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