When a town votes to acquire land, the selectmen, town treasurer, finance committee and ultimately the voters must decide upon the appropriate method of payment. Although land bank funds provide a dedicated source of revenue for this purpose, most towns are faced with land costs which significantly exceed their annual land bank receipts. Thus, town financial planners must consider the availability of funds from other sources as well including, but not limited to, borrowing, federal and state grants, and private contributions (for instance, in Falmouth, Wellfleet, Truro and Harwich local land trusts have donated privately raised funds toward the purchase price of a town acquisition).
The best method to pay for a particular land acquisition project will depend upon a host of factors at the time of purchase including cost, the land owner's financial needs, available revenue sources, current interest rates, and the ability to meet legal and other financial obligations. Since land is considered a capital asset, many towns may also want to include proposed acquisitions in their capital improvement plans. For these reasons, land acquisition projects are inherently complex and should routinely involve the services of qualified financial advisors.
Land acquisition programs may be funded annually from land bank receipts and other sources exclusive of borrowing. This strategy, considered fiscally conservative, limits the amount of land acquired to that which can be paid for from available funds. Town Meeting/Council may authorize land purchases from available funds with a simple majority vote.
Towns may decide to use land bank funds alone or in combination with other municipal or outside sources including the state land bank matching funds, grants (Self Help), and private contributions. To stretch available funds, the Land Bank/Open Space Committees may seek to negotiate purchases for less than fair market value, using such techniques as bargain sales and conservation restrictions.
Advantages:
No impact on the town's tax rate or debt service charges. Full amount of land bank funds available for land acquisition; no interest payments. Depending on the market, may preserve future land bank funds for acquisition during periods of declining real estate values.
Disadvantages:
Substantially limits the amount of land that can be purchased in any given year and increases the likelihood that some high priority properties will be lost to development before acquisition by the town is possible. Larger properties may be unaffordable using annual proceeds only, particularly in towns with relatively smaller receipts.
If available funds are insufficient to support land acquisition needs, some form of borrowing may be necessary. Borrowing, whether short-term or long-term, requires a two-thirds vote of Town Meeting/Council. In general, a town borrows by issuing securities (notes or bonds) in exchange for funds received as a loan. Securities are purchased by an underwriter (a bank or securities firm) with the intent of reselling them to investors. The purposes, terms, and procedures for issuing municipal debt are strictly controlled by M.G.L. Chapter 44 which sets limits on the total amount of debt a municipality can incur. The debt limit may not exceed 5% of its total equalized valuation. For most towns, this limit provides more than ample capacity to borrow for normal capital expenses, such as land acquisition, new schools, sewers or other large public projects. A municipality may incur debt outside its debt limit only if it anticipates reimbursement for the same amount within one or two years, depending on the source of anticipated revenue.
How Does Proposition 2 1/2 Affect Borrowing?
Proposition 2 1/2, (MGL Ch. 59, Section 21C) establishes two types of restrictions on the annual real estate tax levy. Communities are prohibited from levying more than 2 1/2 percent of the fair cash value of all taxable real and personal property in the community. This is referred to as the "levy ceiling." Second, the amount that a community's tax levy can increase from year to year is limited to 2 1/2 percent of the previous year's levy, plus an amount derived from the value of new construction and growth. This is called the "levy limit." The law also provides some flexibility for communities to levy more than their limits through debt overrides and exclusions.
If a town cannot absorb the debt service charges within its operating budget and fee revenue is either not available or inappropriate, then the only option is to seek voter approval for a debt exclusion from the annual levy limit. If the exclusion is approved, the debt service is excluded from the limits imposed by Proposition 2 1/2 for the duration of the debt. On the other hand, an override increases a community's levy limit for the fiscal year voted and becomes a part of the base for calculating future year's levy limits. Thus an override allows a permanent increase in the property tax levy (usually sought to increase the operating budget), whereas an exclusion allows a temporary increase to fund the debt service associated with a specific capital project.
Short-term Borrowing
Short-term borrowing is frequently used to finance capital expenditures until market conditions favor long-term bonding or other revenues (such as Land Bank funds or state grants) become available to pay off the loan. Short-term loans, called notes, are typically issued for one year or less. The costs to the town are minimal, since very favorable interest rates (3% or less) are generally available and the debt is only carried for a short period of time. Short-term borrowing provides financial flexibility at relatively low risk. Notes are issued for the following general purposes:
Revenue Anticipation Notes (RANs)
are issued in anticipation of the collection of local revenue, primarily property taxes. The town must have a cash flow which demonstrates a need for borrowing. Initiated by the town treasurer with approval of the Board of Selectmen.
Grant Anticipation Notes (GANs)
are issued in anticipation of the receipt of a state or federal grant. The town must have a grant agreement indicating the state or federal agency's financial commitment. Initiated by the town treasurer with approval of the Board of Selectmen.
Bond Anticipation Notes (BANs)
are issued in anticipation of the receipt of proceeds from the sale of bonds by the town. Prior action by finance committee and town meeting required to authorize loan in conjunction with bond issue.
Advantages:
Short-term notes provide flexibility by allowing quick access to funds at any time during the fiscal year. The ability to access funds is an important consideration for municipalities since property tax revenues (and land bank funds) are only collected periodically and property owners are not always willing to wait to sell their land. RANs are particular useful for financing land acquisition projects prior to the collection of land bank funds.
Disadvantages:
Only leverages funds for short periods of time. Does not substantially increase a community's long-term buying power, thus some properties still at risk. If amount borrowed is large enough, it may require a vote to temporarily exclude the debt from levy limit set by Proposition 2 1/2.
Long-term Borrowing: Municipal Bonds and Bonding
Municipalities may borrow and repay debt over a number of years for projects they cannot afford to pay for out of operating budgets. Long-term borrowing is often viewed as an equitable way to spread out the burden of paying for capital projects that will be enjoyed by future residents. Capital expenditures, including land acquisition, generally have an expected useful life of 20 years or more, although long-term borrowing may be authorized for any period greater than two years. Long-term borrowing must be authorized by a two-thirds vote of Town Meeting/Council.
What is a Bond?
- A bond is an interest-bearing certificate of debt representing the obligation of a government body to repay a certain sum by a specific date. Interest rates are general fixed for the term, or date of maturity of the bond. Bonds are issued by a government to finance long-term projects such as the acquisition of buildings or land, and construction or maintenance of capital facilities.
What Types of Bonds are Used?
- General obligation bonds are the least expensive form of credit available to governments and are used exclusively by Massachusetts towns. They are backed by the "full faith and credit" of the issuing government which is obligated to raise taxes or to take whatever action is necessary to ensure payment.
What is the Debt Service?
- The debt service is the direct cost to the town for borrowing money. It is the total annual principal and interest payment related to a particular bond issue. The amount of the debt service depends upon the value of the bond and the interest rate secured at the time it is issued. Currently, tax-exempt interest rates are at their lowest level in years, with most long-term bonds being issued well below 5%.
In the example below, the total interest payments account for $247,500, or roughly 25% of the total amount borrowed. Thus if this were a land purchase, the cost of borrowing would be the cost of the land ($1,000,000) plus the cost of borrowing ($247,500). In larger bond issues, the debt service can be substantial, especially if the initial interest rates are high. For this reason, financial advisors frequently wait to market large bond issues until favorable conditions prevail.
Debt Service Charges on $1 Million for Ten Years
| Year | Outstanding Principal | Principal Payment | Interest Payment at 4.5% | Total Debt Service |
|---|---|---|---|---|
| 1st | $1,000,000 | $100,000 | $ 45,000 | $145,000 |
| 2nd | $ 900,000 | $ 100,000 | $ 40,500 | $140,500 |
| 3rd | $ 800,000 | $ 100,000 | $ 36,000 | $136,000 |
| 4th | $ 700,000 | $ 100,000 | $ 31,500 | $131,500 |
| 5th | $ 600,000 | $ 100,000 | $ 27,000 | $127,000 |
| 6th | $ 500,000 | $ 100,000 | $ 22,500 | $122,500 |
| 7th | $ 400,000 | $ 100,000 | $ 18,000 | $118,000 |
| 8th | $ 300,000 | $ 100,000 | $ 13,500 | $113,500 |
| 9th | $ 200,000 | $ 100,000 | $ 9,000 | $109,000 |
| 10th | $ 100,000 | $ 100,000 | $ 4,500 | $104,500 |
| Total | -0- | $1,000,000 | $247,500 |
Another factor influencing the cost of municipal bonding is a town's bond rating. Towns are assigned a bond rating that reflects the level of confidence inventors have in their ability to pay back the debt. The higher the bond rating, the lower the interest rate and the higher the ratio of money available for land acquisition (or other capital expenditure) rather than for servicing the debt. One of the factors that investors who assign bond ratings consider is the manner in which a community plans for and manages growth. Open space preservation and conservation are considered sound planning strategies for guiding growth to desirable areas, thus reducing infrastructure needs and contributing to a community's sound financial status.
While interest charges on borrowing account for the majority of the cost associated with issuing bonds, there are other costs to account for as well. Such costs include legal and financial advisory fees, developing the bond prospectus, printing the bonds, and the bond rating report. These costs are typically $4.00-5.00 per $1000 of the bond amount.
Advantages: Allows towns to act immediately to purchase as much open space as possible based on total amount of anticipated revenue from the land bank. Maximizes buying power over shortest period of time, thus reducing risk of losing high priority properties to land development. In the long run, bonding is more cost effective when property values are rising.
Disadvantages: Requires town to carry debt service charges for as long as twenty years. May require authorization to exclude all or a portion of the debt service from levy limit set by Proposition 2 1/2. Adds to total town debt, reducing ability to bond for other municipal needs.
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