all their popularity and at last count, there were 103 of
them in Chicago alone TIFs remain poorly understood, sometimes
by the people who stand to benefit most by them. One part of the
TIF puzzle is the difference between TIF bonds and developer notes,
a difference that can go straight to a developers bottom line.
Most states have adopted TIF legislation
that gives municipalities the power to capture real estate taxes
generated from new development in certain areas and apply those
new tax revenues to help pay for eligible costs of development.
Chicago and many municipalities elsewhere use TIFs extensively to
kick-start commercial and industrial developments.
The source for incentive payments
under TIF is generally real estate taxes, while some municipalities
also include sales tax incentives as part of the TIF. As a policy,
Chicago limits its TIF assistance to incremental real estate taxes
only and doesnt pledge any new sales taxes as part of its
But what form of TIF assistance can
a developer receive, and how do TIF dollars reach the commercial
developer? The structure of a TIF deal will determine how a developer
benefits from the economic incentive. Reaping the benefit of TIF
dollars doesnt have to mean receiving those TIF dollars immediately.
There are basically two forms of TIF assistance: a TIF bond and
a developer note (sometimes referred to as a "pay-as-you-go"
A TIF bond is issued by a municipality
and sold through an underwriter, which results in immediate available
proceeds to pay for eligible costs. But a common TIF structure involves
issuing a developer note, which turns into an obligation for the
developer, who is repaid over a negotiated term; that doesnt
usually produce immediate funds for the development.
A bond seems to be a better vehicle,
at least from the developers viewpoint, since it provides
cash more quickly. But from the municipal perspective, bonds arent
that easy to set up. To sell a TIF bond, underwriters generally
want one of several assurances a general obligation pledge
from the municipality, a completely built project generating the
new taxes that are the source of bond repayment, or a national credit
tenant or user whose credibility assures performance and project
Except for major redevelopment initiatives
with broad political support, general obligation bonds are usually
not issued because of the financial and rating risk to the issuing
authority. And except for a few highly credit-worthy national users,
an underwriter wont be able to sell bonds until a project
is built to assure the new tax stream.
In addition, issuing a TIF bond before
completing the project and generating taxes is not an efficient
way to utilize the new increment.
Lets say a redevelopers
total budget is $24 million, with $6 million reimbursed from TIF
for eligible costs. A municipality issuing a developer a TIF bond
worth $6 million must sell a bond of about $8 million, since about
$2 million of the bond proceeds will be used for such non-project
related costs as capitalized interest, interest reserves and bond
With a two-year gap between project
commencement and collection of incremental taxes after reassessment,
a bondholder will want proceeds from the bond put aside to pay interest
on the bond (rather than merely accrue) until those new taxes are
paid and funds are available to pay debt service.
Similarly, most bondholders will
require an interest reserve of one years debt service to be
put aside in case an interruption occurs while receiving tax payments
resulting from delays in the tax collection process, legislative
changes or a casualty.
an $8 million bond means having a new tax increment available to
pay not only debt service on $8 million, but 110% to 115% of $8
million. Bondholders are risk-averse and want a cushion on the annual
revenue projections. So on average, if the debt service is $640,000
for the $8 million bond (8% constant), you will need at least $704,000
in increment annually to satisfy the bondholders (1.1 x $640,000).
With such difficulties considered,
its a small wonder that a municipality may issue a developer
note and not a bond. A developer note is merely an obligation to
pay the developer a stated principal amount bearing interest at
a negotiated rate. In essence, the developer "buys" his
own bond but doesnt come up with any dollars to buy the note.
The note is issued to the developer to consider the eligible costs
that the developer pays as part of its overall development costs.
Payments under the note are reimbursed to the developer for certain
In our example, the developer would
receive a developer note for $6 million at, say, 8% interest. After
the project is built and generates new taxes, the municipality begins
paying interest and principal on the note, including interest that
accrued before the new tax assessment and payment. Except for incidental
costs, there are no major issuance costs and consequently no need
to finance more than $6 million.
Its also not necessary to meet
underwriter debt coverage ratios further eroding the amount of funds
available for the project.
Again using our example, only about
$480,000 of increment (8% constant x $6 million) is needed to fund
the annual obligation as opposed to about $704,000 under the bond
structure. (For purposes of simplicity, ignore the effect of the
interest rate differential for bonds versus notes).
If the developer needs that $6 million
at the time of construction, he or she will have to use the developer
note as collateral for additional financing, since those funds represented
by the note are payable over a possible 20-year term. However, once
the project is completed and generates increment, it is then possible,
as Chicago sometimes does, to redeem the note by issuing a TIF Bond.
At that point the developer receives
the full amount of his incentive, and the municipality usually doesnt
have to worry about capitalized interest or other significant reserves
added to the amount of financing. Also, the interest rate on the
bond is less than under the note, which is an incentive for the
municipality to redeem the note, if possible.
Negotiating a TIF incentive package
involves analyzing the form of the obligation to be issued. Receiving
bond proceeds may be the developers preferred structure, but
might not be available. Understanding developer notes will allow
a developer to capture TIF revenues more efficiently and enhance
its project if the funds represented by the note can be financed
for the short term without having to issue bonds.