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The Beauty of New Market Tax Credits (James Harkins Commentary)

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One of the most important parts of my job as a real estate professional is understanding the financial tools available to clients. The goals of most buyers, as well as of those needing help with new construction or substantial rehabilitation projects, would be impossible to achieve without guidance on financing.

This is especially true for clients looking to develop in areas of economic decline. Specialized financing is often needed for new developments in rural or blighted areas. New Market Tax Credits are an excellent tool for financing developments in such locations.

The NMTC Program was enacted in December 2000 to spur development in low-income communities. The federal government allocates the tax credits to the Community Development Financial Institutions Fund. Organizations that serve low-income communities can apply to the CDFI Fund for status as a Community Development Entity. Once this status is granted, the CDE becomes the allocator of the NMTCs to businesses in its community. (NMTCs aren’t reserved for brick-and-mortar expenditures; they can also be used for large equipment purchases. However, I’m focusing here on how the NMTC program can benefit real estate projects.)

Real estate projects must meet certain requirements to qualify for NMTCs. First, the project must be in a Qualified Census Tract, defined as a tract that has a poverty rate of at least 20 percent or a median family income of less than 80 percent of the larger area’s median income. Second, the majority of the project must be for a commercial real estate use. Residential can be a component, but it adds complexities to the transaction. Finally, the project can’t contain any “sin” businesses (liquor stores, tobacco stores, adult book stores/novelty shops, gambling halls, etc.).

A project that meets these criteria is called a Qualified Active Low Income Community Business and can apply to its local Community Development Entity to receive the New Market Tax Credits. Typically, the equity provided through NMTCs is between 20 percent and 25 percent of the project cost, depending on professional fees, transaction costs and the spread between the dollar and the actual price paid for the tax credits. Supply and demand sets the price for the tax credits, and today they’re selling for about 80 to 85 cents on the dollar.

An NMTC project typically is leveraged. The equity from the tax credit investor and a loan from a leveraged lender both go into an investment fund. In an ideal situation, the financing will be set as an interest-only, non-recourse note for a seven-year compliance period. At the end of the seven years, the tax credit investor will typically exercise a put on the investment back to the Qualified Active Low Income Community Business for a nominal amount. Ideally, there will be substantial equity in the project at the end of the compliance period, allowing the QALICB to pay off or pay down the leveraged loan, or it may choose to refinance.

In the past 14 years, more than $40 billion in New Market Tax Credits have gone to qualified businesses, leading to job growth, an increase in the tax base and the revitalization of areas that otherwise would not see economic growth. A few projects that have been financed in part through NMTC are Mann on Main in downtown Little Rock, the Chancellor Hotel in downtown Fayetteville, the Arkansas School for Mathematics, Sciences & the Arts’ residence hall and student center in Hot Springs and many projects at Arkansas Baptist College in Little Rock.

The complexities of the New Market Tax Credit program go well beyond this explanation, so I recommend that clients who may qualify for NMTCs consult an attorney experienced in this area. The attorney can coordinate the process, from preparing the documents for the loan closing to helping with the sale of the tax credits themselves.

I also advise clients to contact a Community Development Entity in their area because it will provide the initial application and will ultimately decide which Qualified Active Low Income Community Businesses will get the tax credits. In central Arkansas the CDE is Heartland Renaissance Fund, an affiliate of Arkansas Capital Corp. Group. It would be a great starting point for those needing more information on NMTCs.

James Harkins is a partner and executive broker with Flake & Kelley Commercial of Little Rock. He can be reached at JHarkins@Flake-Kelley.com.

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