: Flexibility on real estate product types/land uses Understanding their true market niches Delivering infrastructure and development-ready sites Careful underwriting and structuring Taking measured risks
Regional and Long-Range Context CMAP’s GO TO 2040:
100,000 acres of infill development by 2040
Infill to account for 50% of projected 2.4MM regional population growth
Home price declines sharpest on suburban fringe
Infrastructure dollars scarce; more emphasis on “value-capture” techniques
How will all of this (often difficult and expensive) infill development be achieved?
Source: Chicago Metropolitan Agency for Planning
The Private “Capital Stack”
Then Now(when a project is even financeable)
TIF’s Fundamental Timing Issue
Substantial Completion
Project Generates New Incremental Taxable Value
Taxes Collected/TIF Funds Paid over to
Developer
TIF Agreement Finalized/Construction
Start
YEAR 1
SubstantialOccupancy
YEAR 3YEAR 2
Mismatch: Public Gap Financing is most needed
HERE…
…but only becomes available HERE
Structuring the Deal
What is the financing problem we are trying to solve?1. Public infrastructure creating the entire financing gap?2. Fundamentally sound private project unable to raise all the capital
needed?3. Private project has access to all the capital it needs, but returns
are insufficient to allow private investors to proceed?
TIF Deal Structures
Pay-As-You-Go Annual reimbursement starting at project completion TIF is not “financed” or monetized
Monetizing Future TIF Revenues from Project Itself TIF Note issued to Developer/Affiliates, incentivizing them to put more equity
into project up-front; or TIF Note pledged to lender, serving as additional collateral and allowing more
debt to be obtained; or Revenue Bonds issued based on future flow of TIF revenues from project
Backing Bonds with Other Revenue Pledges District-wide TIF Bonds using existing “proven” TIF cash flow General obligation – full faith & credit Sales tax or other municipal taxes (e.g. utility, telecom, etc)
Key Risks
Must be understood and allocated in the financing structure Construction Risk Delay Risk (construction, lease-up, payments) Sale/Lease-Up Risk Assessment/Taxation Risk Statutory Risk Ongoing Operational Risk
Triggers
Conditions before closing of TIF deal Other financing in place Pre-leasing Others
Conditions to TIF funding (after completion) Construction completion Occupancy thresholds Consistency with initial public goals
Conditions to TIF funding (during construction) Developer equity already invested/spent Order of funding (commingled with private debt) Project is “in balance”
Sharing the Upside When is it Appropriate? When public dollars are subjected to equity-type risk Public gap financing is solving a private “capital stack” problem,
not a fundamental project financing gap or public infrastructure issue
Public sector selling land into deal
How to Implement? Test Net Operating Income at full stabilization against a
benchmark “True-ups” at sale or refinance, or commencement of next phase Using TIF to make loans
Vastly Different Forms of TIF Debt
TIF Note: Municipality grants TIF note to developer Municipality pays interest and principal on the TIF note to
developer Developer or bank lends funds to the project, and is repaid
by TIF revenues generated by the Note
TIF Loan: Municipality raises up-front funds from TIF fund balance,
bonds, or other municipal borrowing Municipality lends the funds to the developer during
construction, and is repaid from project cash flow or sale/refinance proceeds
Part 3: Innovative Uses of TIF and Other Public/Private Development Finance Tools
Moderne Building (Milwaukee, WI)
Key project in City of Milwaukee’s Park East development area
203 rental apartments and 14 condos; all market-rate Condo component taking advantage
of significant value premium on floors 27-30
Financing closed late 2010: Private senior debt supported by HUD
221(d)(4) loan guarantee program City of Milwaukee: subordinate loans
to address shortages of private mezzanine capital and condominium financing
Moderne Building (Milwaukee, WI)
City of Milwaukee: $3.3MM Mezzanine Loan $6.0MM Construction
Loan
City: 2nd mortgage on apartments; 1st on condos
City issued GO bonds w/TIF repayment to fund loans
(in m
illio
ns)
Homestead of Morton Grove Senior Housing
80% market rate 20% affordable to very low
income Addressed specific needs identified
in community Senior Needs study $22.5MM project IHDA/Treasury Bonds (Dec 2010
deadline) 4% tax credits, TCAP and HOME
Funds TIF assistance from Lehigh/Ferris
TIF: $1.1MM TIF grant $1.7MM TIF loan
New Markets Tax Credit ProgramCapital the project was already able to obtain (Leverage Sources)
Subsidy from tax credit investor
(NMTC Equity)
Increased financing available for project (15-20% more than otherwise available)
NMTC Structure
(About a 4:1 ratio)
Supports industrial, community facility, commercial, mixed-use, and operating business financing in qualifying Low Income Census tracts
Hotel Belleview (Dallas, TX)
$19 mm LEED historic rehab TOD boutique hotel project
Layered financing to address shortage of traditional capital (financed June 2011)
Innovative combinations of sources: EB-5 foreign equity: $5MM New Markets Tax Credit equity from
City of Dallas-controlled NMTC provider
Police/Fire pension fund debt Historic Tax Credits
Testa Produce (Chicago, IL) 90,000 square foot LEED
Platinum freezer/cooler facility (first of its type in US)
$23 million project Significant appraisal challenges
Purpose-built facility
Challenging market climate
Appraisal industry’s lack of recognition of value impacts of green features
$15.3MM in senior Recovery Zone Facility Bonds
$2.0MM in New Markets Tax Credit equity
HUD 108 Loan Program Strong compatibility with TIF and
other economic development tools
Program targeted at low/moderate income populations
Eligible uses include economic development, job creation, building rehab
Excellent way to provide capital during the construction process, with TIF revenue stream pledged as the repayment source
HUD (through private
investors)
City
Project
LoanSecurity: Pledge of
Future CDBG Entitlement
Loan Security:varies
Green Exchange $55 million Green office and
retail business incubator on Chicago’s Northwest Side
275,000 square feet LEED Platinum and Historic
Rehab Project halted at 30%
construction due to credit environment (syndicated construction loans)
Now substantially complete Major anchor tenant: Coyote
Logistics
Green Exchange
Solution: City of Chicago assistance package: $15 million HUD 108 Loan $10 million TIF note (cash
flow/repayment source)
Subordinate to $20MM Senior Recovery Zone Facility Bonds
“Project TIF Note” provided to enhance debt coverage and allow reasonable returns
Balance of existing TIF district revenue available to protect City as backup repayment source on 108 Loan
Dallas “TOD TIF” Created in 2008 $185MM projected
expenditures (2009 dollars) “Robin Hood” TIF:
40% of TIF revenue from Lovers Lane/Mockingbird area of North Dallas made available for projects in Southern Dallas
20% of TIF revenue from Lovers Lane/Mockingbird for affordable housing district-wide
TIF closely linked with efforts to support dense, pedestrian-friendly development near Dallas Area Rapid Transit (DART) stations Image: City of Dallas
Lancaster Urban Village (Dallas, TX) $27MM mixed-use TOD project near
DART LRT station Residential rental component:
200 units of workforce/mixed-income housing
51% deed-restricted affordable units
Commercial/parking component: Neighborhood-serving 1st floor retail;
structured parking for all project components including adjacent job training center
Financing: HUD 221(d)(4) and HUD 108 Funds City of Dallas TIF and PPP Funds New Markets Tax Credits
Tower Automotive Site- Milwaukee 84 heavily blighted acres in inner-
city Milwaukee 2MM square feet of obsolete
buildings City purchase and TIF district
creation in 2009 Range of public/private funding
sources including TIF, tax credits, capital funds, state grants
Goal: create high quality business park land
Demolition, clearance, master planning in process
General Obligation bonds with projected TIF as repayment source
Delivering Infrastructure
Goal: bring property to a “serviced greenfield” condition
Phase 1: Retail and rental apartments
Problem: Substantial pre-leasing needed to obtain private financing
Problem: Convince potential tenants that the infrastructure will be available
Solution: Contingent TIF deal up-front with extensive “triggers”
Areas to bePubliclyDedicated
Contingent Public-Private Financing $98MM TIF assistance package;
largest in Chicago history Components:
TIF/Special Assessment Bonds to fund public infrastructure component
TIF/GO Bonds to fund planning, environmental, site prep, etc.
Triggers: Bond capacity test Pre-leasing thresholds Minimum equity requirement
Image courtesy McCaffery Interests
Resources Illinois Tax Increment Association (ITIA) Semi-annual conferences (AICP CM Credit) Online resources Legislative updateshttp://www.illinois-tif.com/
Council of Development Finance Agencies (CDFA) National footprint Focus on technical education and best practices Webinars on TIF and other toolshttp://www.cdfa.net/
Real Estate Economics Public-Private Partnerships Tax Increment Financing New Markets Tax Credits Economic Development Area Plans &
Implementation Fiscal & Economic Impact
Tony Smith221 North LaSalle StreetSuite 820Chicago, IL 60601(312) 424-4254www.friedmanco.com
S. B. Friedman & Company