Incredible magical mystery money
The New Markets Tax Credit program can be a powerful economic development tool — if you can figure out how it works.
From the pages of In Business magazine.
In 2000, Congress passed legislation that created the New Markets Tax Credit program to spur private investment in low-income communities nationwide. Designed as an economic development tool for neighborhoods that have difficulty attracting investment, the program is administered by the Community Development Financial Institutions fund (CDFI), which is a division of the U.S. Department of the Treasury.
By providing private investors with a federal tax credit, neighborhoods with higher than average poverty, lower median incomes, or high unemployment can get an economic boost from development that will bring jobs, provide essential services, health care, or even grocery stores.
Since 2001, the NMTC program has created or retained about 198,000 jobs nationwide, supported the construction of nearly 32 million square feet of construction space, 75 million square feet of office space, and 57.5 million square feet of retail space. That’s enough progress to have earned the program a recent five-year renewal.
The benefits of the program are obvious, but the process can be cumbersome and extremely competitive.
Through a competitive application process, the CDFI fund allocates tax credit authority to Community Development Entities (or CDEs) that in turn lend money to local communities. The CDEs serve as financial intermediaries to move private capital from an investor to a qualified business in a low-income community as determined by the census track.
Forward Community Investments (FCI) in Madison is a CDFI and there are more than 20 others across the state, with the majority being located in the Milwaukee area, according to Salli Martyniak, FCI president. Being a CDFI automatically qualifies Forward Community Investments to be a CDE, meaning it can apply for new markets tax credits through a competitive application process.
CDEs must be legally established entities with a primary mission of serving low-income communities and a commitment to maintain accountability to the residents they serve. They use their authority to offer tax credits to investors in exchange for equity in the CDE. The Wisconsin Housing and Economic Development Authority, Park Bank, and The Alexander Co. have all received new markets tax credit allocations in the past, Martyniak notes.
New markets tax credits can also go to big banks, such as Chase or Wells Fargo, making the allocation of awards that much more competitive.
“When we submit an application, we may be going up against another 300 applications asking for tax credits for their institutions, so we’re up against the JP Morgan Chases of the world, or Wells Fargo, or US Bank,” Martyniak states.
FCI has been fortunate to receive back-to-back allocations the past two years, each worth $20 million in tax credits. “When we get it, we celebrate!”
Seth Harrop, manager in the new markets tax credit practice at Baker Tilly Virchow Krause LLP in Madison, explains that once a CDE receives an allocation of tax credits, it monetizes them by partnering with investors, frequently large banks, who provide cash for the value. With that cash in hand, the CDEs can offer loans with more favorable terms than conventional borrowers would typically see for businesses located within qualifying communities. That might mean lower interest rates or origination fees, higher loan-to-value, flexible provisions such as subordinated debt, or lower debt coverage ratios and longer maturities.
With the exception of “sin” businesses, such as liquor stores or gambling institutions, for example, Harrop says borrowers can be nonprofits, manufacturers, grocery stores, clinics, or hospitals, to name a few. Farms also are not allowed because the new markets tax credits are not intended to be an agricultural subsidy.
“The borrower gets these low-interest loans that are typically structured as interest-only for seven years, which would be highly unusual from a conventional bank,” Harrop explains. “At the end of the seven-year period, the portion that represents the tax credit equity is typically made available as a permanent equity injection into the business. That’s one of the most common structures.”
In addition to being located in a low-income census track (determined by specific criteria), Harrop says a business has to have a plan in mind such as a capital expansion, building a new facility, or purchasing some large equipment. “There has to be some new spend in order to take advantage of these tax credit dollars and a need for subsidy.”
The complicated transactions are just as complicated to close, usually involving many attorneys. For that reason, deals usually start at the $5 million range on the low end. “You have to get to a level of economies of scale to drive enough benefit from the program,” Harrop notes. “This is not grant money. Borrowers are getting loans.”
On a $5 million loan, for example, a portion would be made available to the borrowers at the end of the seven years as permanent equity that they could keep. In the meantime, “they’ve received $5 million in loans that are at rates that might be 50% of what they’d get at a bank, and it’s interest-only for those seven years, so it’s a good benefit to the borrower,” Harrop adds.
Martyniak (FCI) notes that Wisconsin has been fortunate to receive several allocations over the years, but last year only two were awarded — one to her group for the aforementioned $20 million and one to Milwaukee-based First-Ring Industrial Redevelopment Enterprise Inc. for $35 million. “That was a small year for Wisconsin,” she admits. “Normally there’s more allocation.”
FCI uses the tax credits to help communities redevelop distressed areas, and the tax credits benefit the projects because a large bank, a JP Morgan for example, purchases the allocation. “In exchange for investing in CDEs, investors claim a tax credit worth 39% of their original CDE equity stake, which is claimed over seven years. If the investor doesn’t have a tax liability in a given year they can carry the tax credit forward to the next year.”
She describes it using simple math: “If an investor has a $1,000 tax liability each year for seven years, their liability is reduced by an average of $60 per year for years one through seven. The benefit to the business is an equity infusion equal to roughly 30% of the total project amount. So if a project costs $1,000, the business finances 70% of the project through a conventional loan and the other 30% is financed at a very low interest rate by the investor’s injection of capital.”
FCI hopes to work with Operation Fresh Start soon on the purchase and rehabbing of its new building. Martyniak describes the benefits to a nonprofit, again using simple math: “Let’s say their project is worth $100 and tax credits come in as $30. That means they don’t have to fundraise those $30 because it comes from the tax credits.”
In Madison tax credits have been used to fund nonprofit projects such as the Goodman Community Center, Access Community Health Centers, The Urban League of Greater Madison, and the Madison Children’s Museum, as well as for-profit projects like Block 89 and The Edgewater Hotel, which have benefitted from being lumped into a low-income neighborhood designation due to the number of students residing nearby.
When the Madison Children’s Museum refinanced its construction debt in 2011, three banks joined forces to make it happen. Park Bank provided the permanent financing, US Bank purchased the tax credits, and Johnson Bank provided the credits. FCI helped the museum structure and utilize $6 million in new market tax credits.
At the time, Johnson Bank’s Greg Dombrowski noted the banks came together to support a project that will give back to the community for generations to come. “The intended outcome of the NMTC program is to stimulate economic investment, especially in this environment,” remarked Dombrowski, regional president of Johnson Bank. “We hope this project leads to other projects that inspire healthy growth.”
Most of FCI’s credits have been directed toward projects in Milwaukee or where it has partnered with other CDEs to make significant projects come to fruition.
In Platteville for example, FCI teamed with WHEDA to build a hotel on a blighted street. “We put in $6 million and WHEDA put in $10 million of its past NMTC award.” The developer in that case was a group of Midwest hotel developers who decided to use their benefit to build a new library and a health clinic, both adjacent to the hotel and intended to serve the low-income residents of Platteville and surrounding communities. “It’s a three-for-one,” Martyniak states.
FCI applies for new markets tax credits every year. In fact, everyone applies at the same time. The organization submitted its application at the end of 2015 and should know by July or August if it will be selected to receive an allocation. If selected, it typically would work with a community advisory board to determine if a project is eligible. If so, FCI informs the CDFI fund that it’s ready to use a portion of its award, and those credits then pass from the CDE to the investor.
Last year, Martyniak requested $50 million in tax credits but received $20 million, which could be a sign of the times. “When the program first started allocations were in the hundreds of millions of dollars, and those in the $150 million range weren’t unusual,” she observes. As the program has grown in popularity, she has noticed some reduced amounts.
Still, the New Markets Tax Credit program has proven very beneficial for communities nationwide with over 75% of investments made in highly distressed areas. For every $1 invested by the federal government, the program has generated more than $8 of private investment.
The program’s recent five-year extension was authorized with $3.5 billion of tax credit authority per year, notes Harrop. “That’s really not a lot of money for an entire country in any one year, so it’s a pretty niche program and a scarce resource.”
Martyniak admits it’s a complicated process, “but if you have the right people and partners involved, things happen.”
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