Rehabilitating a historic property requires strict compliance with more building regulations than would be necessary for ground-up construction. Although a historic rehabilitation involves increased costs, a developer can secure both state and federal tax credits that, when combined, can recover up to forty percent (40%) of the construction budget. So, how can you use these incentives to aid your next financial project?
First, the subject property requiring rehabilitation should be a historic building. In general, a property that qualifies for the historic rehabilitation tax credit (HTC) will be listed on the National Registry of Historic Properties, be eligible for such listing, or be within a historic district. In addition, the rehabilitation expenses must be qualified rehabilitation expenses (QRE) as determined by the National Park Service.
The federal HTC is issued by the National Park Service, while the state HTC is awarded by the State Historical Preservation Office. The HTC is awarded to the entity that actually rehabilitates the property. Now, let’s say that you are awarded this hefty tax credit, but you are unwilling or unable to use the tax deduction. What do you do now?
As it turns out, there are people or entities out there that would like to use your HTC. These investors will invest in the original entity (you!) at a rate less than the tax credit’s total value. In return, they will most likely expect the following: use of the tax credits, a preferred return, and other fees such as an asset management fee, a share of cash flow, or an ability to be bought out of the entity in at least five (5) years.
In large markets involving tax credits that are valued at five million dollars ($5 million) or more, investors may include large banks, insurance companies, and Fortune 500 companies. In middle markets with tax credits ranging from one to five million dollars ($1-$5 million), investors may look like smaller corporate businesses and individuals with a large passive income stream.
All of this tax credit work can be time sensitive and difficult. This is where we come in as the broker and/or syndicator of the deal. Here at the Cherrytree Group, we can help you secure the right type of investor, negotiate the best terms, and ensure that you understand the syndication process better. You will learn what risks the investor is taking on your deal and what the nature of the relationship between the developer and the investor is when commercial real estate issues such as lease-up, operating deficits, and economic uncertainty present themselves.
By way of example, assume there is a blighted property that has historic significance. The owner wants to get rid of it so you can purchase it for $1. However, the costs to rehabilitate the building and reposition it for commercial use will be approximately $2 million. As it stands, the property is worth very little, and the bank will only approve a construction loan of 80% of the $2 million valuation or $1,600,000, leaving the developer short of $400,000. In this case, federal and state tax credits would generate $400,000, which after transaction costs, fees, and investor return would result in $320,000 equity to the developer. Therefore, the tax credits and debt financing would cover all but $80,000 of the rehabilitation cost. The developer could, therefore, complete the renovation, and his/her equity requirement of $80,000 would only be 8% of the cost, which is reasonable.
The next time you find yourself at a historic rehabilitation site with tax credits on the horizon, we hope you hear from you!