A retail developer's goal in obtaining public incentives in connection with the development of a project is to off-set the developer's cost of public improvements. Note that, in general, any public incentive financing must be payable toward public improvements. This is true due to general prohibitions against governmental assistance of private enterprise and to allow bonds associated with such improvements to maintain tax exempt status, thus lowering the cost of lending. Public incentives revolve around the abatement or reduction of taxes otherwise payable in connection with a development, and a typical menu might consist of personal and real property taxes; sales taxes; income or franchise taxes; and impact fees.
The critical question for a developer to answer when negotiating public incentives is: "what is the net gain of direct and indirect, temporary and permanent benefits (i.e. taxes and jobs) created by the development?" The net gain describes those benefits that would not occur "but for" the project. This is in contrast to benefits that may be transferred from an existing project within the same taxing jurisdiction to the new project to be developed. As an example, a new big box center may cannibalize sales tax dollars and jobs from mom-and-pop stores located within the same taxing jurisdiction, resulting in a diminished net gain to the taxing jurisdiction. In addition, a retail development will create both direct and indirect benefits. Direct benefits are those directly related to the construction and operation of the development. Indirect benefits are those created from the infusion of the development's jobs and tax dollars into the local economy. Temporary benefits are those that occur during the construction period, and permanent benefits are those occurring during the operational period of the real estate development.
Once a real estate developer understands the quantitative impact of his project on the local economy, he is in a position to analyze and negotiate public incentives. Public incentive categories tend to be available to developers in a hierarchy of importance, as follows: (1) abatements of taxes; (2) improvement districts; (3) tax exempt financing.
Tax abatements are typically associated with tax increment financing (TIF) statutes that allow the abatement of real property and/or sales tax revenues generated with respect to a defined geographic area (such as the site of a retail development) and are available in many states. In a TIF financing structure, the taxing jurisdiction gives up tax revenue from a development and to which it would have been entitled in order to direct those funds toward the payment of public improvements within the development. Payment in lieu of tax (PILOT) programs work in much the same way. Keep in mind that, even though a state does not have a statutory TIF financing structure, a developer may achieve the same result through a negotiated agreement with a taxing jurisdiction.
The second broad category of public incentive financing generally available to developers is improvement districts. Improvement districts, like TIFs, allow a developer to capture tax revenues generated from a development. The main difference between the two is that improvement districts are not focused on a taxing jurisdiction giving up taxes but, rather, allowing a developer to add additional taxes and fees within the development to pay for public improvements. The most prevalent example of an improvement district allows a developer to assess owners within a district sum equal to the difference between the fair market value of the property before the development occurs versus the fair market value of the property after it is developed and the public improvements installed.
Even if the foregoing methods of structuring public incentive financing for a development are unavailable, a developer should still explore whether some form of tax exempt financing is available to it for the construction of public improvements. This would, at the least, allow a developer to obtain a lower interest rate on that portion of his debt.
The foregoing discussion only scratches the surface of the considerations that must be taken into account when negotiating for public incentive financing. Before entering into negotiations with a taxing jurisdiction, a developer should have a firm grasp of all issues associated with its request, including, just to name a few, the jurisdiction's debt capacity and whether the developer's request will count against the jurisdiction's statutory or constitutional limits, who will bear the risks of funding and non-performance, applicability of bid laws, whether leases in place or to be negotiated would violate federal tax exemption of a proposed bond issue, and required debt service coverage ratios.