TABLE OF CONTENTS
LIST OF FIGURES
LIST OF TABLES
LIST OF BOXES
This chapter describes the endogenous economic risk category. These risks are largely project-specific and can be defined as risks determined by internal factors, processes, or decisions within the control of project stakeholders. These risks often result in the project not generating the economic development anticipated, affecting the local government’s financial and fiscal standing. Common risk types in this category include: (1) economic growth impact and related risks; and (2) fiscal impact risks.
Economic growth impact and related risks can impact the use of value capture techniques when prior to project implementation, potential investors or lenders perceive the project’s economic development or value capture revenue forecasts unreliable or unrealistic. This may impact the ability to secure the capital needed outright, or to secure it at financially viable cost, forcing changes in project scope and/or delays in its implementation. These risks may include:
During its first few years in the 1990s, the Dallas Area Rapid Transit (DART) system struggled to fund transportation projects using the transit joint development (TJD) value capture technique. A clear illustration of this situation was the Cityplace twin tower project. In this project, a developer offered to share costs for the light-rail transit (LRT) station construction. However, a downturn in the local real estate market forced the developer to pull out of the deal. Consequently, the Cityplace twin tower project was canceled (38).
The Cityplace tower is a 42-story office building that opened in 1988 in the district of uptown Dallas. In 1996, DART’s LRT service started operation. However, the Cityplace LRT station did not open until 2000. Over time, the area surrounding the Cityplace tower has slowly filled in with the highly successful mixed-use West Village project that is serviced by the DART subway line and the McKinney Avenue trolley (39).
Similar situations occurred in other parts of the country during this period. Multiple planned transit oriented development (TOD) and TJD projects failed to break ground around suburban LRT stations because of unrealistic real estate market expectations (e.g., St. Louis, Pittsburgh, and Buffalo). A review of these experiences concluded that the main problem in these early TJD projects was the lack of appreciation for the complexities of TJD by both public and private sector partners (38). Over time, transit agencies and developers across the country have acquired more experience and knowledge working with TOD/TJD, and lessons have been learned and shared, resulting in successful TJD projects.6
In an example like this, mitigation strategies can focus on ensuring that local government leadership is knowledgeable about the complexities and fully invested in the success of TJD, as well as supportive of policies that bolster the value proposition for developers (e.g., financial and regulatory incentives, and public investment). It is also important to work with developers with a successful track record who understand and appreciate the complexities of TJD.
Fiscal impact risks share many similarities with economic growth impact risks, with the primary difference between them being the timing of their materialization. While the economic growth impact risks described earlier may materialize prior to project implementation, fiscal impact risks typically materialize after project implementation. Fiscal risks impact the local government’s ability to service project-related debt or to sustain basic government services as a result of commitments made to a single project, or excessive commitments made to several value capture projects. Common examples of fiscal impact risks include many of the economic growth risks listed earlier, as well as being excessively reliant on the use of value capture tools (e.g., TIF districts) overcommitting future tax revenue, and compromising the delivery of basic services.7
Fiscal risks materialize when, despite any of the conditions listed above, the local government manages to persuade lenders and proceed with the project, and economic growth and associated tax revenues do fall below expectations. This may force a local government to decide between servicing debt and sustaining basic government services not only at the project location, but also throughout its jurisdiction. A similar situation may develop when a local government relies excessively on value capture to fund various development projects across its jurisdiction, overcommitting its budget capacity, and effectively exacerbating its exposure to many of the risks described in this primer.
A TIF district is a delimited geographic area in which incremental property tax value revenues resulting from an infrastructure investment are captured to fund or finance the infrastructure investment. TIF districts rely on the principle that infrastructure investments spur economic development leading to an increase in property values within the district and property and sales tax revenue growth (1). Several factors drive real property value increases: three are particularly important in the context of TIF districts. First, property values may increase because of inflation. Inflation affects property values irrespectively of other real value appreciation factors. Second, property values may also increase due to “natural growth,” which is mainly driven by supply and demand. Finally, property values can also increase because of the economic development generated by investments made in their vicinity (40).
Several States require local governments to demonstrate that a proposed TIF district passes a “but-for” test prior to being created. The but-for test involves demonstrating that the economic development generated by the project can be expected to result in property value increases that would not occur without the investments funded by the TIF district. The but-for test prevents local governments from establishing unnecessary TIF districts in cases where development and property value appreciation will occur anyway because of inflation or natural growth (41). In such cases, the TIF district may end up diverting future tax revenues from other basic municipal services, or from other local government units, such as school districts, effectively affecting its fiscal standing. In practice, this means that TIF projects that do not pass the but-for test do not create additional revenue and are subsidized by the local governments, diverting funds that would otherwise be assigned to essential services (e.g., sewerage, electricity, etc.) to subsidize the TIF project.8
For instance, a study concluded that several TIF districts in the City of Chicago have not generated the economic development expected when the but-for test was completed (42). Another study published by the Lincoln Institute of Land Policy also agrees with this statement. After studying more than 30 TIFs over several decades in Chicago, it was concluded that in most cases, TIF projects have not generated the economic development expected in the But -For test. According to this study, although there are State statutes and regulations requiring the TIF pass the but-for test, in general, the requirements for passing the test are vague enough that almost any TIF with strong political support can pass the test (43).
To mitigate these risks, local governments should perform rigorous but-for test feasibility studies based on realistic expectations and that stress-test developers’ assumptions. Other strategies include performing thorough analysis to ensure TIF revenues are not overcommitted and monitoring project performance to confirm that the benefits of TIF projects are realized over time.9
6 TJD also entails legal risks. The National Academies of Sciences, Engineering, and Medicine published a comprehensive analysis of legal issues and risks that may be encountered by local governments using TJD: https://www.nap.edu/catalog/14588/transit-oriented-and-joint-development-case-studies-and-legal-issues.
7 Some States like Wisconsin have established a 12-percent value cap to prevent communities from relying excessively on TIF. The law provides that a community shall not have more than 12 percent of its taxable base captured in tax incremental districts (Wis. Stat. §66.1105, §60.85, §66.106).
8 For additional information on TIF analyses, including examples of “but-for,” the following links offer additional insight, specialized software and training information:
9 Information about TIF success stories with references to potential mitigation measures for TIF economic growth and fiscal risks by the Commercial Real Estate Development Association can be found in: http://www.naiopchicago.org/wp-content/uploads/2018/10/FINAL-TIF-Report-2018.pdf.
