By Dan Martin
Managing Director–Sperry Van Ness/Prism Commercial Real Estate, Inc.
By now you may have heard the words, “New Markets Tax Credits.” Or maybe you haven’t. If you haven’t, don’t feel too bad. In an informal poll of Midwest real estate developers, less than two out of ten developers had ever heard of the New Markets Tax Credit program. And of those who had, misconceptions abound about the program. Here are some quotes:
“Oh, that program funds only health clinics and community centers.” FALSE
“There’s a $5 Million cap on New Markets Tax Credit deals.” FALSE
“You can’t use New Market Tax Credits on shopping center deals.” FALSE
“Hotel developments don’t qualify.” FALSE
“After your done with legal, accounting and consultant fees, there’s nothing left” ABSOLUTELY FALSE!
How about some facts?
According to Rafael Rios, managing director DRI’s Community Development Resource division, in 2010 alone, New Markets Tax Credits purchasers invested more than $2.253 billion in real estate development deals, funding close to ten million square feet of office space and over four million square feet of retail space.
Interested? Yeah. I thought so, but before you start calling Mr. Rios (DRI’s number can be found at the end of this article) you should know at least the basics. A good start would be to read the New Markets Tax Credit “primer” below.
New Markets Tax Credit Program • The New Market Tax Credit (NMTC) Program encourages investment in Low Income Communities (LICs). Generally, LIC’s are: o Census tracts with a poverty rate of at least 20%: or o Census tracts where the median family income for such a tract does not exceed 80% of the median family income for the state or area. • The NMTC program provides federal income tax credits equal to 39% of Qualified Equity Investments (QEIs) in Community Development Entities (CDEs) that serve as intermediary vehicles for the provision of loans, investments, or financial counseling in LICs. By way of example, a $20 million development project within an LIC would generate $7,800,000 in federal tax credits, e.g., 39% of $20 million. At closing, a simple $20 million leverage loan NMTC structure would take on the form diagramed below:
In the above diagramed structure, the tax credit investor purchases the federal tax credits at a discounted rate of $0.72 on the dollar. Over the last year, the purchase price for NMTC has ranged from $0.68 to $0.72. Note too that the CDE has taken a fee at closing equal to 3 percent of the total QEI or project cost, i.e., $600,000 (3 percent 0f $20 million).
During the seven year life of a NMTC leverage loan structure, the Developer/QALICB makes annual interest payments to the CDE on both the A and B QLICI Loans. The CDE passes the QLICI A Loan interest payment up to the Commercial Lender and pays the QLICI B Loan interest payment to the CDE Managing Member as a management fee. The annual QLICI B Loan interest payment is typically calculated at .5 percent of project QEI, e.g., a $20 million project translates to a $20 million QEI which, in turn, results in a QLICI B Loan interest payment of $100,000 annually. At $100,000 annually, the B Loan interest rate is approximately 1.9 percent, i.e., $100,000 on $5,016,000. During the seven year life of a $20 million NMTC leverage loan structure, annual payments would flow as indicated in the diagram below:
The rate, term and recourse requirements of the QLICI A Loan are a function of developer and project credit worthiness. Terms of the leverage loan are typically set two weeks before closing based on either LIBOR or the weekly average seven year Constant Maturity Treasury for the two weeks prior to the week of the closing plus a spread to be determined by the lender based on the credit quality of the borrower. The loan to value ratio will typically be set at 70 percent of value and, the NMTC equity provided by the investor is typically taken into account in meeting these ratios. Maturity of loan is typically no greater than 8 years from closing. While some lenders require a sinking fund for principal payments, the typical leverage loan is interest only with interest payments made monthly. Typically, the lender and investor will be affiliated, i.e., the lender will have an affiliate that acts as the investor. As such, while the lender will offer a “below market” rate, it will still earn an above market yield due to the NMTC’s. The lender underwrites the credit quality of the borrower, manages all aspects of the loan to the borrower and earns CRA credit for loans and investments made through the CDE. QLICI B loans are typically non-recourse to borrower.
At the conclusion of the seven-year NMTC leverage loan term, the QLICI B Loan promissory note is subject to a put/call agreement allowing the Developer/QALICB to purchase the $5,016,000 QLICI B promissory note for $1,000,e.g., less than $0.0002 on the dollar. The diagram below illustrates close-out of the NMTC leverage loan structure:
Equity Investors in a CDE receive a federal tax credit for 5 percent of the investment amount for each of the first 3 years and 6 percent for each of the next 4 years (39 percent total). This means the NMTC leverage loan structure must stay in place seven years in order for the tax credit investors to avoid a tax recapture.
According to Mr. Rios, there are certain “rules of thumb” upon which developers may rely. First, in your typical real estate deal, you can figure on a NMTC “subsidy” equal to no less than 20 percent of your project cost (all inclusive). Second, don’t assume your community doesn’t qualify for New Markets Tax Credits. By way of example, all of the property east of State Street, west of Michigan Avenue, south of Madison and north of Roosevelt is within New Markets Tax Credit eligible census tracts. Who would have thought? New Markets Tax Credit financing can even be used for mixed-use developments provided that annual residential revenues don’t exceed 80% of total project revenues.
Now, as for that number you can reach Mr. Rios at 312-368-0770. If you want to find out whether your project is in a New Markets Tax Credit eligible area, go to the Novogradic website at novoco.com.
Oh. BTW. We expect a new round of NMTC allocation will be announce next week in the amount of $3.5 BILLION. Happy hunting!
Dan Martin, CCIM, Managing Director, Sperry Van Ness/Prism Commercial Real Estate, Inc. in Arlington Heights, Il. Martin has now sold, leased or bought over $400 million in primarily retail properties. Recent deals have brought him face to face with realities of the New Markets Tax Credit Program, so the result is this article (with intellectual help from many). Dan can be reached as always at his email address, firstname.lastname@example.org