What are Community Facilities Districts?
Community Facilities Districts (“CFDs”), also known as Mello-Roos Districts, are special tax districts that were created in 1982 through the Mello-Roos Community Facilities Act of 1982 as a means of obtaining additional public funding and financing for various services and infrastructural improvements in California by imposing special taxes on property. In bonded CFDs, improvements are funded through the sale of land-secured municipal bonds. Property owners within the district boundaries pay an annual special tax until the debt service on the bonds is completely paid off over a designated period.
CFDs were created by and named after Senator Henry Mello and Assemblyman Mike Roos, who authored the legislation, in response to Prop 13, which limited local government entities and special districts from being able to access certain funding opportunities for new facilities. Prop 13 restricted property taxes to be 1% of the assessed value and limited the rate of increase on the assessment of property to 2% per year.
The CFD special tax, by contrast, is assessed against the property but is not based on the assessed value of the property. This makes it a viable option to secure funding despite the limitations imposed by Prop 13.
Who Can Form a Community Facilities Districts?
Any public agency with the authority to provide public services and facilities may form a Community Facilities District. Cities, counties, school districts, and special districts are common users of this avenue. Thousands of CFDs are formed in California to fund billions in public infrastructure.
Over 482 municipalities, 58 counties, 4000 estimated special districts, 2300 independent special districts, and approximately 1000 school districts can utilize CFD funding in California.
Formation Process of Bonded CFDs
There is a 7-step process that is required in order to form a viable bonded Community Financial District:
Step 1 Initiation of CFD: It begins with an initiation process where a property owner or government entity begins the process of establishing a CFD.
Step 2 Adoption of Local Goals and Policies: Local goals and policies must be adopted by the agency proposing this special tax district. These are effectively the rules that must be followed by participants for the prospective CFD. Following this stage, the Rate and Method of Apportionment must be developed and determined. The Rate and Method of Apportionment outlines how a tax will be levied or charged, on which property, under what conditions, for how long, and at what rate.
Step 3 Resolution of Intention: If there are no objections to the rules and policies proposed in the previous stage, the formation of a CFD is then formally proposed.
Step 4 Public Hearing: A public hearing is held and if there are no majority objections by the participants, then the CFD formation process continues.
Step 5 Resolution of Formation / Resolution to Incur Debt: This step is when the district is approved to be formed and the issuance of debt is authorized.
Step 6 Election: An election is held amongst the residents or property owners. In order to establish a CFD, a two-thirds affirmative vote of property owners is required if there are no more than 12 registered voters living within the proposed district. However, if more than 12 registered voters are living in the district, a two-thirds vote of registered voters is required.
Step 7 Issue Debt: The last step in the formation process is to issue any debt necessary such as land-secured municipal bonds or bank loans.
Once the formation process is complete, a special tax is imposed on all property within the Community Facilities District. This tax is not an ad valorem property tax. It is in addition to the standard property tax that exists in that region.
Things Bonded Community Facilities Districts Can Finance
Bonded Community Facilities Districts can finance a multitude of capital projects.
Capital Projects (Lifespan of Over 5 Years)
- Park, recreation, parkways, and open-space facilities.
- School facilities.
- Childcare facilities.
- Public utilities such as water transmission and distribution facilities, natural gas pipeline facilities, telephone lines, facilities for the transmission or distribution of electrical energy, and cable television lines.
- Flood and storm protection (storm drainage and treatment systems and sandstorm protection systems).
- To eliminate any fixed special assessment liens or to pay, repay, or defease any obligation to pay or any indebtedness secured by any tax, fee, charge, or assessment levied within the area of a community facilities district or to pay debt service on that indebtedness
- Governmental facilities that the legislative body that is the creator of the CFD is authorized by law to contribute revenue to, or construct, own or operate.
- Infrastructural improvements deemed necessary to bring buildings into compliance with seismic safety standards or regulations.
- Infrastructural improvements on private property but for a public benefit, such as but not limited to, highways, roads, and sewage systems.
- Infrastructural improvements related to preventing or repairing damage caused by soil deterioration, earthquakes, aftershocks, or hazardous substances.
- Infrastructural improvements related to energy efficiency, water conservation, and renewable energy.
Why Use Bonded Community Facilities Districts?
- Versatility: A CFD is versatile and can finance virtually any infrastructural improvements that a local agency manages using special taxes.
- Flexibility in Financing: The taxes are flexible in the way that they can be charged and the Rate and Method of Apportionment (RMA), which determines the breadth and scope of taxes used in financing the CFD, is not subject to the strict principles of benefit assessment engineering. Additionally, CFD taxes are often a favored approach because the financial markets are familiar with this revenue stream and are willing to lend against it.
- More and Quicker Development in Region Where CFD Exists: Since CFDs allow for considerable flexibility and versatility in project development and do not require as much private market financing, developers are incentivized to develop more projects and more frequently in CFD regions. This results in substantial improvement to facilities and infrastructure.
- Community Facilities Districts May Be Appealing to Homebuyers: CFD financing encourages development so it often results in many improvements to the infrastructure in the participating communities. The capital is often used for the construction of public schools, hospitals, museums, police stations, fire stations, streets, and sewage systems. These amenities may be appealing to homebuyers who are looking to live in a well-maintained neighborhood with growing property value potential.
Case Studies of Neighborhoods that Benefited from Community Facilities Districts
Many neighborhoods routinely benefit from improvements financed through Community Facilities Districts. Here are some real-life stories of successful improvements made to infrastructure by utilizing this financing structure.
Sewer System Project
A Community Services District with a large geographic area was supported by a failing septic system. The District General Manager was required to develop options for funding the collection system and an expansion of the sewer system that serves the rest of the area. The project involved a very large initial capital expenditure, followed by ongoing normal operating costs.
There were a couple of funding options for acquiring the capital, however, it was determined that the Community Facilities District special tax would be the most optimal due to its flexibility and ability to effectively cover multiple incurred costs associated with the project.
The project was successfully funded using CFDs, and the District General Manager was able to fix and expand the sewer system.
City of Folsom – FPA Development Project
In 2017, the growing City of Folsom needed to fund various portions of the Folsom Plan Area (“FPA”). The FPA was a substantial development area and is currently a community that consists of 6 different neighborhoods on approximately 3,500 acres of land. The goal for the FPA was to contain over 10,000 residential units and over 5 million square feet of non-residential buildings, including office and retail.
The City was using CFD financing to fund a portion of the estimated $877 million backbone infrastructure and public facilities necessary to serve the FPA at build-out but needed assistance to move forward in the most optimal way. The City maximized the CFD financing structure by creating a financial plan that allowed for a consistent special tax per EDU for all the FPA-wide improvements and services, increased flexibility in the debt service structure, and minimization of the number of line items on a potential future homeowner’s property tax bill.
Water System Improvement Project
The Nevada Irrigation District and a citizen's steering committee were in need of funding for improvements to their failing water system. The main issue in that district was that the wells were failing and needed to be connected to a reliable water source. Community outreach efforts explained the various financing options to the stakeholders and supported them on their decision to vote on and establish a Community Facilities District. It was the most optimal choice because of the flexibility it offered for the financing of a working water distribution system.
A unique CFD financing structure was developed that allowed for considerable flexibility for the property owners in the district to pay the fees associated with the CFD. One of the features established enabled property owners to prepay special tax liens ahead of the levy going on the tax rolls, so the people who were wary of incurring a long-term obligation had the opportunity to prepay. Additionally, connection fees were financed through the CFD, so property owners who did not have cash on hand were able to participate in the financing process over the payment period, and the people who joined the district at a later date were equipped with a mechanism for joining the process.
Del Norte High School Project
Del Norte High School is a public high school located in San Diego that is part of the Poway Unified School District. Like many other schools in that district, the means of funding used to satisfy the capital requirements in the construction of this project was through Community Financial Districts.
The school’s layout is radial and consists of multiple buildings connected to a central area. It has been designed for approximately 2,500 students.
The total construction costs, including land acquisitions, landscaping, planning, engineering, furniture, equipment, state agency fees, and contingencies were estimated to be approximately $150Mil.
Del Norte successfully utilized the capital provided by CFDs and opened on August 19, 2009.
What are the Drawbacks of Bonded Community Facilities Districts?
- Administrative Burden: A CFD can be complex to administer over time due to many moving parts. The annual tax needs to be calculated and billed annually, parcels need to be tracked, payment delinquencies need to be monitored, specialized reports need to be created, and bond administration and reporting are needed. Therefore, the use of specialized consultants may be crucial to the management of CFDs.
- Higher Taxes: CFDs are special tax districts that result in additional taxes for the participants involved. This can sometimes be undesirable if the taxes are substantially higher than in adjacent communities.
- Penalties if Property Owner Fails to Pay Tax: Since the bond issued by a CFD is considered a lien against a property, failure to pay the tax may result in foreclosure. CFDs are notably subject to accelerated foreclosure laws.
Is a Community Facilities District Special Tax Option Right for Your Community?
A CFD may be the most optimal financing structure to meet the construction goals in neighborhoods where a high level of development is desirable to either improve upon outdated facilities or in newly developing areas that need to secure capital in order to build out infrastructure.
The flexibility of a CFD allows for unlimited opportunities in shaping and reshaping neighborhoods through a special tax levied against the property of residents living in a CFD district.
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