In my experience with site selection, economic development, incentive negotiation, and tax credit compliance, I am always amazed at the amount of money left on the table during expansion and relocation projects. The old adage says hindsight is 20/20, but in reality, I think it may be lack of knowledge. Project managers either overestimate the potential benefits, which can cripple the long-term economics of the project, or pursue the wrong economic program.
In recent years, project managers - for expansions as well as new facilities - have been overlooking the benefits of partnering with a qualified community development entity (CDE) to offset the cost of capital via the federal New Markets Tax Credit (NMTC). While not every project is eligible, those that are may potentially see reduced cost of capital of up to 50 percent.
How the Tax Credit Works
Typically, tax credits and incentives come after a company has had significant up-front cash outlays. While tax credits and incentives are valuable offsets against total project costs, what if you could reduce total project costs overall? By reducing the cost of debt interest, thereby limiting cash outflows for the project itself, a project is more likely to survive the first few years.
Capital market rates are computed on a project-by-project basis utilizing multiple factors, including but not limited to credit score, type of financing, and location of the project. While it is good business sense for lenders to pursue self-sufficient projects with little or no risk, the NMTC is designed to provide eligible lenders an incentive to offset the cost of doing business in low-income communities (LICs).
Since its inception in December 2000, the U.S. Congress has promoted the NMTC as an economic development catalyst for LICs across the country. It is designed to provide a federal tax credit (IRC Sec. 45D) to investors of CDEs, which in turn utilize investor funds to make below-market financing available in LICs. Congress believed the reduced cost of capital would reduce the number of business failures within LICs and spur additional investment.
To offset the reduced return rate and risk factors associated with projects in LICs, eligible CDE investors receive a 39 percent tax credit over a seven-year allowance period. Thus, the credit subsidizes the investor's risk and provides a significant return for pursuing LIC projects. As an example, if the project is eligible, the cost of capital can be 200 to 500 basis points lower over the first seven years of the project. From a cash-flow projection, this benefit far outweighs the benefits of other incentives. Although approximately 30 percent of existing census tracts in the United States qualifying for this program (most rural areas qualify), business leaders continually overlook this program.
The following real-world examples highlight the benefits of the NMTC. Each project was unable to move forward due the prohibitive nature of the respective cost of capital. Each project's cost of capital was based on its corresponding financial projections, proposed location of the site, credit score, etc. After exhausting the normal capital markets, the projects were able to find "affordable" capital via a NMTC lender. These projects highlight that not every project will be able to utilize NMTC funds, but those that can will have access to a lower cost of capital (financing or refinancing).
Case Study: Georgia
The first project was an expansion of a rural Georgia manufacturing/warehouse facility. The company had a long history in the community, but due to its rural location, traditional financial institutions bypassed the project to pursue projects in other areas such as Atlanta. Based on the size of the project, the local financial institution, with which the company had a 20-year relationship, determined it was unable to lend such a large amount.
After careful review with multiple lenders, the company was able to establish the cost of capital for the $10 million project as 8 to 10 percent. The cost of capital for similar projects in non-rural areas was significantly lower. Over the first seven years, the company determined the cost of interest via an interest-only repayment schedule would exceed $5,600,000. Thus, those lenders willing to provide funding would have charged such exorbitant rates/fees that it precluded the project from moving forward; the cost of capital for the project was economically infeasible.
After reaching out for assistance, the company was notified the project site was within an eligible LIC, thereby making the project eligible to partner with a NMTC lender, the CDE. After several weeks of discussions with various NMTC lenders, the project was offered financing on similar terms (interest only with balloon payment or gradual interest/principal payment) with a reduced interest rate of 4 percent. The reduced cost of capital provided almost $3,000,000 in savings. The reduced cash-flow requirements of the loan created long-term sustainability for the project.
Case Study: North Carolina
second project involved a mixed-use retail development site in North
Carolina that involved a former textile facility. While North Carolina
has a rich textile history, the last 30 years have not been kind to the
industry in that state. Facilities that began operations in the late
1800s were shifting overseas. Due to the age and lack of ability to
suit existing manufacturing requirements, a large number of textile
facilities sit empty. One existing facility, located within the city
limits of a major metropolitan area of North Carolina, caught the eye
of a developer. That developer believed the city's growth and
reclamation of inner-city areas would soon include that in which the
facility was located. The developer approached the corporate owner and
acquired the empty facility for pennies on the dollar.
developer envisioned a mixed-use facility with retail, office, and
condominium development. Due to the age of the facility, coupled with
the developer's vision to restore the facility to its period charm, the
cost of capital was significant. In several situations, lenders
informed the developer that the money was available, but only if the
developer tore down the existing structure and built something new from
the ground up. The developer maintained his stance that the history of
the facility would be a draw for commercial and individual tenants.
exhausting efforts with traditional lenders, the developer determined
that the cost of capital was prohibitive. But upon speaking with a
non-traditional lender, the developer determined that the site was
NMTC-eligible with the potential for historic rehabilitation credits.
The developer went back to several of the original lenders that
bypassed his project to seek another review. Two of the in-state
lenders had subsidiaries approved as CDEs with NMTC allocations
available for lending. After negotiating with both lenders, the
developer was able to reduce the cost of capital (the tax credits were
sold by the CDEs to provide equity to the developer) by 30 percent.
This project underscores that the lender contact with which you are
negotiating may not know of the NMTC program or the financial
institution's capacity to assist.
What to Do Going Forward
that the dollar signs have your attention, you may be asking, "What are
the minimum steps necessary to determine site eligibility? How do I
find potential NMTC lenders? How do I determine if the project will
meet eligibility standards? How do I calculate the potential benefits?"
Without getting into too much technical detail, the Community
Development Financial Institutions Fund (CDFI Fund), a United States
Treasury Department subsidiary agency, has oversight of the NMTC
program. Eligible CDEs on annual basis seek a tax credit allocation
that they can pass on to CDE investors. Once a CDE receives an
allocation, the CDE is required to push investor funds out into in the
market place within certain time limits. Failure to do so can cause
recapture of the credit for investors.
While some CDEs seek an
allocation for "pipeline" projects, other CDEs pursue projects upon
receipt of an allocation. Information on CDEs that receive a NMTC
award, their core business strategy, and areas of lending is publicly
To be eligible for NMTC program benefits, a project
must fall within a designated LIC. A company can determine census tract
eligibility in one of two ways, and I recommend you check both. First,
if you know the census tract number for the project site - most
economic development officials can provide this number - you can
cross-reference the number against the eligible census tracts published
by the CDFI Fund. A list of eligible census tracts is available on the
CDFI Fund website: www.cdfifund.gov. In addition, you can verify the
potential street address of the project through the CDFI Fund's NMTC
mapping program, which is also available at the CDFI Fund website.
Overall, the mapping program is very user-friendly. Very infrequently,
the site will not be able to map a particular address. If this problem
arises, personnel with the CDFI Fund program are very helpful in
determining site eligibility.
Once you have taken the steps to
determine if the site is within an eligible census tract, you must find
a qualified NMTC lender. As stated earlier, the CDFI Fund on publishes
the recipients of NMTC awards (eligible CDEs); this information is
available at the CDFI Fund website. The annual publication contains
information regarding the CDE's business strategy, as well as the
geographic region in which the CDE anticipates placement of funds. Each
CDE summary contains relevant contact information for CDE personnel.
Thus, you can cross-reference these publications in attempts to find
Pursuant to IRS guidelines, the borrower must
meet certain "eligible business" tests, thereby earning a designation
as a qualified active low-income community business (QALICB). Certain
business activities are automatically ineligible - some but not all
include golf courses, racetracks, gambling facilities, and stores where
the principal business is the sale of alcoholic beverages. CDEs are
acutely aware of eligible business structure rules and can provide
assistance with the technical details. If cursory information indicates
that additional research or assistance is necessary, most CDEs will
provide contact information for trusted legal counsel available to
discuss the project (project picks up legal costs).
have determined that the project site is within an eligible area, that
an NMTC lender is available, and that the business constraints listed
above are not burdensome, you should proceed with calculating benefits
to determine if the project should move forward, then factor in the
costs of meeting business structure requirements, as well as any
transaction costs (costs of attorneys). If the reduced cost of capital
outweighs the costs of the program, you have another incentive for the
J.D., CPA is the managing director of TaxCrop, LLC, a site
selection/incentive consulting firm. He has more than 15 years of
experience advising clients, from small business to Fortune 500
companies, on issues of tax liability and government incentives. In
addition, he is a faculty member at South Carolina State University,
teaching taxation, economic development, and entrepreneurship. Mr.
Masino can be reached at email@example.com.