urban redevelopment: public financing options · urban redevelopment: public financing options...
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Urban Redevelopment:Public Financing Options
National Business InstituteMadison, WI
August 11, 2008
Public Financing Options
– TIF– Business Improvement Districts– NMTC– Affordable Housing Tax Credits– Historic Tax Credits– Other Districts and Tools
Tax Increment Financing (TIF) Overview
• Allocates Future Increases In Property Taxes To Pay For Improvements
• Takes Place Within A Specific, Limited Geographic Area
• Lasts Up To 27 Years From Date The TIF District Was Created For Blight And Conservation; 20 Years For Industrial, Or Less
TIF Chart
How TIF WorksNormal Property• Taxed At Specific Rates By Several Different
Government Jurisdictions• Increases In Value Are Taxed At The Same Rate; Extra
Revenue Accrues To The Taxing BodiesProperty Within A TIF• All Taxing Jurisdictions Continue To Receive Taxes
Based On The Base, Or “Frozen” Assessed Values• Taxes Generated By Increases In Value Are Allocated
To The Municipality For Improvements In The TIF District
Why Use TIF?
• Municipality Only Jurisdiction For Redevelopment – Protect Long-term Fiscal Condition
• Financially Powerful• Leverages Private Investment
Business Improvement Districts
• Designated Sub-area Of Community
• Additional Tax To Pay For Facilities Or Services Beyond Usual
• Owners Representing 40% Of Property Value Can Block
Uses and Issues• Downtown District
Improvements & Marketing
• “Greenfield” Infrastructure In IL And CA
• Back-up For Developer Commitments In Redevelopment And Town Center Projects
Issues
• Issue: Tax Rate/Market Competition• Issue: Necessity re Market Conditions –
Windfall• Issue: Equity• Issue: Political Impact on Referenda
New Markets Tax Credits
• The New-new Thing• New Markets Tax Credit Supports
Commercial And Industrial Development In Qualifying Areas
• Increases Access To And/Or Lowers Cost Of Capital
• Supplements TIF, EZ And Other Funds
New Markets Tax Credits
• NMTC: a tax credit for equity investments in CDEs
• Community Development Entities (CDEs): Mission to serve low-income communities
• Low-Income Communities (LICs): 20% poverty or where median family income is below 80% of AMI
CDFI Fund(U.S. Treasury)
Private Investors
Qualifying Project/Business
(QALICB)
QEIQLICICommunity
Development Entity(CDE)
Allocation of NMTCs
7-yearStream ofNMTC Benefits
New Markets Tax Credits
New Markets Tax Credit
• Cdes Use Investments To Make “Qualified Low-Income Community Investments” (QLICIs)
• QLICIs Include:– Capital or equity investment in, or loan to any “Qualified
Active Low-Income Community Business” (QALICB),– Equity investment in, or loan to, any CDE– Purchase of a loan from another CDE – Financial counseling and other services to businesses located in
LICs
Enhancing Conventional Debt
QALICB(Project)CDE
Tax Credit Benefits($3.9 MM over 7 Yrs)
7-Year Mini-Perm Loan@ Low Blended Rate
($9.5MM)
NMTCInvestor
Lender
Cash Up-Front($2.5-$3MM)
Interest-Only Debt Service w/Balloon In Year 7
7-Year Loan at Conventional Market Terms ($7-$7.5MM)
•$500k in CDE fees and other transaction costs
(placeholder amt)Sinking Fund
for Loan Repayment
Year 7
QALICB(Project)CDE
Return on and of capital provided via tax credits
NMTCInvestor
LenderPrincipal Repayment
($7-$7.5MM)
Principal Repayment($7-$7.5MM)
Remaining $2-$2.5MMcan be forgiven or
restructured
Increasing Available “Soft Money”
QALICB(Project)CDE
Nominal InterestForgivable Loan
($9.5MM)
NMTCInvestor
CharitableDonations
GovernmentGrant
Pooling in Upper-Tier Investment
Fund
$10MM
$5MM
$2.5 MM
$2.5 MM
Tax Credit Benefits($3.9 MM over 7 Yrs)
•$500k in CDE fees and other transaction costs
(placeholder amt)
QALICB(Project)CDE
Forgiveness ofOutstanding Debt
($9.5MM)
CharitableDonations
GovernmentGrant
Year 7
Return on and of capital provided via tax credits
NMTCInvestor
NoRepayment
Needed
Sample Retail Project
Project Cost $16 million
Maximum Supportable Debt*
$9.7 million
Required Equity $6.3 million
Projected IRR on Equity
9.4%
Project cannot provide a market-rate level of return and is unlikely to be feasible
*Based on minimum required debt coverage assumption of 1.25
Project Cost $16 million
Maximum Supportable Debt*
$11.5 million
Required Equity $4.5 million
Projected IRR on Equity
17.4%
NMTC-supported loan with reduced interest rate and more flexible terms allows project to achieve reasonable rate of return. Total credits used: $11.5 million
Without NMTC With NMTC
Sample Mixed-Use Project with NMTC Subordinate Debt and Gap $
Project Cost $50 million
Maximum Supportable Debt*
$24.3 million
Equity** $8.7 million
Up-Front Gap Need $17 million
In order to allow a market level of equity return, up-front TIF of $17 million needed
Project Cost $50 millionMaximum Supportable Debt*
$24.3 million
NMTC Subordinate Debt
$12.5 million
Equity** $7.2 millionUp-Front Gap Need $6 millionNMTC Subordinate Loan of $12.5 million reduces up-front TIF need by $11 million***. Total credits used: $50 million.
Without NMTC With NMTC
*Based on minimum required debt coverage assumption of 1.25**Based on minimum required IRR assumption of 17.5%***NMTC subordinate debt assumed not to be a dollar-for-dollar replacement for TIF because of small interest payback requirements
Affordable Housing Tax Credits• Section 42• Credit Up To 90%
Over 10 Years• Discounted Value
About 70 Cents Currently
• Multiple Layers
Affordable Housing Tax Credits• Allocated by
WHEDA• Bonus in Housing
Bill• Targets HH at 40 to
60% of AMI • Families and
Seniors
Historic Tax Credits
• 20% of Eligible Basis
• SHPO and Dept. of the Interior Approvals
• Up to 100% Value• 5-Year Hold• Can be Layered
Other Special Wisconsin Tools
• Lake Associations and Lake Districts• Sanitary Districts
The Interplay Between Public and Private Financing
• Debt, Equity And Financing Gaps• Types Of Financing• Measuring Returns• Appropriate Returns
Is it Debt or Equity?
• If It’s Not Debt, Its Equity• Debt: Must Be Paid Back First Before Cash
Flows To “Owners”• Multiple Layers: 1st, 2nd, N-th – All Have
Priority And Typically Lien On Property• Public Funds: Can Be Debt Or Equity
Depending On Terms
Types and Sources of FinancingRisk-Reward-Time Horizon Matching
Partial List:• Construction Loan—Commercial banks• Mini-Perms—Commercial banks or other construction
lender• Mezzanine Debt—Various such as Cohen Financial• Permanent Financing (Mortgage)—Life insurance
companies, REITs, pension funds• Equity—Developer funds, syndication (LP or LLP), joint
venture, corporate, REITs, pension funds• Tax Credit Equity—Syndicators/Corporate buyers
Financing Parameters• Debt based on value and/or cash flow• Typical private debt/equity 75% to 85% debt depending on
property type• Developers seek to minimize equity• Seek to substitute public $ for equity• Tax credits also available• Mezzanine debt substitutes for equity -- participating• Typically: 20% of non-public funds as equity, but often
will be less– Mezzanine debt– 2nd or 3rd position public debt– Grants/reimbursements
Definitions of Return
• Net Operating Income• Cash Flow From Operations• Return On Investment Or Cost (Stabilized Annual)• Return On Equity (Stabilized Annual)• Internal Rate Of Return On Cost• Internal Rate Of Return On Equity• Profit Margin On Sales
What Are Appropriate Returns?
• Risk-adjusted Rate Of Return• Returns On Total Cost Of 8% To 13%• Returns On Equity Of 15% To 25%• Profit On Sales Of 9% To 14%• Annual Cash-on-cash (Equity) Returns Of
8% To 12% (Stabilized Year)
Residential Project Profit Benchmarks
• Profit After General And Administrative: Margin On Sales Of 9% To 14%– Developers seek 14% plus 5% development fee or G & A– Public-private deals around 9% plus 3-1/2 to 4-1/2% G & A– Average homebuilder around 5%
• General Contractor Profit Layer– Mid-rise and higher– Separate overhead and profit around 8% to 10%– General conditions is a hard cost– Developer profit should be lower
Why Assist a Development Project?
• TIF Should Be• Need-based/Financing Gaps and Extra-ordinary
Costs• Competitive
• Benefits Should Exceed Assistance• Contributes to Community Goals• Accurate Estimates of Fiscal Benefits• Secondary Economic Impacts• “Intangible” Benefits• Policy and Practical Limits
What Drives Financing Gaps?
• Extraordinary costs• Land assembly• Control density and character
How to Address “But For” at the Project Level
• Have A Formal TIF Application And Review Process
• Require Applicant To Justify The Level Of Assistance Requested Via Analysis Of Profit/Returns, Extraordinary Costs, And Public Costs
• Review In Detail And Challenge Key Assumptions If Needed
ExampleSources 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
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
IRR on Cost 10.0%IRR on Equity 18.6%
Returns Analysis (with TIF)Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10
SOURCESNOI (less Reserves) ‐ 1,061,875 1,469,769 1,467,664 1,465,517 1,463,327 1,634,344 1,632,066 1,629,742 1,627,372 1,624,955 Reserve Payout 200,000 Reversion 22,047,791TOTAL 1,261,875 1,469,769 1,467,664 1,465,517 1,463,327 1,634,344 1,632,066 1,629,742 1,627,372 23,672,745
USESDebt Service 1,245,640 1,245,640 1,245,640 1,245,640 1,245,640 1,245,640 1,245,640 1,245,640 1,245,640 1,245,640 Debt Repayment 11,345,186 Equity Distributions 16,235 224,128 222,023 219,877 217,687 388,704 386,426 384,102 381,732 11,081,919
TOTAL ‐ 1,261,875 1,469,769 1,467,664 1,465,517 1,463,327 1,634,344 1,632,066 1,629,742 1,627,372 23,672,745
Annual Debt Coverage 0.85 1.18 1.18 1.18 1.17 1.31 1.31 1.31 1.31 1.30
Leveraged Cash Flow
Equity Contributions (2,966,208) ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐Equity Distributions ‐ 16,235 224,128 222,023 219,877 217,687 388,704 386,426 384,102 381,732 11,081,919
TOTAL (2,966,208) 16,235 224,128 222,023 219,877 217,687 388,704 386,426 384,102 381,732 11,081,919
Annual Cash‐on‐Cash Return 0.5% 7.6% 7.5% 7.4% 7.3% 13.1% 13.0% 12.9% 12.9% 12.8%Leveraged IRR 18.6%
Unleveraged Cash FlowNOI ‐ 1,061,875 1,469,769 1,467,664 1,465,517 1,463,327 1,634,344 1,632,066 1,629,742 1,627,372 1,624,955 Reversion Proceeds ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ 22,047,791 TIF Assistance 2,500,000 ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐
Total Project Costs (19,982,382) ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐ ‐
TOTAL (17,482,382) 1,061,875 1,469,769 1,467,664 1,465,517 1,463,327 1,634,344 1,632,066 1,629,742 1,627,372 23,672,745
Annual Yield on Cost 6.1% 8.4% 8.4% 8.4% 8.4% 9.3% 9.3% 9.3% 9.3% 9.3%Unleveraged IRR 10.0%
Common Components of “Gap Analysis”
• Checking Pro Forma Math And Cash Flows• Independent Construction Cost Review• Reviewing Project Debt Capacity• Benchmarking “Top Line” Revenue Sources• Benchmarking Soft Costs, Developer Fees,
Etc.• Estimating Profit And Rates Of Return
Other Considerations
• Detailed review can also help with structuring process
• Avoids appearance of arbitrary assistance• Can save significant municipal resources• Back-end participations/“kickers”/up-side
sharing
Forms of Financing• Direct Reimbursement• Pay-as-you-go
– Interest Writedown– As Sales Taxes
Received From State– TIF (Developer) Notes
• Monetizing Developer Notes– Banks– Special Revenue
Bonds• General Obligation Bonds
Sharing the Upside (But Not the Risk)
• Public Assistance Reduces The Risk• Upside Sharing Common
– Like Waterfalls In Partnership Deals• 1st Dollar Or Margin?• Common Forms
– Junior Loan Instead Of Grant (More WI)– Top Line Share Over Selling Price– Bottom Line Share Over Return Threshold– Sharing In Sales Proceeds And/Or Refinance
Access to TIF Funds• Direct Reimbursement• Tif-supported Bonds - Provides Funding Upfront
And Is Paid Over Time From Future Increment– General Obligation Bonds– Special Revenue Bonds
• TIF Note - Developer Holds TIF Note, Finances The Extraordinary Costs Upfront, And Is Paid Off Over Time From Incremental Revenue Collections
• Redevelopers’ Interest Reimbursement (Annual)
Direct Reimbursement• Municipality Reimburses
Eligible Costs As Incurred• Established TIF With
Balances Or “Ported”• Agree To Use General
Increment Vs. Project Increment (“Out-of-pin” Vs. “In-pin”)
• Not Very Common• Most Likely Used For
Start-up Expenses Or Infrastructure
General Obligation Bonds or Alternative Bonds
• Carry full faith and credit of municipality or other revenue source such as sales tax
• First $10 million per year “bank qualified”
• Best interest rate• Impose levy but can abate
GO & Alt. Rev, Cont’d
• Most Often Used For Infrastructure, Land Acquisition (Tax Exempt)
• Can Be Used For Developer Assistance (Taxable)
• Sometimes Structured As Loan (Wisconsin)
Special Revenue Bonds• Secured By Designated Revenues Such As TIF
Increment And Others• Require Detailed And Substantiated Projections
– Taxes Of Comparable Properties– Timing– Collection Rate– Future Tax Rates And Equalization Factors
• Full Disclosure/OS• Placed Institutionally
Special Revenue Bonds, cont’d– Wm. Blair & Company– Oppenheimer– Stifel Nicholas– A. G. Edwards– LaSalle Bank– Harris Bank
• Structures Include Potential For Construction Funding• Still Reimbursement• May Involve Capitalized Interest Reserve, Etc.• May Be Tax Exempt If Do Not Fail Dual Test
– Private Purpose And– Paid From Other Than General Taxes
• Example– Wheeling Westin Hotel
Wheeling Westin Hotel• Hotel And Retail Project• Very High Profile• $120 Million Plus Project; $23
Million Assistance TIF And Sales Tax
• Eligible Costs Were Land Acquisition And Infrastructure
• Multiple Pledges– Project Property Tax
Increment– District-wide Increment– Adjacent District Increment– Sales And Hotel Tax From
Project• 2005 Issue At 6%, Tax Exempt• Placed By Wm. Blair &
Company
Westin Hotel
Developer Notes• Pledge Of Incremental Revenue, Usually Just From Project
But Can Be Broader• Revenue Received As Available Against Rate And
Principal Amount• Held By Developer, Sold, Or Used As Collateral• Sale Of Note Usually Requires Significant Yield• Use As Collateral Becoming More Common
– Increase Construction Loan– Pledge Notes– Developer Responsible For Loan In Usual Manner
• Harris, Lasalle, And Chase Have All Considered And/OrDone
Interest Reimbursement• Financing Costs For
Obligations Issued To Pay Interest On Debt To Pay Project Costs
• Typically “In-pin” But Can Use District Revenues
• Paid Annually As Funds Available
• May Also Be Used (Or Notes Can Be Used) To Support A Loan Layer With FHA Insurance (20-year Piece)
Some Closing Thoughts
• Projects That “Pencil” – Its tough enough without a public-private partnership
• But, if need help, help is there– TIF is Widespread and Effective– Communities want to do projects– New Markets deals are getting done too
• Public Sector: Need-based Policies
• Private Sector: Expect Thorough “Underwriting”
Resources• Real Estate Market Analysis: A Case Study Approach, Schmitz & Brett, Washigton,
D.C: ULI-the Urban Land Institute• Real Estate Finance & Investments, Brueggeman & Fisher, McGraw-Hill Irwin• Real Estate Development, 3rd Ed, Miles, Berens & Weiss, Washington, D. C.: the Urban
Land Institute• Building Owners & Management Association International. http://www.boma.org• Institute of Real Estate Management. http://www.irem.org• The Business of Building, Measuring Your Success, 2001 Cost of Doing Business Study.
Washington, D.C.: National Association of Home Builders.• Real Estate Research Corporation, Real Estate Report. www.RERC.com• PricewaterhouseCoopers. Korpacz Real Estate Investor Survey
[email protected] • National Building Cost Manual. Carlsbad, CA: Craftsman Book Company• RSMeans Square Foot Costs. www.rsmeans.com• Dollar & Cents of Shopping Centers. Washington, D.C.: ULI-the Urban Land Institute.• Dollar & Cents of Multi-family Housing: A Survey of Income and Expenses in Rental
Apartment Communities. Washington, D.C.: ULI-the Urban Land Institute.• American Council of Life Insurers. 2004. Commercial Mortgage Commitments,
Washington, D.C.: American Council of Life Insurers.
• Development Strategies• Public-Private Partnerships• Market & Financial Feasibility• Area Plans & Implementation• Developer Solicitation• Tax Increment Financing• New Markets Tax Credits• Special Service Areas• Fiscal Impact
221 North LaSalle StreetChicago, IL 60601Phone: 312-424-4250Fax: 312-424-4262www.FriedmanCo.Com