Integrating New Markets and Historic Tax Credits North Carolina Affordable Housing Conference
September 16, 2010
Fundamentals of Federal Historic Tax Credits
• HTC program has been in existence over 20 years. • Provides dollar for dollar federal income tax credit for rehabilitation of historic income producing properties (commercial, industrial, agricultural, or residential rental). • National Park Service and State Historic Preservation Officer approve and monitor (i) qualification of building for HTC and (ii) development of and compliance with plans and specs for rehabilitation to ensure historic character is maintained. • HTC is equal to 20% of “qualified rehabilitation expenditures.” Qualified rehabilitation expenditures must exceed the acquisition costs of the “Historic Building.”
• HTC is not competitive, but National Park Service must certify that building qualifies for credit and that rehabilitation was completed in accordance with approved plans and specs. 2
Fundamentals of Federal Historic Tax Credits (cont.)
• Building must be listed on the National Registry of Historic Places or be located in and add to the significance of a registered historic district. • HTC is taken all at one time when the project is placed in service.
• Subject to recapture for 5 years. • Less technical than LIHTC, but requires substantial interaction with National Park Service on Plans and Specs. • As with LIHTCs, some states have state HTC programs, many of which “piggyback” on Federal HTC programs. • Allocation of HTCs among partners follows profits.
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Historic Tax Credit Project – Single Tier Structure Diagram General Partner
Developer
Cash
Property Owner
Lender(s)
99.99% Interest (including 99.99% of HTCs Profits and Losses)
Investor
• Property must be located in a qualifying area or be listed on National Register of Historic Places. (Part 1) • Developer/GP work with National Park Service on satisfactory plans and specs for qualified rehabilitation of Historic Building. (Part 2) • HTC based on 20% of qualified rehabilitation expenditures. • HTC claimed on date project is placed in service. • No significant future monitoring by National Park Service after building receives certification that rehabilitation was completed in accordance with agreed upon plans and specs. (Part 3) • Five year compliance period during which Property Owner must remain owner of property and Investor must remain partner in Property Owner in order to avoid recapture. • Tax basis in historic building is reduced by amount of HTC.
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Historic Tax Credit Project – Lease Pass-Through Structure Diagram General Partner
Developer
Cash & .01% Interest Services
Property Owner / Landlord Lender(s)
Cash Rent
Master Tenant
Master Lease & “Pass-Through” of HTCs
99.99% Interest (including 99.99% of HTCs, Profits and Losses)
Investor
Rent
Sub Tenants
• Substantially similar to single tier structure on technical points, with addition of Master Lease and Master Tenant between Investor and Property Owner. • HTCs are allowed to be passed through to Master Tenant upon Property Owner/Landlord and Master Tenant making valid Pass-Through Election. • Important to maintain integrity of Master Lease. • No reduction in tax basis of historic building, instead Master Tenant must include HTC amount in annual income pro rata over term of lease. 5
Historic Tax Credit Project Structures Comparing Advantages and Disadvantages Single Tier Advantages
Lease Pass-Through
– Simplicity – fewer entities, fewer documents required
– No mandatory basis reduction in property or HTC Investor’s partnership interest – GP receives higher tax basis and depreciation with respect to property – Minimizes HTC Investor’s participation in property owner’s cash flow
Disadvantages
– Investor has potential to receive higher distributions of cash flow and losses
– More complex, leading to higher transaction costs and higher on-going administrative costs
– Mandatory basis reduction of depreciable property and HTC Investor’s basis in partnership interest
– Master Tenant recognizes income in amount of HTC via amortization over term of Master Lease (Note: this result may be attractive to some Investors)
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Diagram of Combined LIHTC and HTC Project with Lease Pass-Through Structure Cash .01% Interest
General Partner
Developer Property Owner/ Landlord
10% Interest
Cash Cash Master Lease and PassThrough of HTCs
LIHTC Investor
Rent
Master Tenant
Cash (99.99% Interest Including 99.99% of HTCs)
Lenders
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HTC Investor
Combined LIHTC and HTC Project with Lease Pass-Through Structure
Comments • LIHTC Investor holds 89.99% limited partner interest in Property Owner receiving 99.99% special allocation of depreciation on property. • Lease Pass-Through Structure avoids reduction in basis of property and accordingly no reduction in LIHTC. • Can dismantle HTC Structure at end of 5 year HTC compliance period.
• Can have different investors for LIHTCs and HTCs.
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Fundamentals of New Market Tax Credits
• NMTC program has been in existence for almost 10 years. • Provides dollar for dollar federal income tax credit for investments in community development entities (“CDEs”) that use substantially all the invested funds to make investments in qualifying low-income community businesses (“QALICBs”). • QALICBs must be located in low-income communities designated by census tract. Certain businesses are excluded (e.g. residential rental activities, golf courses, country clubs, horse tracks and other gambling businesses, massage parlors, stores where principal business is sale of alcohol for consumption off-premises). • The U.S. Treasury through the Community Development Financial Institutions Fund (“CDFI”) allocates to CDEs the dollar amounts on which NMTC can be claimed through highly competitive process.
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Fundamentals of New Market Tax Credits (cont.)
• CDEs are domestic corporations, limited liability companies or partnerships certified by the CDFI. They must demonstrate a primary mission of servicing or providing investment capital for low-income communities and maintain accountability to residents of low-income communities (representation on governing or advisory boards). • CDE must invest substantially all of the QEI in QALICBs through “Qualified Low-Income Community Investments” (“QLICIs”). Can be debt or equity (but not a “grant”). QLICIs must stay “invested” during 7 year compliance period to avoid recapture. • NMTC = 39% of QEI taken over 7 years (5% first 3 years and 6% last 4 years). • Requirements for qualification as QEI, CDE, QLICI and QALICB are very technical with primary burden on CDE.
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Sample Structure New Markets Tax Credit Structure • QEI triggers credit delivery period. Total NMTC = 39% of QEI delivered over 7 years.
Investor
$10M
Qualified Equity Investment (QEI)
100% Interest in CDE, NMTCs, Profits, Losses and Cash Flow
Community Development Entity (CDE)
Loan A $7M
Loan B $3M
Qualified Low Income Community Business (QALICB)
• Loan A = Qualified Low Income Community Investment (QLICI) based on market rate interest. Interest-only with balloon payment at end of 7 year compliance period. • Loan B = Also a QLICI. Typically has below market interest rate (e.g. 2%) and, provided all other requirements are met (e.g. debt service on Loan A and Loan B paid, no violations of NMTC requirements by QALICB), final payment generally reduced to fraction of principal outstanding (but QLICI must be characterized as “bona fide debt” versus a “grant”).
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The Tax Credit Marketplace
Federal
North Carolina
South Carolina
Low Income
Yes
Refundable
No
Historic / Mill
Yes
Yes
Yes
New Markets
Yes
No
Yes
Renewable Energy
Yes
Yes
Yes
Brownfields
No
Yes
Yes
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Which Credits Work Well Together? Low Income and Historic
Low Income and Renewable Energy New Markets and Historic New Markets and Renewable Energy
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HTC Funding
HTC Investor Managing Member:
NTCIC Investment Fund X, LLC
NOLA Manager, LLC HTC
Project Lender Local/Regional Bank
Lessor (Landlord) NOLA Operating Co., LLC 89% Man. Member: NOLA Mgr, LLC 10% Member: NOLA Operating Co., LLC 1% Member: State HTC Investor, LLC
HTC Equity
Master Lease HTC Lease Payment
Master Tenant NOLA Operating Co., LLC 99.99% Man. Member: NTCIC IFX, LLC .01% Member: NOLA Manager, LLC
HTC Equity
State HTC Investor LA State Credit Fund
Developer
Tenants
HTC & NMTC Funding Equity
Leveraged Lender Local/Regional Bank
Repay SHTC Bridge Loan
Equity Bridge Loans
Constr./Perm Loans
NOLA Investment Fund, LLC
NMTC NMTC Equity
HTC & NMTC Investor NTCIC Investment Fund X, LLC
100% Member: NTCIC IFX, LLC
LA State Credit Fund
QEI
SHTC
NMTC
QEI
HTC
NMTC
NTCIC Sub-CDE
Second Sub-CDE
NTCIC Investment Fund X, LLC
NOLA Investment Fund III, LLC
QLICI 1 SHTC Equity
Managing Member:
Repay HTC Bridge Loan
Project Investment Fund
State HTC Investor
Affiliated Developer Entity
QLICI 2
Lessor (Landlord) NOLA Operating Co., LLC 89% Man. Member: NOLA Mgr, LLC 10% Member: NOLA Operating Co., LLC 1% Member: State HTC Investor, LLC
HTC Equity Master Lease HTC Lease Payment
Master Tenant NOLA Operating Co., LLC 100% Member: NTCIC IFX, LLC
HTC Equity
NOLA Manager, LLC
Developer
Tenants
Combining The Tax Credits Federal Historic Tax Credits: Total Qualified Costs:
QREs Tax Credit Percentage Federal Credits Federal Credit Price Total Equity to Developer
$12 M 20% $2.4 M $1.00 $2.4 M
Combining The Tax Credits New Markets Tax Credits: NTCIC CDE Allocation
$ 11 M
2nd CDE Allocation
$
Total QEI
$ 16 M
Tax Credit Percentage New Markets Credits New Markets Credit Price NMTC Equity to Project
5M
39% $6.24 M $.70 $4.37 M
Combining The Tax Credits
Total Tax Credit Investment: Federal Equity
$2.40 M
NMTC Equity
$4.37 M
TOTAL EQUITY
$6.77 M
What Makes a Project Attractive to Investors
• Tell a good story – Project Economics (low loan-to-value, strong debt service coverage ratios, pre-leasing) • Minimize risk of something going wrong
– High level of Community Impact • Job creation
• Grocery or other services
– Developer Experience • Market (CRA)
Issues for Lenders with NMTC • Lack of direct security interest • Forbearance • 7 years, interest-only • Limited reserve accruals
Sponsor as Leveraged Lender • Sponsor receives grants, pledges or other funds and loans them through the new markets structure • Caveats – Understand the restrictions on the money being enhanced • Some grants only fund on a % of completion basis, • Some grants/loans need to be secured by mortgage on property (AHP)
– Labor Intensive for Sponsor • Set up new entity to act as QALICB • Annual reporting requirements • Need to have cash at closing for leveraged loan
INVESTOR
NMTC Equity $
SPONSOR Leveraged Lender (LL)
2,925,000
$
7,075,000 NMTC Leveraged Loan
Total $ 10,000,000
Investment Fund 100%IM
QEI $ 10,000,000
NMTC $
CDE
QLICI Loan $ 7,075,000 Equity $ 2,925,000 Total $ 10,000,000
TBD LLC QALICB
Rent payments via operating lease
SPONSOR (operating entity)
3,900,000
Legislative Update & Current Bills • Codification of Economic Substance – impact on Tax Credit Transactions
• HR 4213 – Extend LIHTC 1602 for 9%, extend NMTC program, extend GO Zone Deadlines for LIHTC and GO Zone HTC
• S 3326 –
5 year carry-back provision for LIHTC investments, extend 1602 for a year and expand 1602 to 4% credits
• HR 2628 / S 1583 – Multi-year extension of NMTC program, increase the annual funding and exempt NMTC from AMT
• HR 3715 / S 1743 – Several enhancements to the HTC program
• HR 2336 – Energy retrofits for real estate owners
• HR 4868 – Affordable Housing preservation bill
Contact Information
Robert L. Mendenhall 704.444.3520
Marshall Phillips 704.295.9394
[email protected]
[email protected]
Kirk Carrison
Leigh Ann Smith
919.688.5600
980.386.3855
[email protected]
[email protected]
