When a real estate development project is presented to a community, each incentive request to fill in the financing gap must pass the “but for” clause. Many times over my career I’ve helped craft an incentive for a developer. These developers have claimed to need it for the development project to occur.
How many times has the development maybe warranted an incentive, but maybe not, and the community still went ahead with it because of the need or desire for that development?
Sometimes communities want to see the development occur, so they take the developers’ word. We advocate for a thorough review of proformas and legitimate construction costs, confirmation of bank debt and owner’s equity, and a variety of other tests.
A Tale of Two Cities . . . and incentive requests.
In two recent instances, a community committed to providing an incentive by completing the work to provide it. However, when the rubber meets the road, the developer or the local elected officials have rejected the incentive and the development is occurring anyway.
Wait, what?
I thought the development would not occur without the incentive. We (staff and consultants) were told an incentive was needed. In both instances, the requested support for each project ranged between $750,000 and $1 million. This isn’t chump change for small municipalities.
Much work went into preparing for the incentive. One community created an entire Tax Increment District. This process takes weeks of planning, meetings, research, and votes by elected officials and taxing jurisdictions.
The development deal was dangled in front of the other municipality with the threat of it locating it in another community, absent the incentive.
In both instances, the incentive was not an outrageous request. One request was for 15% of the total investment, and the other was for 5% of the total investment. Reasonable requests for $5,000,000 and $20,000,000 projects respectively.
Still a Happy Ending?
So, what happened? In one community the City was concerned about another (insert type of business here) coming in and competing with their existing (type of business). They voted down the incentive and the developer decided to build the project anyway. What appeared to be a necessary incentive turned out not to be necessary at all. Staff and consultants felt confused, even violated. Yikes. The development occurred and the City did not pay out an incentive. The tax increment district was not created and planned street improvements were not funded from the increment.
In the other instance, the community wanted to impose a minimum assessed value contingency in the development agreement. The developer said, “no thank you, we will self-fund”. What? Since the development was in a tax increment district already, the community didn’t have to pay out the incentive and will still see the benefit of the increment. Again, staff felt confused and nearly violated but the community was afraid the development would go away. It appears to be staying.
Best Practices for Assessing the Gap
How do we prevent the granting of unnecessary incentives? Best practice is to review financial documents thoroughly and critically to identify a true gap. Examine construction costs, proforma, debt commitments, and owner equity commitments. There isn’t much more one can do except have the critical conversation that this gap must be sincere and there is truly no way the development could occur without the incentive.
As a developer myself, I am transparent with the municipality about the gap. I show them my proforma and development costs. They are also shown my ability to obtain financing, and the amount of owners’ cash being contributed to the project. I show them that this development will truly not occur without their support.
Is your community willing to say no prior to it going to a vote? Are your elected officials prepared to risk losing a development when shaky financials or a weak argument is presented for an incentive? Are we as staff or consultants representing a deal willing to ask difficult questions and face our elected officials if the community down the road is offering a larger incentive?
It’s a delicate dance. How does your community approach it?
Related Articles
Redevelopment of the Irish Hospital
Underwriting Considerations for a Development Project
Putting the Financing Puzzle Together
The Financial Incentive for Property Redevelopment
Available Training Courses
The International Economic Development Council offers several courses including Real Estate Development and Reuse available at various times throughout the year with virtual and in-person options.
