In The News

New Markets, Historical Opportunities

Jul 21, 2015
DFW Real Estate Review

A variety of economic development tools help support new projects and the redevelopment of existing buildings. But one initiative, the New Markets Tax Credit Program, has been used to improve the very health of those who live in a community. That has been the case with a new 44,378-square-foot health clinic that sits next to DART’s Hatcher Station in the Frazier Courts area of South Dallas. Rates of health issues in the neighborhood—for things such as cardiovascular disease, cancer, stroke, and diabetes—had become the highest in the city, according to the Baylor Health Care System. The Hatcher Station clinic, which opened in May and is run by Parkland Health & Hospital System, is expected to handle more than 60,000 patient visits a year. A range of for-profit and nonprofit organizations worked with Dallas’ Office of Economic Development to make Hatcher Station a reality, according to Dorothy Hopkins, president and CEO of Frazier Revitalization Inc. But the $19.8 million clinic would not have happened without key financing from JPMorgan Chase, for which the banking giant received a $5.85 million New Markets Tax Credit that it will claim on its federal income taxes over a seven-year period, Hopkins says. “Conventional financing for projects like these is nonexistent in low-income areas such as Frazier,” she says. “The rents aren’t there. The demand is not there. Lenders will not lend. The projects can’t be underwritten.” Created by the U.S. Congress in 2000, New Markets Tax Credits create “a very attractive layer of the capital stack for developments in unproven markets,” says R. Rhys Heinsch, principal at Dallas-based Catalyst Urban Development. The credits were used to help fund his company’s Lancaster Urban Village, a $30 million mixed-use, transit-oriented development. 


Another notable incentive is a pair of tax credits—one federal, one state—for preserving and rehabilitating historic structures and properties. The Texas Historical Commission often serves as the first stop for inquiries about those credits on historic properties. That is partly because it serves as the liaison for applicants with the National Park Service, which makes final determination and approvals, according to a commission spokesperson. The federal program provides a 20 percent income tax credit for rehabs of historic, income-producing buildings. The commission also provides an initial application process for state credits, while the Texas Office of the Comptroller has final say on the use and transfers of those credits. The Texas Historic Preservation Tax Credit, which applies to franchise taxes, will cover up to 33 percent of eligible costs through low-cost equity and/or sale proceeds, according to Phillip Geheb, a real estate attorney in the Dallas office of Munsch Hardt Kopf Harr. That 25 percent tax credit program from the state became effective in January. Yet it has already been used, in combination with the Federal Rehabilitation Tax Credit Program, on a number of notable projects in downtown Dallas, including the Hilton Statler, One Main Place, 1700-1712 Commerce, 211 North Ervay, and the Butler Building, Geheb says. “The policies behind these tax credit programs are to encourage the private market to invest in projects that otherwise would not be constructed or preserved,” he says. “The net benefit generated through participation in these programs fills a critical gap in the capital stack for these projects and helps generate economic growth in areas of North Texas that would otherwise lag behind.”


The city of Dallas is a significant player in the new markets program in particular. That’s partly because a nonprofit the city created in 2009, called the Dallas Development Fund, serves as an authority in this area for allocating tax credits under the program. The fund is one of at least 263 “Community Development Entities” that compete each year for what amounts to the right to help allocate a basket of tax credits. Other North Texas operations that serve as Community Development Entities include the Dallas-based Texas Mezzanine Fund, a for-profit lender that deploys new markets tax credits into projects statewide, both real estate and non-real estate based. In early June, an arm of the U.S. Treasury Department announced that it had awarded the Dallas Development Fund the equivalent of a total of $45 million in new markets tax credits. (Each dollar that a given development project uses from the allocation works out to 39 cents of actual federal income tax credit for an investor in a project.) This is a significant amount and the third such award—which are usually good for three years from the date when they’re handed out—that the Development Fund has received since 2009. It received a $55 million allocation in 2010 and one for $30 million in 2012. The funds have helped support numerous projects in the area, including the NYLO Hotel and Lancaster Urban Village. “We have a separate board that approves each transaction, and then they’re recommended to the city council, which makes final approval for each deal,” says Karl Zavitkovsky, director of Dallas’ Office of Economic Development. The Texas Mezzanine Fund received allocation awards totaling $213 million between 2008 and 2013. An issue for both the Dallas Development Fund and the Texas Mezzanine Fund is that the federal law authorizing the new markets credit program expired on Dec. 31 of last year. A pair of identical, bipartisan bills are pending in Congress— one in the House, the other in the Senate—that would provide permanent authorization for the program, along with nearly $5 billion in annual credit authority that is indexed to infl ation and an exemption from the Alternative Minimum Tax. President Barack Obama included a similar proposal in his 2016 fiscal year budget, according to Bob Rapoza, spokesman for the Washington, D.C.-based New Markets Tax Credit Coalition, an advocacy group. Congress limits how much in total new market tax allocations that the Treasury Dept. arm can hand out to Community Development Entities like the Dallas Development Fund, Rapoza said. The cap for fiscal 2014, for instance, was $3.5 billion. Generally, only 70 to 80 community development entities get allocations in a fiscal year, he added. “There are easily two to three times that number that have qualified applications and records of success.” 


Securing tax credits on a development, though sometimes labor intensive, can enhance returns and make projects viable that otherwise would never see the light of day. Here’s a look at some things to keep in mind when seeking new markets tax credits, which go for investment in low-income areas, and historic credits, which apply to renovations of historic properties.


Transactions can be complicated: When working with the Dallas Development Fund, for instance, applicants must raise cash, such as loans or grants, and channel that cash via a pass-through entity to a subsidiary of the Fund. The closing checklist typically contains 100 items or more. The earlier applicants can get up to speed on the process, the better.

Who gets the credits: New Markets credits go to investors who have qualifying “passive activity” income. This has been defined as activity in which the taxpayer did not materially participate during a given tax year. The passive activity requirement tends to limit New Markets credits to banks (such as Bank of America or PNC], insurance companies (AIG) and some Fortune 500 companies (AT&T).

Value of the credits: In return for providing fi nancing with lower borrowing costs and more lenient terms, banks, insurers and large companies get a New Markets allocation, with every dollar of allocation turning into 39 cents of tax credits for which they can take a given portion over seven years. Although numbers in the real world vary, a rule of thumb is that this 39 percent credit translates into a return of four to five percent, possibly lower.


What’s available: The Texas Historical Commission is the primary conduit for two significant tax credits—the Federal Rehabilitation Tax Credit Program, which is worth 20 percent on income of historic, income-producing buildings, and the Texas Historic Preservation Tax Credit, worth 25 percent on renovations of historic buildings. On top of that, Texas offers a sales tax exemption on labor for repairs, restoring or remodeling of certain historic buildings, and local authorities sometimes offer property tax incentives on given landmarks.

Value of the tax credits: The federal credit generally translates roughly into a seven percent annualized return over the life of the credit, although that varies based on the deal and how much cash flow the investor will receive based on their ownership interest. The state tax credit will typically cover 30 percent to 33 percent of eligible costs through low cost equity and/or sales proceeds.

Hurdles to consider: For federal tax credits, it’s best to engage a historic consultant early in the process, as some negotiation and work may be necessary with both the National Park Service (which makes final determination and approvals) and the Historic Commission. The owner of the state credit can take that credit on their state taxes, but that would lower the deduction they otherwise would get on their federal income taxes. There again, it’s important to consult with outside attorneys and accountants on how best to handle that.

SOURCES: Dallas Development Fund, Texas Historical Commission, and Phillip Geheb, real estate attorney at Munsch Hardt Kopf & Harr. 

By: Jeff Bounds