In the late 1990’s, two changes in the law combined to create an easier, cheaper source of capital that Developers can utilize to fund various public purpose infrastructure improvements in residential and other developments. This procedure essentially allows Developers to use tax-exempt public financing to defray traditional development costs by assessing the ultimate property owner for certain infrastructure improvements. This article will briefly discuss the statutory authority used to levy these assessments and will then address the practical problems of real estate practitioners regarding notice to homeowners in the assessed area.
Changes in the Law
The Private Activity Bond Regulations and Special Assessment Supplemental Bond and Procedures Act (the “Act”), 50 ILCS 460/1 et seq., both adopted in the late 1990’s, permit the temporary use of tax-exempt bond financed improvements by Developers during an initial period of construction, if certain criteria are met. Most significantly, the improvement must carry an “essential government function”. The bonds issued to finance these so-called public purpose infrastructure improvements are paid by assessments levied against the benefited properties by agreement with the developer/land owner. The benefits to the Developer include the marketing appeal of selling more home for less, the potential benefit of lower interest rates offered to municipalities, the elimination or reduction of the cost of financing the improvements, and the cost of letters of credit for the bond-financed improvements.
Assessments used to pay for the bonds are imposed pursuant to either the Special Service Area (“SSA”) statute, 35 ILCS 200/27-5, et seq., or the Special Assessment Law (“SAA”), 65 ILCS 5/9-2-1 et seq. The statutory procedures for SSAs and SAAs vary widely, with one noted difference being the requirement of Court approval for a Special Assessment. However, the preference for assessing properties using either procedure on a “benefits” basis most frequently results in the same net effect to the land owner. A “benefits” based as opposed to an ad valorem based assessment means that identical classes of property owners (i.e. single-family versus multiple-family) are assessed the same amount for the improvements financed by the bonds. This way, the Developer can “spread” one assessment amount on all single-family lots and another assessment on the multiple-family lots, without variation for the value of each individual housing unit.
Communities Utilizing Special Financing
For a municipality, there are several potential benefits to special financing. The municipality is guaranteed that funds are available to construct the public improvements which are ordinarily installed up-front, for the entire development or unit of a development. Bond issuances must exceed a threshhold amount in order to justify the costs associated. Additionally, this type of financing is often accompanied by a separate per unit impact fee or other consideration, like infrastructure improvements, that are over and above what is customarily required from a developer. Municipalities also may take notice that the assessment often results in buyers and therefore the community getting more home than would otherwise be constructed. These inducements, along with the fact that all costs associated are borne by the developer, have resulted in multiple uses of special financing in Chicago and the suburbs. William Blair & Company reports that Special Service Area or Special Assessment Area financing has been utilized in:
- Round Lake
- Wonder Lake
- Pingree Grove
The “public purpose” improvements that are eligible for funding are improvements that have traditionally been deemed as the Developer’s cost of doing business. These include:
- Sanitary sewer mains and plant expansion
- Water mains, wells and storage
- Storm sewers and detention
- Public land
- Curbs & gutters
- Streets & paving
Notice to Prospective Buyers
As mentioned previously, a matter of growing concern is the notice of the assessments, or lack thereof, to prospective owners, many of whom may be first-time home buyers. The following is notice that should be afforded prospective buyers in each respective assessed area and a brief analysis of practical problems that may result from assessments along with some proposed additional disclosures that may help bolster notice to unsophisticated buyers/owners.
Notice in SSA’s
- Initial land owner/developer signs a Declaration of Consent, consenting to the imposition of the special tax which is recorded against the property and, as such, should appear on the title policy.
- The municipal ordinance establishing the SSA must be recorded against the properties located within the SSA boundaries and, as such, will appear on the homeowner’s title policy.
- Most municipalities require the initial homeowner to sign a rider to the sales contract which discloses the special tax allocable to the homeowner’s property. Often the Developer uses the assessment as a marketing tool with the sales pitch that the assessment lowers the purchase price by removing some of the initial development costs and allowing those to be paid over the life of the bonds (most frequently 31 years). This is often times suggested to be akin to a second mortgage.
- The assessment may be included on the previous owner’s tax bill. Counties have discretion as to whether to bill and collect “benefits based” Special Service Areas on the tax bill.
Notice in SAA’s
- Court Order confirming the assessment and Assessment Roll and Report must be recorded against all properties subject to the assessment and, as such, will appear on the title policy.
- Most municipalities require the developer to attach and the initial owner to sign a Rider disclosing the special tax allocable to the property. The same sales approach used in a Special Service Area is applicable in an SAA.
- Assessments may appear on the tax bill, but counties have discretion as to whether to bill and collect special assessments.
As mentioned above, most Developers utilizing this type of financing are in the business of informing buyers of the assessments as part of their sales pitch of more house for less money up-front. It has been pointed out that these disclosures can always be improved upon and municipalities approving bond-financed public improvements are best served by requiring adequate and thorough disclosures.
Secondary transactions, however, pose some potential practical problems that warrant some discussion. These include potential issues associated with the purchase price for the second transaction. While approved contract language may place the burden of an established assessment on the seller, the seller’s ignorance that the entire assessment must be paid off during the contract negotiations and failure to include that amount in the purchase price will result in one unhappy seller. In the era of 100%-financed purchases, the question also arises as to whether the seller will have the funds to pay off the assessment absent some significant appreciation in the property. On a similar note, if the assessment is included in the negotiated purchase price, a question arises as to whether the lender’s appraisal will support the purchase price. Obviously, the loan will fail if the appraiser does not account for the assessment and the appraised value is less than the purchase price.
The shifting of the cost of the assessment to the buyer raises its own set of problems. Does the buyer grasp the significance of the assessment including the amount of the annual payments, interest rate, total amount owed? Has the buyer’s acceptance of the assessment been accurately reflected in the purchase price, i.e. has the price been reduced accordingly, or is the buyer essentially paying twice for value of the improvements? Other potential concerns are whether the buyer understands any pre-payment prohibitions or penalties associated with the assessment? Finally, a question arises as to whether the buyer’s lender will permit the buyer to escrow the assessment along with buyer’s real estate taxes?
One way to help better inform the seller and buyer in this secondary transaction is to require a full disclosure of all assessments in the various approved real estate contracts. The disclosure should require the seller to identify the existence of an assessment, disclose the assessment amount, including the schedule of annual payments, and clearly identify whether seller will pay the assessment or whether the buyer will take title to the property subject to the assessment and assume the annual payments. This will help to eliminate any confusion as to the existence, amount, annual payment and the party ultimately responsible for the assessment. This will also require the parties to fully bargain the impact of the assessment at contract time as opposed to some later and more inappropriate time in the transaction.
Special financing appears that it is not going away as there will always be communities that will deem that the benefits outweigh any potential burdens associated with the assessments. Real estate practitioners need to be aware of the existence of this type of special financing, and with adequate disclosures, all parties to the transaction will at a minimum understand the impact of the assessment.
–Christian G. Spesia
Special mention to Myles Jacobs, Brumund, Jacobs, Hammel & Davidson; Ray Fricke, Ungaretti & Harris; and Peter Raphael, William Blair & Company.