Public Land Finance

There are many ways to finance real estate development.   Owner or investor equity and bank debt are the traditional ways to fund development.  But there is another way, unknown to the general public, rather mysterious and complex, and dominated by experts in this niche industry.  Developers can unlock serious funding for public infrastructure if they can develop relationships with governmental entities that are willing to sponsor their plans and can assemble the team of attorneys, engineers, consultants, and financiers that it takes to get it done.

Public finance is a local industry.  As far as I can tell it differs from state to state and some states utilize the tool more than others.  In Colorado they have Metro Districts, in Nevada they have Special Assessment Districts, and in California they have Community Facilities Districts.  I’ve worked on several Community Facilities Districts (CFDs) but assume the mechanisms are similar in every state and also assume all 50 states have a similar tool on their books.

CFDs in California are commonly called Mello-Roos districts, named famously (or infamously) after the California legislators who sponsored the bill that created the structure.  All these districts are a way to promote development of public infrastructure while funding it with a tax assessed on the land that is developed and assumed to have a much-increased value once the roads, sewers, electric lines, stoplights, fire stations, and water tanks are completed that will benefit the land.

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A developer/landowner must partner with a municipal agency that has the legal authority to levy a tax.  Municipal agencies (cities, towns, utility districts, services districts) will engage if there is some benefit to them such as a new fire truck or a new well.    It also allows them to build their empire by increasing the size of the public infrastructure they manage and the residents/customers for their services.

When the developer owns all the land, they can vote to allow a special tax to be levied on the land.  The municipality can then sell tax-exempt bonds based on the special tax they are going to collect over the next 15, 20 or 30 years.  The municipality will engage an investment bank to do their magic to figure out how much total dollar volume can be sold based on the projected tax collection.  They’ll figure out what interest rates need to be offered (lower rates mean more debt can be serviced) and how to sell the bonds to institutions and retail clients.  Of course, the bigger the issuance the bigger the commissions collected by the bank so they’re properly motivated.

The bonds are sold with many disclosures to ensure that bond buyers know the revenue sources that will pay them, what the bonds paid for or will pay for (the facilities), and how the bonds fit into the overall tax load on the properties that will pay them back.  The tax load cannot be too high relative to the value of the property.

The bonds are generally regulated by the SEC and can achieve a rating from the bond rating agencies.  However, if the bonds are being sold ahead of the development happening that will create the value that will support the bonds then you have “story bonds”, with no rating.  The buyer has to believe the seller’s story and believe they can execute on what they promise.  As a bond owner, you look forward to the day in the future when your cash flows are supported by the 1500 new families that own new houses in the brand-new subdivision rather than paid by the one developer/landowner who is in the early stages of taking a large risk in developing the land.

The public financing can significantly reduce the upfront capital investment in the project required by the owner when the bond proceeds are used to acquire the completed public infrastructure from the developer, but the tax obligations and servicing of the debt, and ultimately repaying the bond debt, remain attached to the land until they’re paid off.

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