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02-23-2021 JOINT FINANCE COMMITTEE PACKET Meeting of the Joint Finance Committee AGENDA Tuesday, February 23, 2021 7:30 a.m. Elk River City Hall Upper Town Conference Room 1. CALL MEETING TO ORDER 2. CONSIDER AGENDA 3. CONSENT AGENDA Considered to be routine and noncontroversial by the Economic Development Finance Committee and will be approved by one motion. There will be no separate discussion of these items unless a Committee member, staff member, or citizen so requests, in which case the item will be removed from the consent agenda and considered under the regular agenda. 3.1 February 11, 2021 Meeting Minutes 4. GENERAL BUSINESS 4.1 Delta (Riverwalk) TIF Request 5. ANNOUNCEMENTS 6. ADJOURNMENT Meeting Protocol No sidebar discussions No interruptions State your concern Ensure you understand Don’t take things personally Adhere to time limits Come prepared Ensure all are heard Special Meeting of the Elk River Joint Finance Committee Held at Elk River City Hall Thursday, February 11, 2021 Members Present: Ryan Hardin, Charlie Blesener, Rhonda Magnussen, Dan Tveite (7:41 am), Chad Vitzhum, Larry Toth Members Absent: Nate Ovall and Denny Chuba Staff Present: Colleen Eddy, Economic Development Specialist Others Present: Mikaela Huot, Baker Tilly 1. Call Meeting to Order Pursuant to due call and notice thereof, the meeting of the Elk River Joint Finance Committee was called to order by Vice Chair Toth at 7:32 a.m. 2. Consider Agenda Motion by Hardin and seconded by Vitzhum to approve the Joint Finance Committee agenda. Motion carried 5-0. 3. Consent Agenda Motion by Hardin and seconded by Magnussen to approve the January 26, 2021 Joint Finance Committee meeting minutes. Motion carried 6-0. 4.1 Sportech LLC Tax Abatement Application Ms. Eddy presented the staff report. Ms. Huot presented the financial analysis. The group asked about job creation goals and how they would be managed and accounted for and it is a 14 year abatement but the lease is for 12 years. The job creation goals have state reporting requirements and the lease concern could be addressed with the applicant. The group discussed that Sportech is dedicated to this community and felt that they would be able to fulfill the requirements. Motion by Magnussen and seconded by Toth to recommend approval of the Sportech LLC Tax Abatement application to the EDA. Motion carried 6-0. 4.2 COVID Small Business Emergency Loan application for Mystery Chambers Ms. Eddy presented the staff report and the revised Mystery Chambers loan application. Motion by Blesener and seconded by Vitzhum to approve the Mystery Chambers COVID Loan application with the stipulation that the loan agreement(s) are completed and executed as needed. Motion carried 6-0. 5.1 Announcements No announcements 6. Adjournment There being no further business, Mr. Tveite adjourned the meeting at 8:17 a.m. Minutes prepared by Colleen Eddy. _____________________ Tina Allard City Clerk ___________________ Cal Portner EDA Executive Director The Elk River Vision A welcoming community with revolutionary and spirited resourcefulness, exceptional service, and community engagement that encourages and inspires prosperity. Updated: August 2020 Request for Action To Joint Finance Committee Item Number 4.1 Agenda Section General Business Meeting Date February 23, 2021 Prepared by Colleen Eddy, Economic Development Specialist Item Description The Delta Apartments TIF Application Reviewed by Cal Portner, City Administrator Reviewed by Action Requested Review application and provide a recommendation to the Economic Development Authority on the requested Tax Increment Financing Application. Background/Discussion In early fall 2020, the City of Elk River received an application from Sun Rae Apartments, LLC for Tax Increment Financing (TIF) assistance for the redevelopment of the former Saxon site to offset a portion of the costs necessary to construct 176 units of market rate apartments. The application requested up to 26 years of TIF. City policy limits redevelopment project assistance to 15 years. The request was reviewed by the Joint Finance Committee (JFC) on September 26 and December 29. At the Dec. 29 meeting, the applicant indicated no less than a 20-year term of assistance would allow the project to be financially viable. In early January, the city was informed that a new developer was interested in taking on the project and acquiring the property from Sun Rae. Stonewood Development, LLC submitted an application on February 5, 2021. The request for assistance was the same 26 years as originally requested. Included with the application is a preliminary preapproval letter from Bank Forward indicating that 20 years of TIF would be an assumed revenue source to obtain financing for the project. The applicant also provided a purchase agreement for $2,000,000 between Sun Rae Apartments, LLC and Stonewood Development, LLC indicating acquisition of the property and subsequent construction of the project was contingent upon 20 years of TIF. The maximum term of assistance pursuant to the city policy is 15 years and less than what the applicant has requested. As outlined in the analysis, adjusting the financing assumptions for total development costs would increase the project performance and reduce the level of public assistance to terms that could be supported within the city’s policy criteria. Financial Impact N/A Mission/Policy/Goal The City of Elk River shall utilize TIF to encourage desirable development or redevelopment that would not otherwise occur but for TIF. Attachments  TIF Application  Purchase Agreement  Financial Analysis Memo –Updated To: Members of the Joint Finance Committee Cal Portner, City Administrator Colleen Eddy, Economic Development Specialist From: Mikaela Huot, Director Date: February 17, 2021 Subject: Financial Needs Analysis for proposed Riverwalk Tax Increment Financing Redevelopment (TIF) District project – based on new development team (Stonewood Development, LLC) Background In late summer/early fall 2020, the City of Elk River received an application from Sun Rae Apartments, LLC for financial assistance through Tax Increment Financing (TIF) to assist with financing the redevelopment of the former Saxon site and offsetting a portion of the redevelopment costs necessary for subsequent construction of 176 units of market rate apartment housing units. The original application included a request for up to 26 years of tax increment assistance and the City’s current policy limits the level of assistance for redevelopment projects to 15 years. The request for assistance has been reviewed by the Joint Finance Committee (JFC) at two meetings (September 26 and December 29) as consideration for the project and level of assistance to be recommended for this project. At the December 29 meeting, the applicant indicated no less than a 20-year term of assistance would allow the project to be financially viable. Following the December JFC, in early January, the City was informed that a new development entity was interested in taking over redevelopment of the project site and acquiring the property from Sun Rae Apartments, LLC. The new entity, Stonewood Development, LLC submitted an application to the City on February 5, 2021. The request for assistance has been consistent (up to 26 years) with what had been originally requested. Included with the application for assistance is a preliminary preapproval letter from Bank Forward indicated that 20 years of TIF assistance would be an assumed revenue source to obtain financing for the project. The applicant also provided a purchase agreement for $2,000,000 between Sun Rae Apartments, LLC and Stonewood Development, LLC indicating acquisition of the property and subsequent construction of the project was contingent upon 20 years of TIF assistance provided by the City. The purpose of this memorandum is to provide a summary of Baker Tilly’s review of the development project costs and operating pro forma as provided by the applicant (Stonewood Development, LLC) to assist the City with making a determination 1) if the project as proposed would be unlikely to proceed “but-for” the requested Tax Increment Financing (TIF) assistance, and 2) if assistance was necessary, to determine the appropriate amount and terms, if any, of public assistance. Prior to establishing a tax increment financing district, there are findings that need to be made by the City that include: 1) determination that the project qualifies as a TIF district and 2) determination that the project as proposed would not proceed without public assistance (meeting the “but-for” test). When reviewing requests for financial assistance it is important to understand how the level of financial assistance would impact the ability of the project to proceed as proposed and maximize new value created on the current project site. Project Summary The applicant is proposing to construct two 98 unit residential apartment buildings on the former Saxon auto site for completion of a total of 176 new units with underground parking. Phase 1 of the project is expected to commence construction in 2021. The applicant intends to commence construction of the second building (Phase 2) shortly thereafter, but has indicated construction could start 2-3 years after phase 1. Applicant Request for Assistance Stonewood Development, LLC has requested assistance that includes 90% of incremental revenues for up to 26 years related to redevelopment of the project site. Consistent with the original application submitted by Sun Rae Apartments, LLC, the application includes an approximate $31.556 million project funded through a combination of debt and equity. The applicant’s supporting financial information includes updated sources and uses of funds with a revised total development cost of $34.7 million with 80% as debt financing and 20% as private equity. Financial assistance through pay-as-you-go tax increment financing from the City of Elk River has been requested to provide additional revenues to support the required level of debt and project cash flow to repay annual debt service payments. Typical extraordinary redevelopment costs that cannot be supported solely by the project alone could justify the need for public financial assistance and allow the project to proceed as proposed to provide appropriate upfront funding and meet the minimum debt coverage requirements. The applicant has indicated the receipt of City financial assistance is necessary for the project to proceed. The updated sources and uses of funds from the applicant’s financial materials is illustrated in the table below. Sources Amount Uses Amount First Mortgage $27,762,071 80% Acquisition $2,225,000 6% Equity $6,940,518 20% Professional $1,368,591 4% General $2,842,024 8% Site Development $1,671,415 5% Construction $17,537,997 51% Concrete $4,347,650 13% Development Fee $1,499,634 4% Construction Management Fee $1,499,634 4% Contingency $1,710,645 5% Total $34,702,589 Total $34,702,589 Tax increment financing has been requested as pay-as-you-go and would not be an upfront funding source and instead be used to support repayment of first mortgage debt service Estimated Total Development Costs by Phase Phase 1 Amount Phase 2 Amount Acquisition $2,225,000 Acquisition $0 Professional $789,572 Professional $581,247 General $1,485,601 General $1,356,423 Site Development $1,026,010 Site Development 647,990 Construction $8,768,998 Construction $8,768,998 Concrete $2,173,825 Concrete $2,173,825 Development Fee $822,197 Development Fee $822,197 Construction Management Fee $822,197 Construction Management Fee $822,197 Contingency $855,323 Contingency $855,323 Total $18,968,652 Total $15,733,938 Qualifications The City of Elk River has been approached by Stonewood Development LLC for redevelopment of the project site and would require the establishment of a Tax Increment Financing Redevelopment District. Tax increment financing is a tool the City may consider using to support financial assistance for the project, subject to meeting the but-for test and need for public financial participation. A blight inspection confirming qualification of the building as substandard for inclusion in a Tax Increment Financing District was completed in 2015 and would provide the basis for which a Redevelopment TIF District could be established. Project Financing There are generally two ways in which assistance can be provided for most projects, either upfront or on a pay- as-you-go basis. With upfront financing, the City would finance a portion of the applicant’s initial project costs through the issuance of bonds or as an internal loan. Future tax increment would be collected by the City and used to pay debt service on the bonds or repayment of the internal loan. With pay-as-you-go financing, the applicant would finance all project costs upfront and would be reimbursed over time for a portion of those costs as revenues are available. Pay-as-you-go-financing is generally more acceptable than upfront financing for the City because it shifts the risk for repayment to the applicant. If tax increment revenues are less than originally projected, the applicant receives less and therefore bears the risk of not being reimbursed the full amount of their financing. However, in some cases pay as you go financing may not be financially feasible. With bonds, the City would still need to make debt service payments and would have to use other sources to fill any shortfall of tax increment revenues. With internal financing, the City reimburses the loan with future revenue collections and may risk not repaying itself in full if tax increment revenues are not sufficient. The project financing as requested includes pay-as-you- go for reimbursement of eligible costs. Tax Increment Revenue Assumptions The County Assessor provided a taxable value estimate for the project. To estimate the amount of available TIF revenues generated by the proposed project, certain assumptions were made based on the value of the project, construction schedule, and anticipated financing terms. • Total existing value of $548,300 o Parcel ID: 75-704-0205, 75-521-0120, 75-521-0110 o Base value as of Jan. 1, 2020 o Original net tax capacity (ONTC) of $6,854 o Assuming classification as residential rental  Rental classification is 1.25% • Estimated total market value upon completion o $21,759,300 o 176 new units at $123,632/unit • Classification for all units as rental o Rental class rate (1.25% per unit) • Incremental value based on difference between existing and new land/building value • Construction commences in 2021 and is completed in 2022 o Project values 100% complete for assess 2023 and taxes payable 2024 • First increment collected in 2023 o Election to delay first increment by up to 4 years • Net present value (discount) rate of 4% • 0% annual market value inflation Tax Increment Revenue Estimates Revenue Estimates Estimated annual available increment (full buildout) $332,678 Total gross tax increment (15 years) $4,648,892 City retainage (10%) $464,892 Net amount available for development (90%) $4,184,000 Estimated Present Value Revenues (15 Years) $2,819,203 Financial Needs (Pro forma Analysis) including But-For Upon approval of a TIF district and project, the City must make several findings, including the “but for” test: that the proposed development would not reasonably be expected to occur solely through private investment within the reasonably foreseeable future. The applicant has stated that but for the provision of tax increment financing, the project as proposed would not occur. Based on the applicant’s stated position relative to the need for tax increment financing assistance, the City could make its “but for” finding and provide tax increment assistance. We recommend, however, that the City review the provided assumptions to consider if the project meets the but-for test and, if so, what an appropriate level and type of TIF assistance may be based on the information submitted by the applicant. Following thorough evaluation of the project as provided allows the City to be prepared to make an informed “but-for” decision based on the likelihood of the project needing assistance, as well as the appropriate level of assistance. To complete this analysis, we reviewed the applicant’s provided operating proforma and constructed similar ten-year project proformas, showing a result if the project received financial assistance as pay-as-you-go (reimbursement for TIF eligible costs) and showing a result if the project did not receive assistance. Our analysis of the proformas included a review of the development budget, projected operating revenues and expenditures, and the project’s capacity to support annual debt service on outstanding debt. The purpose of evaluating the operating proformas is to understand the potential cash flow performance through initial development of the project and the annual operations of the project over a 10-year period to assist with determining if the project is financially feasible and would need public participation. Measuring project feasibility is typically accomplished by analysing a combination of 1) projected rate of return – both annual and cumulative and 2) estimated debt coverage ratio (DCR). Rate of return analysis illustrates the projected return to the applicant using the available cash flow after payment of operating expenses and debt as a measurement to the initial equity investment. Industry standards for development types indicate the level of investment a developer is willing to make based on projected returns from the project. Should the projected annual and cumulative returns fall below those standards, the project would require reduced level of equity participation and/or increased cash flow. Debt Coverage Ratio (DCR) is a calculation detailing the ratio by which operating income exceeds the debt payments for the project. If the DCR is greater than 1.0 it indicates the project has operating income that is greater than the debt-service payment by some margin; conversely if the DCR is less than 1.0 it indicates the project is incapable of meeting its debt-service payment and would need to seek additional revenue sources in order to pay its debt. Typical lending standards will require a DCR of greater than 1.0 as a measure of cushion in the event actual revenues and expenses are different than projected. We reviewed the financial information as provided by the applicant to assist with making the determination 1) that tax increment assistance is necessary and 2) what is an appropriate level of assistance. We analysed the financial information as provided by the applicant including total development costs as compared to operating income to estimate both the projected rate of return and debt coverage ratios. The level of debt financing the project can obtain and support is based on the net operating income (NOI). The annual lease and other (parking) revenues and operating expenses have been provided by the applicant to project the NOI. Review of the operating proformas based on with assistance as pay-as-you-go and with no assistance provides the range of financial feasibility for this project and what the estimated gap would be without assistance. It is important to note that certain assumptions were made based on the applicant’s provided information and market industry standards for annual lease rates, vacancy rates and annual revenue and operating expense inflators in order to understand the project performance. Adjustments made to those assumptions assist in understanding potential impact on project performance and what a required level of assistance (number of years and total amounts) may be. To understand viability of the project and need for an appropriate level of public assistance, we provided a sensitivity analysis to the proformas with adjustments made to the total project costs (including land acquisition, development and construction management fee and contingency) and corresponding funding sources, as well as projected annual lease rates and operating expenses. As stated earlier within the memo, the property was previously purchased for redevelopment in 2014 by Sun Rae Development, LLC. Sun Rae Development, LLC and Stonewood Development, LLC have entered into a purchase agreement contingent on receipt of 20 years of TIF for an estimated purchase price of $2,000,000. Included with the application for financial assistance is an appraisal for the property supporting an “as is” estimated value of $1,750,000 “reflective of the land value less demolition of the existing building (estimated demolition cost of $189,000). All other financing and operating performance assumptions remaining the same, reducing the total development costs including potential purchase price and other related development costs is expected to positively impact the project performance and would reduce the level of public assistance that is necessary. However, any of the adjustments would not eliminate the need for public assistance. Upon review of the annual cash flow performance, increasing the projected lease rates beyond what is currently estimated would also result in additional cash flow that would provide both a higher debt coverage ratio and rate of return. Realizing these adjustments are all based on assumptions. The purpose of the sensitivity analysis is to test the level of assistance that may be needed using those assumptions to understand if the recommended level of assistance could be consistent with the City’s policy objectives and less than what has been requested. Analysis also requires a balancing of existing market conditions with what the project could support. Additional factors that may impact project feasibility and level of public assistance include review of the City’s current TIF policy and implications to the financing assumptions. The City’s TIF policy provides for TIF District terms be limited to the minimum term necessary to meet the project needs. Only projects exceeding the objectives identified in the policy will be considered to exceed those general thresholds. A Redevelopment District term has a maximum level of 15 years. The application includes a request for 26 years of assistance. A supporting preapproval letter from the potential lender has indicated that 90% of the tax increment revenues over 20 years is needed to support debt service. As outlined in the analysis, making adjustments to the financing assumptions would assist with increasing the project performance to a level that could be supported within the City’s policy criteria relative to the 15-year term of assistance. Also related to policy guidelines is the requirement of owner cash equity of 10%. The applicant’s level of equity as proposed is 20%. The City commissioned a Comprehensive Housing Market Study Update in 2018. At that time the study identified a potential demand for approximately 864 new housing units through 2025. There was also strong demand for additional market rate (172 units). Conclusion The applicant has requested financial assistance related to redevelopment of the former Saxon site and subsequent construction of two 98-unit market rate apartment buildings. Through submission of the tax increment financing application and supporting financial information, the applicant has indicated that the project would not occur as proposed without financial assistance from the City due to below market debt coverage and rates of return. The applicant has provided documentation from a potential lender indicating prequalification of financing for this project subject to: availability of sufficient equity such as cash, land or acceptable soft costs, appraisal, environmental and title for the property, and a minimum 20 year TIF equal or greater than 90% of the total tax estimate. Based on the financial analysis and available financing assumptions, without financial assistance, the project does not appear to be feasible. The applicant’s operating proforma without tax increment assistance is less than 1.0x DCR and with assistance using tax increment revenues as available cash flow, would be closer to 1.13-1.21x DCR, which is generally an acceptable level required for this type of project. Without assistance, the projected annual and cumulative rate of return is below industry standards for this type of project and with annual public assistance the project is projected to achieve marketable returns. Both the rate of return and debt coverage analysis indicate that the provided financing structure would not be financially viable without one or more of the following: 1) reduction in project costs 2) additional annual cash flow, and/or 3) additional funding sources. The projected performance of the project without as or would be necessary to obtain a level of debt financing necessary to fund all project costs and provide a reasonable return. Considerations for level of public assistance parameters include: • Public to private investment • Public assistance (TIF) and private equity • Extraordinary costs • Financial gap The applicant has requested tax increment financing from the City as a method of providing the additional cash flow revenues required to achieve financial feasibility. In addition to tax increment financing, we’ve also reviewed other possible methods that could be used to increase financial feasibility and reduce the level of public participation that has been requested and may be needed for the project. Adjusting the assumptions related to land and other development costs to a level that can be supported by a reduced term of assistance and annual revenues (lease rates) all have positive impacts to the project; thus, resulting in an estimated reduction in the potential level of assistance that is needed for the project to proceed and support the extraordinary redevelopment costs of the site. The maximum term of assistance pursuant to the City’s policy is 15 years and less than what the applicant has requested. As outlined in the analysis, making adjustments to the financing assumptions for total development costs would assist with increasing the project performance and reduce the level of public assistance to terms that could be supported within the City’s policy criteria relative to the 15-year term of assistance. Thank you for the opportunity to be of assistance to the City of Elk River. Please contact me at 651.368.2533 or Mikaela.huot@bakertily.com with any questions or comments.