The basic concept of transit-oriented development (TOD) is to combine residential, retail and commercial uses with public open space near transit. A TOD allows people direct access to transit and to live, work, play and shop in a pedestrian-friendly environment. Development around transit also promotes compact development, mixed-uses and enhanced auto, pedestrian and bicycle connections. Most TODs are located within 1,500 to 2,500 feet from a transit station or stop. From the perspective of transit agencies and government, TODs are clearly a proven way to:
- Increase ridership.
- Reduce traffic congestion.
- Reduce environmental pollution.
- Reduce the demand for oil.
- Enhance tax revenue from increased land value and expanded development.
- They capture premium rental rates and price points.
- Increase density of development.
- Increase net proceeds from the refinance, and/or sale of the TOD.
- Increase retail sales from access to transit riders.
- Increased productivity.
TODs are Generating Premium Rental Rates and Price Points
The Center for Transit-Oriented Development recently completed a study that revealed that the demand for housing within walking distance of transit will more than double by 2025. The center went on to state that currently, properties within a five- to 10-minute walk to a transit station are selling for 20 to 25 percent more than comparable properties further away — a price premium that is likely to increase as traffic jams worsen. According to a study by the nonprofit Congress for New Urbanism, while less than 25 percent of middle-aged Americans are interested in living in dense areas, 53 percent of 24 to 34 year olds would choose to live in transit-rich, walkable neighborhoods, if they had the choice.
According to the Urban Land Institute (ULI), residential properties for sale near commuter rail stops in California consistently enjoy price premiums, including a 17 percent advantage to properties in the San Diego region. A study completed by California State University at Fullerton indicate that “…there are premiums of 4 to 30 percent for office, retail and industrial buildings located near rail transit in Santa Clara, Dallas, Atlanta, San Francisco and Washington, D.C.”
Yet many governments and private developers have failed to capitalize on the economic and development potential of transit investment. Therein lies the need for this proposed 10-part approach to structuring finance plans for TODs.
A Ten-Part Approach to Structure Public/Private Finance Plan for TODs
The ten-part approach to successfully structuring public/private finance plans for TODs should be helpful to private developers to convert a TOD which is financially infeasible to a project, which is attractive to the equity and debt capital markets. Equally important, this 10-part approach allows transit agencies to achieve a competitive return on their investments in land located around stations, infrastructure and the transit system. This return on investment (ROI) can be used by transit agencies or operators to cover all, or a portion, of the cost of transit stations and possibly a significant portion of the transit system. In order to cover a substantial portion of the cost of the transit system, transit agencies will need to leverage the non-tax income and tax revenue generated by all of the TODs along the entire transit alignment.
Part 1: Private Partner Equity and Debt
Private developers and/or private investors provide at-risk cash, referred to as equity for projects. These investors expect a return on their investment. That return is dependent on their investment goals, the source of funds and the level of risk in the project. Equity investors are also the owners of the development. The primary reason the returns on an equity investment are high when compared to the interest rate on a construction loan is that equity investors are the last to be paid. They share in the funds available after expenses and after debt service payments. The amount of equity required for a project is most often determined by the construction lender or the provider of the permanent loan. The equity portion of development financing typically ranges from 10 to 25 percent or more. The balance is financed with debt.
The loan to the developer is limited to a percentage of the project cost, commonly referred to as loan-to-cost (LTC). Currently, the LTC for most developments ranges from 75 to 90 percent. In other words, the construction lender will provide on the average 80 percent of the project financing, in the form of debt, and requires that the balance of the project cost (20 percent) be in the form of equity, or at-risk cash.
Part 2: Public Partner(s) Capital Investment
If the financial analysis reveals a basis for a public partner to invest in a TOD, there are multitudes of funding sources to tap. Investment could be in the form of cash, bonds, grants and/or tax credits. Many public facilities also generate operating income, which can be used to support bond financings. Public partners should think creatively when trying to optimize operating income. For example, public facilities such as libraries, new sources of income can be introduced to help cover a portion of the debt service and/or operating expenses. For example, a public/private finance plan could include community funding programs, income from an on-site retail shop and/or café, income from operating the library garage after hours and on the weekends, renting out major spaces and/or classroom space after hours, lease payments for naming rights for the library, selected rooms and/or public spaces.
For most traditional commercial developments, land cost equals 10 to 15 percent of the total development budget (TDB). Government–owned land should be viewed by government officials as an investment and should expect a return on that investment. The public partner can sell the project site, or structure a long-term land lease with a developer. Government officials should not underestimate the income which can be generated from a land lease, nor the ability to leverage the base rent, which is typically a guaranteed annual payment from the developer (See Part 3).
Part 3: Non-Tax Income Generated by the Project
One of the most powerful techniques to solve any “gap financing” requirements is to optimize non-tax income generated by government-owned land serving as the TOD site and from any proposed public facilities on site. Public partners should view their real estate assets as a potential major source of income. Under a land lease arrangement, the government entity, or public partner is able to retain ownership of the project site and also realize any appreciation in land value achieved to date and in the future. Developers like land lease arrangements because they can avoid upfront cash outlays required to purchase a TOD site. Depending on the results of preparing a developer pro forma, the public partner, and their consultant should structure a land lease, which includes up to nine types of land lease payments paid by the selected developer to the public partner, the land owner. The nine types of land lease payments include: 1) construction rent, 2) base rent, 3) index rent, 4) participation rent, 5) participation in any sale proceeds, or refinancing, 6) maintenance, operation and security (MOS) payment, 7) home-run insurance, 8) land lease payouts, and 9) interest income.
Public partners should also be able to generate non-tax income, or operating income from any on-site public facilities. Many public facilities throw off traditional operating income, such as user fees, or admission charges, but there are other creative types of operating income that can be realized. These more creative types of income include:
- Introduce complimentary retail space, such as a coffee shop or café.
- Lease advertising space in appropriate areas of the facility.
- Lease naming rights.
- If the facility or system is large enough, lease pouring rights.
Part 4: Tax Revenue Generated by the Project
Another important source of income from a TOD is the multiple types of tax revenue generated by commercial leasehold improvements developed on government-owned land. In addition, if the project site is owned or purchased by the private developer, the land will generate property tax annually. Depending on the building types included in the commercial development portion of the proposed TOD, projects will generate substantial tax revenue, such as:
- Property tax
- Personal property tax
- Sales tax
- Hotel occupancy tax
- Corporate income tax
- Local and state income tax
- Utility taxes
TIF is not a new, or additional tax imposed by a government entity. Therefore, citizens and property owners are not required to pay any new or additional tax. If the city is the primary public partner, city officials and their consultant will need to determine the annual tax revenue generated by the redevelopment project for each government entity. Using the results of this analysis, city officials should approach each entity receiving tax revenue from the project to negotiate using their respective portion of the property and/or sales tax increment. City officials should then leverage their portion, or all of the annual tax increment to support a TIF-backed revenue bond. Like the non-tax income, the tax increment generated by the TOD can be leveraged to fully support a sizeable revenue bond, which covers all, or a major portion of a TOD and transit-related facilities and improvements. In other words, for many TODs the income realized by the public partner can cover 100 percent of the transit facilities, amenities and improvements, so there is little, or no capital outlay required of the transit agency.
Part 5: Federal Funding Programs
There are a multitude of Federal funding programs available from several agencies. The limitations of this single chapter does not allow a comprehensive listing of funding programs, so the focus will be on programs directly related to TODs. The Federal agencies focused primarily on real estate development include:
- U.S. Department of Housing and Urban Development (HUD)
- U.S. Department of the Treasury
- Federal Housing Administration (FHA)
- Fannie Mae
- Freddie Mac
- Federal Home Loan Bank
- Federal Transit Administration (FTA)
- Direct investment
- Below-market rate subordinate loans
- Grants (direct investment or as additional security for a loan)
- Interest rate buy-downs on third-party loans
- Loan guarantees
- Soft second mortgages
- Credit enhancement
- Tax credit programs
- Program to increase a homebuyer’s purchasing power
Part 6: State and Local Funding Programs
Like Federal funding programs, there are a multitude of state, county and local government funding programs and an enormous number of finance instruments. State and local governments have the power to tax and the ability to issue tax-exempt debt. Under the U.S. Internal Revenue code, the interest payments on most debt issued by state and local governments are exempt from Federal income taxes. Based on this policy, investors accept a lower interest rate on tax-exempt municipal debt than on taxable debt. Debt issued by state and local government entities is categorized by the source of revenue pledged to cover the debt service. General obligation (GO) bonds are backed by the full faith and credit of the issuing government entity, while revenue bonds are backed by the pledge of specific income stream(s) generated by the project. GO bonds are used to finance facilities which are considered essential to a functioning government.
In addition to traditional municipal bonds, state and local governments provide a wide range of financial assistance to finance redevelopment projects or solve the required “gap financing”. At last count there are nearly 30 public/private finance instruments available to state and local partners to finance redevelopment projects. Instruments such as:
- Tax increment financing (TIF)-backed revenue bond
- Certificates of participation (COP)
- Assessment district bonds
- Special tax bonds (supported by the levy of special taxes)
- Lease revenue bonds
- Tax lien bonds
- State infrastructure bank (SIB)
- State revolving loan funds
- Economic development programs
Tax credit programs are increasingly important to private developers, and while the limitations of space in this chapter does not allow a detailed description of the tax credit industry, public and private partners of redevelopment projects should be aware of the four primary federal tax credit programs: 1) historic preservation tax credits, 2) federal brownfield expensing tax credits, 3) new market tax credits (NMTC), and 4) low-income housing tax credits (LIHTC).
Part 8: Transit Station Operating Income
There are at least five types of non-farebox income that transit agencies should attempt to capture in order to enhance cash flow, or solve a financing shortfall. These sources of income other than the farebox include:
- Tenant lease income from support retail space for commuters.
- Income from advertising placed on the exterior and interior of transit stations and commuter parking facilities.
- Income from the shared use of commuter parking facilities.
- Income from naming rights and possibly pouring rights for the entire transit system.
- Interest income from Land Lease Payouts ( a payment based on the Present Value of the land lease payment for land under condominium housing developments).
Part 9: Tri-Party and Public-Public Partnerships
Another source of funding or cost sharing is “Public-Public” Partnership(s), or Intergovernmental Agreements between a transit agency and other governmental entities, such as a city, county or state governments. If public-public partnerships were structured a transit agency could share the cost, risks and responsibilities for financing, designing, developing and constructing a TOD. Before transit agencies approach a potential public partner, they should document how the TOD will generate economic benefits and improve the quality of life for local residents.
For situations where a transit agency does not own any, or adequate land around a transit station, the agency may have to structure a Tri-Party Agreement between the agency, private landowner(s) and a private developer. If the transit agency does not have sufficient funds to acquire the land, they will need to demonstrate the financial return for the landowner(s) to provide the land in exchange for an equity position in the TOD.
Part 10: Infrastructure Funds
Over the last few years Infrastructure Funds have been formed in the capital market. Infrastructure funds allow investors to own part of a professionally managed portfolio of infrastructure assets, such as:
- Rail facilities and other transport assets
- Toll roads
- Communications assets, such as broadcasting towers
- Materials handling facilities
- Goldman Sachs: $6.5 billion
- Macquarie: $4.0 billion
- Deutsche Bank/RREEF: $3.0 billion
- JP Morgan: $3.0 billion
- CIT Group: $2.5 billion
The proposed 10-part approach to structuring the financing of TODs and transit-related developments provides a multitude of funding sources, ways to generate additional income and enormous flexibility, all of which should lead to creative public/private finance plans for TODs, transit systems and transit-related facilities.
John Stainback is president/CEO of Stainback Public/Private Real Estate, LLC (SPPRE). Will Reed is vice president for finance with SPPRE.