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Posted almost 13 years ago

How Residential TIF Financing Can Save Baltimore's Neighborhoods

The Devil is Always in the Details. The question of why developers don’t rehab houses in transitional areas has a very simple answer – but it is not the answer that you think. Frequently tossed around, but wrong, answers include fear of crime and theft. In our experience of renovating 500 or so houses in transitional areas over the past 10 years, we have never feared for our safety. And as long as you don’t leave the doors unlocked and the window openings wide open, we haven’t had much trouble with theft either. So why don’t we do more renovations in transitional areas then? The answer is in the details. Let me walk you through a gut renovation in a transitional area…

We buy the shell for $5-10K. We plan to spend $75K to renovate the house, including an all new modern layout, mechanical systems, abatement of all lead paint, new trim, doors, kitchens and baths. The result is a lovely and healthy home, capable of attracting a rent north of $1200/mo, which is the minimum we need to keep the house up, make debt service payments and pay all of the other expenses of the home. Here’s where the train falls off of the tracks… We have $85K of cash in this house, so we go to a bank to refinance. Refinancing allows us to get our money back and go do another project. The bank will give us 70% of the appraised value. Because the house is in a transitional area, appraisals are only $100K, so the refinance proceeds are only $70K. So we have $15K “stuck” in the deal. If I were an investor with $100K, after 6 renovations I’m done. $100K is a lot of money – there aren’t hundreds of guys who want to invest in real estate with $100K sitting around. The bottom line? We aren’t to renovate thousands of vacant properties and make any kind of a dent 6 houses at a time.

The problem is that there is a $15K per house shortfall, which prevents this cycle from being 100% replicable. The investor can’t fund it without depleting their operating capital and grant money isn’t a long term fix to the problem. There is another beneficiary in this system that gains from a shell being renovated. The City Tax Collector. The renovated property will have a new assessed value of at least $85,000. Property taxes will be at least $2,000/yr. This $2,000/yr is found money to the City. It invested nothing to get this return. My suggestion is that the City should.

If the City funded the $15K shortfall in the form of a forgivable loan paid back by property tax revenues from the property, the investor would do that project. Property taxes to the City would increase by $2,000/yr. At a 6% interest rate, which is more expensive than the rate at which the City raises money, the $2,000/yr fully amortizes the City’s loan in only 10 years. At the end of 10 years, City is completely paid back and the property tax increase is gravy to the City’s coffers.

There is almost zero risk of loss to the City because property taxes are the most senior lien on a property. After signing on the line for $70K of bank, there is no way that either the Investor or the Bank are going to let themselves be completely wiped out for non-payment of the property taxes. The Investor can recycle his operating capital and renovate continuously. And the neighborhood has a way to rid itself of the dilapidated vacant on an otherwise good block.

Traditional Tax Increment Financing (TIF) won’t work, because it has been designed for large scale commercial projects. The concept is the same and the math works. We need to design a TIF structure that works for small scale residential. The stakes are too big not to.


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