Member Article

There are a number of legal mechanisms that can improve the economics and liability of industrial and commercial development projects for developers willing to take advantage of them. This article will explore some of the incentives available to developers that will assist in maximizing profits and freeing-up capital that would otherwise be devoted to conventional construction or permanent loan financing. 1. Tax Incremental Financing Districts (“TIF’s”). In Illinois, TIF’s have been widely used by developers and municipalities for the redevelopment of blighted industrial and commercial corridors. TIF’s are redevelopment project areas created by a municipality in accordance with certain technical requirements set forth under the Illinois Tax Incremental Allocation Redevelopment Act. The purpose of TIF’s is to use the incremental real estate taxes produced by new development in a redevelopment project area to attract private investment into that area. Instead of the municipality collecting such taxes for its general operating fund, these monies are used to pay of TIF bonds or developer’s notes. In effect, the future tax stream is used to pay for public improvements that would otherwise be unaffordable in a distressed or challenging property. Eligible costs for such financing include the soft costs of development (e.g., professional services), as well as certain hard costs, identified under the TIF Act, including the construction of public improvements, site preparation, financing costs, property acquisition costs and demolition of existing structures. However, costs incurred in connection with new construction are not eligible costs. A common misconception with TIF’s is that they can only be established in rundown areas or abandoned industrial yards. However, in recent years, TIF’s have been used in to reclaim properties that do not fit the typical image of deteriorating, blighted old urban neighborhoods. Instead, the qualifying conditions may be unusual stormwater or wetlands areas that cannot be developed with traditional financing. A large TIF area in Aurora qualified under these tests, and is now home to a number of industrial buildings and The Chicago Premium Outlet Mall. To prepare this site for development, more than $20M in TIF bonds were needed to undertake complicated stormwater management and wetlands preservation activities. The eligible redevelopment costs in the TIF are either financed through the issuance of tax-exempt bonds by the municipality, or the developer will front fund the redevelopment costs by receiving developer notes from the municipality. The increment is then used to pay off the notes. If the project is successful and increment builds, the developer can often have the municipality issue TIF bonds to pay off the developer notes. TIF financing allows private developers to tap into the interest free municipal bond market at interest rates that may be much less than market rates for conventional financing and frees up capital for the developer to spend on other aspects of the project. As TIF’s can be used to apply all the incremental real estate taxes from not only the municipality but also the other taxing districts, it may face opposition from such districts, especially school districts. There are technical qualification requirements that are beyond the scope of this article. The best answer to such objections is that in the absence of such incentives, the subject property will remained blighted or vacant with little or no tax base to support the various taxing districts. Once the TIF bonds are paid off, the taxing districts will reap the benefits of such redevelopment. 2. Special Service Areas (“SSA”)/Special Assessment Areas (“SAA”). SSA’s and SAA’s are an intriguing and relatively new method (in Illinois, at least) that some developers are using to fund the cost of construction of roads, sidewalks, detention facilities, sanitary sewer mains and on-site lift stations, water mains, storm sewers, and other infrastructure improvements within a newly developed subdivision. They have traditionally been used in residential developments, but are increasingly being considered to finance public infrastructure in communities that do not have enough tax base to attract and support commercial and industrial projects. Special assessment bonds are issued to pay for the public improvements, and then the special tax assessments are collected against the record owners. In Illinois, special tax assessments were traditionally done on an ad valorem basis, meaning that the assessment was based upon the value of the property. The recent trend has shifted to a non-ad valorem basis, meaning that the assessment is based on a prorate allocation of the benefits of the public improvements to each improved lot. Developers are increasingly seeking to use SSA’s and SAA’s as alternative financing mechanisms for industrial and commercial developments. By using assessment financing, developers are able to free up capital that would otherwise be devoted to a traditional acquisition or development loan. The two most utilized bonds are fixed rate and variable rate bonds. In a variable rate deal, the special tax will be prepaid and retired prior to the sale of lots to any user. Additionally, interest rates for variable rate bonds are often much lower than the market rate for typical construction loan financing. In contrast, in a fixed rate bond deal, the special tax is amortized over a longer period (e.g., 30 years) and is paid on an annual basis by the owners of the property. As a normal rule, the amount of bond issuance is usually equal to about 35% to 45% of the property’s market value as appraised for finished lots. This is due to the fact that the institutional market for such bonds has made a risk assessment relating to the possible need to foreclose on the property if the development is unsuccessful. For this reason, the value is deeply discounted for such purposes. As a result, the developer can use this financing mechanism for only a portion of its development needs. The developer is then further limited to the amount of funds that can be used. For example, a certain percentage of the bond issuance is withheld and placed into various funds to cover the costs of bond issuance, administrative costs, and capitalized interest (to cover interest payments on the bonds until the delayed collection of the special tax). As a result, developers still have to front fund a portion of the costs of the public improvements. Eligible public improvements are usually limited to on-site improvements. The costs for off-site improvements are only reimbursable to the extent that they are “specifically and uniquely attributable” to the proposed development. For example, the eligible costs for an expansion of a water plant would be limited to the amount of benefit that was specifically and uniquely attributable to the proposed development (i.e., its prorata portion of the total cost). 3. Industrial Revenue Bonds (“IRB’s”). IRB’s can be structured as tax-exempt revenue bonds issued for traditional manufacturing companies to finance the acquisition of assets such as land, buildings and equipment or to construct new or renovate existing facilities. Taxable bonds have also been used to finance government related construction activities for otherwise unqualified commercial activities. For example, a municipality could fiannce a parking deck to be leased to a riverboat casino. Interest rates are generally lower than private financing, usually up to 2.5% below conventional rates in tax exempt deals. Interest rates may be fixed or variable. The disadvantage of tax exempt IRB’s lies with their technical eligibility restrictions. For example, the bond proceeds must be used by a manufacturing facility and at least 75% of the bond proceeds must be used for expenditures directly relating the manufacturing process. Under special tax rules, not for profit enterprises can also use similar financing, such as a blood bank or battered women’s shelter. 4. Enterprise Zones. An Enterprise Zone is a specific geographic area targeted for economic revitalizing and is authorized under the Illinois Enterprise Zone Act. They encourage growth and investment in distressed areas by offering tax advantages and incentives to businesses located within the zone boundaries. The foregoing are just some of the many economic incentive available to developers for commercial and industrial development. However, the availability and amount of such incentives will ultimately depend on the municipality’s appetite for development and the bargaining power and financial strength of the developer. By: Bruce L. Goldsmith and Dennis P. Lindell