Cherrytree Group Blog

Twinning of Tax Credits

[fa icon="calendar"] Apr 1, 2015 12:30:00 PM / by Warren Kirshenbaum

Historical buildings lend themselves very well to multifamily residential use.  

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When performing an adaptive reuse of a historic building, in addition to the possibility of utilizing historic tax credits (HTC's), if a certain number of the residential units are designated as affordable there may be a possibility to secure low-income housing tax credits (LIHTC's).  In such a project, there will need to be a twinning of the two different types of tax credits, and successful completion of the project will hinge on the attention needed to be paid to the structuring of the transaction, the coordination between the requirements of each program, as well as the specific protections needed by the tax equity provider(s) and/or the lender(s).

Typically, one of the types of projects that could generate HTC's and LIHTC's would be an old mill or factory that is listed on (or eligible for listing on) the National Register of Historic Places, or is in a Historic District.  When such a building is repurposed into a multi-family residential rental apartment building, while retaining its historic character it may be eligible for HTC's on both the federal and state levels.  Additionally, when a portion of the building's units are reserved for tenants that meet certain HUD defined income criteria, such as those not exceeding 60% of an area's median income, it may be possible to apply for LIHTC's, which can also generate a state and federal tax credit.

The twinning of the tax credits in a deal can realize a net equity contribution to the project of approximately 40% of the project's costs.  This level of tax credit equity can be sufficient to satisfy a lender's sponsor equity requirement (assuming there is sufficient confidence on the lender's part in the substance of the developer/owner's guarantees) and sizing the debt itself to a level that can generate increased cash flow for the deal.

There are significant issues to account for in these projects, in that conducting the rehabilitation of the building in a manner that retains is historical character can be more expensive than general construction.  There are detailed guidelines in place by the arbiter of the tax credits: the National Park Service on the federal level, and the State Historic Commision on the state side.  Requirements such as period specific windows, facade, and other such items are cumbersome.  Also, the LIHTC program is competitive, and therefore, may result in your project being passed over for tax credits.  Furthermore, in a state like Massachusetts,  the tax credit award may be doled out in multiple rounds, which could extend out for 18 months or more.  Consequently, in the end over 40% of the project's costs may be covered by tax credit equity, the trailing equity needed for project expenses in the first two years of pre-construction and construction can be significant, sometimes in the vicinity of 15%-20% of the project's costs.  These costs will have to be covered by bridge financing, mezzanine financing, or even bringing in outside investors.  Moreover, the receipt of LIHTC's requires the recording of a Land Use Restrictive Agreement, which obligates the the building owner to keep the property affordable for a designated time period, usually 15 years, which is the recapture period for the tax credits.  Effectively, this creates a project that is more valuable in terms of cash flow rather than residual value.

Additionally, there may be several tax credit equity providers, as there are state and federal HTC's and LIHTC's, all of which may be taken by different investors, and then there may be a construction lender, a permanent lender, as well as the bridge financing or project level equity providers, there will be several sets of documents, each of which has different safeguards, protections, requirements, and default procedures, and all of these concerns need to be addressed.

These deals are not for the faint of heart, but when structured correctly and managed efficiently they can be very lucrative, rewarding in the sense of having maintained a part of our history and beneficial to the community at large. 

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Topics: Historic Rehabilitation Tax Credit, federal tax credits, Federal Tax Credit, Low Income Housing Tax Credit (LIHTC)

Warren Kirshenbaum

Written by Warren Kirshenbaum

Warren is the President and CEO of the Cherrytree Group, a tax credit consulting, brokerage, and syndication firm.

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