New Markets Tax Credit Program

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The New MarketsTax Credit Program

A CEOs for Cities Briefing Paper:How This New Incentive CanStrengthen America’s Cities

by

Jim Miara

Prepared for

April 2004



This briefing paper was commissioned by CEOs for Cities to stimulate discussion at theorganization’s Spring 2004 national meeting to be held on May 6 and 7, 2004 in Chicago.Conclusions expressed herein are the opinions of the author and do not necessarily reflect anofficial policy or position of CEOs for Cities or any of its members or sponsors.

Copyright 2004 CEOs for Cities. All rights reserved.

One Post Office Square, Suite 1600Boston, MA 02109

617.451.5747www.ceosforcities.org



New Markets Tax Credit Program

A CEOS for Cities Briefing Paper for Members:How this New Incentive Can Strengthen America’s Cities

by Jim Miara

Prepared for

CEOs for Cities

A national, nonpartisan alliance of mayors, business executives, university presidents and civic leaders that strengthens the economic competitiveness of cities

through an exchange and application of best practices, ideas, and advocacy.

April 2004

Preface: This paper is divided into three sections: an overview, a detailed description of the New Markets Tax Credit program, and profiles of closed and pending deals.Section I is intended to bring the reader up to date (mid-April 2004) on the program by providing a gendescription of its objectives, some perspective on how the NMTC program compares with other subsidsome potential problems, and finally some comments by practitioners.Section II provides program details: how the program is administered, which census tracts are eligible,

qualifying investments and investors and how NMTCs are allocated.Section III describes the financial structure of two deals that closed using NMTCs, and then providesexamples of four pending deals in Columbus, Ohio, that can move forward with the help of NMTCs.

Table of Contents

I. Overviewa. Powerful Toolb. Getting Up To Speed

c. First-round Cautiond. Practitioner Comments: The

Importance of NMTC

II. The Programa. Community Development Entities

b. Qualifying Low-Income Communitiesc. Qualifying Investorsd. Qualifying Investmentse. Applying For NMTCs

III. Anatomy of a Deala. Tacoma, Washingtonb. New Bedford, Massachusettsc. Deals In The Pipeline



I. Overview

Powerful Tool The New Markets Tax Credit program(NMTC) was passed by Congress inDecember 2000, as part of theCommunity Renewal Tax Relief Act. Theprogram is designed to stimulateinvestments in commercial real estate andbusiness ventures located in low-incomeurban and rural areas. Over a seven-yearperiod (2001-2007), $15 billion of

investment capital will be eligible for taxcredits. The NMTC program providesinvestors with tax credits that total 39percent of their investment, distributedover a seven-year period.

Although the program is in the earlystages and its full potential has yet to beexplored, economic developmentpractitioners insist that the NMTCprogram is a much-needed catalyst forprivate-sector investments. Usedcorrectly, they say, the NMTC programcan close financing gaps and bringdifficult, previously stalled projects tofruition.

“In terms of programs that have existed,this is one of the most powerful tools tocome along in the last decade,” said

Joseph Pettiford, administrator with the

National Trust for Historic Preservation’sCommunity Partners Program. “There issome wariness about it, just as there wasabout the Low-income Housing TaxCredit (LIHTC) program when it wasintroduced in the 1980s. But those whosee how it can work are running with it.”

The NMTC program is frequentlydescribed as a “shallow subsidy,” incontrast to the deeper LIHTC incentive.But the NMTC program is more flexiblethan the LIHTC, which means it can beapplied to a wide range of commercialinvestments that further community-development goals. “The best way tothink about the program,” explains BuzzRoberts, vice president for policy at LocalInitiatives Support Corporation (LISC),“is [community economic developmentpractitioners] have access to $15 billion at2 or 3 percentage points below the ratethat we would otherwise. When you havea marginal deal, if you can lower the costof capital by 2 or 3 percentage points, itcould work.”

According to Bob Milbourne, presidentof the Columbus Partnership, animportant NMTC program asset is itsability to reassure private-sector investors.“In every community we search forprivate investment: Where is it going tocome from for major projects? It’s been

very hard to identify private sources,”Milbourne explains. “The NMTC is thedevice that will elicit private investment.It will bring private investors into urbanprojects. That’s been our experience herein Columbus.” The ColumbusPartnership received commitments from15 corporations for $275 million, which

was used to support the organization’s

application for $190 million in NMTCs.

Getting Up To Speed

The NMTC program offers individualand corporate taxpayers a credit against

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federal income taxes for qualified equityinvestments (QEIs) made throughinvestment vehicles called communitydevelopment entities (CDEs). In turn,CDEs make loans and equity investmentsin commercial enterprises located inqualifying low-income rural and urbancensus tracts.

The NMTC program is administered bythe Community Development FinancialInstitutions Fund (CDFI Fund), an office

within the U.S. Treasury Department. The CDFI Fund began accepting

applications for $2.5 billion first-roundtax credit allocations in spring 2002 andby August had received 345 applications.

The first-round applicants requested anaggregate of $26 billion, an indication,CDFI Fund officials say, of theextraordinary demand for the product.Sixty-six CDEs received NMTC authorityin March 2003; however, the firstallocation agreement was not signed untilfall 2003 and some were not completeduntil as late as January 2004. According toa Treasury Department report, as ofMarch 2004, "29 allocatees reported thatthey have issued Qualified EquityInvestments (QEIs) for a total of $473million from investors."

The average first-round allocation was$38 million and ranged from $.5 millionto $170 million. Six CDEs received

allocation awards of more than $100million. Eighty percent of the NMTCs were awarded to CDEs that serve urbanand suburban areas, as opposed to ruralareas.

Phoenix Community Development andInvestment Corporation, a subsidiary ofthe city of Phoenix, received the largestallocation, $170 million, in November2003. Phoenix was the only city to receivean NMTC allocation in the first round.Phoenix officials say the major portion ofits NMTC allocation will supportcommercial real estate investments indistressed neighborhoods. Another focus

will be loans to minority women-ownedbusinesses. As of April 2004, Phoenix hadyet to close a deal.

The names of awardees of the $3.5 billionsecond round of NMTC allocations arescheduled to be announced in late-April2004. CDFI Fund officials report that thesecond round received fewer applicationsthan the first round (271 vs. 345), butmore money was requested ($30.1 billion

vs. $26 billion). Non-profit organizationsor subsidiaries of non-profit organizationsaccounted for that 38 percent of second-round applicants, according to CDFIFund officials. Nineteen percent of theapplicants were banks, thrifts or bankholding companies, and 6 percent ofapplicants were government-controlledentities or their subsidiaries.

First-round Caution

Economic development organizationsproceeded cautiously during the firstround of applications, either limiting theirrequest or sitting out, waiting until theprogram is tested and its parametersbecome more apparent. This hesitancy

was particularly evident among banks andcity governments. "Banks and cities, for

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the most part, sat out the first round,"explains John Leith-Tetrault, director ofthe Community Partners Program for theNational Trust for Historic Preservation."But now that they understand theusefulness of NMTCs we see more ofthem participating."

To date, relatively few deals usingNMTCs have been completed. As noted,only $473 million of the $2.5 billioncredits available were applied as of March2004. Practitioners attribute the slow paceto the steep learning curve. Thomas

Lattimore, CEO of Seattle-based ImpactCapital and LISC’s Washington Stateprogram director, used NMTCs allocatedto LISC in a $12 million adaptive re-useproject in downtown Tacoma, one of thefirst deals to close. The closing, saidLattimore, “was somewhat akin tobuilding an airplane while you’re flying it.Investors had to do their analysis to see

what their return would be. After the400th deal, everyone will feel morecomfortable.”

The learning process is likely to continueslowly, officials say, because many of theorganizations that won allocations in thefirst round did not apply for round two.Several first-round awardees reporteddifficulty meeting the application criteriafor second-round credits, particularly theaggressive CDFI Fund time requirements.

In order to be considered for a second-round allocation, at least 50 percent ofthe first-round allocation must have beencommitted by the March applicationdeadline.

Many first-round awardees, includingLISC and NTHP, will not compete in thesecond round because of the 50-percentrule. (LISC received a $65 million first-round allocation and NTHP received$127 million.)

"Tough economic development deals intough communities take time to cook,"explains LISC’s Roberts. “In our case,most of the deals we wanted to do wereslow-cook, and we were not able to getthem done in time. I respectfully disagree

with the way Treasury structured its time

requirement for second-round bidding.” Adds NTHP's Leith-Tetrault: "Youshouldn't be forced to get deals out tomeet a deadline. The 50-percent rulecould cause people to throw creditsaround to deals that don't need them."

Even CDEs with small allocations haddifficulty meeting the 50-percent rule.Nuestra Comunidad, a Boston-basedCommunity Development Corporation,had none of its $1 million first-roundallocation committed by the applicationdeadline. "We signed our allocationagreement in January, and there was no

way we could have commitments in placeby March," explains Kevin Wynn,Nuestra's director of lending andtechnical assistance.

CDFI Fund spokesman, Bill Luecht,acknowledged the stringent timerequirements, but insisted that awardeeshad sufficient time to meet the deadlines."Some took longer than others to close[sign the allocation agreement], whichmade things more difficult. But part of

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the evaluation for the allocation was howmany commitments they had in hand.

Treasury wants to make sure the creditsare being used."

Practitioner Comments: The Importance of NMTC

The majority of community economicdevelopment practitioners surveyed saidthe NMTC program is extremelyimportant, although most acknowledge,as one said, “It will not make a bad deal agood deal.” Its strength is fillinginvestment gaps in projects that havesome economic fundamentals in place.“It’s a shallow subsidy if you just take it inthe simplest form,” explains JosephFlatley, CEO of Massachusetts HousingInvestment Corp., which has closedseveral deals in which NMTCs wereapplied. “But it can be used within aleverage structure that can cover asignificant portion of the project. For

example, if you have a project with amillion-dollar gap between what it costsand what it’s worth, NMTCs can fill thatgap by 25 percent. So it’s a valuable tool.”

Practitioners offer conflictingrecommendations regarding whether citygovernments should themselves apply foran NMTC allocation or work throughexisting community developmentorganizations. “Find somebody else to doit,” Flatley advises. “The city of Boston

works through us. We have been doingthis for a long time, and we know howthese deals can be structured.” He arguesthat using NMTCs to full advantagerequires specialized expertise that takes

time, and money, to acquire. Scale, i.e.,the volume of deals, is also important.

Lynda Dodd, NMTC coordinator for thecity of Phoenix, said the city applied foran allocation for control purposes. “Wedid consider partnering with a local CDE,but that CDE’s service area expandsbeyond Phoenix.” A potential drawbackof a city administering the NMTCs, shesaid, is that investors worry that politicalpressure could be exerted to fund projectsthat are not financially viable. InPhoenix, she said, the CDE’s board,

which by law has strong communityrepresentation, insulates decisions fromuntoward political influences.

II. The Program

Community Development EntitiesNew Market Tax Credits can be appliedonly to equity investments in certifiedCommunity Development Entities. Withthese funds, CDEs are expected to usetheir local knowledge to make loans andinvestments in businesses located in low-income communities. A CDE must havea primary mission of communitydevelopment through capital investment.Only a for-profit CDE can pas tax creditsto investors, but nonprofit organizationscan apply for an NMTC allocation andbring in investors by forming a for-profitCDE as a subsidiary, partnership orlimited liability company.

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Qualified CDEs must ensureaccountability to residents of low-incomecommunities by including communityrepresentation on a governing or advisoryboard. A CDE can meet the communityaccountability requirement through itscontrolling parent organization. The

Treasury Department certifies CDEs.Certified Community DevelopmentFinancial Institutions (CDFIs) andSpecialized Small Business InvestmentCompanies are automatically qualified.

CDE eligibility is offered to such entities

as community development banks or venture funds, community developmentcorporations, small business investmentcompanies focused on low- andmoderate-income communities, NewMarkets Venture Capital companies andother investment funds.

CDFIs are specialized financialinstitutions that serve low- and moderate-income areas. New Market VentureCapital companies are newly createdentities licensed by the Small Business

Administration. They direct investmentsand loans towards smaller firms in low-income areas “that will benefit fromcapital managerial, and entrepreneurialassistance.” Small Business InvestmentCompanies are private venture firmslicensed by the SBA to invest in smallgrowing businesses.

An entity may receive CDE certificationeven if it does not plan to seek an NMTCallocation, but instead intends to sellloans to a CDE that has received anNMTC allocation or wants an investment

or loan from a CDE that has an NMTCallocation.

CDEs that received NMTC allocationsmust use at least 80 percent of committedfunds (Qualified Equity Investments) byMay 2006 and 100 percent of their QEIs

within five years after entering into anallocation agreement. The QEI must stayin the CDE for seven years. Investors canclaim the NMTC in the taxable year in

which they make the investment in theCDE.

As of February 2003, the CDFI Fund, the Treasury division that administers theNMTC program, had certified 821organizations as CDEs. One year later,that total has risen to 1362, an increase of64 percent.

Qualifying Low-IncomeCommunities

The NMTC program defines low-incomecommunities that are eligible forinvestment under three categories: 1. Acensus tract with a poverty rate of 20percent; 2. A metropolitan area censustract with a median income below 80percent of the median for the entiremetropolitan area or below 80 percent ofthe statewide median income or

whichever is greater; and 3. A non-metropolitan area census tract (or county)

with a median income below 80 percentof the statewide median.

Analysts say most urban census tractsqualify for NMTC investments underthese definitions. Eighty percent ofmedian income ($50,200 nationally)

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encompasses moderate-incomehouseholds as well as low-income.

“Substantially all” (85 percent) of theinvestor’s NMTC equity investmentsmust be used for eligible purposes. ACDE can use NMTC investmentproceeds to provide loans and equityinvestments to eligible businesses or otherCDEs, to purchase loans made to eligiblebusinesses by other CDEs, to providefinancial counseling and other services toeligible businesses and to finance its owneligible businesses. For example, a

shopping center developed and operatedby a CDE could be eligible.

Qualifying Investors

Any taxable investor, including anindividual, company or investment fund,that invests in a CDE is eligible.Examples of qualified investors are banks,

venture capital funds, finance companies,

individuals, and corporations. Investors will receive tax credits based on theamount of their equity investment in aCDE. Tax credits are claimed over sevenyears, starting on the date of theinvestment and one each anniversary: 5percent for each of the first three yearsand 6 percent for each of the next fouryears for a total of 39 percent. Theinvestor’s basis is reduced by the taxcredits, and they can be appliedretroactively to projects dating back toDecember 2000.

Equity investments can take the form ofstock or any capital interest in apartnership and must be paid in cash.Equity investments must be made within

five years of the tax credit allocation tothe CDE.

The NMTC program includes a“recapture” provision. Within the firstseven years after the investment is made,an investor could lose the tax credits ithas claimed, plus interest, if: 1.Substantially all of the cash proceeds arenot used for eligible purposes; 2. Theinvestor cashes out its equity investmentin the CDE; or 3. The CDE loses its

Treasury certification as a CDE. Treasuryis expected to write rules for curing

violations within a reasonable period toprevent unwarranted recaptures.

Qualifying Investments

Almost all businesses located in low- ormoderate-income areas could qualify forloans or equity investments. These couldinclude small technology firms, inner-cityshopping centers, manufacturers, retail

stores or micro-entrepreneurs. A businessmust meet several eligibility requirements:1. Be located in a qualifying census tract;2. Have a substantial connection to thatarea by having at least 50 percent of thebusiness’s income derived from activity ina low-income community; 3. Have asubstantial portion of the business’sproperty located in low-incomecommunity; 4. The employees of thebusiness must perform a substantialproportion of their work in the low-income community; and 5. Less than 5percent of the business’s assets can beheld in unrelated investments.

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Applying for NMTCs

The $15 billion in tax credit eligibility isbeing made available through acompetitive process over the seven yearsof the program (2001-2007).

Administrative delays moved the firstround, $2.5 billion, to 2002, and thesecond round, $3.5 billion, to 2003.Second-round awardees will beannounced in late April, according to

Treasury officials.

CDE applicants undergo a “review

process to identify those best suited tohave the greatest communitydevelopment impact,” according togovernment documents. The reviewincludes the CDE’s business strategy tomake investments in low-incomecommunities, capitalization strategy toraise equity from investors, managementcapacity, targeting to areas of highestdistress, and impact on jobs andeconomic growth in low-incomecommunities where investments aremade.

III. Anatomy Of A Deal

Tacoma, Washington

One of the first deals to close usingNMTCs took place in February 2004 in

Tacoma, Washington. The project, AlbersMill Lofts, was a $12 million renovationof an historic property consisting of

commercial space on the first floor and36 market-rate loft apartments on the topfour floors. Albers Mill Lofts is locatedon a former Superfund site and in aFederal Renewal Community. Renovationof Albers Mill Lofts is part of Tacoma’srevitalization plan for the Thea Foss

Waterway, which includes adapting vacantbuildings for new uses and transformingcontaminated properties into a publicspace, including 1.5 miles of waterfront

walkway, public event plazas, marinas,shops and cultural centers. Tacomaofficials expect Albers Mill Lofts to be acatalyst for community economicdevelopment.

NMTC authority of approximately $11million was provided to the project byLISC, which operates in WashingtonState in conjunction with Impact Capital.“Albers Mill Lofts had been workingthrough the pipeline for a number ofyears, getting historic designation anddesign plans in order,” relates TomLattimore, Impact Capital’s CEO andLISC’s Washington State programdirector. “When the deal was originallyconceived, the market was better, and aprivate loan could have been had. But thedownturn in the economy changed that.”

The project was languishing, Lattimoresays, until NMTCs became available.“NMTCs significantly decreased the debtservice while significantly increasing the

amount of equity financing to theproject.” As Lattimore explained,NMTCs filled a critical need for capital toclose a gap in construction costs, “and theaccess to equity meant a lower a cost offinancing to make the deal feasible.”

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According to a report of the deal writtenby Ruth Sparrow, an attorney with Seattlelaw firm Garvey Schubert Barer, whorepresented Heritage Properties, LLC, thedeveloper in the transaction, the financingstructure was multifaceted, both in termsof participants and financing tools.Sparrow writes: “US Bancorp CommunityDevelopment Corporation (USB CDC)provided the NMTC equity investment inconsideration for NMTCs, historicrehabilitation tax credits and othereconomic benefits. Other financingincluded bridge financing provided by aCommunity Development Block Grantloan and local tax incentives. US BankNA provided a construction loan to theproject, which was taken out by theNMTC financing. USB CDC’s NMTCequity investment in New MarketsInvestment I [LISC’s subsidiary CDE],financed a loan and equity investment bythe CDE in the project. The additionalNMTC equity is an important component

of the overall financing of the project….“The parties also negotiated theirrespective rights and obligations,including consent rights and complianceobligations taking into account theeconomic and compliance risks of each ofthe parties. The developer [HeritageProperties, LLC of Anchorage, Alaska]controls the day-to-day management ofthe project. USB CDC retains consent

rights necessary to protect its significanteconomic investment in the project, andthe CDE maintains an important role inoversight of NMTC compliance of theproject and achievement of its mission ofserving the low-income community. TheCDE that transfers its NMTC authority

to the transaction has its own interests inthe success of the project and willnegotiate rights and obligationsaccordingly.”

New Bedford, Massachusetts

Another of the early deals closed with thehelp of NMTCs is Coffin Lofts, NewBedford, MA. The Coffin Lofts projectsis a $5.8 million renovation into mixed-use properties of three vacant historicbuildings in the Central New BedfordHistoric District in downtown NewBedford. When completed, the buildings

will be interconnected by a commonelevator and lobby and consist of 18mixed-income residential units on upperfloors, and four artist live/work spacesand more that 5,000 square feet ofcommercial space on the ground floor.

Financing for the project was structuredby the Massachusetts Housing

Investment Corp.(MHIC), a non-profitprivate financier of affordable housingand community development inMassachusetts. MHIC, which received a$25 million NMTC allocation in the firstround, describes its mission as “providingfinancing that would not otherwise beavailable and extending the impact of thatfinancing to ensure the broadest possiblebenefit.”

MHIC’s CEO, Joseph Flatley, says theNMTC program fits perfectly with hisorganization’s mission. “It supports ourcore competencies,” Flatley explains,“and takes advantage of existing infra-structure. Our goal is to maximize the

value-added by our capital structure, and

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use this added value to support projectsthat would not otherwise be feasible.”

In the Coffin Lofts project, the NewMarkets Fund (MHIC’s subsidiary CDE)

will provide approximately $4.2 million,including $1.1 million in subordinate debtand $1.9 million in combined historic andnew markets tax credit equity. Subordi-nate debt financing that will flow throughMHIC’s structure are HOME loans of$550,000 each from the City of NewBedford and the Massachusetts Depart-ment of Housing and CommunityDevelopment. Added subsidies include a$300,000 Federal Home Loan Bank(FHLB) Direct Subsidy and a $1.4 millionFHLB Subsidized Advance throughCompass Bank. Of the 18 residentialunits, five will be set aside for low-incomehouseholds, six for households at orbelow 65 percent of area median incomeand seven will be market rate.

Compass Bank is providing 20-year,fixed-rate financing to MHIC’s CDE. TheCDE’s loan to the project will not berefinanced. At the end of the NMTCcompliance period, Compass Bank isexpected to exercise its option to acquirethe CDE’s note to the project.

Deals in the Pipeline

More than 270 CDEs applied for NMTCallocations in the second round,requesting a total of $30.1 billion in taxcredits with only $3.5 billion available.

Among the second-round applicants wasColumbus Inner City Partnership (CICP),subsidiary CDE of the Columbus Part-nership. CICP requested $190 million inNMTCs and had $275 million in

commitments from private investors tosupport its applications. CICP is awaitingthe announcement of second-roundawardees, scheduled for late April.

If CICP’s application is successful, sevenprojects in downtown Columbus will getthe financing they need to get underway,according to Bob Milbourne, president ofColumbus Partnership. “There are manyprojects that almost make sense but neverget done,” explains Milbourne, referringnot only to Columbus projects but also tothose in cities across the country. “It’sone thing to say these projects are close,but it doesn’t matter if they’re close ifthey don’t get done. The NMTC is acatalyst for the private investment weneed to get them done.”

The projects in CICP’s pipeline include:• Renovation of a failed downtown

shopping center. A $40 millionadaptive reuse project is proposed.

• Renovation of a 100-year-old formerdepartment store for office use bystate employees. The building wasdonated to CICP. The cost ofrenovation is $30 million.

• Expansion of the city’s art museum.CICP will lend $15 million at zerointerest to the museum for theexpansion. The museum is eligible forNMTC credits because it is located ina qualifying census tract. At the end of

seven years, the museum will pay backthe loan without interest.• Creation of a working capital fund for

small businesses. Qualified businesses will be eligible for low-interest loans.

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New Markets Tax Credit Program

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