TAX INCREMENT FINANCING (TIF)
EXPLAINED

Tax Increment Financing (TIF) is a remarkably effective and popular economic development tool. TIF, more often than not, is difficult to explain and understand. Essentially TIF provides a self-financing mechanism for economic development by unlocking and leveraging increased real estate tax revenues created by the increased property value assessments an approved development project generates. As a rule of thumb, TIF can generate an up-front cash equity around 13% of a Project’s total cost. Most TIF projects are structured so that no project costs or tax burdens are shifted to the local taxpayers. Getting TIF requires a political process.

Many TIF projects provide immediate benefit to the local communities in the form of economic development, jobs, public infrastructure, public improvements, increased goods and services, and potential sales tax revenue increases. TIF is an effective low cost tool for municipalities to use to make economic development a reality in this challenging and competitive environment.

All TIF projects statutorily must address a minimum number of, but not all of, the mandatory and discretionary criteria defined in that State’s TIF Statutes. The most important of which being the absolute need to pass the “but-for test.”  The “but-for test” is that the proposed development project would not be economically feasible “but for” an allocation of TIF.

Because of the “but-for test” typically any improvements made prior to finalization a TIF allocation could jeopardize all or part of that Project from receiving any TIF whatsoever. An exception to an early work start would be if the Developer and the Municipality have entered into an acceptable non-binding memorandum of understanding which could allow a Developer to proceed with project improvements, at their own risk, prior to a final TIF allocation. This is sometimes done in the interest of moving a time-sensitive project forward, but this move carries the risk that the purported Project may not in fact receive a TIF allocation from the required political bodies in the Municipality, despite the memorandum of understanding.

TIF History

The State of California created the Tax Increment Financing mechanism in 1952 as a way to raise local dollars needed to capture Federal matching funds. Over time, as TIF was adopted by other states its focus turned to providing financing for projects which were unattractive to private capital markets. Currently, all states except Arizona have passed enabling legislation for TIF programs. Use of TIF has increased as Federal funds for community redevelopment have declined relative to need.

TIF Approval Process

The TIF approval process begins with the City or a City-designated Community Redevelopment Authority (CRA) declaring an area as Blighted and Substandard. Although this may have negative sounding connotations, the Blighting Designation can be used in a wide variety of circumstances which meet an acceptable number of mandatory and discretionary criteria to statutorily justify the TIF allocation for a Project. To accomplish a blight designation the City may require a formal Blight Study, and a separate formal Cost/Benefit Analysis – both of which are typically performed by qualified planning consultants on behalf of the City at the expense of the Developer. Some forward-thinking Cities have already identified and Blighted specific areas in an effort to encourage economic development.

Most jurisdictions welcome viable Projects using TIF, and will try to approve a TIF Request in around 3-4 months. This of course may vary from jurisdiction to jurisdiction.

Assuming the Project is supported in the Blight Study and the Cost/Benefit Analysis, to complete the needed Blight Designation the City or CRA must:

· Hold a public hearing per that State’s open meeting laws, with proper legal notice

 
· Provide notice of hearing to all registered neighborhood associations located within a one mile radius and to all political subdivisions effected by the redevelopment area

· Prepare a Redevelopment Plan and/or Redevelopment Contract indicating:

o the boundaries of the redevelopment project area

o proposed land uses and scope of the project and eligible expenses

o population

o land and building intensities

o changes in zoning

o traffic flow

Upon approval of the Project the City or CRA issues a TIF Bond, sometimes referred to as a TIF Note, amortized by the Incremental Tax Payment (explained below). The TIF Bond/Note is used for allowable TIF expenses such as site acquisition, site work, and public improvements like utilities, streets, landscaping, engineering & architectural fees, legal fees, and more. The TIF Bond/Note is a municipal bond which factors against that City’s overall bond lending limit for the duration of the TIF Bond.  Some jurisdictions will allow building construction to also be a TIF eligible expense and therefore eligible for payment thru the TIF Bond issued.

PLEASE NOTE: the upper limit of any TIF allocation, regardless of the sum of approved

TIF expenses, is the amount of a Note or Bond that the Incremental Tax Payment would

amortize during the TIF time period, generally 15 or more years.

After a TIF Bond is issued the Developer may commence implementation of the approved TIF Project. Properties in the Project have two tax valuations. A Base Valuation is established by the assessed value of the property in its predevelopment state on January 1 of the year previous to either TIF approval or TIF Project commencement. Property taxes resulting from the base assessed value are treated like normal tax revenue and are not subject to any use or monetization by the Developer. The increase in property value resulting from the development results in additional tax revenue which is then used to pay off the debt incurred for the redevelopment. For example, the maximum repayment period for the TIF bonds in Nebraska and many states is set at fifteen years although there is a trend in other states for longer TIF bond periods as a means to generate even more funds for economic development.

Unlocking Cash from a TIF Bond for Economic Development

There are six fundamental terms always present in a TIF process:

·         TIF Bond, aka TIF Note – The municipal debt a City or CRA issues to the Developer, at a negotiated interest rate, which is retired through the Incremental Tax Payment to the Developer. The amount of the TIF Bond is the amount of TIF approved for a project, which typically, but not always, is the sum of the allowable TIF expenses.

Please Note: People often confuse the TIF Bond or TIF Note with the TIF Loan which a Bond/Note holder, i.e. the Developer, may use to monetize the TIF Bond/Note, creating a lump sum cash equivalent of the projected Incremental Tax Payments created through the TIF allocation.

·         Base Year - the year that the City or CRA establishes the TIF district and/or approves the TIF Project

·         Base Assessed Value - the assessed value of project property in the Base Year

·         Base Tax Payment – the amount of real estate taxes due for project property in the Base Year

·         Incremental Assessed Value - the as-built assessed value of project property at completion  minus the Base Assessed Value

·         Incremental Tax Payment – the amount of real estate taxes due for the as-built project property minus the Base Tax Payment. The Incremental Tax Payment flows to the Developer as the debt service to pay off the City’s Bond granted to the Developer.

Essentially the Incremental Tax Payment is the “meat and potatoes” of a TIF project, as this Incremental Tax Payment is the cash flow stream generated by the creation of the TIF Bond.  In most jurisdictions the Incremental Tax Payment begins about 18 months after a Project has been brought online and coincides with the typical twice a year payment of real estate taxes due.

A Developer has three options with the TIF Bond the City or CRA has issued them.  Those options are:

1.      Monetize the TIF Bond using an assignment of proceeds of the Incremental Tax Payment to amortize a TIF Loan. TIF Loans are typically only secured by a security interest and/or assignment of the TIF Bond. In most Projects additional securitization such as use of the Project Property as additional collateral is typically not required. Personal guarantees are often required by the individual lenders for approval of a TIF Loan, but this practice can vary from lender to lender and project to project.  

The semi-annual payment of real estate taxes triggers the disbursement of the Incremental Tax Payment, which typically is also semi-annual to match gross real estate tax receipts received by the taxing authority. TIF Loans typically are structured for the Principal and Interest payment made under the TIF Loan to match the semi-annual nature of the Incremental Tax Payment. TIF Loans are typically at rates far below conventional real estate lending as the Loan being underwritten is backed by a private municipal bond.

2.      Sell the TIF Bond to an investor at a discounted rate to generate a lump sum cash payment to the Developer for the benefit of the Project.

3.      Do nothing but receive the Incremental Tax Payment. This option is very rarely used as most Projects passing the “but-for test” need the equity that the monetization or sale of the TIF Bond creates.

PITFALLS WITH TIF

While TIFs have enjoyed considerable political support, there are four fundamental issues of concern for public and private interests.

A major public concern may be that the public is providing a subsidy for an action which would have occurred anyway. Numerous examples exist where successful companies received a TIF even though it is likely that the company had access to sufficient private capital. Supporters of TIF argue that the subsidy pulls the activity into blighted areas. Therefore, even though the company could have financed the project privately, it would likely be located outside the blighted area.

The second public concern is that the TIF Project will push costs on to the wider community through the need for additional infrastructure improvements or the expansion of needed municipal services. However, the Cost/Benefit analysis, or any Blighting a jurisdiction may have previously done are required to ensure that TIF Project’s benefits outweigh its costs or public burdens in order to statutorily be approved for the use of TIF.

Of concern to the private sector is the exposure a Developer, Lender, or Investor that purchased the Developer’s TIF Bond may have if the As-Built Real Estate Assessment is not to a sufficient level to generate the projected Incremental Tax Payment. Coming below the projection for the Incremental Tax Payment may trigger a repricing of a TIF Bond sold, or may create a scenario whereby the Developer would need to subsidize any payments due to amortize a TIF Loan. It is prudent for all parties involved to be realistic in their expectations of the As-Built Real Estate Assessment, and care should be used to consider projected assessed valuations using methods in addition to the Cost Method. If possible, looking at comparable property assessments could be very helpful in projecting a realistic As-Built Assessed Value. In certain circumstances an informal visit with the local County Assessor could be a viable option in properly projecting an As-Built Assessment, provided the conversation with the County Assessor does not adversely affect your desired TIF allocation by potentially politicizing, or prematurely broadcasting your proposed Project.

Finally, all parties should be concerned of whatever ramifications may occur if a TIF Bond is made, monetized, and the unlikely circumstance that not all Project Improvements are implemented. This is a rare occurrence, but one that is possible.

SUMMARY

TIF is an effective tool for economic development that if properly implemented is not a burden to a taxing body or its citizens. Although sometimes misunderstood, TIF is used to unlock cash flow in the form of Incremental Tax Payments which can be used to provide needed equity for a potential Project. Given its wide and successful implementation it is likely the use of TIF will increase in the coming years. TIF truly is a bright spot in the midst of challenging lending and development environments.

[i]