Tax Increment Financing &Proforma ReviewStan Riffle, Arenz, Molter, Macy & Riffle, S.C.Frank Roman, Ehlers

How TIF works

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Eligible project costs

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Public works & improvements

Financing costs

Real property assembly costs (land write-down)

Professional service costs

Administrative costs

Contribution to Community Development Authority or Redevelopment Authority

Relocation costs

Organizational costs

Pro-rated costs of utility infrastructure

Cash grants (requires developer agreement)

Environmental remediation

Projects within ½ mile of district

• Communities want to: encourage quality economic development

eliminate blight

rehabilitate property

provide housing

• Developers & investors need to: cover their costs

earn a reasonable, risk-adjusted profit

attract investment capital (equity and debt)

Why incentivize development?

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• Tax increment financing is THE most powerful tool in Wisconsin for economic development

• The “But For” test required per statute (Wis. Stats. 66.1105)

Is there a gap that needs to be filled to make project happen, as the proposed use and design, of the same quality, and in the same time frame expected?

Why incentivize development? (continued)

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A. Project development costs: Land / soils / environmental remediation Sitework / infrastructure cost

Utilities brought to siteOn-site roads, utilities

Stormwater detention Extraordinary building costs Structured parking vs. surface stalls Impact fees, assessments Pricing pressures: labor, materials

Determine if funding gap exists

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B. Funding sources and availability:

Construction, permanent debt

Loan-to-Value, debt coverage constraints

Equity returns

IRR, cash-on-cash requirements

State grants/programs (i.e. TEA grants)

Determine if funding gap exists

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B. Funding sources & availability:

Tax credits

Low income housing tax credits (LIHTC)

New market tax credits (NMTC)

Historic preservation

Tax increment financing structures

Grant, loan, PAYGO

Determine if funding gap exists

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C. Project operations shortfall

Inferior rental rate environment

Insufficient returns on equity

Debt service coverage / loan default

Investment hold period

• If gap can’t be bridged, project does not proceed

• Development capital will be directed to where it can earn competitive, risk-adjusted returns

Determine if funding gap exists

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Income-producing rental & commercial projects:Cash on cash (COC) returns

Example: Annual cash flow of $50,000 divided by $500,000 investment results in 10% COC return

Snapshot in time; 8 – 12% average over investment period

Internal rate of return (IRR) Discounted present value (annual cash flows + net proceeds after sale

of project) over entire investment period

Within reasonable market ranges ~12 – 18%

Net operating Income /capitalization rate = Project value

Measuring developer profit

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• At beginning of project - grant or loan City/Village cash contributed up front – may require borrowing

Lowers developer equity, increases investment returns

Highest risk to municipality – money out the door

• During TID term, pay-as-you-go (PAYGO) preferred Developer recoups portion of annual property tax payments

Higher equity required, reduces developer return

Developer may “monetize” MRO note, but incurs additional debt

Transfers risk to developer; must produce value or assistance reduced

When is assistance provided & who assumes risk

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Goal is to reduce municipality risk of debt exposure & repayment

When is assistance provided & who assumes risk

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• Municipality promises to pay developer a portion of tax increment collected, as it is collected (pay as you go)

Typically takes form of “Municipal Revenue Obligation” (MRO) issued under a development agreement

Developer typically needs cash up front for capital stack, so will look to monetize the MRO by assigning future payments to their lender and developer receives a discounted amount of future cash flows

When costs are paid by developer

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• Corroborate developer base case for errors & assumptions

• Internal & external resources for applicable building costs, rents

• Discussion with assessor regarding comps, valuation & approach

• Examine alternate scenarios - with & without TIF assistance, structure of assistance (grant, loan, PAYGO)

• Determine if projected assistance is in compliance with community policies and funding abilities

Evaluate alternate scenarios, considerations

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• Does proposed project require requested assistance, within reasonable market return parameters (‘But For’)?

• What is optimal structure for providing assistance?

• How does increment generated by the project affect overall TID cash flows and other municipal financial obligations?

Fundamental considerations

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• Used by assessors to remove impact of property taxes

Net Operating Income = Effective Gross Income (Revenues less Vacancy) less Operating Expenses

Add back Property Taxes to determine Adjusted NOI

Combine market capitalization rate and property tax mill rate (the “loaded” cap rate)

• Adjusted NOI divided by loaded cap rate = value

• Calculate correct tax

Review with assessor to affirm assessed values

Determine value: loaded cap rate analysis

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Project budget: PAYGO structure

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Loaded cap rate analysis

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A1

Slide 18

A1 ExampleAuthor, 1/27/2020

Operating cash flow (without TIF assistance)

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Corrected taxes

Key Return Metrics

Sales analysis (without TIF assistance)

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YEAR 2029SALE ANALYSIS END OF YEAR 10Net Operating Income End of Year 1,859,976Divided By Cap Rate 6.25%Gross Sale Price 29,759,613DEVELOPER MORTGAGE FINANCING 15,621,573DEVELOPER SECONDARY FINANCING 0Net Sale Amount 14,138,040Sales Expense 3.0% (892,788)Final Amount 13,245,252

City of Stellar WI - Stellar Apartments

Sales Analysis

170 Market-Rate Multifamily UnitsNo TIF Assistance

Sales analysis (without TIF assistance)

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• Financial gap exists without TIF assistance

• Cash-on-cash Year 10 = 5.8%; 4.46% 10 year average

Typical range of 8 – 12% once stabilized

• IRR year 10 = 9.54%

Typical range of 12 - 18% at stabilization/sale

Under this scenario, project unlikely to attract investment capital, unlikely to be undertaken.

Investment return metrics – IRR, COC

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• Determine Tax Increment

Assessed value less base value at TID creation

• Timing of tax increment

Construction year 0

Valuation year 1

– Revenue year 2

• TID Costs & policy considerations

Evaluate TID assistance to developer

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• Administrative costs at formation, ongoing

• Policy or need for retainage for other TID projects

• Municipal Revenue Obligation Payments

Calculate principal & interest payments

Evaluate TID assistance to developer

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“Pay as You Go” model1.

3.

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Development value assumptions

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Proposed development

Tax increment projections

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Projected increment based upon tax rate and base value

Total projected increment

Value from previous slide

Tax increment cash flows: revenue

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Tax increment cash flows: expenditures

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Total development incentive of $2,726,350

Tax increment cash flows: Total

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City of Stellar, WisconsinTax Increment District #1Cash Flow Projection

HIDE HIDEMRO calc MRO Total Dated Date:

Year avail totals Revenues Year Principal Est. Rate Interest Year1.5% 5.00% 30%

2019 0 2019 0 12,000 12,000 (12,000) (12,000) 2,195,000 20192020 (180) (180) 2020 0 5,000 5,000 (5,180) (17,180) 2,195,000 20202021 382,000 (258) 381,742 262,120 244,750 2021 135,000 5.00% 109,750 114,523 5,100 364,373 17,370 190 2,060,000 20212022 525,552 3 525,555 159,353 361,000 2022 258,000 5.00% 103,000 157,666 5,202 523,868 1,686 1,876 1,802,000 20222023 528,180 28 528,208 157,802 365,100 2023 275,000 5.00% 90,100 158,462 5,306 528,868 (661) 1,215 1,527,000 20232024 530,821 18 530,839 159,077 366,350 2024 290,000 5.00% 76,350 159,252 5,412 531,014 (175) 1,041 1,237,000 20242025 533,475 16 533,490 161,120 366,850 2025 305,000 5.00% 61,850 160,047 5,520 532,418 1,073 2,113 932,000 20252026 536,142 32 536,174 158,943 371,600 2026 325,000 5.00% 46,600 160,852 5,631 538,083 (1,909) 204 607,000 20262027 538,823 3 538,826 162,732 370,350 2027 340,000 5.00% 30,350 161,648 5,743 537,741 1,085 1,289 267,000 20272028 541,517 19 541,536 255,328 280,350 2028 267,000 5.00% 13,350 162,461 5,858 448,669 92,867 94,156 0 20282029 544,225 1,412 545,637 539,661 0 2029 5.00% 0 163,691 5,975 169,667 375,970 470,126 0 20292030 546,946 7,052 553,998 547,903 0 2030 5.00% 0 166,199 6,095 172,294 381,703 851,830 0 20302031 549,680 12,777 562,458 556,241 0 2031 5.00% 0 168,737 6,217 174,954 387,504 1,239,333 0 20312032 552,429 18,590 571,019 564,678 0 2032 5.00% 0 171,306 6,341 177,647 393,372 1,632,705 0 20322033 555,191 24,491 579,682 573,213 0 2033 5.00% 0 173,904 6,468 180,372 399,309 2,032,014 0 20332034 557,967 30,480 588,447 581,850 0 2034 5.00% 0 176,534 6,597 183,132 405,316 2,437,330 0 20342035 560,757 36,560 597,317 590,587 0 2035 5.00% 0 179,195 6,729 185,924 411,392 2,848,722 0 20352036 563,561 42,731 606,291 599,427 0 2036 5.00% 0 181,887 6,864 188,751 417,540 3,266,262 0 20362037 566,378 48,994 615,372 608,371 0 2037 5.00% 0 184,612 7,001 191,613 423,759 3,690,022 0 20372038 569,210 55,350 624,561 617,419 0 2038 5.00% 0 187,368 7,141 194,509 430,051 4,120,073 0 20382039 572,056 61,801 633,857 626,573 0 2039 5.00% 0 190,157 7,284 197,441 436,416 4,556,489 0 20392040 574,917 68,347 643,264 635,834 0 2040 5.00% 0 192,979 7,430 200,409 442,855 4,999,344 0 2040

Total 10,829,825 408,267 11,238,092 2,726,350 2,195,000 531,350 0 3,371,482 140,917 6,238,748 Total

Notes:1) Asumes initial years' negative balances funded by another source such as General Fund or Utility Bond revenues, repaid when increment is generated2) City to retain 30% of increment for other project costs within the TID

Projected Revenues Expenditures Balances

Municipal Revenue ObligationExpendituresProjected Revenues Expenditures

TBDTax Increments

Interest Earnings/ (Cost)

Total Revenues

2,195,000Other TID

Project Costs Admin.Total

Expenditures Annual CumulativePrincipal

OutstandingOther

Projected TID Closure

• Incorporating TIF revenues into PAYGO structure

• Re-evaluate developer returns

validate the “But For”

• Development agreement & policy parameters may now be established

How does tax increment fit: Gap analysis

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Operating cash flow: with TIF assistance

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PAYGO assistance added in

Sales analysis: with TIF assistance

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Sales analysis: with TIF assistance

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• Financial Gap now solved, development likely to proceed Cash-On-Cash No TIF: Year 10 = 5.56%; 4.30% 10 year average

Cash-On-Cash With TIF: Year 10 = 5.88%; 8.48% 10 year average [Typical market range 8 – 12% as stabilized]

IRR No TIF: Year 10 = 9.54%

IRR With TIF: Year 10 = 12.44% [Typical market range of 12 – 18% at sale]

• Use metrics to establish allowable return limits in Development Agreement

Investment return metrics…revisited

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• Minimum % equity in project – “skin in the game”

25% per example; 10% plus suggested

• Ratio of equity to assistance ( = or > )

2.625x Equity > Assistance per example

• Payback period for increment to recover assistance provided

• Shortfall guaranty, no contest on assessments below certain level

Municipal policies & other project costs

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• Portion of increment utilized for other costs

Percentage of Increment withheld by municipality for other TID project costs including ½ mile radius

Street lights, sidewalks, bike path

Retainage for TID administrative fee

Municipal policies & other project costs

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• Development incentives can help positively impact a community for blight, renovation, or economic growth

• Is it an appropriate use of public funds, and within policy / goals of the municipality

• Validate need for assistance; is the return reasonable to offset risk without unduly enriching the developer?

Final impressions

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• Utilization of TIF pro forma analysis to substantiate available project cash flows and recommended financial structure

Transparency, third-party validation of request

• Include “Lookback” provision in development agreement to share in project success above negotiated return thresholds

But for the assistance, the project would not have occurred!

Final impressions

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Your presenters

2/19/2020 40

Stan RiffleAttorneyArenz, Molter, Macy & Riffle, S.C.sriffle@ammr.net

Frank RomanEconomic Development Advisorfroman@ehlers-inc.com(262) 796-6176