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 “piggy-back” on Federal HTC programs.

• Allocation of HTCs among partners follows profits.

3

Historic Tax Credit Project – Single Tier Structure Diagram

• 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.

Developer

Property Owner

General Partner

InvestorLender(s)

DeveloperFee

99.99%Interest

(including 99.99% of HTCs Profits

and Losses)

Cash

Cash

Services

.01%Services

4

Historic Tax Credit Project – Lease Pass-Through Structure Diagram

• 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.

Developer

Property Owner / Landlord

General Partner

InvestorLender(s)

DeveloperFee

99.99%Interest

(including 99.99% of HTCs, Profits

and Losses)

Cash

Cash

Services

15% Interest

Services

Master Tenant

Sub Tenants

Rent

Cash & Services

.01% Interest

85% Interest

Rent

Master Lease &“Pass-Through”

of HTCs

5

Cash

Historic Tax Credit Project StructuresComparing Advantages and Disadvantages

Single Tier Lease Pass-Through

Advantages – 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

– Mandatory basis reduction of depreciable property and HTC Investor’s basis in partnership interest

– More complex, leading to higher transaction costs and higher on-going administrative costs

– Master Tenant recognizes income in amount of HTC via amortization over term of Master Lease (Note: this result may be attractive to some Investors)

6

Diagram of Combined LIHTC and HTC Project with Lease Pass-Through Structure

DeveloperProperty Owner/

Landlord

General Partner

HTCInvestor

Master Tenant

LIHTCInvestor

Lenders

(99.99%Interest

Including 99.99% of HTCs)

DeveloperFee

Cash

Services

Cash

Rent

Cash

Cash

89.99% Interest

(Including 99.99%

Special allocation

of Depreciation &

LIHTCs)

Cash

.01% Interest

.01% Interest10% Interest

Master Leaseand Pass-Through ofHTCs

7

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.

8

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.

9

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 StructureNew Markets Tax Credit Structure

• QEI triggers credit delivery period. Total NMTC = 39% of QEI delivered over 7 years.

• 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”).

Investor

Community Development Entity (CDE)

Qualified LowIncome CommunityBusiness (QALICB)

QualifiedEquityInvestment(QEI)

100% Interest in CDE,NMTCs, Profits, Lossesand Cash Flow

$10M

Loan A Loan B$7M $3M

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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

Developer

Managing Member:

NOLA Manager, LLC

HTC InvestorNTCIC Investment

Fund X, LLC

Lessor (Landlord) NOLA Operating Co., LLC

89% Man. Member: NOLA Mgr, LLC10% Member: NOLA Operating Co., LLC

1% Member: State HTC Investor, LLC

Master Tenant NOLA Operating Co., LLC

99.99% Man. Member: NTCIC IFX, LLC.01% Member: NOLA Manager, LLC

Project LenderLocal/Regional Bank

State HTC Investor

LA State Credit Fund

HTC

Master Lease

Lease Payment

HTC Equity

HTC HTC Equity

Tenants

HTC & NMTC Funding

Developer

Managing Member:

NOLA Manager, LLC

HTC & NMTC Investor

NTCIC Investment Fund X, LLC

Lessor (Landlord) NOLA Operating Co., LLC

89% Man. Member: NOLA Mgr, LLC10% Member: NOLA Operating Co., LLC

1% Member: State HTC Investor, LLC

Master Tenant NOLA Operating Co., LLC100% Member: NTCIC IFX, LLC

State HTC Investor

LA State Credit Fund

HTC

Master Lease

Lease Payment

HTC Equity

HTC

HTC Equity

Tenants

NTCIC Sub-CDENTCIC Investment

Fund X, LLC

Project Investment Fund

NOLA Investment Fund, LLC100% Member: NTCIC IFX, LLC

Leveraged LenderLocal/Regional Bank

SHTC

SHTC Equity

Repay HTC Bridge Loan

Repay SHTC Bridge Loan

AffiliatedDeveloper

EntityEquity

Equity Bridge Loans Constr./Perm Loans

QEI NMTC

QLICI 1

NMTC

NMTC Equity

Second Sub-CDENOLA Investment

Fund III, LLC

QEI NMTC

QLICI 2

Combining The Tax Credits

Federal Historic Tax Credits:

Total Qualified Costs:

QREs $12 M

Tax Credit Percentage 20%

Federal Credits $2.4 M

Federal Credit Price $1.00

Total Equity to Developer $2.4 M

Combining The Tax Credits

New Markets Tax Credits:

NTCIC CDE Allocation $ 11 M

2nd CDE Allocation $ 5 M

Total QEI $ 16 M

Tax Credit Percentage 39%

New Markets Credits $6.24 M

New Markets Credit Price $.70

NMTC Equity to Project $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

NMTC Equity 2,925,000$ 7,075,000$ NMTC Leveraged Loan

Total 10,000,000$

QEI 10,000,000$ NMTC 3,900,000$

QLICILoan 7,075,000$

Equity 2,925,000$ Total 10,000,000$

Rent paymentsvia

operating lease

CDE

Investment Fund 100%IM

INVESTOR SPONSORLeveraged Lender (LL)

TBD LLCQALICB

SPONSOR(operating entity)

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. Mendenhall704.444.3520rmendenhall@mayerbrown.com

Marshall Phillips704.295.9394marshall.phillips@reznickgroup.com

Kirk Carrison919.688.5600kirk_carrison@ntcicfunds.com

Leigh Ann Smith980.386.3855leigh.ann.smith@baml.com