Historic preservation tax incentives offer capital solutions.
the current economic climate, creative thinking is critical when it comes to
securing the financing needed to purchase or rehabilitate real estate. With
underwriting standards still extremely tight, banks remain less likely to lend,
and when they do, loan-to-value ratios are low and collateral requirements are
high. This continues to be a major challenge for some businesses.
addition, in some highly developed metropolitan areas, it can be difficult to
find properties that are financially feasible. However, urban centers that were
developed historically as port cities, trading outposts, or early
industrialized sites are often rife with turn-of-the-century structures that
are well-suited for conversion into apartments, offices, and restaurant
adapting a building to modern usage while preserving and restoring its historic
character can be daunting — and expensive. Without the support of historic
rehabilitation tax credits, the risk involved would not be worth it for
investors and owners.
Tax Credit Calculations
listed on the National Register of Historic Places, located within historic
districts, or those that can be listed on the National Register are eligible
for the historic tax credit at both the state and federal levels. The
property’s rehabilitation must meet certain standards that are designated by
the National Park Service to maintain the building’s historic character.
owners can use these tax credits to offset federal and state tax liabilities,
or they can “sell” the tax credits and use the capital to offset rehabilitation
costs. (Although federal historic tax credits are issued to the property owner
and are non-transferable, a tax credit investor can be admitted to the property
ownership in exchange for a capital contribution in a transaction that has
“economic substance” as defined by the Internal Revenue Service.) Add to this the intrinsic value of a historic
property — including desirable location and positive sentiment associated with
revitalizing a piece of a neighborhood’s history — and historic preservation
becomes worth a second look.
fact, developers can use historic tax credits as a financing tool. For example,
a historic building costs $200,000 to buy and another $800,000 in qualified
rehabilitation expenses. The historic tax credit amounts to 20 percent of the
QREs on both the state and federal levels, which would be $320,000 in this
example. A developer may monetize the federal tax credits and receive a term
sheet for the purchase of the state tax credit, thereby raising actual capital
(in tranches as construction progresses) for the federal tax credit. This could
add $137,600 in construction capital and $275,200 in net monetization proceeds.
a situation where the bank is only offering a loan of 60 percent of the cost of
the purchase price and QREs, or $600,000, there would be a $400,000 equity
requirement to fund the transaction. As mentioned above, the historic tax
credit would cover $275,200 (after factoring in transaction costs) of the
equity required, leaving slightly less than a $125,000 equity requirement,
which is 12.5 percent of the purchase price and QREs.
financing commercial real estate transactions traditionally require a 20
percent equity contribution by the borrower. By requiring less than the average
equity requirement of 20 percent, historic tax credits make such transactions
possible. As a result, the historic tax credit program has been one of the
nation’s most successful and cost-effective community revitalization programs
developers, owners, and managers look to fill gaps in project funding, state
and federal tax credits can make or break the feasibility of resurrecting
desired buildings with significant community value. As shown above, these
credits on the state and federal level, together with accelerated depreciation,
can combine to offset as much as 45 percent (on a gross basis) of a
construction project’s budget. Note that with transaction costs, which include
the tax credit investor’s purchase discount, the net capital generated may be
in the 33 percent range.
Fort Point Channel area in South Boston is a good example of an area benefiting
from the historic tax credit. This urban area is comprised of several buildings
that were owned by the Boston Wharf Co., and previously had been used as
warehouse space and for other port and trade-related uses much more prevalent
in the early 20th century. Now, these historically significant buildings are
being adapted for use as residential apartments, storefronts, restaurants, and
office space. Similarly, many other metropolitan areas offer historically
valuable buildings in prime locations in need of varying levels of attention.
the process, the property owner applies to the state historical commission for
both federal and state tax credits. In some states, an approved request on the
state level is distributed via a competitive allocation process, wherein an
owner can request an allocation of the total amount at various points
throughout the year. In this scenario, owners may find themselves going back to
the state several times as more funding is needed and approved.
process of applying for and securing historic tax credits typically requires a
development team including a lawyer, a consultant, and a syndicator. Seeking
out information about this process before the project commences allows for the
potential tax credit equity to be built into a proposed budget or development
pro forma, which can lead to even greater control over financing costs.
incentives such as the historic tax credit manage some of the inherent
challenges in preserving a historic building, as well as providing solutions to
potential financing conundrums.
Kirshenbaum is founder and president of The
Cherrytree Group, a Massachusetts-based consultant, tax credit broker, and
syndicator. Contact him at email@example.com.