Presenting a live 90-minute webinar with interactive Q&A. Today s faculty features: John R. Orrick, Jr., Partner, Linowes and Blocher, Bethesda, Md.

Transcription

1 Presenting a live 90-minute webinar with interactive Q&A Mixed-Use and Economic Development Financing Structures and Options Leveraging Construction and Mezzanine Loans, Preferred Equity, Tax Increment and EB-5 Financing, Tax Credit Funds WEDNESDAY, DECEMBER 10, pm Eastern 12pm Central 11am Mountain 10am Pacific Today s faculty features: John R. Orrick, Jr., Partner, Linowes and Blocher, Bethesda, Md. Debbie A. Klis, Of Counsel, Ballard Spahr, Bethesda, Md. Daniel J. Kolodner, Partner, Klein Hornig, Boston The audio portion of the conference may be accessed via the telephone or by using your computer's speakers. Please refer to the instructions ed to registrants for additional information. If you have any questions, please contact Customer Service at ext. 10.

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4 MIXED-USE AND ECONOMIC DEVELOPMENT FINANCING STRUCTURES AND OPTIONS STRAFFORD PUBLICATIONS WEBINAR DECEMBER 10, 2014 John R. Orrick Jr. Linowes and Blocher LLP 7200 Wisconsin Avenue, Suite 800 Bethesda, Maryland (301) / jorrick@linowes-law.com

5 John R. Orrick, Jr. Linowes and Blocher LLP 7200 Wisconsin Avenue, Suite 800 Bethesda, Maryland (301) Mr. Orrick specializes in commercial and real estate finance. He has represented numerous clients in diverse transactions including joint ventures, mezzanine loan transactions and other commercial financings. Mr. Orrick has also represented developer groups in TIF/development dis trict municipal bond financings in Maryland. 5

6 SECURED COMMERCIAL LOANS PREFERRED EQUITY MEZZANINE LOANS 6

7 THE CAPITAL STACK Equity 20% to 60% of project costs. Pays return based on performance. Mezzanine or Performing Debt Gap financing to cover costs not supported by debt or equity. Usually paid through performance. Debt 40% to 80% of project costs. Pays interest, secured by lien. 7

8 CHARACTERISTICS OF SECURED DEBT Secured by Mortgage or Deed of Trust on Real Property Plus Security Interest in Personal Property Promissory Note With Stated Rate of Interest (Variable or Fixed) and Stated Maturity Date Covenant Protection to Lender Affirmative and Negative Including SPE Covenants Priority Repayment in Insolvency Proceedings Often Limited by Loan-to-Value and Debt Service Coverage Criteria 8

9 SECURITY FOR SECURED DEBT Property Value Typically Amount of Loan will not exceed 70-75% of appraised value of Land and Cost of Construction Recourse to Borrower Assets Other Than Real Estate (Unless Loan is a Nonrecourse Loan) Guarantees by Parent, Manager, Sponsor and/or Individuals Who Comprise Sponsor Group Expected Cash Flow Derived from Borrower Debt Service Coverage Pre-Sales and Pre-Lease Commitments Subordination, Non-Disturbance and Attornment (SNDA) Agreement (if Existing Tenants) 9

10 SECURED DEBT PERFECTION AND PRIORITY Mortgage Recorded in Land Records - First in Time, First in Priority Subordination Agreements Between Creditors Assignment of Leases and Rents, Construction Agreements and Plans and Specs Security Agreement and UCC Filings 10

11 SOURCES OF SECURED DEBT Single Lender (Whole Loan) Loan Participation (Multiple Lenders) Pooled Loan Structure - CMBS 11

12 SIMPLE JOINT VENTURE WITH ONE LENDER AND DEVELOPER/INVESTOR 25% Equity Operating Partner/ Developer Real Estate Investor LENDER (Whole Loan) Mortgage Loan Venture / Property Owner 75% Debt (Whole Loan) 12

13 Junior Loan TWO LOANS WITH DEVELOPER/INVESTOR JOINT VENTURE Operating Partner/ Developer Real Estate Investor 10% Equity 15% Junior Loan SENIOR LENDER Senior Loan Venture/ Property Owner 75% Senior Loan JUNIOR LENDER 13

14 Limited Partnership EQUITY LEGAL STRUCTURE FOR BORROWERS Limited Liability Company (LLC) Real Estate Investment Trust Business or Statutory Trust Corporation (S or C) 14

15 CHARACTERIZATION OF PREFERRED EQUITY Equity in Borrower Entitled to a Preference in Timing or Amount of Payment Above Common Equity (Sponsor) Not Secured by Any Pledge of Assets Subordinate to Debt in Insolvency Proceedings Within Governing Instruments of Borrower, Preferred Equity May Exert Complete or Restricted Control Over Borrower: Control Over Major Decisions Right to Remove Manager Redemption Rights / Buy-Sell Provisions May be on Disproportionate Basis to Invested Capital Carried Interests or Promote Payments Are a Form of Preferred Equity Granted for Services 15

16 BORROWER STRUCTURE REVENUE DISTRIBUTION AMONG PARTIES Waterfall for Distributions Pro rata / Preferred returns / promotional returns (may distinguish operating from capital events) Clawbacks based on other deals / events Provision for Fees for Services Tax Distributions Repayment of Member Loans Provisions for Dissolution Liquidation Payments and Distribution of Hard Assets 16

17 OTHER PREFERRED EQUITY ISSUES Decision Making - Fiduciary Duties if Management Rights Exercised Waiver or Limitation Within Governing Document Characterization as Debt vs. Equity Tax Treatment Single Level of Taxes; Capital Gains vs. Ordinary Income Tax on Distributions Potential Dilution if Additional Capital Needed 17

18 MEZZANINE DEBT CHARACTERISTICS Loan to Equity Owner of Borrower Not Debt of Borrower Secured by Pledge of Ownership Interests of Borrower Structured as Debt, but Often With Profit Participation Features Structured Subordination to Senior Debt, But Generally Possessing Rights to Control Borrower and Receive Preference on Distributions, so Senior to Equity 18

19 DOCUMENTATION FOR MEZZANINE LOAN TRANSACTION Loan Agreement Addresses use of funds, borrowing period, conditions for advances, draw schedule, negative and affirmative covenants of borrower, representations and warranties, events of default, and remedies to lender upon events of default Promissory Note States terms for repayment of principal and interest Pledge Agreement Pledge of member interests in partner/ member of property owner Guaranty Documents UCC Financing Statement 19

20 DOCUMENTATION FOR MEZZANINE LOAN TRANSACTION (CONT.) Amendment to Property Owner Operating Agreement to enforce remedies of removal of General Partner, foreclosure of interests in membership/partnership interests, Article 8 opt-in Warrants / Equity Conversion Right Inter-Creditor Agreement with Senior Lender (Cure Rights, Rights to Substitute Management; Rights to Foreclose and Replacement of Borrower Guarantees) Certificates for Membership Interests 20

21 OPTIONAL FEATURES IN MEZZANINE LOAN TRANSACTIONS Equity Kicker/Warrants Option to obtain direct interest in joint venture entity Convertibility Features Allow conversion of all or a portion of principal investment into equity Prepayment/Redemption Penalties UCC Insurance 21

22 MEZZANINE LENDING OTHER ISSUES Inter-Creditor Agreements and Standstill Provisions Method of Perfection Article 8 / Article 9 of Uniform Commercial Code Transfer Taxes Limitations on Foreclosure of Interest Charging Orders Remedy for Partnerships / LLCs Article 9 Requirements for Foreclosure Notice provisions, commercial reasonableness, rights to deficiency Fraudulent Conveyance / Preference Issues 22

23 PRIMARY LENDER WITH DEVELOPER, INVESTOR, AND MEZZANINE JOINT VENTURE INVESTOR/LENDER Intercreditor Agreement Mezzanine Loan Pledge of Ownership Interests in Property Owner Operating Partner/ Developer Mezzanine Borrower 10% Equity 15% Mezzanine Loan MORTGAGE LENDER Mortgage Loan Property Owner 75% Senior Loan 23

24 PRIMARY LENDER WITH DEVELOPER, INVESTOR, EQUITY FUND AND MEZZANINE JOINT VENTURE Operating Partner / Developer Private Equity Fund 1% Equity From Local Real Estate Investor 10% Owner 90% Owner 9% Equity from Private Equity Fund MEZZANINE LENDER MORTGAGE LENDER Mezzanine Loan Pledge of Ownership Interests in Mortgage Borrower Mortgage Loan Mezzanine Borrower Property Owner 15% Mezzanine Loan 75% Senior Loan 24

25 Mixed-Use and Economic Development Financing: Structures and Options (Historic Tax Credits, New Markets Tax Credits, and Low Income Housing Tax Credits) Strafford Teleconference: December 10, 2014 Daniel Kolodner, Klein Hornig LLP 25

26 Key Federal and State Tax IncentivES Federal and State Tax Credits are available to: Build affordable housing (the low income housing tax credit or LIHTC) (IRC Section 42). Rehabilitate historic structures (the historic tax credit or HTC)(IRC Section 47). Develop commercial projects in low-income areas, or to employ low-income people (the new markets tax credit or NMTC) (IRC Section 45D). Develop energy from renewable sources (the renewable energy tax credit, which has both an investment tax credit or ITC, and a production tax credit or PTC) There are also various associated State Tax Credits 26

27 Rehabilitation (Historic) Tax Credits 27

28 There are Two Types of Federal HTC: 10% & 20% Credit Qualification Permitted Use 10% Credit 20% Credit Building older than 1936 and neither listed on National Register of Historic Places nor located in Historic District and contributing Commercial, may not have residential rental Requirements Must exceed $5,000 of qualified rehab expenditure, or building basis, whichever is greater Listed on National Register of Historic Places or located in Historic District and recognized as contributing to district Commercial, may have residential rental Same 28

29 The 20% Rehabilitation Tax Credit Fundamentals Preservation aspects jointly administered by NPS and State Historic Pres. Offices (SHPOs). Tax Aspects Administered by the IRS. Tax Credits = dollar for dollar reduction in tax liability (contrast with deduction). RTC is the most important (in dollar volume) federal preservation program. 29

30 The NPS Rules: Parts 1, 2, and 3 Historic Preservation Certification Application Part 1 - Evaluation of Significance Part 2 - Description of Rehabilitation Part 3 - Request for Certification of Completed Work 30

31 What Types of Buildings Qualify? The NPS Rules: Certified Historic Structure Requirement Part 1: Option #1 Building is listed in the National Register of Historic Places Part 1: Option #2 Building is located in a registered historic district and certified by the National Park Service as being of historic significance to the historic district. 31

32 What Types of Buildings Qualify? The NPS Rules (cont d) Historic Preservation Certification Application Part 1 Evaluation of Significance Part 1 is used to establish that a building: Does or does not contribute to significance of a district; Has preliminarily been determined to be eligible for National Register listing; and Contributes to proposed historic district. 32

33 What Types of Rehabilitations Qualify? The NPS Rules (cont d) Historic Preservation Certification Application Part 2 Description of Rehabilitation Must be preceded or accompanied by Part 1. Part 2 is submitted to SHPO. SHPO forwards to NPS. Description of proposed rehabilitation. Processing Fee of $500 to $2,500 (depending on size). 33

34 What Types of Rehabilitations Qualify? The NPS Rules (cont d) Historic Preservation Certification Application Part 3 Request for Certification of Completed Work Must be preceded or accompanied by Part 2. Part 3 is submitted to SHPO. SHPO forwards to NPS. Part 3 must generally be received prior to the date that is 30 months after the date of the tax return upon which HTCs are claimed (the 30 Month Rule ) unless a statement is filed with IRS prior to such date extending the 3 year statute of limitations. 34

35 What Types of Buildings Qualify? The IRS Rules: Depreciable Building Requirement Must be a building. Building is defined as a structure or edifice enclosing a space within its wall and usually covered by a roof Building must be depreciable. Depreciable buildings are generally those used for nonresidential (i.e. commercial) or residential rental purposes. (See Section 168(e)) 35

36 What Kinds of Buildings Qualify? Almost Anything But a Personal Residence Apartments Hotels Office Buildings Warehouses Distribution Facilities Back-Office Support/Computer/Call Centers Sports Facilities Mixed Use of Any of the Above 36

37 What Types of Rehabilitations Qualify? The IRS Rules: Substantial Rehabilitation Requirement The QREs incurred during any 24-month period** selected by the taxpayer and ending in the taxable year in which the building is placed in service must exceed the greater of: $5,000, or The adjusted basis of the building. **A 60-month period may be used where written plans completed before the rehab begins show that the rehab is expected to take place in phases and is reasonably expected to take more than 24 months. 37

38 What Types of Rehabilitations Qualify? Definition of QREs Qualified Rehabilitation Expenditures (QREs) is the tax term given to those development costs on which rehabilitation tax credits can be claimed. QREs are any amounts chargeable to a capital account made in connection with the renovation, restoration or reconstruction of a qualified rehabilitated building (including its structural components), except as provided by law. 38

39 What Types of Rehabilitations Qualify? Definition of QREs QREs include costs related to: walls, partitions, floors, ceilings; permanent coverings such as paneling or tiling; windows and doors; air conditioning or heating systems, plumbing and plumbing fixtures; chimneys, stairs, elevators, sprinkling systems, fire escapes; 39

40 What Types of Rehabilitations Qualify? Definition of QREs (cont d) QREs include costs related to: construction period interest and taxes; architect fees, engineering fees, construction management costs; reasonable developer fees* The Safe Harbor Revenue Procedure highlights the concept of reasonable developer fees. It is now important to get third party back-up of all cash-flow based fees, including deferred developer fees 40

41 What Types of Rehabilitations Qualify? What is Not a QRE? Land & Interest Carry on Land Building Acquisition & Interest Carry on Acquisition Acquisition-Related Costs Site Improvements & Landscaping Enlargements & Demolition Personal Property Tax Exempt Use Property 41

42 The 20% Rehabilitation Tax Credit Calculating the Allowable Credit Credit equals 20% of all QREs incurred: Prior to the start of the 24-month period selected (so long as they were incurred in connection with the rehab process that resulted in the substantial rehabilitation of the building); During the 24-month period; and After the last day of the 24-month period but before the last day of the tax year in which the measuring period ends. 42

43 The 20% Rehabilitation Tax Credit When is the Credit Allowed? Credit is generally allowed in the year in which the building is placed in service (provided substantial rehabilitation test has been met). Placement in Service means that the all or identifiable portions of the building is placed in a condition or state of readiness and availability for a specifically assigned function. If you plan on monetizing the Credit, it is very important to plan ahead and bring in any partners/investors prior to the Placement in Service date. 43

44 The 20% Rehabilitation Tax Credit Who Can Claim the Credit? The Credits belong to the taxpayer(s) that owns title to the property when the QREs are placed in service. A landlord that incurs QREs can elect to pass the credit to its long-term tenants. When property owner is a pass through entity, the Credits are allocated in accordance with taxable profits. 44

45 Tax-Exempts and Historic Tax Credits: Be aware of tax exempt use issues with Historic Tax Credits Section 47 of the Code provides that QRE s eligible for Historic Credits do not include expenditures allocable to the portion of the property which is (or may reasonably be expected to be) tax exempt use property. A tax exempt entity as an owner of or tenant in a historic building can cause a loss of Historic Tax Credits so careful structuring of any tax exempt entity participation is required. Grants/donations to the owner of a historic building can also cause tax issues and potential reduction of Historic Tax Credits if not handled appropriately. 45

46 Tax-Exempts and Historic Tax Credits: Tax Exempt Ownership: Who is a Tax Exempt entity?* Governmental/State entities Any organization exempt from income taxes (such as a 501(c)(3)) Any foreign person or entity Any Indian tribal government Can the Tax Exempt (or its sub-entity) make a 168(h) election to be taxed as a for-profit entity? Will the same Tax Exempt be the end-user of the Building? *IRC Section 168(h)(2)(A) 46

47 Tax-Exempts and Historic Tax Credits: Tax Exempt Use: Specific limitations on Tax Exempt Use by enduser tenants 50% limitation (up from 35%) What counts towards the limitation? Qualified vs. Disqualified Leases to Tax Exempt Entities Did the tax exempt participate in the financing? Is there a fixed purchase price/option to buy under the Lease? Is the Lease term in excess of 20 years? Has there been a sale/leaseback with the Tax Exempt 47

48 The 20% Rehabilitation Tax Credit Recapture Credit previously allowed is recaptured if any portion of the project which includes QREs is disposed of prior to the fifth anniversary of placement in service. Amount subject to recapture decreases by 20% during each year of the five year period. Disposition includes any sale, exchange, transfer, gift or casualty. Subsequent rehabs that do not comply with the Secretary s Standards can trigger recapture. 48

49 Recapture Risks Recapture Risks: Building ceases to be investment credit property Subsequent rehabilitation of the building that does not meet National Park Service standards; Building is otherwise converted to an improper use, such as personal use or goes out of service Over 50% of the Building is leased to a tax-exempt entity 49

50 Recapture Risks Recapture Risks: Change of Ownership of owner/lessee If the Investor sells more than 1/3 of its investment in the entity claiming the credit (owner or lessee) If the owner is claiming the credit and the building is foreclosed on or sold, resulting in a change in ownership of the building. For example, where the tenants go dark and the general partner/developer does not have funds to support the owner s debt service payments. If the lessee is claiming the credit in a lease passthrough, and the master lease is terminated., including where the tenants go dark as above. Too much nonqualified non-recourse financing 50

51 Recapture Mitigants Recapture Risk Mitigants: The historic property owner contractually agrees to: not alter the appearance of the building or convert it to an improper use, not take any actions or inactions that would cause recapture, not alter the ownership structure of the property, or, if applicable, terminate the master lease BUT under the recent safe harbor, not able to guarantee structure risk. Historic consultant or architect monitor the rehabilitation, and certify regarding the rehabilitation meeting NPS standards Non-disturbance agreements are entered into by the lender so that the lender is allowed to foreclose but must not interrupt the master lease (unless in default). Casualty insurance, including HTC insurance, alleviates liability for destruction of the historic property. Underwriting of tenants to assure rent payments and guarantees of creditworthy developer or general partner. 51

52 Common Investment Structures Single Entity Structure. Master Lease/Credit Pass-Through Structure. 52

53 Single Entity Structure Managing Member (Developer Affiliate) Tax Credit Investor LLC Tax Credit Investor 1% Credits, Profits & Losses, Fees and Cash Flow Developer Equity Historic Tax Credit Equity 99% Credits, Profits & Losses and Cash Flow Tax Credit, LLC (Property Owner) Dev. Fee Developer Loan Proceeds Debt Service Payments Rental Payments Construction/ Perm Lender Tenants 53

54 Historic Tax Credit Syndication The Credit Pass-Through Structure Landlord LLC owns fee simple, undertakes rehab, enters into Dev. Agreement, and earns the Historic Tax Credit. Master Tenant, LLC leases the entire project from the Landlord LLC for a fixed annual rental payment. 54

55 Historic Tax Credit Syndication The Credit Pass-Through Structure Master Tenant, LLC operates the property, subleases to end users and enters into the Property Management Contract. Landlord makes special tax election to pass the Historic Tax Credit through to the Master Tenant LLC. 55

56 Master Lease/Credit Pass-Through Structure Managing Member (Developer Affiliate) Tax Credit Investor LLC Developer Equity 90% Profits & Losses, Fees and Cash Flow 1% Credits, Profits & Losses, Fees and Cash Flow Historic Tax Credit Equity 99% Credits, Profits & Losses, and Cash Flow Landlord, LLC (Property Owner/Lessor) Loan Proceeds Debt Service Payments Construction/ Perm Lender Pass-through of Historic Tax Credits & Share of Residual Lease Payment & Equity Investment 10% Profits, Losses, and Cash Flow Master Tenant, LLC (Master Tenant) Rental Payments Sub-Tenants/ End Users 56

57 Recent Developments: Case Law Virginia Historic Tax Credit Fund 2001 LP v. CIR (3/2011) Tax Treatment of state tax credits Fourth Circuit decision reverses Tax Court (12/2009) Having major impact on state tax credit structuring Consolidated Edison Company Inc. of New York v. United States, No ,(Fed. Cir. January 9, 2013) While not a historic tax credit case, the case changes how put options are evaluated Historic Boardwalk Hall, LLC v. Commissioner, No (3rd Cir., August 27, 2012) Case appealed to 3 rd Circuit, and 3 rd Circuit reversed the Tax Court 57

58 Historic Boardwalk Hall: Conclusions The appeals court decision was primarily decided on the investor not being a partner in the transaction The decision did NOT provide any bright line guidance to restructure transactions, nor did it spell out any actions that could be taken by an investor to be deemed a partner It is possible to draw some preliminary conclusions and/or recommendations based on the decision, but the tax credit industry is still in flux months later Post HBH, historic tax credit deal structuring is being changed to maximize the potential for the investor being a partner in the transaction with a focus on downside risk and upside potential. IRS Guidance (Revenue Procedure ) released in early 2014 Most deals now are being structured to comply with the safe harbor featured in the Revenue Procedure 58

59 Revenue Procedure Establishes a safe harbor for structuring transactions Does not address other tax credits By following the terms of the Guidance, developers can be certain that the HTC generated by an investment will be allocated to the Investor and that Investor will be respected as a Partner No minimum amount of cash needs to be distributed to the Investor (and recent discussions with Treasury confirm this approach), therefore economic substance issues are now less important Investor must receive reasonably anticipated value, exclusive of tax benefits, commensurate with the Investor s percentage interest in the Partnership 59

60 Revenue Procedure Commensurate being interpreted to mean that cash flow and residual distributions in accordance with the % interest of the Investor (99% interest then 99% distributions) But a Flip of interests is allowed after year 5 At least a 5% interest must be maintained, but possible to flip the investor from a 99% interest to a 5% interest BUT economic value of the Investor s Interest must not be reduced through fees, lease terms or other arrangements that are unreasonable compared to non-htc projects This will require additional underwriting and review Subleases are directly challenged Developer Fees and Incentive Management Fees are also at issue if they are cash flow based fees Investor preferred returns are permitted, but they can t be guaranteed 60

61 Revenue Procedure Downside Risk At least 20% of investor equity must be contributed prior to placement in service At least 75% of the Investor s total expected capital contributions must be fixed before placement in service But this 75% portion may be subject to conditions such as placement in service, stabilization or receipt of Part 3 approval Guaranties: Funded guaranties not allowed (including minimum net worth) Impermissible guaranties include: Guaranty of partnership distributions or economic returns Tax structure risk or other disallowance or recapture events not due to an act or omission of the Developer Can t pay costs of audit 100% structure risk now on the Investor (likely to create an incentive for investors to meet the guidance) 61

62 Revenue Procedure The Investor may hold an option to put its interest to the developer at an amount not to exceed FMV Developer may not have a call right at FMV, but because of the ability to structure a flip in interests after the compliance period, there is some ability to structure around this issue The Investor is now going to receive additional cash flow during the compliance period, and the exit will be less certain. Guidance effective as of December 30, Should deals that have closed but not yet placed in service restructure? 62

63 New Markets Tax Credits 63

64 Introduction to New Markets Tax Credits -- NMTC Unlike the other credits discussed herein, the New Markets Tax Credit (or NMTC ) is not based on the cost of the facility. Instead, it is based on the amount of money invested in a community development entity (or CDE ) which, in turn, makes an investment in worthy projects in poor areas, which may include renewable energy projects There are many differences between NMTCs and other tax credits, and they can often be combined to turbocharge the NMTC benefit. 64

65 New Markets Tax Credits Introduction cont. Adopted in 2000, the New Markets Tax Credit (or NMTC ) is in Section 45D of the Internal Revenue Code The program is administered through the CDFI Fund (or Community Development Financial Institutions Fund, a department of the U.S. Treasury). The fundamental purpose of the NMTC is to encourage investment in poorer communities by giving the investor tax credits to improve its return on relatively riskier investments 65

66 NMTC Program Overview The New Markets Tax Credit (or NMTC ) is a 39% federal tax credit available to those that provide qualified equity investments (QEIs) to certain certified community development entities (CDEs) that in turn lend or invest (QLICIs) in qualified businesses (QALICBs) located in lowincome communities (LICs) NMTCs generated by financing raised and invested NOT project-based financing (e.g., HTCs) Administered by Community Development Financial Institutions Fund ( CDFI Fund ) which allocates NMTC allocation authority and oversees compliance with NMTC Program rules 66

67 The NMTC Steps Step 1: Step 2: Step 3: Step 4: Entities form Community Development Entities ( CDEs ) whose mission is to make loans in poorer communities CDEs each describe their proposed activities to the CDFI in an application for an allocation of NMTCs The CDFI Fund competitively selects CDEs to receive NMTC allocations CDEs use these allocations to offer NMTCs to investors in exchange for their qualified equity investments (or QEIs ) Step 5: CDEs use these investments to make Qualified Low-Income Community Investments ( QLICIs ) at low interest rates to Qualified Active Low-Income Community Businesses ( QALICBs ) located in Low-Income Communities ( LICs ). Step 6: The QALICBs build projects that employ people and/or bring business to the LICs. 67

68 NMTC Program Does My Project Qualify? NMTC financing can be available to a project that MUST meet the following: Is physically located in a low-income community Needs an additional source of low-cost financing to fill a gap Will be undertaking commercial activities (mixed-use ok) Does not include certain sin businesses as tenants (e.g., golf courses, race tracks, gambling facilities, certain farming businesses, stores with principal business of alcoholic sales for consumption off premises) 68

69 NMTC Program Does My Project Qualify? And to a project that SHOULD meet some of the following: Is in a highly distressed census tract Will provide jobs and/or goods and services to local low-income community Has total development costs in the $10-30MM range Has all other sources of financing lined up 69

70 NMTC Program What s a Low-Income Community? Census tracts where: Poverty rate equals or exceeds 20%, OR Median income is below 80% of the greater of: Statewide median income or Metropolitan area median income Special rules for Targeted Populations, low population areas, high migration rural counties and GO Zone List of Census tracts can be found at:

71 NMTC Program What s a QALICB? Any corporation or partnership (including nonprofits) engaged in the active conduct of a qualified business; must meet certain requirements regarding gross income, tangible property, services performed, collectibles, and nonqualified financial property In HTC master lease transaction, the Landlord can qualify as a QALICB 71

72 NMTC Program Finding Allocation NMTCs are a scarce resource Federal program is allocated annually and is vastly oversubscribed; may sunset after this year CDEs specialize in certain geographic areas and types of businesses Reach out to CDEs that Specialize in financing historic rehabilitation Target allocation to your geographical area (city/state or urban/rural) Prefer your tenant mix (retail, community facilities, etc.) Will have allocation available on your timeline Already know you or your partners 72

73 NMTC Program Finding Allocation The CDFI website has a wealth of information

74 NMTC Program Basic NMTC Structure LENDER $30 equity Tax Credit Investor $70 loan CDE (Allocatee) Sub-allocation of Tax Credit Authority $100 QEI Leverage Fund CDE (Subsidiary) $39 NMTCs QLICI (>85% of QEI) QALICB Low Income Community 74

75 NMTC Program NMTC Structure w/ Master Lease Managing Member (Developer Affiliate) CDE QEI Tax Credit Investor Developer Equity 99.99% Credits, Profits & Losses, Fees and Cash Flow Non-Member Manager.01% Credits, Profits & Losses, Fees and Cash Flow Historic Tax Credit Equity QLICI 100% Credits, Profits & Losses, and Cash Flow QALICB/Landlord Loan Proceeds Debt Service Payments Construction/ Perm Lender Pass-through of Historic Tax Credits & Share of Residual QLICI Lease Payment & Equity Investment Master Tenant Single Member LLC (Disregarded Entity) Rental Payments Sub-Tenants/ End Users 75

76 NMTC Program Twinning with HTCs - Key Business Issues Pricing Equity Pay-In Schedule (same or faster) Increase Equity by 20-30% Cash Flow, Fees, Tax Priority Payments and other items that reduce the net economics to the developer Different Compliance Periods (5 vs. 7 years) Exit Strategy (unwind may be delayed 2 or 3 years) Additional Guarantees (expanded-negotiable) Operational Limitations (subtenant mix, mixed-use) Fill Gaps/Favorable Interest Only Financing 76

77 Low Income Housing Tax Credits 77

78 LIHTC Background Part of 1986 Tax Reform to encourage the construction and rehabilitation of affordable rental housing Limited credit allocated to states based on population, with floor for low population states Administered by the Treasury Department and allocated by State Agencies under Qualified Allocation Plans Section 42 of the Tax Code (Section 142 governs tax-exempt bonds) Credit is a dollar-for-dollar tax reduction Credit amount based on cost of constructing or acquiring and rehabilitating housing developments 78

79 State LIHTC Allocation Limit $2.50 $2.00 $1.50 $1.00 $0.50 $0.00 '00'01'02'03'04'05'06'07'08'09'10'11'12'13'14 Credits per state are limited In 2000, Congress raised cap from $1.25 to $1.50 in 2001, $1.75 in 2002, and thereafter adjusted for inflation In 2008, Congress raised cap from $2.00 to $2.20 (2008/2009 only) $2.30 per person for 2014 $2,590,000 per-state minimum in

80 Credit Allocation Rules Amount allocated is one year credit amount»taxpayer receives this amount annually for 10 years 10% Nonprofit Set-Aside Private Activity Tax-Exempt Bonds subject to bond volume cap; no credit allocation needed, provided 50% test met (> 50% land/building costs paid with bond proceeds)»bond volume cap also based on population subject to floor»2014: greater of $100 multiplied by the state population or $296,825,000»2013: greater of $95 multiplied by the state population or $291,875,

81 Who Can Use Credits? C corporations can use credits and losses against ordinary income and taxes Passive losses may be disallowed for closelyheld corporations (< 5 individuals hold > 50% of stock value)» Exception (a) if > 50% of gross receipts are derived from real property trade/business in which materially participates or (b) as a deduction against net active income Individuals limited under passive loss rules to approximately $9,900/year at the 39.6% rate 81

82 Key Business Terms Projects owned by limited partnership or limited liability company Limited partner generally receives 99.99% of tax credits, depreciation, losses and profits»in some cases, cash flow/proceeds of capital transaction may be divided differently Limited partner makes capital contributions in multiple installments (generally 3 to 5), based on negotiated development, financing and performance benchmarks General partner guarantees completion/stabilization, amount and timing of credits, and funding of deficits Investor protections (removal/repurchase/adjusters) 82

83 Example: Ownership Structure General Partner 0.01% interest 0.01% share in profits, losses, credits Controls day-to-day decision-making, subject to LP veto over major decisions Share in cash flow, capital proceeds Limited Partner 99.99% ownership interest 99.99% share in profits, losses, credits Does not control day-to-day decision-making Typically, veto power over major decisions Share in cash flow, capital proceeds Limited liability for project debts, liabilities 83

84 Credit Overview Annual credit for a 10-year credit period Basic concept (layman s terms): (Eligible Basis) x (Low Income Percentage) x (Credit Percentage) x 10 = Total Credits Key LIHTC terms:»applicable percentage»qualified Basis»Qualified Low-Income Building»Applicable Fraction»Low-Income Units 84

85 Credit Overview: LIHTC Terminology Credit = Applicable Percentage x Qualified Basis of each Qualified Low-Income Building (IRC 42(a))» Qualified Basis = Applicable Fraction x Eligible Basis Eligible Basis includes special LIHTC adjustments Applicable Fraction = ratio of Low-Income Units to total units (based on unit count or floor area) Qualified Basis determined building by building» Applicable Percentage ~4% or ~9% depending on type of activity (acquisition vs. new construction/ substantial rehab), whether taxexempt bond financed 85

86 Eligible Basis Credit = Qualified Basis x Applicable Percentage of Qualified Low-Income Building Qualified Basis = Applicable Fraction x Eligible Basis New construction = adjusted basis (generally, development cost less land) Acquisition = acquisition cost of building Substantial rehabilitation = capitalized rehabilitation expenditures (24-month rule) Must subtract federal grants» But not loans made from proceeds of federal grants 130% boost in qualified census tracts ( QCTs ) and difficult development areas ( DDAs ) Excludes commercial space but includes common areas 86

87 Applicable Fraction; Low-Income Unit; Qualified Low-Income Building Credit = Qualified Basis x Applicable Percentage of Qualified Low-Income Building Qualified Basis = Applicable Fraction x Eligible Basis Applicable Fraction = smaller of:» unit fraction (ratio of number of low income units to number total units)» floor space fraction (ratio of floor space of low income units to floor space of total units) Low Income Unit = a unit that is both rent restricted and income restricted Qualified Low-Income Building = a building that is part of a project meeting minimum set-aside test (20/50 or 40/60) throughout the 15 year tax credit compliance period 87

88 Minimum Set-Aside Test To qualify as a Qualified Low-Income Building, must meet Minimum Set-Aside test. Owner may elect either of two tests:»20% of Units at 50% of Area Median Income ( AMI ), or»40% of Units at 60% of AMI»Test based on both income restriction and rent restriction Election upon placement in service»in practice, typically made earlier Must meet minimum set-aside (based on actual occupancy) by end of first credit year 88

89 Income Restrictions Either 50% or 60% of AMI, depending on minimum setaside test selected Owner may commit to deeper affordability either in tax credit application or for other funding programs HUD publishes area income figures annually Income restrictions are based on actual household income of household occupying unit»ami adjusted for household size»varies widely depending on location even within a state Boston, MA: % AMI for family of 4 = $47,050 New Bedford, MA: % AMI for family of 4 = $26,

90 Rent Restrictions Gross rent (Including utility allowance) cannot exceed 30% of qualifying income for assumed family size; based on bedrooms per unit, not actual family composition Rent limits change annually with publication of new area median incomes Permitted gross rent will not decrease below original floor (elected at allocation or placement in service) Gross rent (i.e., total amount payable by household for rent plus utility allowance) does not include section 8 (or similar rental subsidies) Rent payable to owner reduced by allowance for tenant-paid utilities 90

91 Applicable Percentage Two Credit Rates:» 4% Credit = 3.25% for June 2014 (Floating)» 9% Credit = 7.58% for June 2014 (Floating)» Not Less Than 9.00% for Buildings Placed in Service After 7/30/08 and Before 12/31/13 (or with binding commitment prior to 12/31/13 of 2014 credits)» Calculation for floating credit rates: % which will yield over 10-year period total credit with present value = 30% or 70%, as applicable, of qualified basis Owner elects to set applicable percentage either (i) when receiving a binding commitment from the state (or when tax-exempt bonds are issued), or (ii) when building is placed in service 91

92 Financing Method Applicable Percentage: Tied to Financing and Construction Methods Construction Method New Construction Acquisition/ Rehabilitation Non-Federally Subsidized (Competitive Credits) 9% credits Acq 4% Rehab 9% Federally Subsidized (Tax Exempt bonds) 4% credits Acq 4% Rehab 4% 92

93 Applicable Percentage: When 4% vs. 9% Credit Rate Will Apply Qualifying for the 4% Credit»Acquisition of building»new construction/substantial rehab if project financed with tax-exempt bond financing Qualifying for the 9% Credit»New construction/rehabilitation if not federally subsidized (which now means financed by tax-exempt bonds)»new rule: below market federal loans no longer disqualify building from 9% credit 93

94 4% Credit for Acquisition Based on the acquisition cost of an existing building Purchase from an unrelated party 50% related party rule Ten-year rule Not placed in service within 10 years prior to purchase Certain placements in service ignored» Acquired from decedent» Placement in service by governmental unit or nonprofit entity» Acquired through foreclosure by insured depository institutions» Property in dilapidated condition not available for use» Buildings assisted, financed or operated under HUD- or Rural Housing-administered programs or similar State law. 94

95 Substantial Rehabilitation Requirement To be eligible for acquisition credit, must fulfill substantial rehabilitation requirement Expenditures during a 24-month period selected by the taxpayer must equal the greater of:» $6,000 per low-income unit (as adjusted for inflation in 2014, $6,300), or» 20% of adjusted basis Rehab expenditures treated as separate new building 4% (tax-exempt bond financed costs, acquisition costs) or 9% credit on expenditures» Will have different credit rates for acquisition and rehabilitation if not tax-exempt bond financed 95

96 9% Credit for New Construction or Substantial Rehabilitation For Buildings Placed in Service After 7/30/08:» Tax-exempt bond-financed ineligible» Federal grants must be excluded from eligible basis to qualify for 9% credit But loans of Federal grant proceeds may be included in eligible basis Properties receiving 9% credits with belowmarket HOME loans now eligible for 130% boost if located in a QCT/DDA» Prior to statutory amendments, were ineligible for basis boost 96

97 Credit Period Credit is an annual credit for a 10-year credit period» May extend into 11th year if partial first credit year Credit period begins when a building is placed in service unless the taxpayer elects to defer the start of the credit period to the next taxable year First year credit reduced to reflect qualified occupancy during first credit year 97

98 Example of Tax Credit Calculation (New Construction, No Tax-Exempt Bonds) 100 Unit Project/70 Low-Income Units Total Development Costs (Including Land) = $10,000,000 Land Cost = $1,000,000 Eligible Basis = $9,000,000 Qualified Basis = $6,300,000 ($9,000,000 X 70%) Applicable Percentage = 7.58% ( 9% credit) Annual Credit = $477,540 ($6,300,000 X 7.58%) 10-Year Credits = $4,775,

99 Example of Tax Credit Calculation (Acquisition/ Substantial Rehabilitation, No Tax-Exempt Bonds) 100 Unit Project/70 Low-Income Units Total Development Costs (Including Land) = $10,000,000» Land Cost = $1,000,000» Building Acquisition Cost = $4,000,000» Other Development Costs = $5,000,000 (assume gut rehab) Eligible Basis = $9,000,000; Qualified Basis = $6,300,000 Applicable Percentage = 7.58% for rehab, 3.25% for acq. Annual Credit = [$91,000 ($4,000,000 x 70% x 3.25%) + $265,300 ($5,000,000 x 70% x 7.58%)] = $356, Year Credits = $3,563,

100 Example of Tax Credit Calculation (Acq/Rehab Or New Construction,Tax-Exempt Bonds) 100 Unit Project/70 Low-Income Units Total Development Costs (Including Land) = $10,000,000» Land Cost = $1,000,000» Building Construction or Acquisition/Rehabilitation Cost = $9,000,000 Eligible Basis = $9,000,000; Qualified Basis = $6,300,000 Applicable Percentage = 3.25% (tax-exempt bonds) Annual Credit = $6,300,000 x 3.25% = $204, Year Credits = $2,047,

101 Equity Calculation Pricing typically based on total credits available to investor (and timing of delivery) and market conditions Expressed as cents per tax credit dollar In first example above, if investor will invest $0.85 per tax credit dollar, equity = $4,058,684» $4,775,700 total credits X 99.99% x 0.85 Equity generally paid in several installments (often 3 to 5 installments) based upon negotiated benchmarks If bond-financed 4% deal, equity = $1,740,201» $2,047,500 total credits x 99.99% x

102 Affordability Commitment 30-Year Minimum Affordability Commitment» 15-Year Tax Credit Compliance Period» 15-Year Extended Use Period Extended Use Agreement Early Termination of 30-year Affordability Commitment» Foreclosure (or Instrument in Lieu of Foreclosure)» Qualified Contract Process Owner may commit to longer affordability to gain points under QAP 102

103 Recapture Recapture on Non-Compliance:» Accelerated portion of credit recaptured (1/3 of credit first 10 years, decreasing through year 15)» If minimum set-aside fails, all accelerated credits recaptured» Otherwise, unit-by-unit (extent of decrease in qualified basis due to unit failing to meet income and rent restrictions) Full Recapture on Transfer of Project or Interest Therein» De minimis (1/3 ownership) exception 103

104 Thank You Daniel J. Kolodner, Esq. Klein Hornig LLP 101 Arch Street Boston, MA

105 Exploring the Advantages of EB-5 Program Financing Financing Mixed Use Developments CLE Webinar December 10, 2014 Debbie A. Klis, Esq.

106 Agenda Overview of the EB-5 Investment Visa Program and its Requirements Types of EB-5 Projects and Ways to Use the EB-5 Program The Regional Center and Job Creation EB-5 Successes Criterion for EB-5 Real Estate Projects The Benefits of the EB-5 Program 106

107 The EB-5 Investment Visa The EB-5 Visa for Immigrant Investors is a U.S. employment-based (EB) visa created by the Immigration Act of 1990 to stimulate economic activity and job growth, while allowing eligible aliens to become permanent residents. The EB-5 Program provides a method of obtaining a Green Card for foreign nationals who invest money in the United States. This Program enables a foreign national to obtain permanent residence status more expeditiously than would most other options. The EB-5 Program has evolved into a low-cost source of alternative financing for U.S.-based projects. - To obtain the visa, individuals must invest at least $1,000,000 creating at least 10 jobs full-time (35 hours) for qualified employees. - By investing in certain qualified investments or regional centers with high unemployment rates (i.e., "Targeted Employment Areas ), the required investment amount is $500,

108 EB-5 Investment Requirements Investment Amount - The investor is required to invest $1,000,000 (or a reduced amount of $500,000, if the investment is within a Targeted Employment Area (TEA), i.e., 150% of the national average unemployment statistic). Job Creation Requirements - Each investor must create 10 full-time U.S.-based jobs from their investment. - Job creation can be through both direct and indirect jobs. Source of Investment Funds - Investor must demonstrate the EB-5 Visa investment capital is from a legal source, acquired, directly or indirectly, by lawful means (e.g., no criminal acts). - Investor must document the path of the funds with bank statements plus supporting documents to establish the source. - Investor can demonstrate a valid "pattern of income" such as through income tax records and savings records to prove funds were accumulated over time. 108

109 Types of U.S. Projects Using EB-5 Funds Real Estate Investments Many EB-5 projects pursued by Regional Centers involve real estate development projects, including: - office and retail buildings - shopping centers - hotels, conference centers, and resorts - casinos and shipyards - big box stores and sports stadiums - apartments and condos - other commercial/residential mixed-use projects Private Equity Investments Originally, EB-5 project money was used for loans to businesses that demonstrate a new commercial enterprise or a troubled business, in industries as diverse as: - manufacturing plants, fishing businesses and dairy farms and IT technology firms - medical device companies, hospitals, and architectural firms - major motion picture films and television studios - other business seeking working capital with job creation to support the loan 109

110 Key Ways to Use the EB-5 Program Form your own Regional Center - Loan to your own project(s) - Loan to third-party projects Procure a loan from an USCIS-approved Regional Center - Confirm the RC s approval in the project s geographical area - As of 5/30 Policy Memo, pre-approved labor codes not required Rent a USCIS-approved Regional Center - Per a rental agreement for a fee or a % of a project s revenues - Actual partner in a joint venture proposed by an outside party Direct Investment by an EB-5 investor directly in a project 110

111 The Regional Center Most EB-5 investment occurs through a Regional Center, which is - An economic entity, public or private, involved with the promotion of economic growth, regional productivity, job creation, and increased capital investment. - An entity that has received Regional Center designation from the USCIS following the submission of documents supported by an economic report, showing: How the regional center will promote economic growth in a region, How, in verifiable detail (using economic models), it will create jobs directly and indirectly through capital investments, and The amount and source of capital committed to the regional center. These Regional Centers act as matchmakers between foreign capital and local developers in need of funds. More and more, the developers are launching their own Regional Center to cut out the middle man. 111

112 Job Creation is a Key Factor Direct Jobs - Identifiable jobs within a new commercial enterprise - Permanent full-time jobs defined as a minimum of 35 hours per week over the course of that project - Construction jobs exceeding 24 months Indirect/Induced Jobs - Jobs shown to be created collaterally, or - Jobs shown to have resulted from the investment in the new commercial enterprise - To include the indirect/induced jobs, the project must be funded through a regional center 112

113 Regional Center Basics Investor must invest 100% of the $1,000,000 ($500,000 in a TEA plus an admin fee) before I-526 can be filed. Money can go: To project immediately To escrow and released when investor s I-526 is approved To escrow and released upon a certain benchmark Regional Center administers the EB-5 projects New Commercial Enterprise investors subscribe to this entity Job Creating Entity recipient of the EB-5 funds that creates the actual jobs 113

114 Pros & Cons of Using an Existing Regional Center The benefits to the developer of using an existing Regional Center: - Avoidance of the time and expense associated with setting up a Regional Center - Developer s only responsibility is to negotiate the loan for the project from the Regional Center or structure rental or joint venture of a Regional Center. - The Regional Center is responsible for locating foreign investors. The downsides to the developer of using an existing Regional Center: - Regional Center might reject the project or might require unfavorable terms and high fees, high interest rate, and a percentage of the profit. - Regional Center would receive the profit spread between the 1-3% pref to the EB-5 investors and the 5-7% (or more) interest on loan to developer, which developer would enjoy with its own regional center. - Developer is missing the opportunity to have a Regional Center in place to fund a pipeline of real estate projects. 114

115 Advantages of Creating a Regional Center Regional Center certification provides legitimacy for the project, which may help in marketing to foreign investors. Regional Center designation is a one-time designation allowing future projects to be marketed without incurring delays. A project may be pre-approved by USCIS. In addition to funding their own projects, Regional Centers can profit by funding projects developed by others. Remove the middle man for lower costs of financing. May count indirect and induced jobs plus direct jobs, in meeting the 10-jobs-per-investor requirement. 115

116 Disadvantages of Creating a Regional Center Regional Center certification takes between 9 and 12 months. - Regional Center certification is not the same as approval of any particular Regional Center project unless the application included an actual project vs. an exemplar project. - Regional Center certification is no longer a small, privileged group. Nearly 400 regional centers have been certified. Newer Regional Centers find it difficult to compete in their marketing efforts with long-existing regional centers with a track record of many immigration approvals The costs of locating investors have increased in recent years Regional Centers have ongoing administrative and filing requirements with the USCIS to avoid de-certification 116

117 Summary of EB-5 Program Successes The U.S. issued 3,463 EB-5 visas in 2011 and 7,641 EB-5 visas in 2012; - Most investors are from China, South Korea, and other Asian countries. - Mexican and Russian visa seekers are now on the rise. The Program brought in $1 billion during the last fiscal year. In 2012, the USCIS approved 3,677 I-526 applications from EB-5 investors. The U.S. Presidential Council on Jobs and Competitiveness has called for the program to be radically expanded over the next few years. The USCIS Office of Performance and Quality reports that in recent years: - The approval rate for initial investor petitions (I-526) has ranged from approval of 53% of all I-526 applicants in FY 2005 to approval of 79% in FY Petitions to remove conditions on residence (I-829) have been approved at a rate of 62% of all I-829 petitioners (FY 2005) to 94% of all I-829 petitioners in This recent trend of increased approval rates is a direct result of the USCIS s greater confidence in its ability to regulate regional centers. 117

118 Criterion for EB-5 Real Estate Projects (1 of 2) Is your real estate development project appropriate for EB-5 funding? Real estate development projects with a tight timeline are preferred as job creation is dependent on the completion of the project. Best to avoid real estate developments with too many contingencies. Infrastructure phases can be separated into separate EB-5 projects. Projects with public/private financing are preferred but not mandatory. Projects with new job creation are preferred by the USCIS as compared to remodeling of an existing building with increase in size. Residential projects work especially when construction periods exceed two years, and the geographic area has a high indirect job multiplier. Projects in perimeter states seem easier to sell than in Middle America. 118

119 Criterion for EB-5 Real Estate Projects (2 of 2) It is preferable but not required that before raising EB-5 funds: - Horizontal development is completed. - Loan commitment from bank is obtained for some of the total project costs. - Anchor office and retail tenants have committed to leasing the spaces and area vacancies in comparable surrounding buildings are low. Construction jobs count if the construction period two years. If the project s completion is protracted because of approvals and other non-construction delays, best to bring in EB-5 money later in the project. The USCIS does not approve indirect job creation for remodels of existing structures. New structures are most favorable for both direct and indirect job creation. 119

120 Residential EB-5 Projects Residential EB-5 projects are growing in popularity Assuming no or very few direct jobs on the premises of the apartments, condos or housing development, job creation numbers for residential projects rely on: - Two year construction period to make use of the construction jobs in the job count If one project s construction period is less than two years, considering bundling one or more projects as one project (must have the same developer) Still doable even with less than a two-year construction period - Approved hard and soft costs to benefit from the indirect and induced jobs created in the regional center 120

121 EB-5 Program Benefits to the Project The EB-5 Program can be used as an alternative funding source - In today's challenging economic times when traditional forms of capital are coming up short, developers seek to close the gap between the development costs and available sources of funds. - The EB-5 Program provides much-needed investment capital to projects that otherwise lack capital sufficient for completion. Investors are promised a low preferred return (0.5% to 2.75% lately), which makes this investment a low-cost source of funding. By creating a Regional Center, middle man fees are cut out. Investors pay an upfront administrative fee ranging between $45,000 and $60,000 each to cover the program promoter's broker costs. Marketers and finders are available in the foreign countries to assist with marketing the project and finding eligible investors seeking sound investments. 121

122 Crowdfunding and the JOBS Act: a Primer for the Financing Mixed Use Developments CLE Webinar December 10, 2014 Debbie A. Klis Ballard Spahr LLP klisd@ballardspahr.com Ballard Spahr LLP 2013