Ehlers_MemoTo: Adam Flaherty, City of Otsego
From: Nick Anhut, Ehlers
Date: May 3, 2017
Subject: Financial and "But For" Analysis for Riverview Landing TIF Request
The City has received a request for tax increment assistance for the Guardian Angels Riverview
Landing development which consists of one initial phase of 143 units of independent living,
assisted living, and secured memory care. The development will be situated on 5.7 acres of the
14 -acre site currently owned by 521 Land Company, a subsidiary of Guardian Angels who
purchased the property in 2016.
This memo is intended to discuss the following:
■ Background describing the amount of potential tax increment financing ("TIF") assistance
available for this project,
■ A review of the underlying economics of the development and its "need" for assistance, and
■ 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 an affordable housing development. There are many approaches to make a "but
for" finding, which this memo will discuss in more detail.
There is also great flexibility in the "business deal" or negotiation on how much TIF can be
directed to a project. If circumstances dictate, a development may not require all the available
TIF. The Council has discretion to reject a request for TIF or it can cap a maximum amount of
TIF based on any of the following:
■ Reimbursement for certain extraordinary (site specific) costs,
■ Dollar amount designed to assist in securing private financing, or
■ Specified time (number of years).
Because there is financial assistance negotiated within a contract, the Council also can make
assistance conditional upon compliance with other factors such as construction completion by a
certain date, types of units or public amenities, and/or a higher level of quality in the exterior of
buildings or landscaping than is required under the zoning code.
,Dill
EHLERS
LEADERS IN PUBLIC FINANCE
www.ehlersdnc,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 in evaluating a TIF request is to determine how much TIF is available. Our
estimate assuming a $12.1 million taxable market value (provided by Wright County) is that the
annual TIF generated from the project will be approximately $159,957, as shown in the chart
below. As discussed at the April 24th council meeting, 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 referenda. It does capture
all other local shares, of which the portion of TIF attributable to the City's tax rate is $53,060.
Total Property Taxes
196,276
less State-wide Taxes
0
less Market Value Taxes
(23,470)
less Base Value Taxes
02,849)
Annual Gross TIF
159.957
The developer has stated the proposed development utilizes 5.7 acres of the larger site, so the
base value assumption has been adjusted to reflect only a portion of the existing land value.
The request is for pay-as-you-go assistance, meaning the developer would only receive
assistance payments over time as TIF is generated from future tax payments. No bonds backed
by the City's other revenues or direct loans would be involved in the transaction. The City can
issue a Note payable solely from an agreed upon portion of the TIF generated from the project.
The developer intends to pledge the TIF Note to help obtain the financing necessary, along with
its equity, to build the project. Upon completion and after payment of taxes, the project would
receive a semi-annual payment of the portion of TIF received by the City. If any year's TIF
decreases below expectations, the developer receives only what is generated. If the TIF
increases, the City is not obligated to pay more than the agreed upon amount.
The developer has requested 90% of the annual tax increment generated over the full 26 years
allowable in creating a new housing TIF district. The stated need is to provide adequate debt
service coverage on a bond issued with the City as a conduit.
TIF Housing Districts
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 dedicated to persons with low to
moderate incomes. The developer has requested to comply with having at least 20% of the units
occupied by persons at or below 50% of median income. This means that at least 29 units must
have tenants with limited incomes. The City can demand a higher amount, but doing so may
slightly increase the financial gap associated with the affordability. For a one-person occupant,
the income is limited to $31,650. This is not an asset test. These income restrictions will remain
in effect for the term of the TIF assistance.
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 project's sources
2
and uses of funds with details on the project costs. The developer has indicated that it plans to
construct the housing in one phase starting in Fall 2017.
For purposes of the analysis below, we analyzed financial projections provided by the developer
and estimating the impact of potential TIF generated from the development. The total .
development costs are $31,099,398, or $217,478 per unit. Below are summaries of our
understanding of project sources and uses.
SOURCES
Developer Financing - Bonds
•
27,808,349
89.42%
Developer Financing - Land Equity
400,000
1.29%
Developer Financing - Cash Equity
2,426,022
7.80%
Subtotal
30,634,371
98.50%
Public - Building & Land Credit
465,027
1.50%
TOTAL SOURCES
31,099,398
100.00%
USES
ACQUISITION COSTS
911,049
2.93%
6,371
Land
400,000
1.29%
2,797
Assessments
511,049
1.64%
3,574
CONSTRUCTION COSTS
24,019,392
77.23%
167,968
Building Costs
20,611,967
66.28%
144,140
Public Amenities
175,000
0.56%
1,224
Community Amenities
1,438,705
4.63%
10,061
FF&E
1,197,600
3.85%
8,375
Contingency
596,120
2.71%
4,169
PERMITS/FEES
0
0.00%
0
SOFT COSTS
PROFESSIONAL SERVICES
868,451.00
2.79%
6,073
Finance, Feasibility, Accounting & Legal
868,451
2.79%
6,073
FINANCING COSTS
3,120,235
10.03%
21,820
Construction Period Interest
1,386,771
4.46%
9,698
Debt Service Reserve
1,733,464
5.57%
12,122
PROJECT MANAGEMENT
0
0.00%
0
Developer Fee
0
0.00%
0
CASH ACCOUNTS
2,180,271
7.01%
15,247
Working Capital & Start up
2,180,271
7.01%
15,247
TOTAL USES
31,099,398
217,478
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
receives a TIF request. The pro forma review measures key factors in the developer's
assumptions to determine if the underlying assumptions are within industry standards. At times,
a developer will show very conservative assumptions, which creates a gap in funding that the
developer may argue creates a need for TIF. By altering some of the assumptions, a gap in
funding may be reduced or eliminated. Below are six key factors we have reviewed for this
project:
1. Land price and site costs
2. Revenues and operating expenses
3. Construction costs
4. Fees and Soft Costs in the Project Budget
5. Financing assumptions and affordability
6. Potential investment returns
1. Land Price and Site Costs: 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.
The developer's subsidiary owns the land and intends to allocate a portion of its cost to
this initial phase of development. The allocated land price computes to a very reasonable
$2,800 per unit or $400,000 total. Typically, a market development's land prices are
closer to $10,000 to $12,000 per unit for property acquisition.
In addition, there are existing assessments of $511,049 of which the developer is
requesting $465,027 credit as an offset. Combined the land and assessment acquisition
costs compute to $6,370 per unit, still within market parameters. High acquisition costs
do drive up equity and debt requirements, which then creates lower debt service coverage
and lower than market returns on equity. It is a policy choice for the council to decide if
the developer's argument has merit.
2. Revenues and Operating Expenses. The proposed annual revenue upon stabilization is
anticipated to be $6.0 million and assumes a reasonable 93% occupancy. The developer
has also indicated this revenue figure assumes discounts to achieve a 10% elderly waiver
minimum. If there were no minimum target or affordability requirements, the
anticipation is the facility could achieve higher revenue with all market rate occupancy.
Operating expenses total 65% of annual budget, which is expected with the service levels
of this type of senior community. We have not conducted a market study to confirm the
revenue levels, but find the levels are in line with other assisted living projects reviewed
throughout the state.
3. Construction Costs. Construction costs of $168,000 per unit are in the middle tier of
today's construction market. The amount includes $596,000 in contingency. Projects
with higher amenities range between $130,000 and $185,000 in construction costs. In
other words, the estimates appear in line with expectations and are not creating an
appearance of a greater need. If the Council is interested in requiring a higher level of
exterior fmish or higher level of amenity for this project, such a condition could be added
to a TIF agreement.
4. Fees and Soft Costs. The developer has indicated there will be not be a development fee
taken as part of the project cost. Typical developer fees range between 4.0% to 8.0% of
the total development cost. Total soft costs compute to 19.8% of the total project costs, or
4
$43,140 per unit and is driven primarily by the bond financing's requirement to fund a
debt service reserve.
5. Private Financing. The assumption is the issuance of bonds for 89.4% of the project
costs at a 5.026% interest rate with an amortization of 35 years. The rest coming from
equity totaling $2.8 million. The bond financing requires funding an $1.7 million debt
service reserve, as well as payment of the City's conduit fee. Without TIF assistance, the
developer's proforma shows the net income at stabilization reaching only a 1.Ix debt
service coverage initially. The developer has indicated 1.2x coverage is necessary to
underwrite and reasonably place the bonds. These are reasonable assumptions for this
type of project.
The developer provided a ten-year projection with revenues inflating 2.0% annually and
expenditures at 2.5%. Carry forward these assumptions, in year twelve net income levels
finally achieved 1.2x coverage.
6. Returns. Return expectations vary by project type and investor. We suggest reviewing
several different evaluation approaches to understand whether the need for assistance
manifests itself in comparison to market driven projects.
Cash on Cost: As a percent of the total development cost, the stabilized net income of the
project demonstrates an initial 6.3% return on cost. Cash on cost, the amount of income
generated before debt payments, helps compare returns independent of equity and
financing levels. Cash on cost returns exceeding 7-8% are typical benchmarks.
Cash on Cash: Assuming invested equity of $2.8 million (land plus corporate), 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 8.5%. Given the level of risk involved in a
new development, investment returns on equity are typically expected to exceed 10%.
Internal Rate of Return (IRR): Guardian Angels has indicated a desire to maintain and
hopefully expand the facility well into the future. However, comprehensive analysis of
market returns also evaluate the potential value of the property and its sale. Stabilized
cashflows and potential sales proceeds before TIF anticipate 8% to 11% Internal Rate of
Return. Typical benchmarks expect 15% to 20% IRR.
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. We provide the following considerations as options for the
Council:
A. Cap the assistance amount to only that level necessary to deliver 1.2x debt service
coverage. The developer's financial projections show $142,422 needed to achieve this
level upon project stabilization. However, this need diminishes with inflationary
assumptions twelve years after initial occupancy. The City could negotiate a final term
for the TIF Note to expire before 26 years.
B. Provide 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 specifically to address the cost
related purely to affordability for the 20% of the units designated, or negotiate the use of
additional TIF to increase the minimum elderly waiver target.
C. Cap the assistance amount as a percentage of increased market value. It is our
understanding that the City has utilized tax abatement in the past which ranged based on
a percent of the assessor's estimated market value increase to the property. Other cities
do use TIF as a percentage of the total project as another benchmark for assistance. For
example, if capped at 10% of market value increase on the site, the committed TIF would
provide the initial coverage required, but only accumulate to approximately $1,100,000 to
$1,150,000.
D. Ask for more information. The developer has provided adequate information to conduct
the initial analysis, but the Council could request an appraisal of the property and/or a
market study to establish the appropriate level of revenue expectations or community
need.
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
-TIF plan sent to the county/school district for comment (they do not have veto
power) at least 30 days prior to public hearing
-Planning commission review of TIF plan for assisted projects' compliance with
land use regulations
Month 2-3 -Publication of TIF hearing notice
- Drafting of development agreement between City and developer
- TIF public hearing
- Consideration of TIF plan by Council
- Approval of development agreement
These dates are flexible and consideration should be given whether to approve the TIF and
development agreements along the same timeline.
Please contact me with any clarifications or questions.
0