Public Tools to Leverage Private Investment

Arthur C. Nelson, Ph.D., FAICP

Presidential Professor & Director, Metropolitan Research Center

University of Utah

Outline

Administrative Tools Indirect Facilitation Tools Direct Financial Tools

Administrative Tools Planning decisions

Rezoning, special use options Streamlined, fast-track review Special area plans; specific plans

Enterprise zones Depends on state laws Targeted areas of low income, aging stock Expedited development review Priority CDBG investment area Priority infrastructure improvement area

Administrative Tools

Economic development offices Information Market analysis and marketing Government ombudsman to facilitate decisions Social, political introductions

Federal and state programs Empowerment zones Enterprise districts

Indirect Facilitation Tools Local improvement districts

Property owner-driven Localized assessments for local physical benefits Stimulates private investment

Special taxing districts Convention center, stadium financing External activities stimulate private investment

Business improvement districts “Clean and safe” measures to attract customers Streetscaping, low-cost improvements Marketing, special events

Direct Financial Tools

Property tax abatement Land write-downs Building write-downs/grants Fee waivers Tax increment financing Low-interest mezzanine financing

Sometimes a form of equity participation Changing property tax practices

Purposes of Financial Tools Leverage private investment. Stimulate investment in targeted areas. Regenerate local economy. Accelerate development/redevelopment that

may occur eventually. Seize unique private investment opportunities

that may stimulate new private investment. Absorb excess capacity in facilities. Generate new tax revenues, utility revenues,

new revenues from induced development.

Property Tax Abatement Property taxes abated for a period of time to

induce private real estate investment. Requires agreement of taxing jurisdictions, not

all of which may be willing. Can be targeted for special areas (such as

enterprise zones), specific investments (such as infill development), or time windows.

Time frames can vary from 100% for a few to several years to declining percentages over a period of time.

Downsides of Abatement

Reduced total revenue if 100% abatement occurs.

Reduced revenue in face of increased needs created by new development.

Favoritism concerns. Sometimes helping those who need the benefit

least. Long-term abatements can backfire if targeted

investment becomes vacant eventually.

Upsides of Abatement New development is stimulated. Infrastructure often at excess capacity,

especially schools; low to “zero” marginal cost to serve new development.

Other revenues generated such as sales taxes, property taxes, state revenue-sharing

transfers, CDBG revenues, etc. Collateral development may be induced outside

abatement areas thereby increasing/offsetting abated taxes.

Land Write-Downs

Publicly-owned, acquired land sold below value. Post-Kelo concerns may result in long-term land

leases. Tax foreclosed land may be assembled with

gaps filled in through targeted acquisition creating developable sites at little public cost.

Trades of land possible resulting in development where desired in exchange for land for other public uses.

Building Write-Downs/Grants Sometimes publicly-owned buildings may be

transferred to the private sector for rehab, redevelopment. Abandoned schools common.

Building construction may be facilitated with a development grant.

Common in exchange for public-use components of the land or building

Grants often from CDBG, economic development funds, state/federal grants.

Fee Waivers

Impact Fees Connection Fees Inspection Fees Application Fees Often waived fees paid from other funds

CDBG Economic development pools Bond arbitrage revenues Federal, state economic development grants

Tax Increment Financing Helps finance improvements in designated areas (TIF districts). Uses new, or incremental, tax revenues generated by the

project after completion to finance improvements. Property taxes in TIF Districts are frozen at a base. New, incremental property taxes can be used to reimburse the

developer for eligible project costs or to retire debt incurred for those costs.

Eligible project costs include, but are not limited to: Costs of studies, surveys and plans Professional services (architectural, engineering, legal, financial, etc.) Property assembly costs (acquisition, demolition, clearing and grading) Costs of rehabilitating, reconstructing, remodeling of existing structures Costs of construction of public works Financing costs, including issuance interest and reserves.

Typical TIF Process

Step 1: A Finding of Necessity is adopted. Boundaries for the TIF District mapped.

Step 2: Redevelopment AgencyStep 3: Redevelopment Plan is prepared,

approved.Step 4: Base Year is declared at adoption. Current

tax base locked in.Step 5: Redevelopment Agency engages in

redevelopment directly or through agreements with developers.

Step 6: Revenue Bonds are sold to finance “front-end” expenses, often infrastructure.

Step 7: Bonds retired from the “incremental” property tax revenues of the TIF District.

The Allocation of Property Taxes Under TIF

Source: Weber (2002) “Tax Incremental Financing in Theory and Practice”

Base Year Assessed Value

Downsides of TIF

Eats into borrowing cap of local government. If successful, can create new population, jobs,

and new public demands but with no new property tax revenue.

Needs cooperation of all taxing agencies. Expensive to prepare. Bond costs high. If new development does not generate new

property taxes to cover bond costs local government steps in.

Upsides of TIF New development is stimulated. Infrastructure often at excess capacity,

especially schools; low to “zero” marginal cost to serve new development.

Other revenues generated such as sales taxes, utility revenues, state revenue-sharing transfers, CDBG revenues, etc.

Collateral development may be induced outside TIF District thereby increasing/offsetting

taxes diverted to debt service.

Variations

Sales taxes may be pledged instead of incremental property taxes. Used (maybe soon abused?) in Michigan.

Utilities do variations of this already through reductions in utility connection charges in exchange for system improvements.

Need not bond anything but merely pledge incremental revenue for improvements on a pay-as-you-go basis. Reduces costs and risks often with similar outcomes.

Low Interest “Mezzanine” Financing Typical L/V ratio is 70-75%. Commercial

lenders reasonably available. Equity investors need

About 15% “unleveraged” rate-of-return. About 30% “leveraged” before tax RoR. The higher the equity the lower financial feasibility.

Public sector may provide “bridge,” “gap”, “soft second”, or “mezzanine” financing.

10-20% of cost; Commercial bank in “First” position. Below market rate.

Private Mezzanine Example

A-note

Senior B-note

Subordinate B-note

Senior Mezzanine Loan

Subordinate Mezz. Loan

Equity

Loan-to-value

65%

65 – 75%

75 – 85%

Owner

Libor + 50-150bps

Asset Yields

Libor + 150-425bps

Libor + 425-1,000bps

Unlimited

Source: Wachovia Capital Markets, LLC and Capital Trust

First Mortgage

Equity

PresentPast

Advantages, Thoughts Return to local government is as low as public

borrowing rate (3-4%) plus it stimulates new tax revenue from development and collateral development.

Can take the place of abatements, write-downs so public merely finances costs.

Can sometimes be used to create a “position” in the equity distribution when project sold or

refinanced in later years. Local government seen as “business-like.”

New Property Tax Practices

Property taxes commonly assessed on Land Improvements Equipment

Property taxes thus distort investment by penalizing improvements and equipment needed for economic development.

Property taxes mostly based on “use” value, not “site” value.

Parking lot taxed as parking lot not its potential use.

Parking Lots and Property Taxes I

1 acre parking lot = 20 stalls $2,000/year stall revenue = $40k/acre Attendant, cleaning, administrative, other

expenses (except property tax) = $20k/year.

NOI = $20k/year. R = 10%, V in use = $200k/acre. Property taxes = 1% of Assessed Value =

$2,000/year

Parking Lots and Property Taxes II

Highest/best use = FAR 10 400k square feet development/acre $6M land value at this intensity Taxes on land at highest/best use =

$60k/acre Parking lot revenue = $40k/acre. Net income =

-$40k/acre

Current Property Tax System

Encourages sprawl. Subsidizes speculation. Under-utilizes expensive public infrastructure

(often built assuming build-out needs). Penalizes investment. Reduces economic efficiency. Reduces job production potential (wages and

jobs increase with density/intensity).

Nelson’s Guide to Choosing Tools

Provide only what is needed to make a deal work based on reasonable RoR.

Provide the mix of public financing tools that minimizes taxpayer exposure to losses.

Take a long view. Attempt to covert public financial support

into a loan or equity position wherever possible.