Todd Heistand, owner of NuStyle Development Corp. in Woodbine, Iowa, had owned 7.6 acres in a blighted area of Omaha, Neb., for six years. He always knew he wanted to do something with it, and when the city decided to build the Qwest Convention Center close to his land, he decided to act.
Heistand knew it would be a challenge to attract businesses to his mixed-use development, which would include 96 apartments. In fact, the multifamily end was the easy part–it made the project feasible. But to make the numbers work, he would need to charge about $20 a square foot in rent for the retail spaces. That would be very difficult in the emerging area in which he was building.
Fortunately, Heistand found something that would allow him to lower his retail rent to $7.50 a square foot: the new markets tax credit, authorized by Congress in 2000 to promote economic revitalization and community development in blighted or underserved areas.
It's a big deal. The new markets program will award a surprising $3.5 billion in tax credits, which are doled out by the Treasury Department's community development financial institutions fund, in 2006. (Compare this to the $789 million in low-income housing tax credits distributed in 2003, the most recent figures available, according to the National Association of Home Builders.)
Community development entities, also known as CDEs, compete for these funds. Community development organizations, small business investment corporations, and even developers are the most common CDEs. They usually partner with a developer to build a project. While retail or commercial space is required, many a new markets development also comes with a multifamily component.
For developers like Heistand and others, these new tax credits can make the difference in whether or not a project happens. If you want to build in a blighted or even emerging area, the new markets program can be an important tool in making a project viable.
"These are places where private capital is not ready to go on its own yet," explains Brian Whitman, executive vice president for Telesis Corp. in Washington, D.C., a firm that plans, finances, and builds urban communities and serves as a CDE in new markets deals. "You need subsidized money. You need some extra incentive to get the investors to the table."
That's what happened with Heistand's project. "We would have had 35,000 square feet of commercial area sitting there in a tough area just waiting for someone to lease," he says. "It would have taken two years for someone to come in and rent that [space], and it would have had high turnover and everything else. With the new markets tax credit, we were able to come up with a [commercial] tenant that came into the area and provided 100 jobs."
While multifamily developers are free to apply for the new markets program, they must remember that these tax credits aren't designed to support residential construction, but rather economic development. That means that the project cannot be strictly residential, but must also serve businesses and create new jobs.
"You can use it for for-sale and rental properties, where at least 20 percent [of the development] is commercial," says Charles Werhane, executive vice president and COO for Enterprise Community Investment in Columbia, Md. "For example, if you have a mixed-use project with ground-floor retail, you can use it. You can't use it in a situation with 100 residential rentals."
But there are other advantages to the program. Unlike the low-income housing tax credit program, accepting a new markets tax credit doesn't limit the amount of rent developers can charge their commercial and residential tenants. In fact, the only real restriction is on the types of clients that can occupy the retail space. "You can't lease to strip parlors, gambling halls, or liquor stores where they sell packaged liquors," Werhane says. "You can do a bar, but not a packaged liquor store."
Those rules apply for seven years, or the length of the tax credits. "The easiest way to think about it is that the tax credits would come into your project as equity and during the compliance period–which is seven years–it would stay there," Werhane says. "After the compliance period, the NMTC equity, or some portion, becomes developer's equity as the NMTC investor leaves the partnership."
Finding the Dollars
If you're a developer who wants to tap into the new markets program, there are two primary routes to take: Apply for funds or partner with another organization serving as a community development entity. The most direct route is to become a CDE and apply to the Treasury Department directly for the new market credits. There are negatives and positives to this approach, though.
Although a developer may be able to reap more equity from serving as its own CDE, Werhane says that strategy is laden with headaches. "Going in on your own is a lot of work," he says. "It's a seven-year commitment to compliance. There's a lot of reporting that has to be done and a lot of things that are required in the program that [developers] are not used to doing. The CDE does all of the reporting and keeps their boards and things like that."
If a developer doesn't want to deal with this overhead, he or she can go to development corporations, community development financial institutions, small business investment corporations that serve as CDEs and partner with them. Developers seeking CDEs can find them at www.newmarketstaxcreditcoalition.org.
Whether developers serve as CDEs or partner with them, they still have to deal with some complications. "You need a big project to make it work because of the legal fees and all of the pieces that go with them," Heistand says. "They need to allocate them down to state investment authority where they can split them up into smaller pots. You have huge banks and syndicators with huge chunks of these [credits], and they're not being divided up fairly."
Still, for a program that's in its infancy, Telesis' Whitman thinks the system is acceptable–for now. "As the industry matures and it becomes less expensive to do these transactions, it may make sense to do them in smaller chunks," he says. "But they had a lot of money to move quickly. They chose to distribute to institutions."