• Real Estate Development Tools for the "New Normal": Tax Increment Financing
  • October 26, 2009 | Authors: Daniel H. Sherman; Jenny A. Lipana
  • Law Firm: Epstein Becker & Green, P.C. - Atlanta Office
  • Introduction

    Much has been written in the past two years about the enormous challenges faced by developers of all classes of real estate, from the smallest of residential urban in-fill units to the sprawling resort-anchored master planned community. Diminished demand, exorbitant land costs, and universal uncertainty are, of course, all contributing factors, but the inability to secure financing is fundamentally the single biggest challenge developers face in today's environment.

    History has shown, however, that out of challenging times come innovative, and often much improved, ways of doing things. Financing of new real estate projects will be no exception. Many believe that development in the "new normal" will see an increase in projects being undertaken as a cooperative enterprise between the public and private sectors using innovative funding mechanisms such as tax increment financing (TIF).

    TIF is not necessarily new. Its use was introduced in California nearly sixty years ago as a way to provide local governments with matching funds for the federal Urban Renewal grant program. It has evolved since the 1950's to facilitate redevelopment of blighted, distressed, underutilized, and underdeveloped areas, as well as new, "greenfield" developments. Local governments and private developers have employed TIF to finance land acquisitions, site development, affordable housing, brownfield projects, road improvements, water and sewer expansion, and building expansion.

    While TIF has generally been the domain of industrial, commercial/office, and in some states, retail development, creative developers and local governments are increasingly looking to TIF as a means to launch mixed-use projects. The process of implementing TIF may seem complex and time consuming, but its utility and flexibility far outweigh the prerequisites required for its use. This article outlines the benefits of TIF in connection with real estate development projects.

    Authority to Implement TIF; Various TIF forms; How it works

    The power and authority to implement TIF are set forth in state statutes. In the absence of such legislation, a local government may not adopt TIF mechanisms. Currently, 49 of the 50 states and the District of Columbia permit local governments to allow some form of TIF. Arizona is the only state without TIF laws. State and local laws may vary differ in their implementation of TIF and thus, it is important to examine all enabling legislation carefully.

    TIF may take a number of different forms. For example, in Georgia the use of TIF is referred to as "Tax Allocation District Financing" and is accomplished by the creation of "Tax Allocation Districts" or "TADs", named for the geographical boundary of the areas subject to the special financing. New Jersey TIF law provides for "Revenue Allocation District Financing." Texas uses "Tax Increment Reinvestment Zones."

    Despite differences in the names of TIF mechanisms among states, the tools generally work the same way. New economic development (or redevelopment) typically causes the value of taxable properties and the corresponding tax revenues associated with those properties to increase. TIF works by capturing the incremental tax revenues gained from such increases in property values and using such funds to retire debt or fund improvements on a pay-as-you-go basis. In practice, a local jurisdiction will issue debt to fund capital improvements, and use the anticipated increase in property values from such investments to finance the debt.

    Designation of TIF District

    Once a local jurisdiction has made the decision to move forward with implementing TIF, state laws may set forth requirements for the physical boundaries of the proposed project area to be designated as a TIF district. In most states, only a municipal government unit has the authority to designate TIF districts. In other states, including Georgia, redevelopment authorities or development commissions may designate TIF districts. Most states require public hearings before approving district authorization. Depending on the state, such hearings may discuss the boundaries of the district, the redevelopment plan, and the financing options. Public hearings enable stakeholders to participate in the planning process prior to approval of a redevelopment plan or creation of a TIF district. Some states also require approval from all governments with taxing authority within the district (e.g., city, county, school district, etc.) in order to use all portions of property tax revenues. Typically, upon creation, TIF districts include commercial and residential properties with blighted conditions and numerous vacant buildings, or are in need of significant environmental remediation. The local jurisdiction may also draft ordinances adopting the TIF district.

    Eligibility

    In order for an area to be designated a TIF district, the local jurisdiction must usually verify that the target area is need of redevelopment, development or renovation. It is important to examine the eligibility of a particular area for TIF assistance under state law. Most states require the jurisdiction initiating a TIF district to develop a "redevelopment plan" or a project plan to demonstrate the needs of the community; why the area needs to be redeveloped; how the municipality plans to revitalize the area; a formal evaluation of project costs; specification of financing; and details of any necessary agreements with overlapping jurisdictions and private parties. It may also serve as a binding agreement between the municipality and the private developer to ensure that the project is completed as proposed. The redevelopment plan may also include provisions for environmental protections, affordable housing requirements, quality of life impact statements, and the power to negotiate and execute contracts with private firms.

    As part of the redevelopment plan, most states require a formal analysis and finding of a "blighted" area or similar designation. States may define "blighted" in different ways, but generally the term is used to describe an area that is older, deteriorated, depreciated, or excessively vacant or abandoned. For example in New York, a "blighted area" is defined as an "area in which there is a predominance of buildings and structures which are deteriorated or unfit or unsafe for use or occupancy or an area where there is a predominance of economically unproductive lands, buildings or structures in which redevelopment could further prevent deterioration that would jeopardize the economic well-being of the people."[1] Other states may not require such a finding. For example, in Georgia, a TIF district may be used for "redevelopment purposes" in a "redevelopment area" for "redevelopment costs."[2]

    In addition to determining whether an area is "blighted," many states also utilize a "but for" requirement to justify the utilization of public funds. Georgia is among the 18 states that includes a "but for" test. States such as Colorado, Connecticut, and Hawaii do not use such a test. A "but for" test means that the local municipality must prove that growth or development would not occur in an area without the TIF. This finding bolsters whether a larger public purpose is served in order to justify the use of public financing. Other states require projects to meet some form of a "but for" hurdle prior to approval.

    Implementation

    The administration of the TIF district is determined by the enabling statute. Certain states permit an initiating jurisdiction to delegate many of its redevelopment powers to a "redevelopment agency." Once an area is designated as a TIF district, the initial assessed property valuation in the district is held constant for a period specified in the individual state's enabling legislation which determines the baseline amount or the base value. In most states, the term of a TIF district is for a specified period. Terms may range state to state from 10 years to 40 years depending upon the enabling legislation and the redevelopment plan. For example, in Montana the time limit is 15 years, in Alabama it is 30 years, and in Florida it is 40 years. Other states, such as Georgia, Hawaii, and Kansas, do not set a specific time period. In Georgia, the TIF district terminates when the local legislative body dissolves the TIF district and only after the all the redevelopment costs have been repaid.[3]

    Once the area is designated as a TIF district, the initial assessed value of the property is set as the base value. The base value for the TIF district is then used to measure incremental property taxes as redevelopment occurs. The theory is that as public improvements are made within the TIF district, private investment increasingly becomes attracted to the area and the assessed value of the property and its taxes rise. For example, if the property tax base is $1,000,000.00 on the date the TIF district is created and the property tax base is $1,500,000.00 one year later, the increment for that year is $500,000.00. This value produces the "tax increment." It is important to note that incremental revenue does not represent a new tax. Rather, incremental revenue is a reallocation of a portion of the municipality's general property tax revenue. Taxes on the increment is placed into a separate fund to finance the TIF projects.

    In general, incremental taxes only involve property taxes, but some states also allow revenue such as hotel occupancy taxes, sales taxes, and other taxes that are generated by new development to be committed to the repayment of redevelopment expenses. The tax increments are then used to finance any debt accumulated when making the improvements until completion of the projection or termination of the TIF district. The particular use of tax increments will depend on the redevelopment plan and the enabling legislation. For example, in Georgia, TIF funds may be used to finance redevelopment costs, which include: "activities, projects and services necessary or incidental to achieving the development or revitalization of a development area or a portion thereof designated for redevelopment by a redevelopment plan."[4] Therefore, in Georgia, TIF funds may be used for grants for capital costs, which include: construction of new buildings; public works or improvements; renovation, rehabilitation, demolition, or expansion of existing buildings; acquisition of equipment; and clearing and grading of land. The taxes on the base value remains the same and continues to be paid to the local taxing bodies.

    Issues to Consider/Risks

    There are risks which every developer should consider when evaluating TIF as a development finance option. A successful TIF project relies upon an increase in property values so that the longer term revenues generated by the new economic development will cover or exceed the costs of the initial investment. Since the loan is repaid through anticipated growth in property values, the inherent risk is in the assumption that property values will materialize to sufficiently cover the costs of the associated debt. Thus, it is important to carefully examine whether the development or project is in an area capable of realizing sufficient value and the probability that a proposed project will produce the anticipated tax growth leading to increases in the value of the property in the proposed TIF district. Additional up-front challenges are presented in those states that have a "but for" requirement, as the analysis and determination of whether a development would have occurred without the expenditure of public TIF funds can be time consuming and potentially costly.

    Conclusion

    TIF has developed into not only a financing tool for many local governments across the nation, but as a land development tool to spur redevelopment. While TIF may lead to many benefits associated with economic development, TIF may not be appropriate in every context. Initiating a TIF district involves a complex process and requires a firm understanding of the enabling legislation. Further, TIF districts may experience unexpected financial difficulties due to the speculative nature of TIF. With a firm understanding of the process, however, TIF may be an opportunity for developers to consider in planning real estate development projects.