Equitable TOD involves a complex financing structure because these projects are always partnerships among public and private entities—each with a different financial objective and thus a different bottom line. A transit agency may seek to simply break even financially through revenue from the land it contributes to a project (also called “joint development”) or parking fees from higher density garages. An affordable housing developer will need government subsidies to include certain quantities and types of below-market rate units. Private developers—and their lenders—may have one set of financial expectations for the market-rate housing, another for the affordable housing, a third for the commercial space, and still another for the office component. They may be able to forgo high rates of return on one aspect of the project or another, but overall the project needs to produce a reasonable return on investment to be financially viable for private investors. All of these pieces need to fit together to give the developer sufficient incentive to build, while also allowing public and nonprofit partners to realize their social and financial objectives.
Although TOD is becoming a more popular development “product,” higher-density, mixed-use projects such as TOD are still not the norm. Challenges to financing equitable TOD include:
Sources of TOD Financing
Because TOD involves a mix of development types (residential, commercial, retail, open space, transit stations, etc.) and often a range of public agencies, private interests, and broad community involvement, TOD developments almost always require a diversity of funding sources. The primary sources of TOD financing include:
1. Private partner equity and debt.
Equity. Private developers and/or investors make long-term equity investments into TOD projects with the expectation of earning a financial return on their initial investment. These equity investors are the owners of the project, and they receive the share of the profits that remains after debts have been serviced. If they do not have enough equity for the project, they can look for equity from other individuals and entities such as foundations and public agencies. About 10 to 25 percent of TOD financing generally comes from private equity investments.
Debt. The remaining funding for a TOD project comes from loans, including short-term construction loans and long-term permanent loans that last for five to thirty years after the project is constructed. Many TOD projects also use some form of “gap financing,” such as bridge or mezzanine loans, to cover the period between the construction and long-term loans. The ability to secure a loan and the terms of the loan will depend on how risky the project is perceived by the potential lender. Some TOD developers, for example, take out bridge loans with the expectation of demonstrating the viability of the project and obtaining long-term financing at better terms. The community reinvestment arms of banks, and other lenders like Fannie Mae that are used to financing community development, are often receptive to funding TOD housing elements. (Fannie Mae’s American Communities Fund is particularly applicable to TOD.)
2. State and local funding and incentives. State and local financing is often essential for TOD. There are many different funding mechanisms, including bond financing, tax increment financing, housing incentive programs, and the prioritization of TOD within standard transportation and community development sources. In addition to providing direct funding for TOD, government agencies can provide market-based incentives to private investors such as tax credits, exemptions abatements, and deferrals. Tax increment financing (TIF) has emerged as an important tool for TOD and is discussed below. See Policy [ADD LINK TO SECTION] for descriptions of other innovative state and local funding programs.
Tax Increment Financing (TIF) . TIF is a tool that many municipalities use to fund redevelopment and community improvement projects; TIF is less commonly but sometimes used to fund anti-displacement and affordable housing preservation strategies in neighborhoods that are experiencing or are likely to experience gentrification. As a public financing tool, TIF banks on the expectation that improvements made to an area will lead to an increase in local tax revenues (from property taxes, sales tax receipts, or both). Legislation in all states except Arizona enables local governments to designate special TIF districts in areas that are slated for revitalization. In these districts, the tax base is frozen at the pre-redevelopment level and increases in tax revenues that come after the new infrastructure or project is in place—the increment—are set aside to either pay off bonds issued to finance the redevelopment or to go toward future improvements. TIF has been used to fund various aspects of TOD projects: the water and sewer infrastructure and sidewalks at Atlantic Station in Atlanta, parking lots at Arlington Heights in Chicago, and the Interstate MAX light rail line in Portland were all funded by TIF.
"As a financing tool, TIF is great, but the challenge is competition for funds. If there is not a written requirement, the housing money goes out the door."
Community Development Network, Portland, OR
While TIF is a promising source of local public funds for TOD, there are reasons to be cautious when using TIF for equitable TOD. Neighborhood economic conditions are only in part determined locally—in a slowing economy, tax revenues may stagnate and delay TIF allocations. In addition, an over-reliance on restrictive TIF funds for non-housing improvements could limit the ability to ensure that mechanisms are put in place to limit gentrification and ensure that residents benefit from the investment. In Portland, TIF allocations enabled a north-south light rail line to be built, increasing access and mobility for residents of the North-Northeast neighborhood. But the timing of the allocations and restrictions on the funds meant that the city was unable to use TIF to meet local affordable housing needs and stabilize residents before housing prices and land values began to rise.
When TIF is used, a portion of the funds should be specifically earmarked for community benefits like affordable housing, parks, or local hiring programs. Recognizing that a successful TIF project is likely to decrease housing affordability in the area, some states and municipalities have passed legislation requiring that a minimum percentage of the TIF funds go toward affordable housing within TIF districts. Utah and California both mandate that 20 percent of TIF funds go toward affordable housing, and Portland scored a huge victory in spring 2007 when the city council adopted a policy to dedicate 30 percent of TIF funds collected in urban renewal districts to housing that is affordable to households with incomes below 80 percent of the area median (see the Case Study)
3. Federal funding. Multiple federal agencies can finance transit oriented development including the U.S. Department of Housing and Urban Development, the Federal Transportation Administration (FTA), the U.S. Department of the Treasury, the Federal Home Loan Bank, Fannie Mae, and Freddie Mac. These agencies provide assistance through a number of mechanisms including direct investment, below-market-rate loans, grants, interest rate buy-downs, loan guarantees, and tax-credit programs.
4. Income generated by the project. The TOD project itself is income-generating. If the TOD project is built on government-owned land and/or includes public facilities, those assets can be leveraged to generate income for the project. Land leases can bring in rents, for example. The commercial components of the TOD will generate additional property, sales, and other tax revenues, which can be captured through tax increment financing.
Overcoming TOD Funding Challenges. Advocates and community developers of equitable TOD can do a number of things to make a strong case for TOD, demonstrate a market, and convince investors that the project will be self-sustaining with its equity-oriented features.
Prepare a strong business plan. A well-conceived, detailed business plan—including short- and long-term financing, tenancy goals and plans to achieve them, and the project’s broad vision—is key. Once lenders and investors commit to a TOD and construction begins, the project must be able to attract the forecasted businesses and other tenants. Failure to do so can skew estimates of projected revenues and jeopardize the project.
Be or find the right developer. A TOD’s comprehensive vision is often formalized by a development team with collective expertise in construction issues, zoning regulations, legal issues, market dynamics and financial risk. Experience is an invaluable asset for the development team, not only in moving forward with the project and navigating obstacles, but also in reassuring investors that the project is in able hands. Developers with long-established reputations for excellence and success in “risky” projects have far greater opportunities for securing financial backing than developers with relatively little experience or an unimpressive track record.
Plan “acceptable” mixed use. Mixed use is central to TOD. Unfortunately, conventional lenders are hesitant to fund mixed-use projects. Typically, investors prefer “horizontal” to “vertical” mixed-used configurations. Vertical mixed use is defined as development in which different levels of the same building house different uses (like retail on the ground floor and housing on upper floors). There is no definitive evidence suggesting that this type of development is less profitable or favorable, but it is a relatively new concept in many areas throughout the United States. Lenders tend to be more amicable to horizontal mixed use (characterized by separation of uses by building). Creative site plans can offer density, walkability, and attractive design in either horizontal or vertical mixed use; a TOD project’s final design should consider aesthetics, community benefit, and the concerns of potential funders.
Secure tenants early. One of the best ways to highlight the project’s market viability is to sign up as many commercial tenants as possible as soon as possible. (Lenders are especially impressed if a project attracts tenants before construction even begins.) This will go a long way not only in ensuring the appeal of a TOD project, but also demonstrating competency of the development team.
Lenders also consider tenants’ financial stability and reputation. Investors want to be sure a tenant can pay the rent over the long haul. This can be challenging in an equitable TOD project that aims to provide opportunities for small, locally-owned businesses and new entrepreneurs that lack the track record of established firms or the reputation of national retailers. Reluctance to deal with lesser-known merchants can often be mitigated by a formal commitment from tenants to pay rent even if their businesses fold, drafting lease agreements that exceed the life of the debts.
Build in phases. Successful TOD projects will appreciate in value for a longer period of time than many conventional developments. Unfortunately, TOD also needs to begin producing revenue almost immediately in order to secure more funding and allow developers to pay off large debts. Planning TOD in phases may mitigate this problem. Early-stage revenue from market-rate commercial tenants could be used to subsidize affordable housing units, community centers, or other beneficial projects.
Give TOD a good name. Many lenders may still be somewhat skeptical about TOD. Auto-focused development is thought to be a reliable investment because it has a long record of financial success all over the United States. If a suburban strip mall loses money, its failure is seldom blamed on sprawl and automobile dependence. TOD does not enjoy this level of security; one project’s failure might cause lenders to question the feasibility of such a development approach—an assumption that may threaten the lending and investment prospects of future TOD. As TOD grows more popular and more projects prove financially successful, lenders will become less hesitant. A track record of TOD success will encourage further private investment.
Highlight double bottom line benefits of TOD. As discussed in the “Why Use It” section, many goals of TOD—such as neighborhood revitalization and improved resident mobility—are not pursued solely for profit. But the social and community outcomes of TOD still contribute to economic success: local businesses benefit from increased residential and worker density, foot traffic, easier access, and improved infrastructure.