Volunteer Fire Departments Special Purpose Districts ELA Municipal Conference Chicago September 2004 ORIX Public Finance LLC Frank D. Hill 10/29/2004 1
Volunteer Fire Departments IRC of 1986 Provision 150(e) authorizes the issuance of tax-exempt obligations by qualified VFD s to finance the costs of acquisition, construction, reconstruction or improvement of a firehouse or fire truck. Organized and operated to provide firefighting services in a municipal area not provided with any other firefighting services. (exceptions apply). Organized as non-profit organizations. Section 150(e) allows direct issuance by the VFD s without the use of a conduit. VFD s Articles of Incorporation, By-Laws, and others may affect the transaction and their ability to incur debt. VFD lease is debt, No nonappropriation language is required. Must be approved by elected officials of the municipality following a Public Hearing. Reasonable notice must be given for the hearing. Requirements in Section 147(f) of the code. 95% or more of net proceeds of the obligation must be used for the t above stated purposes Firehouse and Fire Truck have been narrowly defined by existing ing Treasury Regulations. Ambulances, Loose Equipment, Buildings not used for fire fighting g do no qualify. 10/29/2004 2
Types of Special Purpose Districts Water Districts Sewer Districts Transportation Districts Transportation Authority Fire Districts Emergency Service Districts Transportation Cooperatives Educational Service Cooperatives Purchasing Cooperatives Joint Powers Authority Sanitation Districts Inter-local Service Cooperatives General Purpose Authorities These are examples and is not a comprehensive list. 10/29/2004 3
Differences between SPD s vs. Cities, Counties, School Districts Essentially the same under IRS Code 103 of the Federal Tax Law with differences based on State Laws Tax Base/Revenue sources may be limited, tied to specific revenue e sources, property tax based, sales tax based, special fee based revenue Their ability to Issue tax-exempt leases/obligations may be subject to limitations, qualifications, and restrictions. Governed by elected boards or appointed boards (Agency?) Budgeting, Ability to tax,raise revenue, Authority to Issue are key questions Special Districts have the same needs as Cities, Counties etc, they t have to purchase equipment, provide services, and hopefully finance equipment and projects Difficult to put into one box 10/29/2004 4
Competition for the Financing The competition for financing most municipal transactions is heavy. Point Spreads are Decreasing in the Marketplace Increased appetite vs. less Issuance Competition for Special Purpose Districts comes in the form of traditional t investment banking/bonds, as well as Lease Purchase competitors. Special Purpose Districts projects may lend more to bonding by the t nature and size of the project. Rated/Non Rated/Insured? Difficult to win on rate when brokering or syndicating transactions. Service and relationship play larger roles Competition for VFD transactions is very heavy. Captives, Banks, Brokers, Corporate Lenders. Quality Collateral, Homogenous products. Rate is very important/service and relationship is key Know your customer, know your product, understand the competition. on. 10/29/2004 5
Legal Issues VFD s are more similar in their Legal Requirements. Very specific requirements must be followed. See Handout Special Purpose Districts are much more complicated and require additional legal review due to state and local laws. Cannot put all Special Purpose Districts in one box Consult Counsel 10/29/2004 6
Marketing VFD s & SPD s Trade Shows, Vendor Contacts, Association Meetings Internet, Mail, Phone Establish relationships Vertical Marketing 10/29/2004 7
VFD s Taxable or Tax-Exempt The Internal Code of 1986 contains Section 150(e), authorizing the t issuance of tax-exempt obligations by qualified volunteer fire departments to finance the costs of acquisition, construction, reconstruction or improvement of a firehouse or fire truck. To qualify, a VFD must be organized and operated to provide firefighting fighting services in a municipal area the is not provided with any other firefighting services (except on an emergency basis or a cooperative agreement). A further exception applies if the area has been serviced by more than one fire department continuously since January 1, 1981. The VFD must also be required to furnish firefighting services to the areas under a written agreement within the municipality. VFD s are organized as non-profit organizations. Generally, NPO s must issue through a conduit to issue tax-exempt obligations. Section 150(e) permits tax-exempt obligations to be issued directly by the VFD. Provisions of the VFD s articles of incorporation or by-laws may affect the incurring or securing of debt, such as approval by more than a simple majority of the directors or membership. A VFD s debt will not qualify as tax-exempt unless its issuance is first approved the elected officials of the municipality it serves, following a public hearing requiring reasonable advance notice in accordance with the requirements of Section 147(f) of the IRC. The maximum amount of the proposed financing, f the identity of the initial owner, or manager of the facility or equipment and nature and location of the facility or equipment. 95% or more of the net proceeds must be used for the acquisition,, construction, reconstruction or improvement of a fire house, including land) or a fire truck used or to be used the VFD. The terms fire house and fire truck have been narrowly defined by existing treasury regulations. Financing other equipment or facilities can be done at taxable rates. 10/29/2004 8
Issues Relating to Investment in Municipal Real Estate ELA Municipal Forum Chicago, IL September 23, 2004 Jeff Sharp ORIX Public Finance LLC
Commercial Real Estate Analysis Return on Investment- Bottom Line $ Operation & Maintenance Taxes Management Expenses Location Competing Projects Rent Levels Debt Service (Taxable) Alternative Uses
Municipal Real Estate Analysis Essential Purpose Operation & Maintenance Management Expenses Debt Service (Usually Tax-exempt) Location? (Sometimes) Alternative Uses? (Sometimes)
Who Uses Municipal Real Property? State & Local Governments Cities Counties School Districts State Agencies Airports Municipal Utilities Quasi-governmental
Examples of State & Local Real Property Projects City Hall & Other Administrative Facilities School Buildings, Additions, Athletic Facilities, Public Safety- Police & Fire Stations, Training Facilities Water & Wastewater Plants Landfills University Dormitories & Buildings
Not For Profit Organizations 501 ( C ) (3) Borrowers Health Care Higher Education Secondary Education Para/Quasi- Governmental Organizations YMCA Blood Bank Museums Mental Health Organizations
Examples of Not-For-Profit Real Property Projects Hospitals & Research Facilities YMCA Blood Bank Private College Buildings & Dorms Museums Administrative Facilities
Real Estate Documentation Survey (ALTA) Appraisal (existing projects, not new construction) Phase I Environmental Assessment Title Commitment Legal Opinion Casualty Insurance Collateral
Common Municipal Real Property Collateral Structures Deed of Trust/ Mortgage Usually Non-governmental Ground Lease/ Finance Lease Ground Lease 1.5X Financing Term Sale/Leaseback
Summary & Conclusion Essential Purpose is Essential Documentation is Critical Returns can be attractive
Good luck! Any Questions?
Contact Info Jeff Sharp ORIX Public Finance LLC 866/472-9100 jsharp@orixfin.com
Issues Relating to Investment in Municipal Real Estate ORIX Public Finance LLC 2004 Introduction: Commercial versus Municipal Real Estate- A Study in Contrasts Over the years financial institutions have developed complex analysis techniques to judge both the credit worthiness and economic benefit of investing in commercial real estate projects. These techniques allow an investor to make an informed judgment about the potential of the project to be viable, first as a competitor in the marketplace, and second to provide a reasonable return on investment. Many of the techniques used are analytically complex and ultimately investment decisions are made by evaluating the bottom line. A number of factors are part of any commercial real estate analysis and they include the number of competing properties, occupancy trends, rent levels, the economic vitality of the community and the level of taxation by state and local governments. This is not the case in the world of municipal real estate credit analysis. While the analysis of commercial real estate projects is both highly specialized and complex, the analysis of municipal real estate projects is much more general and pragmatic. For example, the self-sufficiency of a real property project is quite different in the commercial and municipal arenas. To be considered acceptable for investment, a commercial project must generate adequate profits after covering all management expenses, maintenance expenses, debt service, etc. Merely covering expenses is not enough --- return on investment must be satisfactory for a project to be viable. This, however, is generally not true of municipal real estate. Government generally doesn t compete with the private sector, or with other units of government, and many of the functions and services they provide are mandated by law. Generally, they don t have the typical business pressures associated with earning income; instead government levies taxes. Like in a commercial transaction, location may be an important consideration in the placement of governmental facilities, especially for public safety, but visibility and proximity may be of little importance. Essentiality of the service provided becomes the most important consideration. In short, it is an entirely different ball game. Commercial real estate can be grouped into relatively homogenous categories (i.e. office, retail, warehouse, apartment, etc.), which lends itself to comparative analysis with similar properties in and across geographic areas. This makes both initial analysis and subsequent remarketing much easier to accomplish. Conversely, many municipal projects tend to be single-purpose projects that are built-to-suit (such as police/fire stations, schools, court houses, etc.), making income and valuation comparisons much more difficult (if not totally irrelevant) to determine. Also, area competition and changing demographics play a decidedly different role for commercial and municipal projects. For commercial projects, the playing field may be
altered dramatically by teardowns, makeovers, new construction, changes to zoning laws, entrance of a new large employer, etc. Area competitors may also offer discounted terms, such as lower rent, to encourage tenants to relocate. As a result, the commercial market is subject to rapid change, which can have a material impact on the valuation of a property. In sharp contrast, municipal projects tend to share the same monopolistic traits as their municipal owners. Typically, there are no competing municipal entities, and the governmental services provided from a location tend not to change over time. Therefore, there tends to be no material changes, either positive or negative, to the usefulness or valuation of municipal projects. That said other projects which fall under the umbrella of municipal real estate may be closer in form to their commercial counterparts. These projects include real estate that is used for the benefit of not-for-profit (NFP) organizations that provide a variety of services, many critical to their communities. Most NFP s are able to raise capital for projects or equipment on a tax-exempt basis by borrowing through a qualified conduit issuer that has the ability legally to issue tax-exempt debt. The breadth of this category of potential municipal borrowers is expansive. A partial list includes specialized education facilities, health care providers, recreation services, social service organizations, secondary schools and private colleges and universities. These types of organizations and many others like them may legally obtain tax-exempt financing for their facilities and equipment needs. Many of these potential borrowers compete for customers and are dependent upon the same market conditions as the private sector. In fact, they may be largely dependent on revenue sources like tuition and fees for services to operate. Generally speaking this category of municipal borrower requires a higher degree of scrutiny by a lender than a typical governmental entity. Still, many NFP s are well managed and their capital projects may provide sound and attractive investment opportunities. Types of Municipal Real Estate Projects Project Types - Although not exhaustive, the following constitutes a list of municipal and NFP projects that have been financed using a municipal lease: City hall and other administrative facilities School buildings, gymnasiums and additions Libraries Healthcare facilities including hospitals and clinics Police facilities including police stations and training centers Fire stations and training facilities Landfills Public works maintenance facilities Public university facilities Private schools and colleges YMCA facilities Blood bank facilities Museum facilities
Convention facilities and convention and visitor s authority administrative facilities Jails and prisons Municipal Real Property Lease Structure Term 10-30 years generally, depending on project type and borrower s needs. Fully amortizing (balloons are not common in municipal financing). Advance Rate generally 75% to 80% (for existing construction) to 100% (for new construction), with advance rates based on fair market appraised value Construction Funding generally handled via an escrow account held by a trustee, with escrow disbursements subject to lessee and lessor approval. Payment & Performance bonds are required to ensure project completion. Typically closure of an escrow takes place upon receipt of Certificate of Occupancy. Survey an ALTA survey is generally required, particularly for new construction. The survey will set forth the legal description and boundaries of the property. Often, for new construction, a survey will be completed both prior to and after construction. Phase I Environmental Assessment a Phase I is generally required, particularly if the prior usage of the property gives pause to any environmental concerns. In a Phase I report, the environmental engineer will describe the history of the property, provide a visual review of the property (including any obvious environmental concerns), and provide a review of environmental records (such as underground storage tank and remediation records). If the Phase I raises any material concerns, then a Phase II is required. The Phase II usually involves soil samples of at-risk areas of the property. For clearly benign prior usages, an environmental questionnaire may be sufficient for the lender. Appraisal an MAI appraisal is generally required of all properties to be financed, whether existing or new construction. The appraisal will provide three approaches to valuation --- cost approach, income approach, and comparable-sales approach. The appraiser will then establish a fair market value, taking into account all three valuation approaches. Title Commitment a title commitment, and subsequently issued title policy, is generally required for all real property financings. The title commitment ensures that the lender s lien on the real property will be valid subject to certain exceptions, which must be reviewed by the lender for acceptability. The dollar amount of the title commitment should be equal to the loan amount. The type of title policy is dependent on the deal type. For example, for a mortgage transaction, the title policy will be a lender s title policy. For a ground lease/finance lease transaction, the title policy will be a leasehold title policy. The title policy is usually issued by the title company that will be recording the lien instruments.
Insurance typical property and liability insurance policies are required, with the lender listed as loss payee and additional insured, respectively. The amount of the property insurance should cover the amount of the loan. In addition, depending on the location of the property, specialized insurance such as flood or earthquake insurance may be required by the lender. For transactions subject to abatement of rental payments, the lender should require that the lessee obtain rental-interruption insurance as a rider to their property insurance policy. Legal Opinion a validity opinion is required on all real property transactions. This is particularly important, as many jurisdictions have specific statutes regarding the financing of municipal real property, including what types of financings may be entered into and what types of collateral interests may be granted. As a result, it is prudent to have the opinion be issued by local counsel or bond counsel experienced in real property transactions in the relevant jurisdiction. Because of the complexity related to not-forprofit organizations financing capital improvements on a tax-exempt basis, a tax opinion should be required from qualified bond counsel on all NFP real property transactions. Collateral There are many different methods to collateralizing a real property transaction for a municipality. However, the allowable methods vary by jurisdiction, so the lender should always consult with appropriate legal counsel before trying to structure the transaction. The most prevalent collateral structures are as follows: 1) Deed of Trust / Mortgage The municipality grants a deed of trust or mortgage to the lender, thereby securing the loan payable to the lender. The mortgage instrument is recorded in the county records for perfection purposes. The mortgage document will provide the lien grant, the legal description of the property, and the rights & remedies of the parties (including the foreclosure rights of the lender). 2) Ground Lease / Finance Lease The municipality leases the land (the Ground Lease) to the lender (or a trust for the benefit of the lender), and the municipality then leases back the improved property (the Financing Lease) from the lender (or trust). Certain lenders prefer that the lessor s rights be held by a trustee, to further separate the lender from any possible ownership claims. Both the ground lease and the finance lease are recorded in the county records. Generally, the ground lease will have a term that is longer than the finance lease. That way, should the lender need to repossess and remarket the property, there is a sufficiently long term to do so. If all payments are made in accordance with the Finance Lease, the municipality will have lien-free ownership of the property at the end of the financing term. 3) Sale / Leaseback The municipality sells the property to the lender (or a trustee), then leases back the property from the lender (or trustee). In virtually every case, the lender will require that a trustee own the property, to avoid any lender liability issues. The trustee becomes the fee-simple owner of the property, with the sale instrument (the deed) being recorded at the county level. At the end of the lease term, the trustee retains ownership. If the lessee desires ownership, then the
lessee must pay fair market value or a pre-negotiated price. Note: the IRS & Treasury Department are scrutinizing these transactions, as they involve the transfer of depreciation benefits from an entity that can not use them (a municipality) to an entity that can (a lender or trustee for the benefit of a lender). Appropriate tax counsel should be consulted before entering into this type of transaction. Credit Evaluation Being comfortable with the credit-worthiness of the issuer is critical. Most state and local governments maintain a solid financial position and the incidence of nonappropriation or default in the municipal sector is historically very low. Generally, the municipal bond market default rate is less than one-tenth of one percent. The 2003 Association for Governmental Leasing & Finance Volume & Non-appropriation/Default Survey showed $1.043 million of default or non-appropriation versus $3.998 Billion of newly originated volume. This is about.0003%. The sector is, therefore, generally considered stable. During this most recent national recession there were many headlines about state and local government having critical budget troubles, but defaults and nonappropriations were still rare. For these reasons, the credit analysis of a municipal real estate project centers first and foremost on the creditworthiness of the issuer (as opposed to the valuation of the asset financed). It is important to note that municipal credits must be evaluated differently than private businesses. Political pressures do not allow government to maintain large cash balances, so, governments try to maintain positive cash flow from operations with a reasonable rainy day fund balance. Assuming the issuer maintains an adequate financial condition, essentiality and valuation of the property become the remaining critical factors in evaluating whether to invest in a project. In other words, it is critical to become more asset-focused after creditworthiness is established. Also, because these deals tend to be more long-term in nature, the analyst should place more emphasis on the sustainability of the credit over time, regardless of economic conditions. Economic Considerations With straight-forward municipal properties, such as city halls and school districts, economic considerations do not come into play as much --- essentiality takes center stage. But, with more quasi-governmental projects (such as not-for-profits) or revenuegenerating projects (such as prisons, parking garages, etc.), it is more important to look to the area economy and demographics for transaction support. Conclusion There are significant differences in both the attributes and analysis of municipal and commercial real property transactions. Because of the nature of governmental and other community services, there is less emphasis on competitive factors and more emphasis on essentiality. If properly researched and structured, municipal real property can provide an institutional investor with high quality collateral at attractive, tax-exempt rates.