HomeMy WebLinkAboutUnderstanding gap analysis and TIFUnderstanding gap analysis, p.1
Understanding Iowa City’s
due diligence process for
gap financing with TIF
What to expect, time-wise
To be eligible for Tax Increment Financing (TIF) a developer
must show a public benefit to the project and a financial gap to fill. The
City may provide gap financing to projects in designated areas meeting public policy goals.
Projects must be structured so that private debt is maximized and developer equity yields a fair
return while not providing undue enrichment to the developer. City policy for financial
participation in development projects is to be “the last dollars in,” if merited, and should not
exceed developer equity.
After all other financing is secured, a developer may submit an application and the City will
conduct its due diligence. This will involve a thorough analysis of all the project costs including
design, land acquisition, construction loan and permanent financing and projected revenues and
expenses in the operation of the building over 20 years. Through this analysis, we are able to
confirm a stabilized net operating income, the fair market value of the project and most
importantly, whether projected returns to the developer are reasonable.
Once a project appears to show a reasonable financial gap which could be funded with City
assistance, City staff must 1) amend the appropriate urban renewal plan to include the project (if
necessary) and 2) negotiate a development agreement that among other things, stipulates the
type of funding-- rebate or cash up front, a minimum assessment of the property to ensure that
the City is repaid in property taxes (if financing is cash up front and not rebated), and the details
of the minimum improvements, etc.
Here is an estimated timeline for the required steps. It could move a bit faster, but this is a
realistic scenario if everything falls into place.
If the developer:
Has a well-defined concept plan for design and financing of the project, and
has provided all the financial information in the application for gap financing,
then City can provide an initial analysis within two weeks.
If/when the financial analysis meets the City’s Economic Development standards, in that there is
a public benefit to the project and:
there is a financial gap, and
the City participation would be last dollars in, and
the developers would net a reasonable return (as determined by research conducted by our
consultant at the National Development Council (NDC)),
then we can begin negotiating a development agreement. The development agreement can
be drafted within 10 working days, once the developer and the City have agreed to the basic
terms.
When we have a draft development agreement to which all can agree:
1. We may simultaneously send the draft agreement and a staff recommendation to the
Economic Development Committee (a subcommittee of the City Council). This requires at
Understanding gap analysis, p.2
least a week’s time for scheduling the ED committee meeting and for staff to write a
supporting document to send out with the meeting packet, and
2. We will start the process of amending the Urban Renewal Plan to include the specifics about
your project. This requires two City Council meetings, which can usually be accomplished in
about six weeks, given the required time for meeting notices and packet assembly. The first
of the two meetings is for a “Resolution of Necessity” and the second, approximately a
month later, is to adopt the amendment to the plan.
3. If a Development Agreement has been signed by all parties, prior to that 2nd City Council
meeting adopting the plan, then
4. A resolution to approve the Developers Agreement can also be on the same agenda –
providing the Urban Renewal Plan amendment was approved earlier.
Cash up front TIF vs TIF Rebates = who bears the greatest risk?
Cash up front TIFs are politically and financially more difficult. For cash up front, we require,
along with specific performance measures, that the developer agree to a minimum assessment
on the project property (and sometimes, in addition to the project property, a minimum
assessment on other property the developer owns within the district) for a certain period of
years, to enable the City to pay itself back with the TIF increment generated from the project
(and if required, the additional developer-owned property in the area). The duration and dollar
amount determined for the minimum assessment includes the City (public’s) cost of financing
the project until it is recaptured by the TIF revenues the project generates. This option is more
expensive and requires the City bear more risk than the other option – TIF rebates – which is
why it is more difficult, politically.
TIF rebates are still political, but they put most of the risk on the developer. They are simpler
because they only require that the taxes paid on a successful development be rebated back to
the developer – with no financing costs and no risk to the public – with the exception of the
diversion of tax dollars to the TIF fund.
If the financial gap in a project could be covered by a TIF rebate as opposed to cash up front, it
is highly preferable. Tax rebates would begin about 18 months after taxes were paid in due to
the lag time in property tax assessment year and revenue collections. It is important to note that
while property taxes are paid at the Consolidated Property Tax Levy ($38.64 per $1000
valuation in FY14, and subject to change annually), the TIF levy, and rebates are calculated at a
lower rate ($30.36 per $1000 for FY 14, and subject to change annually).
Definitions of key elements of the gap analysis process:
Gap
A financial gap is determined by the difference between all financing sources for a project and
the project costs, with a focus on the developer’s return, which is based in large part on
developer equity and the maximization (attraction) of project debt. This allows consideration of
public financing that fills a gap yet does not provide for undue enrichment to the developer.
Market standards apply. Among other things, our gap analysis requires a firm project
development budget and operating pro forma supported by an independent market study. In the
end, a recommendation to Council will hinge on the reasonability of the developer’s return,
public benefit and availability of public financing.
The gap is not simply the difference between how much a desirable project costs and the
financial resources to which a developer has access.
Understanding gap analysis, p.3
Equity
In the context of real estate development, equity is the difference between the current market
value of the property and the amount the owner still owes on the remaining debt for it. It is the
amount that the owner would receive after selling a property and paying off all debt on it.
Capitalization Rate
A “cap rate” determines value of a project. It is the number of cents of project income (net
operating income, NOI, or annual cash flow) required by an investor for every dollar of purchase
price paid. If a developer demanded a 7% cap rate, they would be willing to pay $1 for every 7¢
of NOI. If they demanded a 10% cap rate, they would be willing to pay $1 for every 10¢ of NOI.
Higher cap rates mean there is higher risk indicated by the investor’s requirement for more of
the annual cash flow. It measures a return on all invested capital - debt and equity.
Market Cap Rate
Market Cap Rates are used to determine value by comparable transactions in the same market.
The same equation is used as for cap rates, but considers an entire market’s actual
transactions, as compared to the investor’s individual demands. Market cap rates in downtown
Iowa City are in the 7% range; in an area that struggles economically, the market cap rate would
be expected to be slightly higher.
For in-depth information on the specifics of Iowa City’s gap analysis, please see the
companion document:
Key elements to the financial analysis
If you have any questions, please feel free to contact me at any time:
Wendy Ford
Economic Development Coordinator
wendy-ford@iowa-city.org
319-356-5248