Introduction to Tax Increment Financing

As a result of the tightening of credit, costly infrastructure requirements or other conditions specific to a project, many projects would not be able to proceed without a subsidy of public funds. One potential source of public funds is a Tax Increment Financing (“TIF”), which provides financial assistance for residential, commercial, industrial or mixed use redevelopment projects.

In essence, this mechanism involves a pledge by taxing bodies of all or a portion of future increases in real estate taxes resulting from the project. The assessed value of a property to be redeveloped is compared with its assessed value upon project completion, and the increased real estate taxes resulting from this spread, or “increment,” is able to be pledged by the taxing bodies for up to twenty years to support the project. These pledged tax revenues then become the source of repayment for a financing the proceeds of which are contributed up front to the developer for use towards project costs.

TIFs are becoming more common in redevelopment projects. Even in tough economic times when the budgets of the taxing bodies are strained, taxing bodies may be willing to consider supporting a TIF. One reason is that the pledge is of taxes that otherwise would not be received but for the redevelopment project, and thus the funding does not come from the taxing body’s budget. Also, if the taxing bodies only pledge a portion of this tax increment, the amount not pledged increases the taxes to be collected by the taxing bodies.

In order to pursue a TIF for a particular project, the developer typically first contacts the Redevelopment Authority for the County in which the project is located. The Redevelopment Authority, in turn, notifies the taxing bodies having jurisdiction over the project of the application, and then the taxing bodies appoint a working group which meets to discuss and evaluate the project, and work out the details of the TIF.

Each taxing body has different objectives and concerns with respect to redevelopment projects within its jurisdiction, and these must be anticipated and adequately addressed in the application for the TIF. Failure to do so can be fatal to the application. For example, in addition to the fiscal impact to the taxing bodies, the applicant should consider and address such matters as whether the project:

  1. Is supported by the community
  2. Will create or retain jobs
  3. Will include improvements to public infrastructure
  4. Includes residential use, will increase the number of school-age children in the area
  5. Will materially burden public services or infrastructure

Through this process, the applicant should consult and work with professionals who are experienced in handling and negotiating the details of TIFs. By considering the project from the viewpoint of the taxing bodies and identifying and addressing their likely objectives and concerns, the applicant can tailor its application to significantly increase the likelihood of success in attaining TIF support.

Basics of Sale-Leaseback Financing Transactions

As a result of market conditions, many investors and entrepreneurs are coming up with creative techniques to facilitate loans to borrowers who are unsuccessful in securing a traditional loan from a traditional lender, such as a bank. One such technique is a hybrid of the traditional sale-leaseback transaction. Here is an example of how it works:

Borrower is a manufacturer that owns the real estate from which it operates. Borrower needs additional working capital, but cannot secure further credit facilities from its bank. Borrower has equity in the real estate it owns and occupies, but needs the real estate for its business and does not want to sell the real estate to generate funds to inject into the business. Investor then offers the Borrower to enter into a “sale-leaseback financing transaction,” which would involve Borrower selling the real estate to Investor for some price somewhat less than current market value, and then leasing back the real estate to the Borrower for market rent. The kicker is that the lease would give the Borrower the right to buy back the real estate within some time period, such as 5 years, at the original sale price plus some escalator (maybe 6% per year).

The benefit to the investor is that it is better secured than if it just made a loan and took back a mortgage. Also, if the Borrower does not repurchase the real estate, it gets a windfall from the purchase of the real estate at below fair market value. However, there are a number of tax issues for the Borrower that may not make this the most attractive structure, including:

  • Capital gains on the sale of the real estate
  • Real estate transfer taxes on the sale of the real estate and its repurchase
  • Loss of depreciation deductions with respect to the real estate

Despite these potential tax issues, this structure may end up working well for both parties. Stay tuned for future postings of creative structures that solve all three of the tax issues discussed above.

Recourse Remorse: Careful with Carve-outs

A New Jersey borrower has learned that violating a non-recourse carve-out can make a loan fully recourse even when the violation is cured before the loan goes into default.

In CSFB 2001-CP-4 Princeton Park Corporate Center LLC v. SB Rental I, LLC, a case noted by the Superior Court of New Jersey, Appellate Division (Docket No. A-6307-07T2) as one of first impression in New Jersey, the non-recourse carve-out guarantors of a conduit loan secured by a commercial property in South Brunswick were held fully liable for the unpaid principal balance of the loan after borrowing a second mortgage loan in violation of the non-recourse carve-outs.

The twist is this: the second mortgage loan had been fully repaid eighteen months before the first mortgage loan went into default, and the Court cites no evidence that the repayment had any effect on the borrower's ability to repay the first mortgage loan.

The guarantors argued that imposition of full liability under these circumstances was an unenforceable liquidated damages provision, where the penalty bore no relation to the injury suffered by the lender: in other words, no harm, no foul. The Court disagreed, finding that the non-recourse carve-out provision simply fixed liability rather than damages, and hence was fully enforceable. Key to the Court's reasoning is that the guarantors were held liable not for some pre-set amount, as in a standard liquidated damages provision, but for the unpaid principal balance of the loan, the contractually agreed amount of the lender's damage.

With the commercial mortgage market in its present perilous state, it is critical that borrowers obey their loan documents to the letter, as sins which might have been overlooked in better times may now be used by desperate lenders to attack the assets of the borrower's principals. The eighteen month gap in the present case between repayment of the second mortgage loan and default under the first raises the specter of lenders looking backwards through the history of a loan to find any excuse for imposing recourse liability.