Economic development incentives are a fact of life in real estate development and construction. Governments package and promote their offerings in highly competitive bids to spark economic activity, create jobs and generate new tax revenues.
For most builders and developers, the challenge is not finding these incentives. The challenge is making sense of all that is being offered and determining what level of incentives, traditional investment and financing, will make a project viable and attractive to investors.
Reducing Construction Costs
Credit is still hard to come by in many markets, so builders and developers are still finding it difficult to launch new projects through financing alone. Using government incentives, developers can reduce the net cost of construction, which can be passed on as more favorable and competitive lease terms for tenants, or a lower cost per square foot for the end user.
State governments have been investing in economic activity for decades, and in many situations, they still dominate the universe of development incentives. Every state is different in the details, but certain programs appear consistently in development proposals:
• Tax Increment Financing (TIF) – TIF districts allow a municipality to effectively fund a portion of project costs and recover the investment through incremental increases in real estate or other taxes in the future.
• Transportation Development Districts (TDD) – TDDs are created to develop, operate, improve and/or maintain projects related to transportation infrastructure.
• Community Improvement Districts (CID) – CID financing is undertaken with an eye toward increasing property values in neighborhoods and communities.
Likewise, the federal government directly and indirectly supports economic development activities. Local and regional projects are made more affordable for builders, developers and end users thanks to federal dollars.
Some programs, such as New Markets Tax Credits (NMTC), are monetized at the point of new investment into projects within certain low-income communities. The flow of funds from these qualified investments reduces the project’s net cost and increases the chances of success. The Tax Relief Act of 2010 extended benefits under the NMTC, which include a tax credit of up to 39% of the qualified investment in a Community Development Entity (CDE). The credit is claimed over a seven-year period; however, the investor makes an investment at the beginning of the project based on a negotiated amount that is less than the credit.
The Low-Income Housing Tax Credit (LIHTC) is a federal program administered by state commissions. It is designed to bring private investors into the affordable rental housing or low-income residential housing market. A developer generates equity in a project by selling or syndicating transferable credits to investors, who are then able to utilize those credits to offset federal and state tax liabilities.
The Historic Rehabilitation Tax Credit allows a developer to recover costs incurred for rehabilitation of certain historic buildings. For purposes of the credit, rehabilitation includes renovation, restoration and reconstruction but not enlargement or new construction. The percentage of costs that can be taken as a credit is 10% for buildings originally placed in service before 1936, and 20% for certified historic structures.
Sifting through the many options may require specialized financial modeling and analysis tools, but it is worth the investment since the ability to explore the short- and long-term impact of incentives on profitability puts builders and developers in a better position to secure the most favorable financing package. A number of incentives have the effect of reducing the cost of borrowed funds.
Maximizing the Benefits
There are several important keys to getting the greatest benefit from incentive financing:
• Make certain that all costs are considered, including land, construction costs and soft costs like development fees.