The policy of the local government establishes certain requirements of a developer who wishes to form a CFD that are aimed at protecting the City in the event of property owner’s default on their property tax payments which are used to pay off the bonds issued pursuant to the CFD. The risk of default is generally considered to be greater in the case of undeveloped (vacant) parcels than in the case of improved or developed parcels.
The increased risk stems from the ratio of the value of the underlying property being assessed to the amount of outstanding debt, and therefore in the likelihood that a foreclosure on the property will generate sufficient revenues to pay off any outstanding debt. In addition, developed CFD’s are typically assessed across numerous property owners, thereby allowing for a diversification which reduces the risk associated with any one property owner’s defaulting on payments. In cases where the CFD covers vacant parcels, it is typical that as little as one property owner is responsible for the debt payments and therefore represents increased risk of default.
Usually, most Cities require as a condition of approval that the developer provide sufficient funds to cover the maximum tax liability on undeveloped parcels for three years, through a combination of debt service reserves, escrow deposit, letter of credit (LOC), or other security in cases when certain value to debt ratios are exceeded, as evidenced through appraisal and or sale of the undeveloped parcels within the CFD.