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By Andrew Hanzl
Working on complex transactions with unique capital structures is nothing new for the team at MCA. In fact, our ability to understand and execute tough deals is how we differentiate ourselves from other Commercial Real Estate Financiers. Today’s topic, New Market Tax Credits (“NMTC”) is an element of commercial real estate deals that compliments this theme, as it is a complex government tax incentive program designed to spark investment in worthy projects. Like most programs involving the government, the New Market Tax Credit program is complicated enough to make your head spin, but let me lay out the basics so you can get a feel for how the program works and how it might be beneficial for real estate developers.
What are New Market Tax Credits?
The concept is straightforward; the federal government created a program in 2000 with the intention to incentivize real estate developers to invest in properties in low-income areas, as a means to spark job creation and economic development. In exchange, the investors would receive federal tax credits. The program has been made available for the rehabilitation of existing properties, as well as the construction of new properties, and is available for almost all types of commercial properties (exclusions include: golf courses, country clubs, casinos or other facilities used for gambling, liquor stores, farming, tanning salons and 100% residential housing). Although almost all types of deals are considered for the program, not all markets are considered. In order to qualify for tax credits, the project has to be located in a “low-income community”, which is an area that has a poverty rate of at least 20%, or an area where the median household incomes do not exceed 80% of the statewide median household income.
Once a real estate developer feels confident that their project is a worthy candidate for the program, a formal application process follows. Candidates will submit applications detailing their business plan; furthermore, tax credit allocations are awarded based upon perceived positive impact on the communities. Some of the main criteria assessed during the application process include number and quality of jobs created, whether the project fills an unmet need, whether the community supports the project, whether the project is environmentally friendly and whether job training is available for the project. Each year, hundreds of projects deemed the most deserving are awarded billions of dollars in tax credits.
In total, $50.5 billion of New Market Tax Credits have been allocated for worthy projects, resulting in approximately 750,000 new jobs, since the program was created in 2001. Furthermore, a record $7 billion in credits were allocated in 2015 & 2016 to projects that are expected to create approximately 166,000 jobs. One interesting note is the program is being utilized to bring manufacturing jobs back to the United States, with 30% of the NMTC involving industrial facilities. Some of the other examples of the credits contributing towards public good include the facilitation of construction of health centers, child care and community centers, schools and grocery stores.
New Market Tax Credits Example
Hopefully, you now have a general understanding of the program and its offerings; I will now elaborate on how the actual tax credits work and how they are instrumental in acquiring deals in motion. Let’s just say a real estate developer plans to build a retail shopping center in a low-income area with a total project cost of $100 million. The developer could potentially claim a tax credit worth 39% of the total project cost or $39 million, which could be claimed over a seven-year period. However, unlike other tax credit programs, New Market Tax Credits are not actually exercised by the developer, rather they are monetized through a sale to a third party investor, with the resulting proceeds being contributed to the project as equity. Typically, after the tax credits are discounted and all the closing costs/fees have been paid, the developer has enough capital remaining to make an equity contribution equal to 20-25% of the total project costs, or 20 to 25 dollars million based on my example. The program is looking for projects that have a “funding gap” that the tax credits will fill, allowing projects that would otherwise not get done, to move forward.
If developers can traverse the process of New Market Tax Credits, this program can make the project economics much more appealing and create positive momentum for low income communities. If you are interested in additional information about New Market Tax Credits or would like assistance securing financing alongside New Market Tax Credits, please contact Andrew Hanzl at [email protected].
The Author, Andrew Hanzl, is a Senior Analyst in the Dallas Office of Metropolitan Capital Advisors.