How to Analyze Tax Increment Financing (TIF) Projects

A commercial real estate developer identifies a property ideal for its use, but because he can’t find a way to make the project financially feasible, he considers looking elsewhere. The city though wants the developer to undertake the project because it would replace property that generates negative social and economic impacts with a property that offers positive ones. What is a possible solution?

Tax increment financing, or “TIF.”

What is Tax Increment Financing (TIF)?

In its simplest terms, TIF:

(1) redirects the incremental increase in certain tax revenues generated by a redeveloped property from taxing districts to the redeveloper

(2) to cover a portion of the project’s costs

(3) in order to make the project financially feasible.

It is the marriage of private (the developer’s) and public (the taxing districts’) monies to facilitate a project that will benefit both private and public, where the project would not otherwise happen.

TIF revenue is only created if the proposed project will generate an increase in tax revenue over that generated by the existing use (or non-use). For example, where a retail center has lost tenants, whether because of changing demographics, moves to newer centers, or other reasons, the tax revenue generated from this property decreases. A fall in rental income reduces the owner’s ability to maintain and repair the property, its real property value goes down, and real property taxes fall. Likewise, the loss of tenants reduces sales and the consequent sales taxes. Further, fewer tenants results in less taxable personal property and personal property taxes.

When a project will rehabilitate the center (or demolish it and construct a new one) and locate new tenants, real and personal property value, sales, and the related tax revenue, all increase. The difference between the increased taxes resulting from the redevelopment and the taxes generated by the existing property is the “increment” potentially available to incent and facilitate the redevelopment.

How Do Cities and Developers Determine if TIF is Appropriate for a Project?

TIF redirects tax revenue from taxing districts to the redeveloper. Accordingly, as part of a city’s determination as to whether the use of TIF is appropriate, it will consider whether the amount redirected is necessary for the project to move forward, and whether the project benefits outweigh the potential impact to taxing districts. This consideration is accomplished through different financial analyses. This article outlines common analyses, and how to decipher them.

It should be noted that while TIF projects generally create benefits other than just increased tax revenue (e.g., new jobs, elimination of blighting conditions such as crime, impairing potential redevelopment of surrounding properties, etc.), this article examines only the financial analyses.

The statutes governing TIF vary by state. Accordingly, this article uses the general framework of TIF within the State of Missouri, and the analyses often considered by local governing bodies and taxing districts within the State. The principles outlined however are applicable to many other jurisdictions.

The three analyses considered here are (1) TIF revenue projections, (2) tax revenues to the taxing districts with the project and the use of TIF compared to revenues with no project (Tax Impact Analysis), and (3) an analysis to determine if the amount of TIF requested is necessary to make the project financially feasible (this can be referred to as part of a “but for” requirement, i.e., that “but for” the use of TIF, the project would not occur).

TIF Revenue Projections

From the developer’s perspective, the determination of how much TIF revenue is available to offset project costs is paramount. It determines, when coupled with the developer’s private monies, the expected return on its investment. Which incremental tax revenues can be redirected most commonly involve real property taxes. Some jurisdictions also permit TIF to capture taxes from increases to activity with the project, such as sales tax. Other activity taxes may also include an incremental increase to individual and corporate income taxes where the local jurisdiction has imposed them.

The starting point for all projections are the assumptions. Below are typical assumptions pages for real property, sales, and personal property. Although personal property is not captured by TIF in Missouri, because the tax revenues created by new property impacts the taxing districts, its assumptions are included.

Real Property Tax Revenue Assumptions

Tax Increment Financing TIF Real Property Assumptions

In order to determine the incremental increase to real property tax revenue, the developer estimates the fair market value (FMV) of the project when completed, and compares it to the FMV of the current property. The FMV is the estimated price that a buyer would pay to a seller for property in the current marketplace, provided both parties are knowledgeable, willing and not under duress. In this case, the projected FMV is calculated by adding to the purchase price 50% of the redevelopment costs ($10,000,000 + (50% x $7,500,000) = $13,750,000). Simplified valuations like this are not uncommon, though cities and developers may use other agreed upon methods, such as the three appraisal approaches to value (i.e., cost, income and comparable sales).

The existing property’s FMV is taken from the tax rolls ($5,000,000). The governing body and taxing districts may challenge such calculations, or require an appraiser to determine projected and existing FMVs. Of course, all the assumptions noted in these analyses can be a point of contention between the public and private parties.

The FMVs are then converted into assessed values (AV). Assessed value is a property’s dollar value, determined by the local government, which is used to calculate real property taxes. Generally the assessed value is determined by taking the FMV and multiplying it by an assessment rate. These rates may differ by land use (e.g., assessment rates could be 15% of FMV for industrial property, and 10% of FMV for agricultural uses).

Real property values are not static over time, and TIF is captured for a period of years. Accordingly, TIF revenue projections will include inflation factors rates for the new project (2%) and depreciation factors if the new project does not occur (-2%). Guidance on all real and personal property valuation assumptions, including inflation and depreciation factors, is often sought from the local tax assessment department, which will determine valuations for tax purposes.

Lastly, the above assumptions note that 100% of the real property increment will be redirected to offset project costs (“captured” by TIF). Because only the incremental increase is captured, the taxing districts will continue to receive the real property taxes generated by the property’s current use through the term of the TIF.

Sales Tax Revenue Assumptions

Tax Increment Financing Sales Assumptions

As with real property, the sales tax revenue projections must establish starting points for existing and post-redevelopment sales. The above assumptions provide that current sales are $500,000, and the projected sales in Year 1 of the redeveloped project will be $3,000,000. New sales are further projected to grow at an annual rate of 3%. Often construction and tenancy will occur in stages. In such cases, more detailed assumptions will show phased-in sales, and then a fixed growth rate upon completion of the phases.

Because the analysis relating to the impact of the project on taxing districts will compare district revenue with the project and TIF vs. no project, the assumptions estimate that if no redevelopment occurs, sales will decrease by 3% every year. A decrease in sales in a blighted property is often supported through sales tax data for the declining property, and the assumption that this decline will continue absent redevelopment.

In the above, the starting increment is projected at Year 1 new sales of $3,000,000 less existing sales of $500,000 = $2,500,000.

The assumptions further note that only 50% of the incremental increase to sales tax revenue (as opposed to 100% of real property taxes) will be captured by TIF.

Personal Property Tax Revenue Assumptions

Tax Increment Financing Personal Property Assumptions

As with the real property assumptions, FMVs are determined for the existing personal property (Initial FMV $100,000) and completed project ($2,000,000), and then multiplied by the assessment rate for personal property (35%).

These projections assume that all personal property, whether redevelopment occurs or not, will annually depreciate at a rate of 10%. Depending on the new project use, however, this assumption will vary. For example, technology companies may frequently update equipment to keep pace with the industry, meaning that because depreciated personal property is regularly replaced with new property, there is no projected decrease in value (and in some cases, there may even be an increase).

Lastly, these projections state that no part of the personal property increment will be captured by TIF. The taxing districts will retain all revenue.

Taxing District Levy Rates

Tax Increment Financing TIF Impact Analysis Totals

The above detail of taxing district levies stresses the importance of understanding not only which types of tax revenue the districts receive, but also whether under the applicable state law those revenues are subject to TIF capture. For this example five districts were used to illustrate four different revenue treatments.

The City and County can levy real property, personal property and sales, but its personal property taxes are not subject to TIF. The State can levy only sales taxes, but they are not subject to TIF. The School District can levy only real and personal property, and only the real property taxes are subject to TIF. And, lastly, while the Blind Pension District can levy real and personal property, none of its tax revenue is subject to TIF. Understanding how state law treats taxing districts differently is vital to projecting a redevelopment’s potential TIF revenue, and the impact of the project on all districts.

TIF Revenue Projections – Real Property Increment

Tax Increment Financing Real Property Revenue Projections

TIF revenue is captured over a period of years. In Missouri it can be redirected for up to 23 years. For space reasons, this example runs for six. The first two columns pull the existing AV and projected AV of the real property from the assumptions page. The initial value remains constant through the TIF term, and the taxing districts will continue to receive tax revenue based on this assessed value. As the projected property value grows at the assumed rated, the incremental AV grows too. The incremental real property tax revenue is simply the incremental AV multiplied by the total levy rate. In Year 1: $2,625,000 x 6.9% = $181,125.

The annual real property increment is then totaled for the TIF’s term. Many analyses will determine the net present value (NPV) of the TIF revenue stream, as developers may borrow funds secured, in part, by such revenue. In the example, the total gross projected revenue over six years is $4,006,895, and the NPV is $3,429,624.

TIF Revenue Projections – Sales Increment

Tax Increment Financing TIF Sales Tax Revenue Projections

The calculation of incremental sales tax revenue is similar, though it must account for, in the case of this example, the limitation that only 50% of the sales tax increment is captured. The initial (existing) sales are shown in the first column, and remain fixed through the term. Taxing districts will receive all tax revenue calculated on this base. The estimated sales increase annually at the assumed growth rate (3%), resulting in a growing sales increment. The revenue calculation is then the total sales levy subject to TIF capture x incremental sales x 50% (in Year 1: 2.25% x $2,500,00 x 50% = $56,250).

The table then reflects the gross and NPV incremental sales tax revenues available to offset project costs. Adding the real property and sales tax increments estimates the total available TIF funds (gross $5,261,185, NPV $4,502,563).

These revenues will be used in the “but for” analysis to determine if the redevelopment, with the assistance of TIF, is projected to generate an acceptable IRR. Additionally, some municipalities may cap TIF revenue at a certain percentage of total project cost. In this example, total TIF revenue divided by total project costs (TIF $5,261,185 / (purchase price $10,000,000 + redevelopment costs $7,500,000)) means that TIF is available to fund 30% of the project. In all cases, however, TIF revenues must exceed the costs the developer is asking be reimbursed by TIF.

Tax Impact Analysis

The purpose of the tax impact analysis is to quantify the projected impact of a TIF project on all affected taxing districts. This requires looking at each type of tax for each district, with and without the project. It should be noted that this type of analysis does not consider the scenario where redevelopment occurs without TIF, as the presumption is that the developer, and all other developers, would not take on the project without TIF revenues.

No Project – Real Property Tax Revenues

Tax Increment Financing TIF Impact Analysis Real Property

This sheet considers real property taxes in the event the project does not happen. The State is absent from this calculation as it has no real property levy. Based on the assumptions discussed above, it is assumed that absent redevelopment, the property’s FMV will decrease annually. The revenue per year per district is simply the initial AV times the district levy rate (Year 1 for the City: $1,500,000 x 1.3% = $19,500).

No Project – Sales Tax Revenues

Tax Increment Financing TIF Impact Analysis Sales

Similarly, the sales tax revenues projected to the three districts with the authority to tax sales (City, County and State) decrease over the six year period as retail sales decrease in the declining property. Revenue per year per district is projected sales multiplied by district levy rate (Year 1 for the City: $500,000 x 3% = $15,000).

No Project – Personal Property Tax Revenues

Tax Increment Financing TIF Impact Analysis Personal Property

While personal property is not captured by TIF in this example, it is impacted by the project, and thus included in the tax impact analysis. Revenue per year per district equals the personal property AV (decreased annually by 10%) multiplied by the district levy rate (in Year 1 for City, $35,000 x 1.3% = $455).

Project With TIF – Real Property Tax Revenues – Real Property Tax Revenues

Tax Increment Financing TIF Impact Analysys Real Property

The “Project with TIF” pages reflect only those tax revenues received by the districts under TIF, and thus do not include any revenues redirected by TIF. Accordingly, in the case of real property, the above table shows that the City, County and School District receive tax revenues equal to the initial AV multiplied by their respective levies. The AV is held static over the term of the TIF. All revenues generated from the increase in real property value over the initial AV is redirected to the project.

Note that the Blind Pension District revenues increase over the period. This is because this district’s levy, in this example, is not subject to TIF capture. Thus, its revenue is equal to the actual real property AV, growing each year, times its levy rate.

Project With TIF – Sales Tax Revenues

Tax Increment Financing TIF Impact Analysis Sales

In this example, 50% of the incremental increase in sales taxes is redirected to TIF. Accordingly, the two districts subject to TIF capture, the City and County, receive 100% of their levy against the initial sales, plus 50% of the increase from this initial amount. The calculation in Year 1 for the City is (initial sales x City tax rate) + (sales increment x City tax rate x 50%) = ($500,000 x 3%) + ($3,000,000 x 3% x 50%) = $52,500.

Note that the State, because its levy is not subject to TIF, receives 100% of its levy against 100% of the projected sales. In Year 1, the State sales tax revenue equals $3,000,000 x 3% = $90,000.

Project With TIF – Personal Property Tax Revenues

Tax Increment Financing TIF Impact Analysis Personal Property

The calculation for personal property tax revenue with TIF is the same as without TIF. In either case, personal property tax revenue is not captured by TIF. However, because the redevelopment assumes that it will include an increased amount of personal property, the related tax revenues to the districts have increased in the With Project calculation.

Tax Impact Analysis – Totals

Tax Increment Financing TIF Impact Analysis Totals

Totaling the above tables by district and tax type, this table details the increase in tax revenues to the affected districts projected to occur as a result of the project with the use of TIF.

“But For” Feasibility Analysis

Tax Increment Financing TIF IRR

A common method to determine whether the use of TIF is necessary for a project’s financial feasibility is through an analysis of internal rates of return (IRR) with and without the use of TIF. Above is a simplified pro forma and unleveraged IRR calculation using the TIF revenues projected above.

The reasonableness of the proforma assumptions is a large part of examining the reasonableness of this analysis. Was the cap rate of the proposed purchase reasonable (10%)? What about the projected cap rate for the reversion calculation (6%)? Rent, vacancy and rent escalation rates? Operating costs? Whether the “Without TIF” IRR is insufficient to incent a private developer to make the investment given the risk of redevelopment (7.14%)? Is the “With TIF” sufficient to incent the investment (13.51%)?

A common method to answer these assumption questions is to look for guidance from third party consultants engaged by the city, the developer, or both. Additionally, for assumptions relating to the valuation of the property for tax purposes, many will look to the local assessment department.

The above analysis begins with a calculation of net operating income (NOI) over the term of the TIF. In order to calculate the IRR, it sets the developer’s initial outlay ($17,500,000) and the projected TIF revenue ($4,502,563) available to offset the developer’s cost. The analysis projects that the gross reversion proceeds ($19,414,965 = Year 6 NOI $1,164,898 / cap rate 6%), less a selling expense of 4%, results in net reversion proceeds of $18,638,366.

The “With” and “Without” TIF IRR calculations are identical except for the initial developer expense. Without TIF utilizes the full project cost ($10,000,000 purchase price + redevelopment costs $7,500,000), and for With TIF, this amount is reduced by the NPV of TIF revenues ($4,502,563). The resulting IRRs are then compared against industry benchmarks and comparable projects to determine (1) if the developer would pursue the project without TIF (is 7.14% worth the risk?), and (2) if the amount of TIF revenue being redirected to the developer is too great (e.g., if 13.51% is unreasonably high in this market, then TIF revenues should be limited).

Consideration as to whether the IRRs do or do not reflect acceptable levels of return to the developer may consider factors like the nature of the project (e.g., including the life cycle of the property, local market conditions such as new development, major employers and their plan, and demographics), the overall risk associated with the property, inflation expectations, and other factors.

A Common Misconception Relating to TIF Analyses

A common challenge to TIF is that the taxing districts will lose tax revenues. The misconception is that if there was no redirection of taxes, the revenues to the districts would be greater because property values and sales would increase. The problem, however, is in the premise that there is the potential for the project occurring without the use of TIF. As discussed above, TIF is generally not available unless the developer can establish that the project is not feasible, and would not happen in the absence of TIF assistance.

Taxing districts can, nonetheless, challenge this assertion through a critique of the “but for” analyses provided (e.g., the IRR analysis above). Additionally, parties can consider how long the property has been on the market, and surrounding properties, to weigh the likelihood of its future development without TIF.

The district’s concerns should also take into account how the TIF is calculated to determine if a reduction in non-captured tax revenue is projected to occur. This of course varies by state, but in the example above, because the districts will continue to receive taxes based on the existing assessed value of the real property during the term of the TIF, and because the projections assume that the property, if not redeveloped, will continue to decrease in value, the taxing districts will actually receive greater real property tax revenue with TIF. Similarly, those taxing districts with the right to tax sales, will receive an increase in revenue owing to the increase in taxable sales if the project occurs, even though 50% of the sales tax increment will be redirected to the project.

Can the Analyses be Manipulated?

This article raises the question, “can developers or cities manipulate the analyses to reach the conclusion they desire?” While it is possible to change the method of each analysis (e.g., change the holding period in the Feasibility Analysis to return different IRRs), because many local governments tend to require similar formats for the analyses (e.g., in Kansas City, most TIF applications provide a Feasibility Analysis covering a 10-year period), such manipulation is less common.

However, results for each analysis can be changed fairly significantly by changes to the assumptions. Attached are the Excel sheets used for this article. Make a change to any of the assumptions and see what happens to the results.

Download TIF Excel Analysis

Fill out the quick form below and we'll email you the Tax Increment Financing (TIF) Analysis Excel worksheet used in this article.

For example, if the post-redevelopment FMV is changed from $13,750,000 to $18,000,000, the available TIF revenue increases from $5,261,185 to $7,171,489, and the “With TIF” IRR rises from 13.51% to 16.58%. Or, if the cap rate for reversion calculation is changed from 6% to 8%, the “With TIF” IRR drops from 13.51% to 9.37%. And these are only two of many of assumptions (e.g., redevelopment costs, calculation of real and personal property FMV, real and personal property and sales inflation and deflation rates, projected sales, NPV rate, projected project income (and all the assumptions within projected income and expenses like rent rate, vacancy rate, CAM charges, insurance costs, management fees, etc.), selling expenses, cap rates, etc.

Accordingly, any party interested in understanding or challenging a TIF analysis may want to focus their attention on the reasonableness of assumptions. For this very reason, of course, developers and cities will look to third-party consultants to provide supportable assumptions.


We’ve discussed common projections and analyses used to determine whether tax increment financing is appropriate, as well as underlying assumptions and how to determine if they’re reasonable. Given that TIF law varies by state, it’s best to consult with an experienced public incentives attorney if you are dealing with TIF. Have you ever prepared, reviewed or challenged any of these analyses? Let us know in the comments below!

How The Equity Multiple Works In Commercial Real Estate

The equity multiple is a commonly used performance metric in commercial real estate, and yet it’s not widely understood. In this short article we’ll take a look at the equity multiple as it’s used in commercial real estate and we’ll also walk through several examples step-by-step.

What Is The Equity Multiple?

First of all, what exactly is the equity multiple? In commercial real estate, the equity multiple is defined as the total cash distributions received from an investment, divided by the total equity invested. Here is the equity multiple formula:

Equity Multiple

For example, if the total equity invested into a project was $1,000,000 and all cash distributions received from the project totaled $2,500,000, then the equity multiple would be $2,500,000 / $1,000,000, or 2.50x.

What does the equity multiple mean? An equity multiple less than 1.0x means you are getting back less cash than you invested. An equity multiple greater than 1.0x means you are getting back more cash than you invested. In our example above, an equity multiple of 2.50x simply means that for every $1 invested into the project, an investor is expected to get back $2.50 (including the initial $1 investment).

What’s a good equity multiple?  As always, this depends. Context is required in order to determine what a “good” equity multiple means. Typically, the equity multiple is most relevant when compared with other similar investments.

Equity Multiple Proforma Example

Let’s take a look at an example of how to use the equity multiple in a commercial real estate analysis. Suppose we have an acquisition that requires $4,300,000 in equity and we expect the following proforma cash flows:

equity multiple real estate example

If we add up all of the before tax cash flows in the proforma above, then we’ll end up with total profits of $9,415,728. This results in a calculated equity multiple of $9,415,728/$4,300,000, or 2.19x.

What does a 2.19x equity multiple mean? This simply means that for every $1 invested into this project an investor is expected to get back $2.19 (including the initial $1 investment).

Is 2.19x a good equity multiple? As mentioned earlier, the fact that it’s higher than 1.0x means the investor is getting back more money than initially invested. However, the equity multiple alone doesn’t say anything about the timing because the equity multiple ignores the time value of money. In other words, a 2.19x equity multiple is much better if the holding period is 1 year versus 100 years. This is why the equity multiple is most relevant when compared to equity multiples of other similar investments.

Equity Multiple vs IRR

What’s the difference between the equity multiple and the internal rate of return? This is a common question since the equity multiple is often reported along with the IRR.

The major difference between the IRR and the equity multiple is that they measure two different things. The IRR measures the percentage rate earn on each dollar invested for each period it is invested. The equity multiple measures how much cash an investor will get back from a deal. The reason why these two indicators are often reported together is because they complement each other. The IRR takes into account the time value of money while the equity multiple does not. On the other hand, the equity multiple describes the total cash an investment will return while the IRR does not. Let’s take a look at an example of how these two measures can be used together.

The equity multiple is a performance metric that helps put the IRR into perspective by sizing up the return in absolute terms. The equity multiple does this by describing how much cash an investment will return over the entire holding period. Suppose we have two potential investments with the following cash flows:

Equity Multiple vs IRR

As you can see, the first investment produces a 16.15% IRR while the second investment only produces a 15.56% IRR. If we were using the IRR alone then the choice would be clearly be the first set of cash flows. However, the IRR isn’t a silver bullet and doesn’t always tell the full story. This can be seen by looking at the equity multiple for both investment options. Although the second potential investment has a lower IRR, it has a higher equity multiple. This means that despite a lower IRR, investment #2 returns more cash back to the investor over the same holding period.

Of course there are other factors to consider. For example, Investment #1 returns $50,000 at the end of year 1 whereas with Investment #2 you have to wait for 4 years to get $50,000 of cash flow. Depending on the context of these deals, this may or may not be acceptable. For example, if you plan on putting all of the cash flow from Investment #1 into a checking account earning next to nothing, then perhaps Investment #2 would make more sense since your cash will be invested longer. On the other hand, perhaps the cash flows from Investment #2 are more uncertain and you’d prefer the peace of mind that comes with getting half of your investment back in Year 1 with Investment #1.

These are issues that would be addressed in a full investment underwriting and there are also several other metrics and qualitative factors that could be considered. With that said, the equity multiple allows you to quickly understand how much cash a project will return to the investors, relative to the initial investment. It also adds some additional context to the IRR when looking at a set of cash flows to help you quickly size up an investment’s absolute return potential.


The equity multiple is commonly used in commercial real estate investment analysis. In this article we defined the equity multiple, discussed what it means, and the walked through an example step by step. We also compared the equity multiple to the internal rate of return since these two metrics are commonly reported side by side. We showed an example of how the equity multiple can add some context to the IRR by indicating an investment’s absolute return potential.

How The Mortgage Constant Works In Real Estate Finance

The mortgage constant, also known as the loan constant, is an important concept to understand in commercial real estate finance. Yet, it’s commonly misunderstood. In this article we’ll take a closer look at the mortgage constant, discuss how it can be used, and then tie it all together with a relevant example.

What is The Mortgage Constant?

First of all, what exactly is the mortgage constant? The mortgage constant, also known as the loan constant, is defined as annual debt service divided by the original loan amount. Here is the formula for the mortgage constant:

Mortgage Constant Formula

In other words, the mortgage constant is the annual debt service amount per dollar of loan, and it includes both principal and interest payments.

How to Calculate the Mortgage Constant

There are two commonly used methods to calculate the mortgage constant. The first simply divides annual debt service by the total loan amount. The second allows you to calculate the mortgage constant for any loan amount by solving for the payment based on a loan amount of $1. Let’s take a look at both methods.

Suppose we have a $1,000,000 loan based on a 6% interest rate and a 20 year amortization. With this information you can simply find the annual debt service using the above assumptions, then divide the annual debt service by the loan amount. On our financial calculator, if we plug in 240 months for N, -$1,000,000 for PV, .50% for I (6%/12), and 0 for FV, then we can solve for the monthly payment. To convert this to an annual payment amount we simply multiply by 12.

mortgage constant calculation

Since the mortgage constant is simply the ratio of annual debt service to the total loan amount, this calculation is just simple division. In this case we take $85,972 / $1,000,000 to get a mortgage constant of 0.085972. As a percentage this would be 8.5972%.

The method above works if you already know the loan amount, but what if you want to find the mortgage constant for any loan amount? If you only know the amortization period and the interest rate, then you can easily solve for the mortgage constant. This is accomplished by plugging this information in on a financial calculator, while using $1 as the present value. For example, consider the same loan terms above of a 20 year amortization (240 months) and a 6% interest rate (0.50% per month). Since we don’t know what the loan amount is (present value), we can simply use $1 as the present value:

Mortgage Constant Calculation 2

When we solve for payment we get 0.007164. Since this is a monthly payment we can multiply by 12 to get an annual mortgage constant of .085972. Notice this is the same 8.5972% mortgage constant we found above. Two different approaches that will result in the same result.

Mortgage Constant Example: Band of Investment

Once you have calculated the mortgage constant, it can be used in a variety of ways. Let’s take a look at a mortgage constant example that uses the band of investment approach to calculate the cap rate, which is commonly used by appraisers.

The band of investment method is a popular appraisal approach to deriving a market based cap rate. It’s frequently used by appraisers to support a market cap rate used in the income approach to valuation. The band of investment method is simply a weighted average of the returns to both debt and equity. These returns can be found by surveying lenders to find out their typical loan terms for a particular property, and also surveying investors to find out their required cash on cash returns for a particular property. Let’s take a look at how the mortgage constant is used with the band of investment.

Suppose we want to find an appropriate cap rate to value an office property in Orlando, FL. First, we can call around to several lenders in the area and ask them what their current loan terms are for this kind of property. If lenders are currently underwriting office properties at a 75% loan to value, with a 25 years amortization, and a 5% interest rate, then we can calculate the mortgage constant using one of the methods above. When we do this the resulting annual mortgage constant is 0.07015.

Next, we can survey local investors to see what their required cash on cash return would be in order to invest in a property like ours. Suppose our investor survey reveals an average 11% cash on cash return requirement. Now we can use these debt and equity returns to estimate a market based cap rate using the band of investment method.

To do this we simply take a weighted average of the two rates of returns to get 8.01%. This is found by taking the mortgage constant times the LTV ratio, then adding this result to the cash on cash return times 1 minus the LTV ratio: (7.015% x .75) + (11% x .25) = 8.01%.

Of course there are pros and cons to using the band of investment method to estimate a market based cap rate, but it’s frequently used in the commercial real estate industry and the mortgage constant is a critical component.


The mortgage constant, sometimes called the loan constant, is a commonly used calculation in real estate finance. In this article we defined the mortgage constant, discussed two common approaches to calculating the mortgage constant, and then we showed how the mortgage constant is used with the band of investment approach to calculating the cap rate.


Mezzanine Financing Basics and The Intercreditor Agreement

Financing short falls within the commercial real estate market have become a common occurrence. The great recession has made traditional lenders more sensitive to risk, frequently leaving developers and project investors with large financing shortfalls. Sponsors can seek out family and friends financing or a larger joint venture (JV) equity injection, but sometimes this gap may be too large to overcome through traditional methods of financing. Mezzanine financing is designed to fill this gap.  In this article we’ll give you a broad overview of mezzanine financing, common mezzanine loan structures, and we’ll also cover the importance of an intercreditor agreement.

What is Mezzanine Financing?

First of all, what exactly is a mezzanine (mezz) loan? Mezzanine financing is a unique financing instrument which doesn’t cleanly fall into a specific category of the capital markets financing quadrant. It’s a general term that refers to any financing vehicle (debt or equity but typically issued by private sector participants) that bridges the gap between senior debt and sponsor equity. It can be structured as preferred equity or as debt.

mezzanine financing

In general, traditional mezzanine financiers are not entitled to receive returns on their investments until senior debt holders are fully compensated.   Because of its subordinate position, the mezzanine loan assumes a higher risk profile than senior debt but retains a less risky position than preferred equity. With this understanding, Mezzanine debt investors seek returns between senior debt lenders and preferred equity investors but this will largely depend on how the deal is structured.

mezzanine financing capital stack

Basic Mezzanine Financing Structure

Mezzanine deals that are structured as debt instruments usually have one of the following forms of collateral:

  • Second deed of trust – This is the most desirable form of collateral to the mezzanine lender because it provides the most tangible form of security. It allows the mezzanine lender to foreclose on the property if the borrower defaults on payments. This type of security is rare since the first mortgage lender typically does not allow this type of arrangement.
  • Assignment of partnership interest – This is the most common form of debt security in the mezzanine finance universe. An assignment of partnership interest gives the mezzanine investor the option to take the borrower’s ownership interest in the property in the event of default. Effectively the mezzanine lender becomes the equity owner and assumes the obligations to the first mortgage lender. This type of arrangement is supported by an intercreditor agreement with first mortgage lender. This intercreditor agreement is discussed in detail below.
  • Cash flow note – This gives the mezzanine lender an assignment of all cash flow from the property in exchange for the mezzanine loan proceeds as well as a percentage of the proceeds from sale of the property. The cash flow note is not a recorded instrument and typically does not need an intercreditor agreement. This is also sometimes called a soft second.

Deals structured as equity have a different set of characteristics. Equity deals are joint ventures between the equity/owner and the mezzanine lender that are guided by the partnership agreements. Major provisions in the partnership agreements cover decision-making authority and specify decisions that require approval from the mezzanine partner. In the event of default with respect to the mezzanine loan, the mezzanine provider may foreclose on the pledged equity interests, not on the underlining property itself, and become the owner of the equity interests in the property-owning entity. Therefore, the owner/sponsor has significantly less control over the project and may lose all control if the property does not perform as expected. These rules are typically enforced by Uniform Commercial Code (UCC) article 9.

With mezzanine financing, owners sacrifice flexibility, control, and upside potential, and will ultimately pay a higher price for the capital. However, in return, owners won’t be required to contribute as much cash and they also gain a partner who might step in to help if the property starts to falter. What actually determines what a mezzanine provider will and will not do in a default scenario is dictated by the intercreditor agreement, a key link between the senior debt lender and the mezzanine financing provider.

Mezzanine Financing and The Intercreditor Agreement

The intercreditor agreement is negotiated by the first mortgage lender and the mezzanine provider. The purpose of the intercreditor agreement is to outline communication channels and provide guidance between the first mortgage lender and the mezzanine investor. More importantly, the agreement gives certain rights to the mezzanine financing provider in the event of a borrower default.

Many first mortgage lenders, mainly conduit lenders, refuse to negotiate intercreditor agreements, especially if the loan has already closed. In fact, conduit loan documentation routinely prohibits selling or transferring more than 49% equity ownership in the property to a partner. Some non-conduit lenders take the attitude that their interests are already covered in the agreement with the borrower and there is no need to complicate matters by bringing in an additional financial partner with different and potentially conflicting objectives.

Other lenders see value in what mezzanine financing providers can bring to the deal. The additional capital can allow the borrowers to purchase the desired property, pay leasing commissions, tenant improvements and pursue other value-adding strategies. In this case, and especially when the mezzanine financing provider is an experienced real estate investor, the first mortgage lender will often welcome their participation. The depth of experience of a reputable mezzanine financing provider can be advantageous for senior lenders, especially if the borrower defaults.

According to David E. Watkins of Heitman Real Estate Investment Management in Chicago, the mezzanine financing provider typically negotiates for several elements in the intercreditor agreement. The big three are listed below:

  • Notification of non-payment or default on the first mortgage. The mezzanine lender wants to know, from someone other than the owner, that the property is being managed professionally.
  • The right to cure any default on the first mortgage. The mezzanine position wants to protect itself by taking over the property and not allowing the first mortgage to foreclose and take possession.
  • The right to foreclose on the property if the owner fails to pay the mezzanine position. First lenders rarely agree to this clause, as a building that is in foreclosure creates uncertainty among existing tenants (who might elect not to pay rent) and prospective tenants (who might view the property as tainted and unstable).

Mezzanine Financing Example Structure

What makes the intercreditor agreement unique is how the instrument secures the mezzanine investor’s interest. It’s common that the agreement secures a 100% interest in the company which owns the underlying property through a bankruptcy remote “special purpose entity”  holding company. This entity will be loaded with special covenants and restrictions and would be structured to ensure the borrower is limited in its ability to file for bankruptcy. An independent director may be appointed as well in order for the special purpose entity to maintain neutrality. The diagram below illustrates what this hypothetical structure might look like:

mezzanine financing intercreditor agreement


As shown above, Plaza Building Holdings LLC is the special purpose entity which secures a 100% interest against the borrower, Plaza Building LLC.  Plaza Building LLC holds the ownership interest in the subject property. The borrower will then make payments to both the mortgage lender and the mezzanine financing provider.


Mezzanine financing can provide borrowers the necessary financing to get a deal done, but it doesn’t come without risk. If a project experiences cash flow shortfalls or otherwise gets stuck in a down market, sponsors/owners will have less control and flexibility in the deal. This article outlined mezzanine financing basics and also covered the importance of the intercreditor agreement.

U.S. Employment Growth Trends by State – December 2012

Here is the December 2012 edition of our employment growth trends data. If you’d like to access more data like this, complete with interactive charts and graphs for every state, MSA, and county in the United States, sign up now for a free trial.


When Will Commercial Real Estate Fully Recover?

The recession officially ended back in 2009 and the economy has been growing ever since, yet it still feels like a recession to most people.  Why is this and how long will it take to get back to normal?  More importantly, what does this mean for commercial real estate? 

First, let’s take a look at the dent made by the 2008 recession. Employment peaked in December 2007 and bottomed out in February 2010, eight months after the recession was officially over.  


Progress is being made and we’ve added back about half of all jobs lost.  If employment growth continues at its current pace, then it will take another 40 months to regain all of the jobs lost since the start of the recession. That would take us out to about 2016, assuming that we don’t have another recession before then, which would result in additional job losses.

However, this doesn’t take into account population growth.  The above analysis shows that it will take at least 4 more years to get back the number of jobs we had in 2007, but since our population continues to increase every year, the hole we have to climb out of keeps getting bigger.  As shown below, the employment-to-population ratio appears to have bottomed out, but it hasn’t started growing quite yet.  This will likely extend out the 4+ years required for a full jobs recovery by several more years.


This is also reflected in the labor participation rate, which has been in a free-fall since the official end of the recession.


And of course while we are slowly adding jobs, the above charts don’t show the kinds of jobs being created, the median wages being accepted, or how many people are underemployed, which we’ll dive into in a future post.

But what does all this mean for commercial real estate?  The CCIM Institute has a nice demand cycle flow chart that illustrates how employment drives demand for commercial real estate. As shown below, demand for commercial real estate is directly or indirectly driven by employment growth.  


Employment growth drives population growth and disposable income.  Office and industrial demand is driven by employment growth. Industrial, residential, and hospitality demand is driven by population growth. And hospitality and retail demand is driven by disposable income.

Since it will take at least 4 more years to get back to the level of employment we had in 2007, it stands to reason that it will take at least as long for commercial real estate demand and construction to recover as well, based on the above demand cycle.  Dr. Glenn Mueller’s latest Cycle Monitor Report tracks where each asset class is in the market cycle and confirms that all property types are indeed still in the recovery phase or just entering the expansion phase.  


In future posts we’ll continue to track employment growth and the cycle locations of various property types. Of course, this analysis is at an aggregate level for the entire U.S. and growth in local markets is uneven.  Our market analysis tools allow you to see exactly where individual states, MSAs, and counties are at in the employment cycle and exactly how fast they are growing. We also publish rankings of local areas each month so you can track all U.S. markets in real-time. Later in this series we’ll dig into specific local markets to see how they are doing relative to the U.S. If you want to keep up be sure to subscribe to our mailing list on the top right hand side of this page.

Debate: Gary Shilling vs Mark Kiesel – Will Home Prices Fall Another 20%?

There’s an interesting video debate between Mark Kiesel and Gary Shilling on the direction of home prices in the United States. Gary Shilling argues that another 20% decline is coming, while Mark Kiesel contends that housing has bottomed and it’s now time to buy. Both of these analysts warned about the bubble as far back as 2004 which makes this an interesting debate.

For a bit of background, Mark Kiesel is a PIMCO portfolio manager who sold his home in 2004 and rented because he saw the bubble coming. And Gary Shilling is a popular economic forecaster who saw the housing bubble before it burst and has recently been talking about why he thinks another 20% decline is coming.

Gary Shilling’s argument:

  • There are 2 million excess units in inventory over and above normal working levels.
  • We built about 1.5 million units per year back in normal times, so 2 million is an enormous number.
  • The robo-signing fiasco is over and therefore banks will start foreclosing again.
  • NAR says that when foreclosures are sold they are sold at a 19% discount.
  • Another 20% decline is required to get back to long-term trend in terms of median prices

Mark’s counter-argument: 

  • There are currently 2.5 million homes in existing inventory, down in the last 7 years from 4 million.
  • There are only 144,000 new homes for sale, which is at a 49 year low. 
  • Existing inventory is at a 7 year low.
  • There were 3.9 million 90+ days delinquent 2 years ago, and today it’s at 2.9 million. 
  • So, no matter what inventories you look at, they are all coming down.

Shilling’s response:

  • Yes, inventories are coming down but they are still huge.
  • When you count in the shadow inventory you’re still over 2 million above a normal working levels.

Mark’s response:

  • Housing is regional.
  • The implied rental yields are 5-12% in some markets and therefore this inventory will get absorbed pretty quickly by investors.
  • We’ve added 2 million jobs in the private sector over the past 2 years. Energy, technology, autos, and manufacturing are all doing well.
  • Some housing markets have shortages and most foreclosures are concentrated in two markets, Florida and Arizona. 
  • Again, housing is regional.


  • People used to say that the real estate bubble was local and concentrated in sub-prime or particular regions. 
  • They said the problems were only concentrated in Arizona, Florida, etc.
  • To say there are a lot of shortages here and there is begging the question. Overall there is still a lot of inventory.

Final points:

Mark: We aren’t in a recession anymore, job growth is occurring in many markets, banks are gradually willing to lend, and the fed is pursuing a reflation policy. Therefore you want to own a hard asset like real estate.

Gary: It would still take a 22% decline to get housing back to it’s long term average identified by Bob Shiller.

August 2012 Employment Growth Rates by State

Here’s a table from our database showing total non-farm employment growth for all 50 states in the US, as well as the District of Columbia. Growth rates are in descending order by year-over-year growth, and the table also includes growth rates for the past month, as well as 3 and 5 year periods. For comparison the growth rates for the entire US were 0.07%, 1.37%, 2.59%, and -3.15%, respectively. How’s your state doing?

State Last Month Growth Year Over Year Growth 3 Year Growth 5 Year Growth
North Dakota 0.40% 6.75% 15.31% 17.89%
Oklahoma 0.65% 2.90% 4.38% 1.49%
Texas 0.35% 2.45% 6.05% 3.98%
Hawaii 0.69% 2.40% 2.69% -3.37%
Indiana 0.18% 2.29% 4.57% -3.01%
Arizona 0.08% 2.27% 2.32% -8.17%
Louisiana 0.12% 2.22% 2.78% 1.50%
Kentucky 0.14% 2.15% 4.02% -1.70%
California 0.08% 2.13% 2.95% -5.64%
Wyoming 0.45% 2.03% 3.36% 1.00%
Ohio -0.04% 1.93% 3.16% -4.33%
Utah 0.32% 1.81% 4.85% -1.64%
Idaho 0.64% 1.62% 2.07% -6.12%
Washington -0.31% 1.53% 2.54% -2.36%
Colorado 0.00% 1.47% 3.03% -1.77%
Oregon 0.54% 1.44% 2.73% -5.17%
New York 0.09% 1.40% 3.10% 0.94%
New Jersey 0.14% 1.33% 0.93% -4.22%
Montana 0.44% 1.31% 0.96% -2.67%
Georgia 0.09% 1.30% 2.41% -5.07%
Massachusetts -0.15% 1.26% 2.49% -1.24%
Nebraska -0.17% 1.25% 1.32% -0.57%
Vermont -0.79% 1.24% 2.26% -1.69%
District of Columbia -1.52% 1.20% 3.74% 5.27%
Michigan -0.17% 1.16% 4.02% -6.41%
Kansas 0.15% 1.08% 1.47% -2.44%
Florida 0.32% 1.07% 2.21% -8.22%
Maryland 0.05% 0.94% 2.29% -1.55%
Tennessee -0.19% 0.93% 3.36% -4.32%
Arkansas 0.22% 0.92% 0.76% -3.06%
Minnesota -0.07% 0.84% 2.62% -2.39%
Virginia -0.33% 0.84% 2.43% -1.25%
Iowa -0.03% 0.78% 1.23% -1.79%
South Carolina -0.32% 0.76% 2.36% -5.27%
North Carolina 0.03% 0.71% 1.87% -4.89%
Illinois 0.17% 0.69% 1.72% -4.68%
Alabama 0.15% 0.61% 0.13% -6.48%
South Dakota -0.37% 0.59% 1.64% 0.17%
Nevada -0.09% 0.46% -0.17% -12.30%
Alaska 0.52% 0.40% 3.03% 3.87%
Missouri 0.68% 0.30% -0.29% -4.94%
Pennsylvania -0.02% 0.27% 2.20% -1.67%
Connecticut -0.42% 0.07% 0.72% -4.47%
New Hampshire -0.10% -0.06% 0.32% -3.36%
Delaware -0.48% -0.10% 0.39% -5.42%
Wisconsin 0.29% -0.16% 0.24% -5.49%
Maine -0.32% -0.20% -0.47% -4.29%
Mississippi -0.17% -0.39% -0.75% -6.27%
Rhode Island 0.24% -0.61% -0.04% -7.23%
West Virginia -0.31% -0.70% 1.28% -1.11%
New Mexico -0.74% -1.65% -2.11% -6.17%

U.S. Employment Growth Trends by State

We’ve created an interesting infographic (click to enlarge) from our database showing employment growth trends for all U.S. states.  If you’d like to dig into this data in more detail with interactive charts and graphs, request an invite.


PropertyMetrics Company Blog

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We’ll be posting updates on this blog as we progress, and we’ll also be sharing our thoughts on commercial real estate investment, finance, banking, economics, technology, and more.