By Harry Allen, Senior Municipal Advisor
and Keith Dahl, Senior Municipal Advisor

Analyzing the Need for Public Assistance in Real Estate Development Projects

Market conditions continue to prompt many developers of multifamily real estate development projects to seek public assistance so they can achieve financial feasibility. At the heart of the issue lies a delicate balance between three core financial components – construction costs, interest rates, and rental rates. Much like a three-pronged stool, these three elements determine the feasibility and profitability of a project. If one leg shifts, the others must adjust to keep the project stable. When the market cannot naturally accommodate these adjustments – and the public entity desires to see the project proceed – public financial assistance may be necessary to fill the gap.

The financial feasibility of rental real estate developments hinge on the relationship and interconnection of the core financial components. Generally, their interplay can be summarized as follows:

• Construction Costs: Heavily influence capital outlay and overall return on investment for a project. Rising construction costs place pressure on project margins which may result in increased rents, pursuing cheaper financing, reducing material quality, value engineering, or possibly increasing density.
• Interest Rates: Significantly impact the cost of financing. Higher interest rates strain debt service coverage ratios, reduce the amount that can be debt financed, and increase the amount of equity.
• Rental Rates: Direct source of revenue for any rental real estate development. Influenced by market demand, location, unit quality, amenities, and competing supply. When rental rates stagnate or increase at a lower rate than construction costs, projects may no longer generate sufficient income to pay for operating expenses, debt service, and provide an acceptable return to investors.

If one or more of these factors move in an unfavorable direction, financial feasibility is jeopardized. Developers may wait for more favorable market conditions, shift their development strategy, or seek public financial assistance to close the gap between what the private market can support and what is needed to move the project forward.

Providers of public assistance must approach these requests with both a high level of scrutiny and strategic vision. Not all projects warrant assistance or the amount of assistance requested, and resources are limited. A structured and rigorous evaluation framework can ensure that public investments are both necessary and aligned with community priorities. The main question that must be addressed is: “What is the minimum amount of assistance required to make the project financially feasible?”

This should be assessed through a transparent financial pro forma analysis. Independent, third-party reviews can validate developer assumptions and confirm if the requested assistance is necessary or excessive. The pro forma analysis typically involves a comprehensive review of several items:

1. Development Costs – Compare to market norms and historical data, as well as identify extraordinary costs that are unique to the site, the project, etc.
2. Available Funding Sources – Debt, equity, grants
3. Financial Structure – Evaluate capital stack, terms, and refinance events
4. Financial Assumptions – Rent growth, inflation, vacancy, interest rates, cap rates
5. Developer Contributions – Cash equity, guarantees, land value
6. Underwritten Rents – Relative to market comparables
7. Operating Expenses – Operating expense ratios, expenses before property taxes, management fees, and reserves, as well as reviewing property taxes, as-if constructed and stabilized
8. Phasing and Timing of Construction – Impact on costs and revenue, as well as estimation of tax increment
9. Projected Cash Flows – From operations with and without public assistance
10. Return on Investment – Assess reasonableness of returns

A recent example where Ehlers conducted a third-party financial review was for Applewood Terrace, a development in Cudahy, Wisconsin, which recently obtained its approvals to break ground later this fall. Once constructed, Applewood Terrace will feature 264 market rate residential units distributed amongst twelve garden-style apartment buildings.  Due to current market conditions and the imbalance of the core financial components caused by construction costs and interest rates, the development was not financially feasible. However, the City viewed development of this approximately 19 acres of tax-exempt land owned by the Cudahy Community Development Authority (CDA) as a priority. Originally, the developer requested a $2 million land write-down and 90% of the annually generated tax increment over 27 years.

Based on the comprehensive review, Ehlers determined the requested structure and amount of public assistance was more than necessary to make Applewood Terrace financially feasible. Following discussions with the city and developer, both parties agreed to tax increment assistance provided over 22 years, repayable from 90% of the annually generated tax increment over the first 10 years and 50% of the annually generated tax increment over the remaining 12 years. In addition, this structure eliminated the need for a land write-down and allowed the CDA to receive $2 million at closing of the land purchase.

Another example, located in Detroit Lakes, Minnesota, where Ehlers completed a comprehensive review was for Highland Lakeview, a 36-unit workforce residential apartment building. The Detroit Lakes Development Authority (Port Authority) has long sought development of this particular property.  Due to rising construction costs and impending tariffs on construction materials, there was an imbalance to the financial feasibility of the project. Therefore, the developer requested $1 million of tax increment financing assistance over nine years.

The Port Authority engaged Ehlers to confirm the amount of public assistance being requested was warranted for the project. Ultimately, through the pro forma analysis, Ehlers concluded the term of assistance was warranted, however, the amount of tax increment was overstated due to the developer overestimating the amount of property taxes and, by extension. the tax increment generated by the project. Following discussions with the Port Authority and developer, both parties agreed to tax increment assistance provided over nine years, repayable from 90% of the annually generated tax increment not to exceed $427,904 in total.

The interplay between construction costs, interest rates, and rental income is foundational to real estate development feasibility. When market conditions create imbalances, public financial assistance can play a crucial role in advancing projects that serve broader community interests. However, such assistance must be prudently underwritten, transparent, and aligned with long-term public goals. By applying a disciplined, outcome-oriented approach, public entities can support development that not only addresses financial gaps but also delivers lasting value to the community.

Required Disclosures: Please Read

Ehlers is the joint marketing name of the following affiliated businesses (collectively, the “Affiliates”): Ehlers & Associates, Inc. (“EA”), a municipal advisor registered with the Municipal Securities Rulemaking Board (“MSRB”) and the Securities and Exchange Commission (“SEC”); Ehlers Investment Partners, LLC (“EIP”), an investment adviser registered with the SEC; and Bond Trust Services Corporation (“BTS”), holder of a limited banking charter issued by the State of Minnesota.

This communication does not constitute an offer or solicitation for the purchase or sale of any investment (including without limitation, any municipal financial product, municipal security, or other security) or agreement with respect to any investment strategy or program. This communication is offered without charge to clients, friends, and prospective clients of the Affiliates as a source of general information about the services Ehlers provides. This communication is neither advice nor a recommendation by any Affiliate to any person with respect to any municipal financial product, municipal security, or other security, as such terms are defined pursuant to Section 15B of the Exchange Act of 1934 and rules of the MSRB. This communication does not constitute investment advice by any Affiliate that purports to meet the objectives or needs of any person pursuant to the Investment Advisers Act of 1940 or applicable state law. In providing this information, The Affiliates are not acting as an advisor to you and do not owe you a fiduciary duty pursuant to Section 15B of the Securities Exchange Act of 1934. You should discuss the information contained herein with any and all internal or external advisors and experts you deem appropriate before acting on the information.