Trying to Get a Handle on Tax Increment Financing Districts

The following is from rural Woodstock resident Susan Handelsman, as result of substantial analysis:

Quantifying the Nebulous “But-For” TIF (Tax Increment Financing) Requirement

Using Cap rate as ‘But-For’ guidance

In every profession there are industry standards guiding decisions. Real estate development investment is no exception. A widely used metric is ‘cap rate’, which simply put is the rate of profit expected on the invested capital. Cap rate is derived by dividing amount of profit by the amount of invested capital.

The industry standard cap rate for any given development proposal can be used as a measurement tool to determine whether a prudent investor “would not develop the property ‘But-For’ “… an inducement of millions of taxpayer dollars in TIF grants and subsidies.

Example: 200-unit apartment building in given region, with developer costs estimated to be \$100,000 per unit=\$20 million; Net operating income (NOI) of \$1,407,920 (assuming 90% occupancy rate, \$900 rent/utilities not included, \$400,000 Property tax and 7% management costs). 1407920/20000000=.0704 or 7.04% Cap rate.

Compare to Cap rate if developer given TIF grants and subsidies of 30% of project cost: 1407920/14000000=.1006 or 10.06% Cap rate.

Compare to industry average Cap rate in ‘worst’ real estate Class: 6.24% Cap rate.

The above scenario illustrates how it would be logical to deny TIF status; “But-For” conditions are not met because prudent investors are known to be accepting the 6.24% return on average.

Cap Rate underlying variables data

Cap rate industry average statistics are divided into categories. These categories include office, industrial, retail, hotel, multi-family residential, and more. The categories of type of real estate development are further subdivided by geographic location (representative of different investment risk). There are other factors determining sub-sub- categories but these often apply to the right of the decimal point. Different categories command different desired rates of return, because perceptions of risk vary.

Cap rate for any given real estate investment is usually a function of comparison to current 10-year bond rates. (Investors have a choice of where to park their money: a safe government obligation, or a somewhat riskier real estate investment. As a general rule: the higher the risk, the higher the expected returns).

TIF law currently describes several discrete classes of development: golf courses, conservation land, transportation centers, railroad, etc. TIF law could similarly incorporate separate ‘But-For’ standards tied to annually published Cap rates according to real estate development class, such as: “not to exceed 110% of most recent industry average cap rate for proposed real estate classification”.

How to police and enforce ‘Cap Rate Standard’ compliance?

In order to police TIF, there must be access to financial information which may be claimed as proprietary. With possession of that information, there must be a person or body empowered to analyze data and accuse bad actors of violations. Create a TIF Czar through A.G.?

Need a mechanism for prompt adjudication of accused violations. A.G. appointed TIF Review Board arbitration?

There must then be a mechanism to enforce judgements in cases of violations. Claw-backs for violations? This is problematic when a shell company operates without funds retained inside the shell, and failed endeavors will likely be uncollectible debt. Municipal liens on property would be good for taxpayers but may impede project’s borrowing capability.

A mechanism for avoiding violations a priori may be preferable, such as mandatory payment of TIF funding after-the-fact, given receipts? That way if receipts are phony there are already civil and criminal penalties available under current law.

Most effective would be: TIF law to define specific penalties for violations, creating an incentive for a newly created analog to RAC (Recovery Audit Contractors) which police doctors’ offices for billing “violations”, in return for a percentage of the recovery. RAC are given broad powers to access confidential data, and the burden of proof of innocence lies with the accused (doctor, or in this case it would be the TIF developer).

https://www.cbre.us/research-and-reports/North-America-Cap-Rate-Survey-First-Half-2018