DISREGARDED ENTITIES & SYNTHETIC LEASES Patrick S. Healy, Esquire Thomas, Shannon Barry & Assoc. Scott Colcombe PNC Bank Barry Surma ABCD Corporation
Single Member Limited Liability Company And an LLC with only one member is treated as an entity disregarded as separate from its owner for income tax purposes. Altoona Development Group LLC (ADG) was the special purpose entity (SPE) and its sole member was the Altoona-Blair County Development Corporation (ABCD), a 501(c)(3), non-profit corporation. ADG is a disregarded entity for federal income tax purposes. The LLC's activities should be reflected on its owner's federal tax return.
Taxpayer Identification Number A single-member LLC that is a disregarded entity that does not have employees and does not have an excise tax liability does not need an EIN. For federal income tax purposes, a single-member LLC classified as a disregarded entity generally must use the owner's EIN for all information returns and reporting related to income tax.
Liability Issues for a Disregarded Entity A disregarded entity is considered the same entity as the owner for tax purposes, but not for liability purposes. All ABCD projects and disregarded entities are structured as nonrecourse debt. The Lender s collateral is limited to the project land, building and fixtures and the assignment of any leases relating to the project. Proper liability insurance on the project is important.
Altoona Development Group
Altoona Development Group ISSUE Expanding student enrollment (designated growth campus) Limited space for on campus building expansions Cost of new construction Eminent Domain in a post Kelo v New London environment
Altoona Development Group ACTION PLAN Underutilized space in Downtown Altoona Buildings adjacent to existing downtown PSU Altoona property Renovation costs significantly less than new construction Utilization of various ABCD Corp funds in project Purchase/assumption options in the lease Transfer of ownership at end of the lease
Altoona Development Group Sources (PHASE I) Bank (Build America Bond) $1,625,000 Anchor Building $250,000 EZRLF $447,500 CDBG $277,500 GAEDC Façade $50,000 ABCD Participation $450,000 Total Sources: $3,100,000 Sources (PHASE II) Bank (Tax Exempt) $2,000,000 Total Sources: $2,000,000
Sources (PHASE III) Bank $1,625,000 EZRLF $250,000 Keystone Communities $447,500 Anchor Building RLF $277,500 ABCD Corp. $50,000 Total Sources: $5,700,000 Altoona Development Group
Altoona Development Group OUTCOMES Cash flow of lease supports project debt service Financial strength of the tenant Use of income approach for as completed appraised value
Blair County Development Corp. II
Blair County Development Corp. II ISSUE Recruitment prospect required EDO to act as developer Concerns about third party ability to secure all secured all required permits (unfounded but real) Compressed construction time to bring project online (Oct.-April) Tenant requires lease cost within a specific range
Blair County Development Corp. II ACTION PLANS Preferred location was in one of ABCD s business parks 15 year lease term, plus two 5-year options Lease rate increases each 5 years Long term lease allows EDO to secure 15 year swap from lender (match asset life to loan term) Utilization of various ABCD Corp. funds in project Land financed with nontraditional terms (10 i%, 10 P&I) Purchase/assumption options in the lease
Gardner Denver Sources: Bank (Tax Exempt) $5,000,000 PIDA $1,400,000 ABCD Corp Seller Financing $300,000 ABCD Corp Direct Participation $1,000,000 ABCD Corp Enterprise Zone $300,000 Total Sources: $8,000,000
Blair County Development Corp. II OUTCOMES Historical financials from 10-K & 10Q Cash flow of lease Financial strength of the tenant Meeting client challenges secures the project and creates 40 new jobs for community Financing structure generates cash flow for organization
Blair County Development Corp. III
Blair County Development Corp. III ISSUE Shuttered former freight car plant production and repair facility (760,000 square foot building) Act 2 investigation was initiated and completed at the reclamation plant in early 2000 s but surround un-developed area was not included Environmental issues on site (suspected plus unknown)
Blair County Development Corp. III ACTION PLANS SPE allows ABCD Corp to gain control of site through BCDC III Utilization of RACP Funds for acquisition and initial renovations IRSP Funds used for assessment and limited remediation Secure IDP Funds for additional improvements Master lease with area developer accelerates on site improvements
Blair County Development Corp. III OUTCOMES Attainment of ACT 2 Cleanup Standards for main building in 2004 Attainment of ACT 2 Cleanup Standards for surrounding property in 2014 Secure protection for new property owner and others who further develops or occupies the site Return the site to a productive use that included creating tax revenue Current building nearly full 30+ acres available for additional development
Blair County Development Corp. IV ABCD Corp. formed Blair County Development Corporation IV (BCDC IV) Property deeded out of Five Investments. LLC, the developer and into BCDC IV to undertake the EA and required mitigation
Blair County Development Corp. IV ISSUE Former uses of site include gas station, dry cleaners, dilapidated commercial and residential structures Soil samples indicate contaminants consist with former rail uses Environmental remediation costs in excess of $600,000 Property eyesore along a major artery into city and UPMC main campus
Blair County Development Corp. IV ACTION PLANS Phase I and Phase II Environmental Site Assessment Eligible for ISRP grant funds up to 75% of total remediation costs Beneficiary responsible for required match of at least 25% of TPC Beneficiary responsible for reimbursement of all other costs incurred by SPE
Blair County Development Corp. IV Assessments: Sources: ISRP $90,275 Match $30,329 Total Sources: $120,604 Remediation: Sources: ISRP $675,750 Match $225,253 Total Sources: $901,003
Blair County Development Corp. IV OUTCOMES Secure ACT 2 designation for site $2 million private investment on site for new Sheetz store New jobs created at the site by tenant Property eyesore eliminated Continuation of urban renewal improvement along Chestnut Ave Transfer of property back to prior owner Site was the 2010 winner of DCED Extreme Makeover competition at Brownfields Confernece
Blair County Development Corp. IV
Key Considerations for Disregarded Entities Beneficiary Pays ALL costs Any legal costs (set up, operating, administrative) Property transfers Audit close out costs (if grant funds are involved) Potential Projects for SPE s Sale/leaseback Brownfield Redevelopment projects EDO/University based partnerships
SYNTHETIC LEASES (Don t Try This at Home)
Synthetic Lease: Operating Lease and Financing Lease Operating Lease for financial accounting purposes: The building does not have to be identified as an asset; nor the lease obligation as debt on the Lessee s financial statements. Financing Lease for federal tax purposes: Lessee can take the rent as an interest deductions instead of booking it as rent payments; and Lessee is entitled to tax depreciate (including component depreciation) of the building as if it was the owner of project.
Basic Structure A Single Purpose Entity (SPE/lessor) is created to purchase the property and enter into a lease, with the corporation. Using the corporation s lease as security the lessor borrows non-recourse debt to fund property acquisition (and development in the case of a Buildto-Suit). The SPE/lessor typically borrows not more than 97% and contributes at least 3% as equity. Lessee cannot have had any interest in the property prior to Lease. Lessee cannot have spent any funds on development of the property/project prior to the Lease. Early identification and coordination paramount.
Lease Payments The Lease Payments are sufficient to pay the entire loan amount (97% of the cost of the project). Lease Payments cover debt service, taxes, insurance, and maintenance. The present value of the basic Lease Payments plus termination payment cannot equal or exceed 90 percent of the fair market value of the leased property. Lessee cannot provide any guaranty other than the contractual obligation to pay a termination payment (discussed below).
End of Lease Options Lessor and Lessee renew the Lease. Lessee purchases Project from Lessor at a Fixed Purchase Option price. An FPO is an agreement between the lessor and the lessee to allow the lessee to buy the property at the end of the lease term for a price equal to the original purchase price (subject to appraisal) less any amortization provided by the lease terms. Lessor sells Project to a third party and receives sales proceeds plus Termination Payment from Lessor.
Lessee Termination Payment If Project sold to a third party at the end of the Lease term, a Termination Payment by the Lessee provides the Lender with additional security. The Termination Payment is typically capped at 80% to 90% of the original loan. The Lessee is thereby effectively ensuring the Lender from the first dollar of loss up to 80% to 90% of the loan, (said differently, as long as the Lessee honors its payment guarantee the property would have to sell at just 10% to 20% of the original loan amount for any of the Lender s investment or return to be lost).
Structural Diagram Single Member LLC- Lessee Rental Payments Lease Purchase Option Equity Owner-Lessor (SPE) Debt Proceeds (Typically 97% of Project Costs) Debt Service Payment Guaranty (up to 80%-90% of loan) Debtor/Lender (Bank)
Financing Attributes/Considerations Synesthetic lease represents a source of long term financing to support long term asset Off balance sheet for lessor Lessor still has maximum control on design/management/administration No debt amortization interest only Distribution centers and corporate headquarter/office complex represent ideal candidates Long Term Financing Characteristics 20-30 year underlying tenor for bonds Generally variable rate 5 year LC tenor swap can be established for longer given underlying tenor of bonds All fees/expenses fixed to establish monthly lease payment Lease payment must meet present value test and be approved by accountant Documentation includes normal financing documentation and executed by lessor, plus acknowledgement agreement executed lessee addressing end of lease plus lease termination options Costs including legal, title, trustee, bank rating agency = 2.5% of proceeds
Financing Attributes/Considerations cont. Lessee must demonstrate strong credit profile Generally Investment Grade Profile must support 5-7 non-amortizing credit Profile must support: Lease termination payment End of lease options Annual lease payments to lessor Lessor must be strong Capacity to fund 3% equity Ability to administer accounting/banking Balance sheet to support financing/swap
Sheetz Warehouse/Distribution Center
Financing Structure Private lender debt finances 96.9% of total project costs Remainder is financed by equity derived from cash injection plus capitalized interest on cash injection during construction
Sheetz Brothers Kitchen
Financing Structure Private lender debt finances 96.9% of total project costs Equity derived from the following Original equity in project Additional cash injection (earns return on equity) Increased value in land based on prior improvements
Sheetz Warehouse/Sheetz Brothers Kitchen OUTCOMES Able to retain Sheetz in PA and in Blair County Over 1,000 jobs at the site Substantial revenue for all local taxing bodies Source of revenue for EDO Return on equity Lease Administration Fees
Sheetz Burlington
Financing Structure Private lender debt finances 96.9% of total project costs Equity derived from the following Cash injection into project Increased value in land based on bringing infrastructure to the project site o (using as is vs. as completed appraised values)
Sheetz Burlington OUTCOMES Project will create approximately 250 jobs at project site Project will create approximately 75 jobs in Blair County Administrative and support functions Source of revenue for EDO
Main Issues Length of the swap specific start date and end date Terms of the swap Frequency of payments (monthly, quarterly, annual) Structure of payments (amortizing, bullet, zero coupon)
Interest Rate Swap Other Factors to Consider Investment Decision vs. Reducing Interest Rate Risk Provides ability to offer a fixed rate Can create accounting disclosures Mark to market accounting requirements (FAS 157) Annual gain or net loss in swap value (can be significant) Increase/Decrease in value (asset or liability) May require a going concern note to financials Critical that client is responsible for any swap breakage fee (client also gets rights to any gain from swap breakage)
Law Offices of Thomas Shannon Barry & Associates 1103 East Carson Street Pittsburgh PA 15203 PNC Bank 3 PNC Plaza 225 Fifth Avenue, 4 th Floor Pittsburgh, PA 15222 ABCD Corporation 3900 Industrial Park Dr Altoona, PA 16602 Patrick S. Healy, Esquire (412) 613 3638 patrick.stephen.healy@gmail.com Scott Colcombe (412) 762-2149 Scott.colcombe@pnc.com Barry Surma (814) 944-6113 barrys@abcdcorp.org