Financing Methods:

Broadly speaking, two primary means of financing infrastructure for economic development have been utilized at the local level of government. These are Special Tax Districts and Tax Increment Finance Districts. Sometimes these two approaches are combined and/or supplemented with project revenues (e.g. parking fees) or by some form of governmental guarantee.

Special Tax Districts:

Special Tax Districts are known throughout the country by various names, including Community Development Districts (“CDDs”), Community Development Authorities (“CDAs”), Municipal Utility Districts (“MUDs”), Mello-Roos Districts, and Special Assessment Districts. They are political subdivisions created to provide new public improvements (such as water, sewer and roads) to specific areas and to allow for those persons directly benefiting to directly pay for these public infrastructure improvements. This structure has been widely used in such states as California, Texas and Florida. California jurisdictions alone have been issuing approximately $1 billion of these bonds per year over the past several years.

The security for the bonds issued by a Special Tax District is the special tax levied on the property within the district. These bonds are non-recourse to the issuer and to the developer. The property within the district is the security for the payment of principal and interest on the bonds. The debt-to-value ratio for a residential development will generally be a maximum of thirty three percent, and once the project is fully developed, this is expected to decline to less than ten percent.

The initial interest rate on the bonds, issued prior to development of the property would be about the same as conventional mortgage loans. These bonds can be refunded once a project is developed. The refunding bonds would have an interest rate that is typically about two percentage points lower than conventional mortgage rate loans. The homeowners, commerical tennants or other end users receive the benefit of these lower interest rates for most of the term of the bonds. The bonds typically have a term of 25 to 30 years, but can be repaid at any time

Institutional investors usually purchase the bonds. The largest buyers of bonds of this type are tax-exempt mutual funds including Franklin, Fidelity and Putnam. The second largest group of buyers is insurance companies such as Allstate, State Farm and numerous others. Although special tax bonds have a good historical repayment record they do pay a higher yield than credit rated municipal bonds.

The maximum special tax betterment or assesment, is fixed to reflect a reasonable relationship between the benefits the property will receive from the improvements. Each property unit pays an appropriate share of the cost of the improvements, which is amortized over the life of the bonds. No property owner can increase the maximum special tax as the result of a default in the payment of its special taxes. Therefore, to increase the credit quality of the special tax bonds sufficient to receive an investment grade rating, the annual special taxes should typically be limited to a maximum of one percent of the expected value of the property fully developed.

Special Tax Districts in Massachusetts

Unfortunately the Massachusetts’ General Laws do not provide a workable mechanism to establish a special district. Consequently, the method to create such a district is through special legislation. Under the Massachusetts Constitution, the common practice is through a home rule petition. In the case of a town operating under the town meeting form of government, this requires that a town meeting authorize the board of selectmen to file the petition with the legislature. In the case of a city, the city council and the mayor must approve. An alternative approach permits special legislation with a two-thirds vote of the House and Senate, provided the Governor introduces the bill. If this approach is used, the local legislative delegation would likely seek a provision that the act will not take effect until it subsequently approved by the town meeting or city council. This method might save time in creating the district. The special legislative route does have the advantage of creating a district that is more likely to meet the specific needs of the developer and his project

Tax Increment Financing Districts

A completely different type of special district that has been used most extensively in the Midwest is the Tax Increment Finance ("TIF") District. The primary distinction between a special tax and a TIF district is that a TIF does not require the levying of an additional tax on top of existing property taxes. The mechanism implemented for a TIF is that the increases in normal proerty taxes are diverted from all taxing bodies that overlay the proposed district, and are pledged to the payment of the obligation needed for the infrastructure within the district.

The TIF concept was utilized in order to encourage development by subsidizing a portion of the cost of infrastructure so as to reduce the developer's investment. In order to justify public investment in a TIF project, the issuing municipality often will make a finding that, without public support, the tax base within the TIF would most likely not experience any growth, and would eventually depreciate. In addition, the municipality may conclude that an investment within the tax increment finance district will be needed to eliminate the deterioration and stimulate new growth.

ADVANTAGES:

Reduced Equity Requirement

With special district financing, the combination of bond proceeds and bank financing is likely to be substantially greater than the amount of bank financing that would be available without bonds, thus reducing the amount of necessary equity.

Higher Return on Equity

The return to the developer is likely to be higher when special district financing is involved.

Making Otherwise Unfeasible Projects Feasible

The higher return on equity can make the difference between a project being able to attract sufficient equity capital to make it feasible or not being able do so and not being able proceed.

Non-Recourse
Unlike most conventional sources of financing, bond financing is non-recourse to the developer.

Long Term Financing
With bank financing the maturity is likely to be in 3-5 years. If development proceeds at a slower pace than anticipated, then the bank financing is likely to balloon. At that time the developer must refinance the loan, possibly with a new loan officer, with a successor bank from out of the area, or subject to new loan policies. Even before a balloon date, many bank land development loans are subject to ongoing appraisal requirements that can result in the need for additional equity. With bond financing, the term of the loan is generally 20-30 years with no balloon or reappraisal requirements.

Infrastructure in Place Earlier
The availability of bond financing allows for the construction of major infrastructure at an earlier stage of development. Rather than trying to succeed by promising initial homebuyers, commercial tenants and local government officials that a road improvement or park will occur later in the development process, the developer can afford to construct critical infrastructure early in the process.

Lower Home or Commercial Unit Prices
When bond proceeds pay for infrastructure costs it enables developers and homebuilders to charge lower prices. Even though the lower price is largely offset by the special tax, the lower advertised price attracts potential homebuyers to a site. In addition, the lower price may enable the resulting mortgage to fit within Fannie Mae or Freddie Mac limits or qualify for FHA insurance or for state or local mortgage programs.

Lower Down Payments
As result of the lower nominal purchase price, a homebuyer will have a lower down payment requirement, which reduces one of the primary burdens of homeownership for many families. The same would be true for a commercial project.

DISADVANTAGES:

Political Process
A special district financing requires the approval of a local governing body to create the district. The district must actually levy the tax or assessment and issue the bonds. Title to the improvements usually is in the district.

Potential Delays
Going through the political process can slow a project by several months. The underwriting process, while involving substantial due diligence, the preparation of an offering memorandum (prospectus) and other documents, and the solicitation of investors, typically does not take much longer than conventional financing.

Possible Additional Exactions
Unless the local governmental body has a strong interest in seeing the project completed, governmental approval may require exactions or proffers in excess of those needed for normal project approvals. These exactions typically may take the form of additional public improvements financed in the bond issue.