Leaving No Stone Unturned: Closing the Funding Gap for Real Estate Developments

Hilary Tyson, Lyndsay Fincher

September 28, 2017

The upfront costs to real estate development can be burdensome for real estate developers. Necessary infrastructure, roads, water, sanitary sewer and drainage facilities need to be constructed and/or existing facilities expanded to accommodate development. Recent real estate development trends in residential, office and retail projects often require an increase in availability and quality of amenities that have significant initial expense and reduce overall income producing square footage and, thereby, long term gains. Conventional financing requires equity and the trend of conservative appraisals may not allow access to dollars from institutional investors sufficient to meet market demands of end use occupants and tenants. The constraints of available funds from institutional lenders may require that real estate developers seek additional funding sources to fill the gaps in order to meet the aspirations of their project plans.

Funding real estate developments through bonds and tax breaks and incentives may be worth exploring to help provide additional sources of financing for developments. Specifically, Special Utility Districts, Chapter 380/381 Agreements, Public Utility Districts and Tax Increment Reinvestment Zones are a few alternative sources of funding that a developer can and should explore to offset some of the upfront development costs.

Special Utility Districts

Many developers establish municipal utility districts, fresh water supply districts and other special utility districts to access funding to complete necessary infrastructure to extend or expand roads and water and sanitary sewer services to a development. The special utility districts may also provide funding for storm water drainage improvements and recreational facilities. The districts are a separate governing authority established with approval by the State, and have authority to issue bonds and collect assessments. They may be established within the jurisdictional limits of an existing municipality or in unincorporated areas of a county outside of any city limits. Construction of improvements is subject to public bid requirements and improvements constructed must be dedicated and/or conveyed to the special utility district or other governmental entity (i.e., city or county). While up front costs for qualified facilities must be born initially by the developer, once the assessed values of the development are sufficient to support the sale of bonds, the bonds may be sold to the public and proceeds from those bonds applied to repay the developer for the initial upfront costs incurred for the qualified facilities. The reimbursements may be applied to hard construction costs as well as soft costs for design and administrative expenses. Often institutional lenders will expand availability of financing by accepting the future reimbursements payable to a developer by these districts as additional collateral.

Chapter 380/381 Agreements

Chapters 380 and 381 of the Texas Local Government Code allow certain municipalities and counties, respectively, to provide grants or loans to developers to fund projects for the purpose of promoting local economic development and stimulating commercial and business activity within its jurisdiction. The city or county is authorized to provide a developer with reimbursements of development costs from various sources of revenue available to the jurisdiction so long as the expenditure complies with the jurisdiction’s current adopted budget or circumstances allow an emergency amendment to such city or county’s budget, and the source of funds for such expenditure is permissible under the applicable governing jurisdiction’s charter or other applicable law.

For example, a city may provide reimbursements of a developer’s funds to renovate the façade of an existing retail center or to add a parking garage to accommodate the requirements of an anchor retail tenant, and fund such reimbursements from the additional sales tax revenues collected by the city as a result of the retail tenant’s operations in the renovated shopping center. In some cases, development dollars may be available from revenues of the jurisdiction and available in advance to fund such project improvements. While the possibilities under Chapter 380/381 of the Texas Local Government Code are expansive, the applicable jurisdiction may place certain restrictions or limitations on the availability of funds. For example, the City of Houston has adopted an ordinance setting forth requirements for any application requesting a Chapter 380 agreement with the city (See http://www.houstontx.gov/ecodev/380/99-674OrdinanceEcoDev.pdf).

Public Improvement Districts

A Public Improvement District (PID), unlike a Special Utility District, is not a separate political subdivision, but is rather a geographical area designated by a municipality or county and made subject to special assessments. A PID has the authority to issue bonds to fund up-front development costs. A PID may also be structured to collect assessments and reimburse developers for up front development costs as the amount of assessments collected may allow. A lien on the real estate secures the obligation of property owners within the boundaries of a PID to pay PID assessments. PIDs may be used to finance costs of streets, water, wastewater and drainage facilities, public art, recreation and cultural facilities, community facilities (i.e., libraries), mass transit improvements, landscaping, and/or acquisition, renovation and/or construction of affordable housing.

Unlike Special Utility Districts, the amount of PID bonds that may be issued is limited to one-third of the appraised land value plus all cost of improvements, or one-third of the land value established by contracts in place. Additionally, the authority to issue PID bonds is retained by the municipality or county establishing the PID, rather than through a separate governing body. Further, PID assessments are fixed over a term of years and will not increase or decrease with assessed values of the property within a PID and may be pre-paid by a property owner at any time, which provides cost certainty to property owners.

Tax Increment Reinvestment Zones

Tax Increment Reinvestment Zones (TIRZs) are a way for a developer to recoup development costs for a project through reimbursements from the city without subjecting the property owner or occupants to additional tax assessments. TIRZs are formed by the city in accordance with Chapter 311 of the Texas Tax Code. The city may establish and set the boundaries of a TIRZ for redevelopment in a blighted area or an area that would benefit from redevelopment by increased density or product type, where redevelopment would add benefit to the economic or social welfare of the TIRZ area. By agreement with the developer, the city establishes a base tax year (which may apply to sales tax revenue or property tax revenues for such base tax year) and as the property values and/or economic activity is increased by the redevelopment, the additional revenues collected by the city over the base tax year for property or economic activity within the TIRZ are used to fund the reimbursements to developers within the TIRZ. In this regard, there is no additional assessment or tax imposed on property owners or occupants, but rather revenues in excess of those collected in the base tax year are diverted to offset costs of redevelopment.

Conclusion

As construction costs continue to increase, infrastructure needs expand, and tenants and end-users require ever expanding amenity packages, new development costs continue to grow. Because of these cost increases along with non-revenue generating items, returns that a developer could historically expect may be decreasing. It is more critical than ever to know all of the options when it comes to securing additional financing for your next development.