What do New Markets Tax Credits (“NMTC”)1 mean to a qualifying project? Here are a few thoughts: (i) a project, which has acquired traditional debt, invested its own equity, and secured additional incentives, but still falls short of its total financing needs, can make up the “gap” by accepting a capital injection that does not require repayment; (ii) the opportunity to gain access to non-conventional financing, with lower than market fixed interest rates, higher loan-to-value ratio and lower debt service coverage, with seven years of interest-only payments; and (iii) low cost capital for impactful projects that benefit economically distressed communities which can provide a permanent net cash subsidy of between 15% to 20% of the project’s capital budget. If any of these, individually or collectively, raise the level of interest, the question then becomes what does a project have to do in order to attract NMTC investment? The simple answer is to make sure the project is “shovel ready.”
Enacted in 2000 by bipartisan legislation, the NMTC program focuses on creating economic growth through capital investment in urban and rural low income communities.2 Over the past two decades, NMTCs have had a major economic impact on communities of need by deploying $61.0 billion of NMTC awards, generating $8 of private investment for every $1 invested by the federal government. The result is the creation or retention of more than 836,000 jobs and the construction or rehabilitation of more than 218.3 million square feet of commercial real estate in all 50 states, the District of Columbia and Puerto Rico.3 After 20 years, the program was scheduled to expire on December 31, 2020 until The Consolidated Appropriations Act of 2021 (the “CAA”),4 extended it for an additional five years and established a minimum annual allocation of $5 billion each of the next five years.5 This legislation represents the largest extension in the history of the NMTC program and is projected to create, annually, 690 new manufacturing expansions and industrial projects; 275 mixed-use projects combining housing, commercial, and social services; 255 new or improved health clinics, hospitals, and medical offices; 775 community facilities and 590,000 jobs.6
For a project to be considered “shovel ready,” it must be able to identify and articulate its economic outcomes since the allocation of the NMTCs will be awarded to the extent the measurable impacts can reasonably lead to success.7 The ability to document the direct and indirect economic and/or community effects will be an important consideration of a funding source’s decision making process. To improve a project’s chances to serve low-income communities and low-income persons through the use of NMTCs, it should consider commissioning an independent community impact analysis to identify and assess its direct and indirect economic impacts. For example, by engaging in an IMPLAN (Impact Analysis for Planning) study, projects competing for NMTCs can be modeled to demonstrate how the investment will impact the immediate and surrounding communities, quantify the impact to the distressed economy, and directly draw conclusions as to the expected growth or changes on the economy of a specific community.8 The results can be used to convince knowledgeable stakeholders that the project will deliver the maximum value of such investment to the target community over time.
To understand NMTCs is to understand the process. NMTCs attract private capital to low-income communities by permitting an investor to receive a credit against its federal income tax in exchange for making a cash investment in qualified projects. The NMTCs total 39% of the original capital investment in the project and is claimed over a period of seven years, with 5% of the investment in each of the first three years and 6% over the remaining four years for a total of 39%.9 Procedurally, the U.S. Congress authorizes the amount of annual NMTCs allocations and the U.S. Department of the Treasury, through its Community Development Financial Institutions ("CDFI"), allocates the annual tax credit authority to specialized financial intermediaries called Community Development Entities (“CDEs”). Annually, CDEs apply to the CDFI to receive tax credit authority. This is a very competitive application process with only about 34% of the CDEs that apply receiving an award.10 Those CDEs fortunate enough to receive an allocation will then seek out cash investments from an NMTC investor in exchange for the awarded tax credits. Any entity or person is eligible to claim NMTCs, however, the industry has evolved to where the large national banks or other regulated financial institutions are the major players. One thing to keep in mind – the cash investment generated from NMTCs is merely a “gap filler” and cannot and will not be the sole source of a project’s capital stake. What this means is that a project has to have its own capital, which, in the NMTC lexicon, is known as “leverage.” The combination of the NMTC equity and the leverage capital must equal the project’s total budget and must be in the form of cash at closing. The NMTC investment, will eventually find its way to a qualified project in the form of debt or equity or a a combination of both.
The ultimate beneficiary of this process is the project, itself. NMTCs have a broad application as to the type of projects it can finance. They can help finance the acquisition of equipment, business operations, or real estate and employed in the acquisition or rehabilitation of retail, manufacturing, agriculture, community facilities, and residential rental or for-sale housing (or any combination of these). It may be easier to point out what they cannot fund. NMTC capital cannot participate in the funding of unimproved leased real property, a business predominantly for the development or holding of intangibles for sale or license, golf courses, country clubs, massage parlors, tanning salons, racetracks or other gambling facility and stores the principal purpose of which is the sale of liquor for off premise consumption, farming activity and residential rental property if less than 20% of the property’s income is from commercial use.11 However, in order to gain access to NMTCs, a project must qualify as a qualified active low-income community business. A qualified active low-income community business is a corporation, partnership, or sole proprietorship, which engages in an active trade or business and satisfies a series of tests which include, but is not limited to, the following: (i) at least 50% of its gross income comes from the active conduct of a qualified business within any low-income community; (ii) a substantial portion of the tangible property of the business’ use (whether owned or leased) is located within a low-income community; and (iii) a substantial portion of employee services are performed in a low-income community.12
What does all of this mean in the terms of dollars to a qualified project? Assume, for example, a $20.0 million qualified real estate project located in a qualified census tract. Further assume the project receives a $20.0 million NMTC allocation from one or more CDE(s) and has an agreement with a NMTC investor to invest NMTC equity at $0.72 per credit dollar. The $20.0 million allocation award along based on the NMTC investor’s pricing will produce $5,616,000.00, cash, for the project ($20.0 million NMTC allocation x 39% x $0.72). Finally assume the project has sourced the leverage capital, which, in this example, is $14,384,000, the remaining capital needed to cover the $20.0 million project budget. It is important to keep in mind that the NMTC capital of $5,616,000 is a gross amount from which the NMTC allocation fees and professional expenses associated from the transaction are paid. Consequently, the rule of thumb is that a net cash benefit to a NMTC project is around 20% +/- or around $4 million.
If the net cash benefit can make up the difference in whether a project can move forward with all of its financing, then the project must do everything it can in order to secure the NMTCs. This means a project needs to be “shovel ready” and in order to get to this point, it should strive to complete or have in place, prior to the closing of the transaction, each of the items on the list below. Once completed, CDEs and the NMTC investors, as the project’s financial stakeholder, can be assured it will have a high likelihood of success with the investment reaching one or more of the particular needs of a distressed community.
On Thursday, April 22nd, Stites & Harbison will present a two-hour webinar on how best to go about making a project “shovel ready” for NMTCs. We will have the following four prominent speakers addressing certain aspects of the NMTC process which will provide important insight on how to improve a project’s chances of attracting NMTCs.
- Rob Bryant, Novogradac & Co. LLP – “Making a Complicated Process Understandable”
- Mike Qualizza, Chief Operating Officer, Urban Development Fund – “Community Impact-The Importance of a Project’s Community Outcomes”
- Courtney Nolan, Vice President-Community Development Tax Credits, JP Morgan Chase – “NMTC Underwriting-What Makes a Project Attractive to an NMTC Investor” and
- Judge B. Wilson II, General Counsel & Secretary, Berea College – “A Project Sponsor’s Perspective: What to Expect from a NMTC Transaction"
Please consider joining us on Thursday, April 22nd from 11:30 am – 1:30 pm EST. To register, click on : New Markets Tax Credit – What it Takes to Make a Project Shovel Ready.
1Section 45D of the Internal Revenue Code of 1986, as amended.
2Community Renewal Tax Relief Act (P.L.106-554).
3“CDFI Fund Announces More Than $3.5 billion in New Markets Tax Credits,” U. S. Department of the Treasury, Community Development Financial Institutions Fund, July 15, 2020.
4H.R. 133, 116th Congress, (2019-2020).
5“New Markets Tax Credit Receives Five Year, $5.0 Billion Extension,” New Markets Tax Credit Coalition, CISION PR Newswire, December 22, 2020.
7“Measuring the impacts of the New Markets Tax Credit Program on our communities,” Baker Tilly.
8“A Look at Procuring New Markets Tax Credit (NMTC) Funding," Sara K M. Gross, IMPLAN BLOG, April 20, 2018.
9IRC Section 45D(a).
10The 73 CDEs receiving awards in 2020 were chosen from a pool of 214 applicants which were headquartered in 35 states, Puerto Rico and the District of Columbia. The CDFI announced that these award recipients were estimated to make more than $682 million in NMTC investments in non-metropolitan counties, approximately 20% of which will be made in rural communities. See https://taxnews.ey.com/news/2019-1005-cdfi, Ernst & Young Tax News Update, U.S. Edition, May 29, 2019.
11Treas. Reg. Section 1.45D-1(5).
12IRC Section 45D(d)(2).