05-28-15 SCC_ TIF RequestMP,n-4--v,))
To: Lori Johnson, City of Otsego
From: Mark Ruff and Nick Anhut, Ehlers
Date: May 14, 2015
Subject: Financial and "But For" Analysis for Apartment TIF Request
The City has received a request for $6,900,000 of tax increment assistance for the rental housing
portion of the Riverbend North development which consists of two phases of 80 units per phase
of rental apartments and approximately 11,000 square feet of commercial buildings on a total of
13.1 acres.
This memo is intended to discuss the following:
■ Background on and amount of tax increment financing ("TIF") projected for this project
■ Our review of the underlying economics of the development and its "need" for assistance
■ Options for the Council to consider if it moves forward
Background on TIF and TIF Projections
Tax increment financing is a tool available for cities and counties to utilize for new
developments that demonstrate a financial need for assistance. The underlying justification for
the use of TIF is the "but for" test. This means that the Council must make a finding that the
project as proposed would not be feasible without the use of public resources. The TIF statutes
(Minnesota Statutes, Section 469.174 to 469.179) do not dictate how such a finding is made,
particularly for a housing development. The State does regulate TIF indirectly through the Office
of the State Auditor's TIF Division, but this regulation focuses more on proper accounting of TIF
dollars and compliance with the TIF statutes once the project is in place. The State rarely
questions a council's rationale for how much TIF is necessary. There are many approaches to
the but for finding, which we will discuss in more detail in this memo.
There is also great flexibility in the "business deal" or negotiation on how much TIF can be
directed to a project. The Council does not need to give a development all of the available TIF.
The Council has discretion to reject a request for TIF or it can offer a maximum amount of TIF
based on reimbursement for certain costs, based upon a certain dollar amount overall, and/or
based upon a maximum number of years. Because there is financial assistance offered, the
Council also has the ability to make assistance conditional upon compliance with other factors
such as construction completion by a certain date, certain types of units constructed, and/or a
higher level of quality in the exterior of buildings or landscaping than is required under the
zoning code.
EHLERS
LEADERS IN PUBLIC FINANCE
www.ehlers-inc.com
Minnesota phone 651-697-8500 3060 Centre Pointe Drive
Offices also in Wisconsin and Illinois fax 651-697-8555 Roseville, MN 55113-1122
toll free 800-552-1171
The first step we recommend in evaluating a TIF request is to determine how much TIF is
available. TIF itself is not complex, but the property tax system in Minnesota increases the
complexity of the tool. Our estimates for the first phase of 80 apartments only, indicate that the
TIF will be approximately $119,000 per year, as shown in the chart below. TIF does not capture
the taxes attributable to the base (existing land) value nor does TIF capture taxes paid to the State
for commercial property or for market value taxes such as school district operating referenda.
Total Property Taxes
137,143
less State-wide Taxes
0
less Fiscal Disp. Adj.
0
less Market Value Taxes
(15,195)
less Base Value Taxes
(2,658)
Annual Gross TIF
119,290
The developer has requested that the TIF district include all of the 13.1 acres. If all of this
proposed commercial and housing development occurred and were captured in the TIF district,
the total TIF per year is estimated to be $259,457 per year.
Total Property Taxes
309,090
less State-wide Taxes
(12,659)
less Fiscal Disp. Adj.
0
less Market Value Taxes
(31,687)
less Base Value Taxes
(5,316)
Annual Gross TIF
259,427
The developer has requested the full 26 years of tax increment in today's dollars of $6,900,000.
It is our estimate that the total amount of TIF with all commercial and apartments included
would be $6,300,000, or $3,150,000 in today's (financeable) dollars at a 5% interest rate with no
inflation.
The request is for pay-as-you-go assistance, meaning the developer is responsible for paying all
of the costs up -front and would receive TIF payments over time. No City bonds or direct loans
would be involved in the transaction. The developer will finance the costs and receive a semi-
annual payment from the TIF received by the City. If the TIF decreases, the developer receives
less. If the TIF increases, the City is not obligated to pay more than the original amount
approved.
TIF Housing Districts
There are many ways to qualify for a TIF district, such as redevelopment, contaminated soils,
and affordable housing. The developer has requested that Otsego establish a housing TIF
district, meaning the TIF must only be used to benefit a building that has a portion of its units
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dedicated to persons with low to moderate incomes. The developer has chosen to have 20% of
the units occupied by persons below 50% of median income. For the first 80 units of housing,
this means that at least 16 units must have tenants with limited incomes. This is not an assets
test. For a one person family, the income is limited to $29,050, for two persons is $33,200, and
for four persons is $41,450. These income restrictions will remain in effect for the term of the
TIF assistance.
The developer has not proposed to restrict rents for the affordable units. It is not a requirement
of the TIF law that rents be limited, but many cities do want to keep rents affordable for residents
on limited incomes. If the City were to require the developer to maintain affordability by
limiting rents, the applicable rents limits including utilities for 2014 are $778 for a one bedroom,
$933 for a two bedroom and $1,078 for a three bedroom unit. The rents and income are adjusted
annually. Commercial can be included in a housing TIF district as long as the development's
total building square footage is not more than 20% commercial at any one time and as long as it
is clear that the TIF does not benefit the commercial property.
Economics of the Request
We believe that it is important for a city council to understand the economics of a real estate
development that is requesting assistance. Below is our understanding of the projects sources
and uses of funds with details on the project costs. The developer has indicated that it plans to
construct the housing in two phases, with each phase being an 80 unit, 3 -story building plus both
tuck -under garages and separate garages.
For purposes of the analysis below, we only analyzed the first phase of housing and assumed
only TIF from the first phase of the housing. We have not received any information relating to
the financial feasibility of the commercial property and the TIF cannot be used to pay for
commercial costs. The developer has indicated that none of the costs below benefit the
commercial property, with the exception of an allocation of the traffic control lights and signs,
which we have reduced proportionately. We have not independently verified the developer's
assertion that the costs below are only housing costs. The total project costs are $11,663,948, or
$145,799 per unit. Below are summaries of our understanding of project sources and uses.
SOURCES
Developer Financing - 30 Years 5.5%
81747,961
75.00%
Developer Equity
2,915,987
25.00%
Subtotal
11,663,948
100.00%
Grants
0.00%
Fee Waiver
0.00%
Other
0.00%
Subtotal
0
0.00%
TOTAL SOURCES
11,663,948
100.00%
USES
Amount
% of Cost
Per Unit
ACQUISITION AND SITE COSTS
3,189,507
27.35%
39,869
Land
1,920,000
16.46%
24,000
Demo/Asbestos Abatement
110,273
0.95%
1,378
Grading
225,000
1.93%
2,813
Wastewater Plant Removal
59,962
0.51%
750
Paving
150,000
1.29%
1,875
Site Road Improvements
340,798
2.92%
4,260
Traffic Control - Lights/Signs
177,594
1.52%
2,220
County Road Curbs/Aprons
90,880
0.78%
1,136
Sidewalks
10,000
0.09%
125
Berms
30,000
0.26%
375
Landscaping
75,000
0.64%
938
CONSTRUCTION COSTS
7,591,600
65.09%
94,895
Building/Land Improvements
6,000,000
51.44%
75,000
Contingency
200,000
2.75%
2,500
Construction Management
160,000
1.37%
2,000
Park Dedication
269,600
2.31%
3,370
SAC/WAC
962,000
8.25%
12,025
SOFT COSTS
PROFESSIONAL SERVICES
652,841.00
5.60%
8,161
Appraisals
15,000
0.13%
188
Architect/Design
360,000
3.09%
4,500
Civil Engineering
110,570
0.95%
1,382
Development Consultant
120,000
1.03%
1,500
Market Research
22,000
0.19%
275
Traffic Study
5,271
0.05%
66
Survey
20,000
0.17%
250
FINANCING COSTS
230,000
1.97%
2,875
Legal/Bond/TIF Counsel
125,000
1.07%
1,563
Construction Period Interest
100,000
0.86%
1,250
TIF Application Fee
5,000
0.04%
63
Management Start up
0.00%
0
TOTAL USES
11,663,948
145,799
The annual TIF for the 80 unit development is $119,000 per year which totals $1,540,000 in
today's (financeable) dollars at a 5% rate. Cities usually keep 10% of the TIF for administrative
costs, which means the net TIF to the developer would be approximately $1,390,000.
Analysis of Economics
To help provide a basis for the evaluation of the "but for" test, we regularly review a developer's
projections for estimated costs, revenues, and expenditures (called a "pro forma") when a city or
county receives a TIF request. The pro forma review measures key factors in the developer's
assumptions to determine if the developer's underlying assumptions are within industry
standards. At times, a developer will show very conservative assumptions, which creates a gap
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in funding that the developer may argue creates a need for TIF
assumptions, a gap in funding may be reduced or eliminated.
reviewed for this project:
1. Land price and site costs
2. Rental rates and operating expenses
3. Construction costs
4. Fees in the Project Budget
5. Financing assumptions and affordability
6. Return on equity
By altering some of the
Below are six key factors we have
1. Land Price and Site Costs: The developer has chosen to allocate much of the land cost
and site preparation costs of both phases of housing to the first phase. This causes a very
high budget for site costs of over $3.1 million. The land price alone of $24,000 per unit
or $1,920,000 is very high for the Otsego market. Typically apartment land prices are
$10,000 per unit for property which can achieve unit rental rates of $1.50 to $1.75 per
s.f.. Properties with lower rents pay much less in land price per unit. Land is a typical
cost for TIF to reimburse, but usually it is in the case of an arm's length transaction
between unrelated parties that is supported by market comparables or an appraisal. We
have been in situations with other cities where a council declined to offer TIF because the
land price was too high and required too much subsidy.
In addition, there are costs associated with the site such as demolition, and site road costs,
which could be spread among the other project components. These high site costs do
drive up equity and debt requirements for the first phase, which then creates a lower than
market return on this equity. It is a policy choice for the council to decide if the
developer's argument has merit.
2. Rents and Operating Expenses. The proposed rents for the units are $1.00 per s.f. which
means a 1,000 s.f. unit rents at $1,000 per month, including all utilities except electricity.
We have not conducted a market study to confirm the rent level. We can say that if rents
were increased by 10%, the increased rental revenue would match the level of annual tax
increment. There is not as much new product in the area. As a comparison, the higher -
end of the market in the area is found in the COR at Ramsey, which we understand to
charge $1.33 per s.f. rents today.
3. Construction Costs. Hard construction costs of $75,000 per unit are on the lower end of
today's construction market. Projects with higher amenities average $125,000 or more
per unit in hard construction costs. In other words, the project is not padding its estimates
to create an appearance of a greater need. If the Council is interested in requiring a
higher level of exterior finish or higher level of amenity for this project, such a condition
could be added to a TIF agreement.
4. Fees. The developer has indicated that they will not be taking a development fee. There
is a development consultant fee of 1.13% and a construction management fee of 1.5
both of which are reasonable.
5. Financing. The assumption is a loan for 75% of the project costs including the TIF costs
at a 5.5% interest rate with an amortization of 30 years. These are reasonable
assumptions.
6. Return on Equity. Assuming 25% equity of $2.9 million, and all costs and rent levels as
projected by the developer, the net income after debt service is an annual return without
TIF of approximately 2% to 3% of equity. Assuming TIF of approximately $110,000 per
year, the annual return would increase to 5% to 6%. In today's market, a 6% to 8%
annual return is what most developers would expect.
Council Options
Real estate is not an exact science. Different developers will have different tolerances for risk
and different cities have various rationales for assistance. There are several economic questions
raised in our analysis above. The Council has the following options:
A. Ask for more information. There are questions about the value of land, allocation of site
costs, and rent levels of the property. The Council could request an appraisal of the
property and/or a market study to establish the appropriate level of rents.
B. Grant assistance based upon on housing affordability. Many communities offer
assistance in a housing district only for the gap between market rents and restricted rents.
The Council could consider focusing any assistance on costs related purely to long-term
housing affordability for the 20% of the units with restricted incomes, and potentially
including restriction of rents.
C. Consider if there are any site costs which are extraordinary in nature, such as demolition
or county road costs, and reimburse the developer for only those costs in an effort to spur
development. The developer would still need to meet the income restrictions for the term
of the TIF district.
D. Cap the assistance amount as a percentage of increased market value. It is our
understanding that the City has utilized tax abatement several times in the past. The
City's assistance is ranged from 1% to 7% of assessor's estimated market value increase.
Other cities do use TIF as a percentage of the total project as another benchmark for
assistance. If the City for example wanted to cap assistance at 7% of market value
increase on the site, the TIF would be approximately $500,00 to $550,000.
E. Reject the request for assistance.
Process
The establishment of a TIF district does require notice to other taxing jurisdictions and a public
hearing. Below is a sample schedule if the Council wanted to proceed with a TIF district for this
project:
Month 1 -Council sets a date for a public hearing
-TIF plan drafted
Month 2 -TIF plan sent to the county/school district for comment (they do not have veto
power) at least 30 days prior to public hearing
G9
-Planning commission review of TIF plan for compliance with comprehensive
plan
-Publication of TIF hearing notice
-Drafting of development agreement between City and developer
Month 3 -TIF hearing
-Consideration of TIF plan by Council
-Approval of development agreement
These dates are flexible depending upon the land use approval process for the project. Many
cities like to approve the land use and TIF agreements at the same Council meeting.
Please contact us with any clarifications or questions.
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