Why New Market Tax Credits Will Benefit Banks More Than Developers In The Future
President Donald Trump’s tax reform proposal will not be unveiled until later this year, but that has not stopped speculation from spreading through the real estate market. Already, investors and market analysts are planning for future deals as though Trump’s plan to cut the corporate tax rate from 35% to 20% is a fait accompli.
Chicago-based Ginsberg Jacobs partner Darryl Jacobs, an expert on tax credits, said that banks and C-corporations are buying as many New Market Tax Credits (NMTC) as they can get their hands on. These credits are designed to promote investment in distressed and low-income communities, but their allocations are based on census data pertaining to poverty, unemployment and median family income. Since the existing census data is seven years old, that means developers in rapidly genrifying submarkets like Fulton Market can take advantage of the credits for their projects.
Banks recognize this and have been buying NMTCs for 86 cents per credit dollar, Jacobs said. Since NMTCs are a fixed 39% of a development’s allocation (four years at 6%, three years at 5%), a bank will see a gross return of 14% on any real estate lending it underwrites, while the projects being underwritten will see a net benefit of 20% to 30%. And that is before accounting for depreciation.
Jacobs said that banks are making these runs on NMTCs because they are looking to minimize their risk long term should Trump be successful in reducing the corporate tax rate to 20%. Banks are afraid that what they pay now will lead to reduced benefits in the future.
Another concern is that some tax credits will be repealed in Trump’s tax reform plan. Jacobs said that NMTCs appear to be safe and the low-income housing tax credit (LIHTC) is off the chopping block, but overall tax credit impact could be adversely affected by a cut to the corporate tax rate because there will be less demand for it. In addition, the future of historic tax credits and renewable energy tax credits is uncertain. If those go away, Jacobs said that financing developments that involve the preservation of historic buildings will be harder to underwrite, and either deals will not get done or buildings will be razed.
If the historic and energy tax credits are cut, states could fill the gap with tax incentives of their own, creating an interesting conundrum in states with budget troubles like Illinois, which has gone two years without a state budget. If developers feel that doing business in these states is not worth the risk, they are likely to go to more business-friendly states. Jacobs said that Texas is looking to establish an NMTC. Missouri already has a historic tax credit, and Nebraska has a NMTC.
In Illinois particularly, Jacobs said there is a race for developers to close deals quickly due to fear that tax credits will not be there if and when tax reform is passed.