Tara Hamacher Brent Parker

Presentation Outline

• Lafayette Hotel Case Study

• Historic Tax Credits

• New Market Tax Credits

Case Study

Lafayette Hotel

San Diego

Imig Manor / The Lafayette Hotel, circa 1940s-1950s.

City of San Diego Historic Landmark City Goal: To preserve & maintain a valuable historic community asset

Built 1943 – 1946 7 separate buildings 109,450 sq ft. Total Rooms 131 Main Hotel 73 rooms Lani Buildings 34 rooms Cottage Buildings 16 rooms Townhome Buildings 8 rooms

2 Restaurants, 2 Bars Olympic Size Swimming Pool Ballroom and Meeting Spaces

Historic photograph of Imig Manor at Opening Celebrations.

Swimming Pool Still Center of Hotel Today

Project Challenges

• Project had to be redesigned after real estate market changed in last recession. • State of the financial markets were poor, could not get a loan. • Redevelopment Agency funding was reduced, then taken away by State. • Large gap in funds, not enough money to renovate hotel.

• Keep all buildings, upgrade entire property, and expand historic designation status to National level and to qualify for 20% Historic Rehabilitation Tax Credit. (Raised $1.3 million of project equity) • Apply for the New Market Tax Credit program to leverage a federal 39% tax credit. (Raised $6.3 million of project equity) • Expand the project to incorporate energy upgrades and increase community benefits to increase chances of finding a New Market Tax Credit sponsor and investor. • Restructure existing debt to 7-year term for New Market program. • Leverage federal and state Energy Upgrade Incentives to pay for extra energy improvements not in prior budget. (Raised $358,000 of project equity)

Solutions

Positioning for the New Market Tax Credit Program 1.) Designed additional Community Benefits through research and interviews 2.) Designed strategy to incorporate cutting edge greening technology and energy certifications

•Increase community impact. •Create a reason to partner with SDSU and educate children •Create a reason for tax credit investors to want to invest in our project. •Increase our property value so we could get larger loan •Reduce operating expenses & build in price stability •Increase our marketing and branding opportunities

New Market Tax Credit Funder Requirements

Does the project have the following?

Energy Audit to Determine Upgrades

FUEL CELL UPGRADES CE5 Units 8 units System Size 40 kw Total Cost $476,490 Rebates -$100,000 Federal Tax Credit -$108,745 -------------------------------------------------- Adjusted Price $267,745 Payback 5.8 Years 20-Year IRR (projected) 11.6% • Serving as a major component of a complete energy efficiency program. • All heat is transferred to pool (76 -79 degrees) • Second hotel in San Diego to use Fuel Cells to offset energy needs. • First hotel to implement this type of fuel cell technology

LEADING THE SMART ENERGY REVOLUTION

ENERGY STAR

3rd party certification of energy performance Energy improvements can reduce operating expenses significantly

There are only two ENERGY STAR certified hotels in San Diego. The Lafayette is the third Energy Star Hotel and the first historic hotel to receive an ENERGY STAR Rating.

California Green Lodging Program Department of General Services

CA program to help hospitality industry reduce waste and save energy DGS issues a certificate to successful hotels DGS assists hotels with marketing their facilities to State employees

Green Key Eco-Rating Program Hospitality Industry Eco-Rating Program in San Diego County 3rd party certification of green operations Supported by the American Hotel & Lodging Association Program partners include: - AAA Travel - Expedia - Travelocity - Freshstay - Green Lodging News - Canada Green Travel The Lafayette would be the first hotel in San Diego County to be certified by Green Key

Lafayette Hotel is now an internship partner of SDSU

Sources & Uses

$18,307,030 New Leverage Loans $ 1,648,010 Pre-Closing RDA Loan $ 1,605,748 Deferred Developer Fee / GC Fee $ 208,745 Fuel Cell State Rebate & ITC Tax Credit $ 150,895 Energy Efficiency Rebates, SDG&E On Bill Financing Loan $ 6,337,500 New Market Tax Credit Equity $ 1,354,105 Historic Tax Credit Equity ================================================ $29,612,033 Total Sources

$19,264,926 Total Debt/Equity Refinanced $ 7,274,111 Construction Costs $ 1,659,853 Developer Fee and GC Fee $ 897,715 CDE Sponsor Upfront Fees & Bridge Equity Fee, Operations $ 515,428 Operating Reserve and CDE Fee Reserve =============================================== $29,612,033 Total Uses

Press Articles to Promote Project are Important

Public relations and marketing are important parts of New Market Tax Credit Projects

Lafayette Hotel Summary

• Combining the programs add a layer of complexity & adds time because NMTC program is not permanent part of tax code • HTCs & NMTC credits can be a valuable solution to solving the funding gap in a project • Going green in historic buildings is a challenge but solutions are available • Tapping into the historical value of a property adds a lot of value for the community, developer, investor and lender.

Historic Tax Credits

Rehabilitation Tax Credits

There are two Federal Tax Credits available for rehabilitation of older buildings

• 20% Federal Historic Rehabilitation Tax Credit – • Listed on National Register or Contributor to National Register District

• 10% Federal Tax Credit for Pre-1936 Non-Historic commercial properties – • NOT listed in National Register and if in National Register District property is

designated as Non-Contributor.

Certain States offer State Tax Credits for rehabilitating historic buildings

• Average 10% - 25%

• Can be combined with Federal Credits

• California is moving toward having a state tax credit

20% Historic Rehabilitation Tax Credit

• Dollar-for-dollar reduction of income tax liability to tax payer.

• Five-year holding period required or recapture of the credit occurs

• A building must be listed on the National Register or contribute to a National Register District to qualify

• Project must be approved by the State Historic Preservation Office and the National Park Service. • Application is referred to as Part 1, 2 & 3

• Prior to construction projects must meet a substantial rehabilitation test. • Must spend more than the adjusted basis within a 24-

month or 60-month measuring period

10% Non-Historic Rehab Tax Credit

• For rehabilitation of non-historic buildings

• Cannot be listed on the National Register

• Can be listed locally

• Must have construction date prior to 1936

• Commercial properties only, cannot be used for housing projects

• National Park Service review not required, wall retention requirements apply

Historic Building

Project

Individually Listed

National Register

Contributes to

National

Register District

Historic Cultural

Monument

Cultural Heritage

Commission Review

& Approval

Must all come together

to approve project &

Obtain Permits

Community

Redevelopment

Agency

(CRA)

Planning

Department

20% Historic Tax

Credit Program

(optional)

Office of

Historic Resources

(OHR)

Part 1,2,3 Application

(Going this route makes

other approvals easier)

Historic Approval Process

30

Developer/ Project

Accountant

Tax Credit Investor

Architect

Attorney

General Contractor

& Subs

Lender or

CDE Historic Consultant

Approvals

Green Consultant

Part 1, 2, 3

Approvals needed

For Tax Credit

Investors

Developer Team Structure

Substantial Rehabilitation

• The qualified rehabilitation expenditures (QREs) during the measurement period must exceed the greater of $5,000 or the adjusted basis of the property at the beginning of the measurement period

• The 24 or 60 month period must end within the tax year in which the rehabilitation is placed in service

• If 10% credit is planned to be taken, adjusted basis will exclude post -1935 additions to the property

• Unless the rehabilitation qualifies as a “phased” rehabilitation, the entire building must be substantially rehabilitated

Qualified Rehabilitation Expenditures (QREs)

• Legal costs

– Generally includes:

• Hard costs

• Insurance premiums

• Site survey fees

• Architectural & engineering fees

• Interior demolition

• Construction period interest and taxes

QREs include amounts incurred by a taxpayer in connection with the rehabilitation of a QRB that are capitalized to the building and depreciated using either a 27.5 or 39 year recovery period.

HTC Recapture

• Recapture of the credit occurs if, within five years of placing in service:

– ownership of the property changes,

– the property ceases to be investment credit property,

– sale of a partnership interest, or

– reduction of a partner’s interest to less 2/3 of original ownership interest

99% Profits &

Capital Interest

P’ship

Investor Developer/

Owner

LP GP

Historic Tax Credit Single-Tier Structure

Basic Structure: Direct Investment

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Alternative Structure: Pass-Through Lease

• Pass-Through of Tax Credits to Lessee

• QRE’s are incurred by Lessor/Owner

• Lessor and lessee make an election to “Pass-through” to the Lessee all or portion of the QRE’s

– Lessee is deemed to have incurred QREs

Alternative Structure:

Pass-Through Lease

Sub Lessee

Alternative Structure:

Pass-Through Lease

LLC

Investor

Developer/

Owner

MM

LLC

MM

Profits &

Capital Interest

99 to 100% Profits

& Capital Interest

Master Tenant

(Lessee) /

Sublessor

Fee Owner/

Master Lessor

Pass Thrue HTC Master Lease Pass Thru HTC Master Lease

Alternative Structure: Pass-Through Lease

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Alternative Structure: Pass-Through Lease

• Requirements: – Must be IRC Section 38 property – Lessee must be original user of property – Lessor must make election to treat QRE’s as incurred by Lessee

• No mandatory basis reduction applies

• Lessee includes in gross income each year an amount equal to the HTC it received from the lessor ratably over the recovery period or tax depreciable life of the property in the hands of the lessor.

– Generally, the HTC that will be required to be recognized as income for residential property is 1/27.5th and for non-residential property is 1/39th

Alternative Structure:

Pass-Through Lease

New Market Tax Credits

New Markets Tax Credit Program

Part of the Community Renewal Tax Relief Act of 2000 Administered through the CDFI Fund, a department of the US Treasury. Creates a tax credit for qualified equity investments (QEI’s) in Community Development Entities (CDE’s)

39% tax credit taken over 7-year period 5% in each of the first 3 years 6% in each of the final 4 years

Investment into a project can come in the form of loans or equity investments This is not a straight 39% calculation. Only funds run through investment funds generate the 39% tax credit.

This is a competitive program and runs on an annual cycle so can be difficult to line up financing sources in coordination with construction schedule.

How New Market Tax Credits Work (Example base on $10mil project)

CDFI FUND (Dept of Treasury)

CDE ALLOCATEE: Receives NMTC

Allocation Sub-allocates

SUB-CDE: Allocation (need to

fund QEI)

INVESTMENT FUND: To fund QEI

LEVERAGE LENDER: Provides loan

NMTC &/or HTC INVESTOR: Provides equity for TCs

$1,288,000 Equity from HTC $1,544,961 Equity from NMTC

$5mm Loan= 50% of QEI @ Market interest rate

$7,832,961 QEI

8% CDE Fee: $800,000 (varies)

QALICB: Project

QLICI Loan A: $7mm @ Market interest

QLICI Loan B / QLICI Equity: $2mm low interest rate loan or invested as equity (some loans are forgivable)

DEVELOPER: Manager

Transaction Costs: $200,000 (varies) Legal

and Accounting

* Not all structures are the same

Banks

DEVELOPER EQUITY

$2,167,039 Equity

Banks

Banks

“But For” Test

41

The NMTC program requires a project to demonstrate that if it were not for the NMTC’s that the project wouldn’t happen. Nicknamed the “But For “ test.

• Include rejection letters from banks • Must have a gap in financing that NMTC can fill

In addition, projects generally must demonstrate the following:

• Located in Low Income Census Tract (Ideally Deeply Distressed) • Have a need to serve the community • Create jobs • Bring economic impact to the area • Incorporate sustainable technologies • Contribute to the revitalization of a deeply distressed or low income

Community.

42

Example Differences in Property Types

New Markets

Income Producing & Owner-Occupied

New Construction or Rehabilitation

Office

Retail

Mixed-use with Housing – Retail 20% & greater

Entertainment/Theater

Grocery Store

Hotel

Non-Profit based uses

Community Centers

Industrial

Manufacturing

Historic Rehabilitation 20% Credit

Income Producing Only – NO O/O

Rehabilitation Only

Office

Retail

Mixed-use with Housing

Entertainment/Theater

Grocery Store

Hotel

Non-Profit uses (case by case)

Community Centers (case by case)

Industrial

Manufacturing

Residential, market or low income

Uses

Acquisition Costs $15,000,000

Hard Costs $20,000,000

Soft Costs $ 2,500,000

----------------

$37,500,000

Sources

1st mtg = 60%

HTC Equity 11%

NMTC Equity 24% $ 8,850,240

Developer Equity 5% $ 1,874,760

----------------

$37,500,000

Example NMTC & HTC Sources & Uses of Funds

HTC Eligible basis

$ 22,500,000

X 20% Tax Credit

$4,500,000 HTC generated

X .95 cents/dollar

$4,275,000 Net Equity

-5 year hold period

-1.5 - 3% annual cash return to partner

-buy-out /exit fee of initial equity contribution. Net HTC after all paid est. .70 -.75

NMTC Eligible Basis

$26,775,000

X 39% Tax Credit

$10,442,250 NMTC generated

X .84 cents/dollar

$9,385,740 Net Equity

-min. 2% fee of allocation of $28,650,000 to CDE $535,500 = $8,850,240 Net NMTC Equity

-7 yr hold (.50bps annual for 7 yrs -$350K)

-Can be structured as partial loan/ equity, all equity. Case by case basis depending on project.

-Project Readiness Test applies

-Must demonstrate “But For Test”

-Must create jobs, have community impact, result in increased benefits to the City, need the subsidy.

-Does not require Prevailing Wage Labor

$22,500,000 $ 4,275,000

Note: NMTC eligible amount depends on what sources of funds can go through NMTC investment fund. 1st mtg. may have issues as it’s a different financing structure.

Differences in Programs

Hold Period Timing of Credit Use Credit vested with

Credit Calculation Qualifications Price per credit range Required Returns

New Markets 39% Tax Credit 7 years from funding 7 year stream of credits Investor into CDE

Based on $ put into investment fund Project Readiness Test, “But For Test”, Job Creation, Community Impact .80 - .84 Does not require cash return. Buy-out fee case by case. *Not Permanent Part of Tax Code.

Historic Rehabilitation 20% or 10% Tax Credit 5 years from C.O. Credits can be taken all in

one year. Within building owner or tenant Based on qualified hard & soft cost rehabilitation expenses Must meet construction Standards and be approved by SHPO/NPS

.85 - 1.00 + Requires min. 2-3% annual cash return to partner. Buy-out fee of 15 – 25% of initial

equity contribution at exit.

Timeframes vary from project to project. Intended to give general understanding of how things need to come together.

Banking on History

Tara Hamacher (877) 268-8481

Tara@HistoricConsultants.com www.HistoricConsultants.com

Thank You for Attending

Brent Parker (562) 256-2336

Brent.Parker@Novoco.com www.Novoco.com