The importance of incentives to building projects
As far as real estate developers are concerned, public incentives are playing a bigger role than ever before as to whether they can secure commercial financing for their projects.
The brownfield and historic tax credits and tax-increment financing offered to developers by the state, city and federal government, along with the grants awarded by downtown development authorities and other public agencies, are pretty much mandatory today in order for a property owner to be able to convince a loan officer to have enough faith in a development to finance it.
But for a lender, it’s about developers having more skin in the game, so to speak.
“It is true these incentives are playing a significant role in these new developments, in part because the lending world has changed so much. The loan-to-value ratio has changed. It used to be that you could get non-recourse financing and get 80 percent loan-to-value ratios. And now the standard ratio is more in the range of 65/35 percent, and it’s very difficult to get non-recourse financing,” said Jon Byl, a partner and economic incentives attorney at Warner, Norcross & Judd.
“The result is these developers and investors have to raise a lot more equity, and that’s a real challenge,” he added.
Byl, who has helped many clients capture public incentives over the years, said developers are limited in how they can raise equity for a project. He said they can try to do that by selling shares in their projects to investors. “But they expect a very high return,” he said of the buyers. “So one of the alternatives for developers is to secure incentives if they are going to make a project work.”
Byl said the incentives became more important to developers after the near-total collapse of the nation’s financial market in 2008 following the subprime-mortgage meltdown of the residential real estate market a year earlier. Those public awards have become even more vital for developers who want to do revitalization projects in urban settings, which are costlier. That situation has remained unchanged since 2008 and is still critical today.
After the lending world changed, the state wiped its brownfield and historic tax credits off its incentives list. That action took place at the end of last year — the same time the Michigan Business Tax went away, which was the levy that offered those credits.
However, Byl pointed out that a developer who filed and was approved for either or both credits before 2011 ended can collect the credits when a project is finished, which could be years down the road. But a developer has to stay on the MBT to get the credits, as the new state business tax doesn’t offer that incentive.
“So any project that received approval by the end of 2011 for a state historic or a state brownfield MBT credit — as long as those projects are ultimately completed — will receive those credits,” he said.
What is a tax credit worth in the new lending world? The answer to that question is essential to a developer’s equity when looking for a commercial loan because these credits are often sold to large companies such as big retailers, manufacturers and, ironically, banks that have a need to reduce their tax liabilities.
Byl said a credit’s market value has hovered around 88 cents on the dollar for the last two years, and the larger a developer’s investment is in a project, the bigger the credit amount.
“In some cases, it used to be a little less than that, and in some cases, it used to be a little higher than that,” he said.
But at the end of last year, transition legislation, as Byl phrased it, arrived in Lansing at the same time the MBT was being replaced. Part of that transition created a steady market value for state tax credits that are being issued under the old tax scheme.
“Developers can either use the credit if they elect into the Michigan Business Tax or they can get a refund from the state of 90 cents per dollar of credit,” he said.
“What’s happening for most projects now is developers will elect into the MBT for that year, meaning they have to file the MBT return. But when they complete a project, they will get a certificate of completion, they’ll turn it into the state, and Treasury has 60 days to write them a check for 90 percent of that credit amount, or 90 cents on the dollar,” he explained. “I have had clients that have done that.”
Byl also said a few of his clients that have checks coming from the state may put those credits on the market as there are some larger businesses that still file under the MBT because they have earned some state job credits they need to use to offset their taxes. Those companies might be interested in purchasing the developers’ credits to further reduce their tax bills.
“But they would be expected to pay at least 90 cents and generally, perhaps, a little bit more to make it worthwhile for both the purchaser and the seller,” he said. “But there’s not a big market because the Michigan Business Tax only exists for those companies that elected into the MBT because of some existing credits, and it could be historic credits, too.”
Byl played an essential role last year in creating the transition legislation, which replaced the incentives offered by the MBT. Byl chairs the Michigan Chapter of the National Brownfield Association and is vice chairman of its board. He and his WNJ colleague, Troy Cummings, met with Lt. Gov. Brian Calley and other members of the governor’s staff to find a way to honor the MBT credits and carve out a new state incentive program.
“In the marketplace, these developers don’t have enough MBT liability to use the credits themselves for the most part and for the vast majority of these projects. So they sell the credits and they get a net of 87 or 88 cents on the dollar, and in some cases as much as 90 cents. So what we strongly suggested to the administration, and what the administration ultimately agreed to, was that 90 cents was a fair number as it matched sort of the high end in the marketplace,” said Byl.
“Also, the reality is when people sold these credits, they usually got paid within a few days after the certificate of completion and did not have to wait as much as 60 days, so 90 cents was viewed as a good number. The administration, the MEDC worked with us on this for a fair amount of time, and we shared examples of sale agreements that we had. It worked out fine,” he said.
Those negotiations resulted in three new bills that became state law to offer $100 million annually in grants and loans for job creation and the redevelopment of contaminated properties. The program covers up to 25 percent of a construction or rehab cost. “The new process is more streamlined and is focused on improving urban areas,” said Byl.
“The administration wants to see urban revitalization. They want to see quality developments in downtown areas, particularly in the challenged downtown areas that need development the most. It has the potential to be pretty effective — just as effective as the historic and brownfield MBT credits.”
Although the state historic credits are a thing of the past, the federal credits still exist and can be rolled into a developer’s equity when seeking a loan. A federal credit is worth up to 20 percent of a developer’s investment, while the state went up to 25 percent. So a developer could once have received a 25 percent credit, with 20 percent coming from the federal government and 5 percent from the state.
But Byl pointed out that selling the federal credit is more complicated than selling the state credit. “The entity that buys a federal historic credit is often a lender and will actually become, for a period of time, one of the owners of a development entity. So it’s a legal process that these parties go through to sell the federal credit to investors,” he said.
“These kinds of things are critical to filling that equity gap. It’s good that we have these programs, otherwise a lot of these projects would never happen.”