Lending practices drastically changed in 2008 after the real estate bubble burst with the tightening of federal banking regulations almost assuring that commercial banks would be far more risk averse. Who could blame them with increased federal underwriting standards forcing changes to such things as loan to value ratio parameters. In short, many traditional commercial lending institutions found themselves unwilling or unable to take on the construction risk of new projects due to increased regulations.
In general, banks have increased scrutiny of commercial or industrial leases as well as potential tenants before extending credit to the developer. Coupled with a weak economic recovery, significant leverage was shifted to tenants due to oversupply and reduced demand. With increased pressure, where are businesses and developers turning for help? The answer is simple – communities.
Businesses and/or developers are looking to the public sector to take on a larger role for their projects through substitution of public subsidies for owner equity; provision of credit through special assessments; and, assumption of risk through publicly issued debt backed by general obligation guarantees.
As communities are asked to take on larger roles in securing new investment, including acting as angel investors, a key change in the delivery of economic development services will be the community’s need to develop its own team to evaluate future opportunities. As part of the process, communities should start with asking key questions about each request for public assistance or incentives. Is this something our community really needs? Is this project feasible? Will our community benefit from this project? Is an incentive or subsidy needed for this project? Who are these guys? Will the business or developer do what it says it will? Though not every question will be required for each project considered, understanding the various components of a project is critical in evaluating what level, if any, a community should invest.
A recent default by a company and community on bonds backed by the community in Missouri led the Missouri legislature to consider legislation creating greater due diligence standards. Although not yet passed, the new legislation would have created a rating system for projects and requiring background checks of key company officials. While nothing similar is being proposed for Indiana, putting in place a good due diligence process helps to remove risk for the community.
(Based on a presentation given by Greg Wathen during the Indiana Economic Development Association Fall Conference on September 14, 2012)
We could have used some due diligence during that Earthcare Energy scam and with the Whirlpool incentives that are now up in smoke.
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