Infrastructure Financing Districts Unlikely Savior for Redevelopment in California

When real estate developers and local governments consider the financial feasibility of a redevelopment project, one of the issues they must consider is how to finance the costs of supporting public improvements.

When California redevelopment agencies dissolved on Feb. 1, 2012, two key public finance tools that helped to fund public improvements in redevelopment areas were eliminated: redevelopment tax increment and redevelopment bonds.  Those tools were frequently used in public/private partnerships to replace old and deteriorating infrastructure — roads, potable water conveyances, wastewater pipelines and storm water systems, for example.  Redevelopment tax increment also paid for affordable housing, environmental clean up, parking structures and other public amenities.  Because it was recognized as a separate, stable income stream by the public finance markets, redevelopment tax increment was a reliable funding source that the bond markets were comfortable with.  

Now developers and local governments are looking for an alternative financing mechanism.  There are several options.  In this post, we will explore some of the key reasons why infrastructure financing districts are an inadequate public finance mechanism for most redevelopment projects in California under current law and in the current real estate market.

Scope and Formation

An infrastructure financing district (“IFD”) is a separate legal entity that is formed by a city  to allocate property tax revenues for public improvements of “community wide significance.” (See Government Code section 53395 et seq.)  IFDs cannot be formed by counties under current law. 

A city must make a specific finding that the public facilities will provide signficant benefits to an area larger than the area of the district.  Fortunately, the public improvements need not be physically located within boundaries of the IFD.  And an IFD may include areas that are not contiguous, which allows a local government to work selectively with cooperative landowners.  Rincon Hill in San Francisco is one example of an existing IFD that is not contiguous. 

IFDs may finance only “public capital facilities” with an estimated useful life of at least 15 years.  Permissible facilities include, but are not limited to, housing, highways, transit, water systems, sewer projects, flood control, child care facilities, libraries, parks and solid waste facilities.  IFD’s can’t pay for routine maintenance, repair work, operating costs or services. Any IFD that constructs dwelling units must set aside not less than 20 percent of those units to increase and improve the community’s supply of low- and moderate-income housing. 

Under current law, an IFD cannot be located within a redevelopment area.  An IFD may not replace facilities or services already available within the territory of the district when the IFD was created, but it may supplement those facilities and services as needed to serve new developments. 

Forming an IFD is time-consuming and difficult.  First, the city adopts a resolution of intention to form the district and notice is provided to property owners.  Then, the city or county must prepare a detailed infrastructure financing plan.  The plan must describe, among other things:

  • The proposed public and private improvements in the district, including the location, timing, and costs of the public improvements to be financed by the IFD;
  • The maximum portion of tax revenue of the city and each other affected taxing entity proposed to be committed to the district for each year;
  • The projected tax revenues expected to be received each year;
  • A plan for financing the public facilities, including a detailed description of any debt;
  • A limit on the total number of dollars of taxes that may be allocated to the district;
  • An analysis of the costs to the city of the providing facilities and services to the area, including a discussion of the tax, fee, charge or other revenue expected to be received by the city as a result of the expected development in the district; and
  • The projected fiscal impact of the district and associated development on each affected taxing entity.  

Once complete, a copy of the infrastructure financing plan must be sent to every landowner and local agencies that will be affected by the IFD. The infrastructure financing plan must be consistent with the general plan of the city within which the IFD is located. 

Every local agency that will contribute property tax revenue to the IFD must approve the plan.  School districts cannot contribute to an IFD.  Once the other local entities approve the infrastructure financing plan, the city forming the IFD must still get the voters’ approval to:

  • Form the IFD and adopt the infrastructure financing plan (requires 2/3 voter approval)
  • Issue bonds (requires 2/3 voter approval and can be sought at the time of IFD formation)
  • Set the IFD’s appropriation limit (majority voter approval).

Upon receipt of the various approvals from public entities and the electorate, the district may proceed.  There are certain exceptions to these voting and other requirements for waterfront projects in San Francisco that are beyond the scope of this post.

What Revenue Stream?

IFDs do not levy a separate tax or increase the rate of tax within the district.  Instead, IFDs passively receive revenues from taxes levied by other agencies.  Specifically, IFDs divert a share of property taxes paid by every landowner within the boundaries of the district.  The county collects ordinary property taxes based upon the then-current assessed value.  From those receipts, all of the affected taxing entities other than the IFD are paid first (e.g., state, county, city, and other entities that existed before the IFD was formed).  Then, the IFD is allocated its portion in accordance with the infrastructure financing plan. This is important: an IFD is only entitled to receive the increase in property taxes that occurs after the IFD is formed.  If the total assessed valuation of taxable property within the district at the time the IFD was formed does not exceed the total assessed value of taxable property within the district at the time property taxes are assessed in future years, the IFD does not receive anything.    

Some have questioned whether the IFD’s share of increased property taxes is enough to justify the effort of creating an IFD.  Today, approximately 65 cents of every ad valorem tax dollar goes back to the counties for distribution, the rest is kept by the state.  As a result, the share of available funds is already less than what redevelopment agencies were able to collect. What’s more, the 65 cents is divided up among the county, the cities in that county, and any other taxing entities that exist within the county that are entitled to a share of the revenue. As a result, the share of available tax revenue is substantially less than would could have been derived from redevelopment tax increment. 

Of course, San Francisco is uniquely structured to take advantage of the IFD law.  Unlike the rest of California, San Francisco is both a city and a county, so property tax revenue does not need to be split between a county government and individual city governments within the county.  However, cities and counties in the rest of the state are not so lucky.  

One other issue is the limited life of IFDs under current law.  IFDs may only exist for 30 years.  As a result, an IFD’s bonding capacity is limited, especially when the improvements that will generate additional tax revenues will not likely be completed until years after the IFD is formed.  The effective IFD tax income stream as a practical matter is more like 25 to 28 years (or even less), limiting the fundraising and bonding capacity of IFDs. 

Public Finance and Market Reality

Recently, at a panel discussion on redevelopment tools hosted by the San Francisco district council of the Urban Land Institute, the public finance professionals on the panel acknowledged that there is no current market for IFD bonds.  And the main reason wasn’t that there are no IFD bonds out there to sell.  The main problem is investor risk.  The income stream supporting IFD bonds is more susceptible to real estate market volatility.  An economic downturn can affect the amount of ad valorem property taxes that are collected.  In addition, in California, every property owner has the right to seek reassessment of property if the assessed value exceeds the current market value.  Therefore, the income stream of overall ad valorem tax payments can be diminished in response to the market.  As described above, an IFD is only entitled to funding to the extent that the future value of the property exceeds the value of the property when the IFD is formed.

Another concern from the point of view of the public finance markets is that there is no independent real property lien on land within the district to secure the IFD’s obligations.   Under the IFD law, the bonds and other obligations of an IFD are not the debt of any city, county or other political subdivision other than the IFD itself.  Only an IFD’s funds or property is liable for the debts of the IFD. As a result, the income stream of future tax payments to the IFD will likely be the only security, unless some sort of credit enhancement is provided.  These risks, unless properly managed, will affect the interest rate and bond rating of any IFD bonds.     

Amending the IFD Law

There have been several efforts by the California legislature to reform the IFD law.  Four bills were introduced last year to expand the authority of infrastructure financing districts.  Most of those efforts have stalled, as some legislators have viewed those bills as a replacement for redevelopment agencies.  Bills were introduced to eliminate the voter approval requirements, extend bond terms from 30 to 40 years, allow IFD territory to overlap with redevelopment areas, and permit financing of transit projects and brownfield clean up.  We will see whether these bills gain any traction in 2012. 

Conclusion

IFDs are an inadequate tool for replacing redevelopment tax increment.  IFDs may make sense in San Francisco because of its unique governmental structure as a combined city and county.  Political considerations as to whether a particular project is of communitywide significance can be better managed and one single governmental entity is making decisions about how to best spend revenues derived from property taxes.  However, even in San Francisco, market confidence in the proposed project will need to be high.  The income stream devoted to the IFD will need to be able to survive an economic downturn.  Investors in the public finance markets will have to get comfortable with the lack of real estate security and assumptions made about future land values.  Until adjustments are made to the IFD law, these risks may be too great in the current economic environment to support a public market for IFD bonds.

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