Financing from Special Financing Districts Continues to Look Attractive

Financing from Special Financing Districts Continues to Look Attractive

Traditional forms of debt financing for residential land development and homebuilding continues to shrink as time goes on. One primary reason is due to traditional lenders making bad real estate loans that ultimately rendered their institutions insolvent. In the 1980s, the savings and loan industry was a stable source of financing for real estate developers and homebuilders. By the early 1990s, the country stood by and watched the federal savings and loan industry disappear over a handful of years. The FSLIC and Resolution Trust Corporation alone closed over 1,043 savings and loan institutions across the country.

Community Facilities District Act (more commonly known as Mello-Roos) was a law enacted by the California State Legislature in 1982.[1] The Act enabled "Community Facilities Districts" (CFDs) to be established by local government agencies as a means of obtaining community funding.

In the 1980s, the use of Special Financing Districts ("SFDs") was just beginning to find its place in residential land development. SFDs across the country generally comprise the following attributes: (i) the lien against the development project is typically on parity with general property taxes and superior to trust deeds, (ii) tax exempt bonds are issued to pay for the development project's public improvements, (iii) the bonds are repaid by the property owners within the SFD through the levy of assessments or special taxes on the property tax bills or through a direct bill process, and (iv) many SFDs have accelerated foreclosure rights upon default in the payment of assessments or special taxes. Basically, many states in this country modified their property tax law to limit and reduce the amount of taxes that would be available for counties and local municipalities to fund new public infrastructure to new developing areas. California was one of the first states to enact this change through Proposition 13 in 1978 and several states followed suit with similar modifications in the years that followed. In order to deal with this public financing void, many states wisely enacted SFD legislation. The table below summarizes some of the popular SFDs in the country and when they were enacted into law:

After the dust settled with the demise of the savings and loan industry and the recession that it created was over, commercial banks and Wall Street investment banks were poised to lend and invest to obtain high yields in residential real estate, especially residential land. Most of us in the industry over the last ten years know very well as to what happened to our commercial banking system and our Wall Street investment banks. Who would of thought that the prestigious Bear Stearns would go out of business overnight after being in business for over 80 years? Additionally, according to the FDIC, the number of commercial bank closures since 2007 that the FDIC insures are as follows:

The list of commercial bank closures will continue to grow over time. Today, the surviving commercial banks are healing their wounds from bad real estate loans and for all practical purposes are currently not in the business of lending on residential land. Eventually, the commercial banks will return to lending on residential land but it will take a few more years and the lending criteria will be much more restrictive. Funding from hard money lenders is available but such money comes at a steep price and typically a short repayment term.

With this debt void in the marketplace for residential land developers and homebuilders, the use of a SFD can help close this financing gap. Essentially, all of the public infrastructure (i.e., roads, water, sewer, storm drainage, public facilities) requirements of a land development project may be financed through a SFD. Excluding land acquisition and private grading costs, the public infrastructure cost is a substantial portion of the land development budget that is necessary to bring raw land to a finished lot status. The cost of borrowing from a SFD typically ranges between 5.5% to 8% depending on the location and credit quality. Since tax exempt bonds are issued by the SFD, the interest rate is significantly below equity rates and hard money lending rates which make it very attractive to land developers.. The use of SFDs across the country seems to be catching on with residential land developers and builders. For example, the table below shows the explosive growth in Community Facilities Districts in California over the last eighteen years:

Obviously, in slow economic times (i.e, early 1990's, and post mid 2006) the use of SFDs is reduced because project demand is reduced. There are many examples of SFDs throughout the country that have experienced similar growth as California's Community Facilities Districts. We expect this growth to continue in the future and we expect SFDs will contribute a much greater portion of overall project funding over the next several years because of the traditional debt funding void.

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