Opening Doors to Affordable Mixed-Use Development

Opening Doors to Affordable Mixed-Use Development 1 Housing Colorado October 5, 2016

2 Session Objectives Learn: The Basics of Low-Income and Historic Tax Credits, including recent Colorado LIHTC program How to Make Calculations Specific to Mixed Use Projects and Those Combining Federal Low-Income and Historic Tax Credits How the Conversion of Historic Properties to Mixed-Use Differs from New Construction of Strictly Residential Properties

Three Benefits of Owning Real Estate 1. Cash Flow 2. Tax Benefits 3. Appreciation To most investors, cash flow is the most important To Tax Credit investors tax benefits are most important Returns generated by tax credits and paper losses (mostly depreciation) The amount of equity an investor will provide to a tax credit project is primarily determined by The amount and timing of project tax credits The projected amount and timing of paper losses The Internal Rate of Return (IRR) they require 3

4 Benefits of Owning Rental Housing (cont.) Cash Flow Tenant rents repay loans and provide cash flow Pro forma Income and Expense Statement OPERATING INCOME Gross Rent + Other Income - Economic Vacancy = EFFECTIVE GROSS RENT Rent Collected - Fully Occupied Uncollected rents vacancy, non-payment etc. Expected Cash Rents Collected OPERATING EXPENSES - Taxes - Maintenance - Insurance - Utilities - Management Fee - Replacement Reserves = NET OPERATING INCOME - Debt Service = CASH FLOW Cash Expenses Cash Available for Loan Payment(s) Return to Lender (Loan Interest) Return to Investor

5 Benefits of Owning Rental Housing Cash Flow (cont) Leases and Rents Residential Based on rent per unit per month =$ Monthly Rent x # Units x 12 Mos. $500/mo. x 20 units x 12 mo. = $120,000 May or may not include utilities Commercial Based on rent per sq. ft per year= $Rent/Square Ft. x Sq. Ft. $10/sq. ft. x 10,000 sq. ft. = $100,000 May or may not include utilities Types Net or NNN Lease rent plus pro rata taxes, insurance and/or maintenance Gross Lease rent includes taxes, insurance and maintenance

6 Benefits of Owning Rental Housing (cont.) Tax Benefits Income tax reduction Tax Credits Dollar-for-dollar reduction in tax liability Eligible Users Primarily corporations Income tax deferral: Primarily Depreciation Represents the physical wearing out of a property Residential Schedule: 27.5 years Commercial Schedule: 39 years Mixed-use Schedule: Depends Commercial 20% or more of gross revenue from commercial sources Residential Less than 20% of gross revenue from commercial sources

7 Benefits of Owning Rental Housing (cont.) Depreciation Acquisition Cost + Improvement Cost* - Non-Depreciable Assets: land, intangibles** - Amount of Historic Tax Credits = Depreciable Basis Depreciable Basis = Depreciation per year/# Years Depreciation * Includes, but not limited to: A&E; Construction Costs; Fees to builders/contractors/ developers; Construction loan fees & interest; RE taxes paid during construction etc. ** Non-physical assets. Examples include marketing expenses, lease agreements etc.

8 Benefits of Owning Rental Housing (cont.) Appreciation Selling price - Purchase price = Appreciation in value

9 Tax Credits Dollar-for-dollar reduction of Federal or State tax liability depending on what type of credit you are using Today - Will only talk about programs in RED State credits reduce state tax liability Varies by state to meet public purposes Colorado approved a State Credit for Low-Income Housing Federal credits reduce federal tax liability - 4 Kinds Historic Rehabilitation Tax Credit (HRTC or RTC) Historic 20% Credit if has historic significance Non-Historic or Old Building 10% Credit if before 1936 Low-Income Housing Tax Credit (LIHTC) New Markets Tax Credit (NMTC) Investment (Renewable Energy) Tax Credit

10 Rehabilitation Tax Credits Rehabilitation of historically significant buildings A Way to save historic buildings and put them to new uses Can be good candidates for conversion to residential One year, up-front credit Decreases depreciable basis, adjusted basis and LIHTC basis Building must be held in its rehabilitated state for 5 years to avoid recapture

11 Rehabilitation Tax Credits (cont.) Historic Rehabilitation 20 percent, one year credit on rehab costs Must qualify Certified historic structure OR contributing building in national register historic district Post Rehab - Commercial, industrial or rental housing Substantial rehabilitation spend greater of $5,000 or property s adjusted depreciable basis Follow Secretary of Interior standards National Park Service (NPS) Under certain circumstances cannot have more than 50% of space occupied by government or non-profit

12 Rehabilitation Tax Credits (cont.) Three Part Process Part I If Building Is not on National Register Owner submits Part I application to State Historic Preservation Office (SHPO) SHPO makes recommendation to NPS NPS certifies building as historic Part II SHPO reviews plans and specs, forwards to NPS NPS approves plans and specs Part III NPS approves completed work

Both Historic and Non-Historic Substantial Rehabilitation Test 13 Cost of rehabilitation must exceed the owners Adjusted Basis (net investment) in the property within either the 24-month or 60-month period under an approved application May include costs incurred after placed-in-service date if incurred by December 31 of the year in which the test period ends

14 Basis for Calculating RTC Include All costs that are part of the depreciable basis except building acquisition Construction costs Interim financing (loan fees and interest) Property taxes and insurance during construction Architectural, engineering and design fees Builder, contractor, developer fees Appraisal fees

15 Basis for Calculating RTC (cont.) Exclude Acquisition costs no credit for buying the building, only for rehabilitating the building Intangible assets (reserves, permanent loan fees, marketing expenses, some legal and accounting, etc.)

16 RTCs Generate Equity 1,000,000 Rehab x.20 Credit Rate 200,000 RTC 200,000 RTC x.95 Credit Price 190,000 Equity

17 Historic Rehabilitation Tax Credits RTC exercise - Calculate the amount of the tax credit and the amount of equity that can be attracted on this historic rehabilitation project if the investor will pay $0.93 for each $1.00 in credits Development Budget (in $000 s) Acquisition Land $ 100 Acquisition Building 500 Rehab 3,500 Developer Fee 500 Construction Interest 140 Permanent Loan Fee 30 Total $4,770

18 Historic Rehabilitation Tax Credits Exercise (cont.) RTC and Equity Total Development Cost $,4,770,000 Less Land - 100,000 Less Building - 500,000 Less Permanent Loan Fee - 30,000 RTC Basis $4,140,000 Credit Rate 20% Tax Credits $828,000 Investment Amount/Credit $0.93 Equity $770,040

19 Low-Income Housing Tax Credits Annual credit for 10 years Project must qualify on three criteria Income/occupancy Rent State approval Affordability Requirements 15-year compliance period 15-year Extended Use obligation Does not reduce depreciable basis in property

20 Low-Income Housing Tax Credits (cont.) Income / Occupancy 20 percent of the units must be occupied by tenants with incomes below 50 percent of the median OR 40 percent of the units must be occupied by tenants with incomes below 60 percent of the median

21 Low-Income Housing Tax Credits (cont.) Rent restrictions All units receiving LIHTCs have rent restrictions Maximum rent includes all utilities, except telephone Restrictions based on number of bedrooms and imputed household size Imputed household size equals number of bedrooms x 1.5 persons per bedroom (one person for a 0-bedroom unit) Rent cannot exceed 30 percent of income qualifier (either 50 or 60 percent of median) for the assumed household size OR go to your state allocating agency website/ www.novoco.com rent and income calculator

22 LIHTC Rent Restrictions (cont.) Maximum rents do not include rental assistance or payments for supportive services from government agencies or non-profits Maximum rents do include any tenant payments for services that are required as a condition of occupancy. In assisted living projects, services must be optional or funded by agencies

23 Low-Income Housing Tax Credits (cont.) State approval 2016 - $2.35 per resident ($2.69 million minimum) State agency allocates credits At least 10 percent set aside for non-profits Qualified allocation plan must consider energy efficiency and historic preservation

24 Low-Income Housing Tax Credits (cont.) Annual credit for 10 years New construction Substantial rehabilitation (greater of $6,000 + per unit or 20% of building basis) Two Programs 9% Credit (Competitive) on all improvement costs not funded with tax-exempt financing, OR 4% Credit (Non-Competitive) on all improvement costs, regardless of financing source At least 50% of project financed with tax exempt financing 4% Credit comes with Tax Exempt Bond approval» Outside the state s regular LIHTC allocation process» non-competitive

25 30% Basis Increase for Some Projects Boost is available for 4% or 9% projects in: Difficult Development Areas designated high cost areas Qualified Census Tracts median income below 60% of AMI or 20% of households below poverty Any project the State Agency determines needs more credits for financial feasibility may have its basis increased up to 30% does not apply to bond (4%) projects

26 Low-Income Housing Tax Credits (cont.) Improvement costs (Eligible for 9.0 Percent Credit)

27 Low-Income Housing Tax Credits (cont.) Acquisition credit Annual credit for 10 years Uses the current 4% credit rate Applies to building value only (not land) Previous owner must have owned building for 10 years waivers for preservation projects Available only with substantial rehabilitation Not eligible for 30 percent increase in basis in QCT and DDA

28 Low-Income Housing Tax Credits (cont.) Credit percentage changes 9 percent was fixed at 9.0% by Housing and Recovery Act of 2008 (HERA) for credit awards made before January 1, 2014 Returned to floating rate, but became permanently fixed with The Protecting Americans from Tax Hikes Act of 2015 4 percent rate floats was not affected by HERA IRS publishes new 4 percent rate monthly

29 Low-Income Housing Tax Credits (cont.) Example #1 New Construction Project in QCT Uses Sources 500 Land 1100 Bank Loan 5000 Res. Construction 401 CDBG 1500 Commercial Const. 5499 Equity 7000 Total 7000 Total LIHTCs Equity 5000 Res. Const. 585 Ann. LIHTCs x 1.3 x 10 Years 6,500 Credit Basis 5850 Total LIHTCs x.09 Credit Rate x.94 Credit Price 585 Maximum Annual LIHTC 5499 Equity

30 Low-Income Housing Tax Credits (cont.) Example #2 Rehab Project Uses Sources $ 2000 Acquisition (1/2 building) 1200 Conv. Loan 5000 Rehabilitation 1221 CDBG 7000 Total 4579 Equity (see below) 7000 Total LIHTCs Equity 5000 Rehabilitation 482 Max. Annual LIHTCs x.09 Credit Rate x 10 Years 450 LIHTC 4820 Total LIHTCs x.95 Credit Price 1000 Building Value 4579 Total Equity Provided x.032 Credit Rate 32 LIHTC 450 Credit on Rehab + 32 Credit on Bldg. Value 482 Maximum Annual LIHTC

31 Colorado State LIHTC Program Recently enacted program, originally authorized 2 year pilot program (2015-2016 award cycles) Extended in May 2016 to authorize 3 more years $5MM/year tax credit cap per cycle CLIHTC works like federal LIHTC, with differences: Cumulative credit award = 30% of qualified basis 6 year credit period instead of 10 years 100% annual credit amount allocated for year of PIS (instead of proportional award tied to leaseup) Currently, CHFA awards CLIHTCs to subsidize 4% LIHTC awards Effect is to create competitive subset of 4% awards Ongoing discussion whether to broaden their use

32 Mechanics of a State LIHTC Investment Investor Options: Integrated Investor, with both Colorado and Federal tax credit appetite Specialized State Investor, who invests equity alongside your federal investor Credits and Pricing CHFA seems to be awarding credit in cumulative amounts ranging from 50-90% of cumulative federal credits Credits are pricing above CHFA expectations, at $.60+ Structure If a separate state investor entity is used, that entity will likely take 1% or less ownership stake in the project partnership Federal investor only gets percentage of federal credits equal to its partnership ownership % But federal tax law requires state investor to have material ownership to be respected as equity investor

33 Financial Illustration State/Federal LIHTC Example New Residential Construction Project in QCT Uses 500 Land 5000 Res. Construction 5500 Total Sources 1922 Bank Loan 500 CDBG 3078 Equity 5500 Total FLIHTCs 5000 Res. Const. x 1.3 6,500 Credit Basis x.032 Credit Rate 203 Max Ann FLIHTC 325 Annual SLIHTC Fed Equity 203 Ann. LIHTCs x 10 Years 2030 Total LIHTCs x.94 Credit Price 1908 Equity State Equity 325 Ann. SLIHTCs x 6 Years 1950 Total SLIHTCs x.60 Credit Price 1170 Equity

34 Using LIHTCs and RTCs Together Can combine RTCs and LIHTCs But RTCs reduce the LIHTC basis $5,000,000 -.20 = $1,000,000 $5,000,000-1,000,000 = $4,000,00 x.09 = $360,000 Rehabilitation Credit Rate RTC Rehabilitation RTC LIHTC Credit Basis Maximum Annual LIHTC

35 Using LIHTCs and RTCs Together (cont.) In Qualified Census Tract or Difficult Development Area You Must Reduce before you Boost! $5,000,000-1,000,000 =$4,000,000 x 1.3 = $5,200,000 x.09 = $468,000 Rehabilitation RTC LIHTC Credit Basis Maximum Annual LIHTC

Example RTC/LIHTC Mixed Use 36 Conversion of a 4 story, 40,000 sqft National Register building into 30 twobedroom apartments and street level retail. The top 3 floors will each have 10 apartments serving tenants at 50% AMI, renting for $900/mo. The first floor will have 10,000 sqft of retail space leasing for $25/sqft on a gross lease basis. Project Description Square Feet and Units Total Development Costs Rents and Income Units SQFT Total SQFT % of SQFT TDC/SQFT Total TDC % of TDC Rent Total Income % of Income Residential 30 1000 30000 75% $ 300 $9,000,000 72% $ 900 $ 324,000 56% Commercial 2 5000 10000 25% $ 350 $3,500,000 28% $ 25 $ 250,000 44% 40000 $12,500,000 $ 574,000 * More than 20% so must use commercial depreciation schedule. Also recall depreciable basis will be reduced by the amount of RTCs.

37 Example Mixed Use (cont.) Sources and Uses Sources Bank Loan (5%, 20 yrs, 1.2 DC$ 2,028,225 Equity $ 9,439,020 City CDBG (Acquisition) $ 750,000 Deferred Developer Fee $ 282,755 $ 12,500,000 Uses Acquisition $ 1,600,000 Construction $ 9,900,000 Developer Fee $ 1,000,000 $ 12,500,000 Gap filled by deferring $282,755 of $1.0M Developer Fee Why? Developer fee in both RTC and LIHTC basis If Fee/TDC reduced by $282K then basis and equity reduced Rules prevent projects from taking advantage To keep in basis, deferred portion of Developer Fee must be paid within 10-12 years typically from CF Most SHFAs limit Developer and consultant Fees When Developer and contractor are the same, total is capped

Example Mixed Use (cont.) 38 RTC includes commercial, market rate and low-income construction costs, but not the building LIHTC covers costs associated with low-income only (no market rate or commercial). But can provide credits for the acquisition See second to last slide for cheat sheet BASIS CALCULATION Uses Total Commercial RTC Residential RTC LIHTC - Const LIHTC - Acq Acquisition Land $ 400,000 $ - $ - $ - $ - Building $ 1,200,000 $ - $ - $ - $ 1,200,000 $ 1,600,000 $ - $ - $ - $ 1,200,000 Construction $ - Low Income Residential $ 7,230,000 $ - $ 7,230,000 $ 7,230,000 $ - Commercial $ 2,670,000 $ 2,670,000 $ - $ - $ - $ 9,900,000 $ 2,670,000 $ 7,230,000 $ 7,230,000 $ - Developer Fee $ 1,000,000 $ 271,130 $ 728,869 $ 857,652 $ 142,349 Total $ 12,500,000 $ 2,941,130 $ 7,958,869 $ 8,087,652 $ 1,342,349

Example Mixed Use (cont.) 39 LIHTC basis reduced by RTCs related to Residential portion of the building May need assistance of accountant, attorney, and contractor to determine appropriate allocation of costs. EX: Elevator, common areas etc. TAX CREDIT AND EQUITY CALCULATION Comm. RTC Res RTC LIHTC - Const LIHTC - Acq Basis $ 2,941,130 $ 7,958,869 $ 8,087,652 $ 1,342,349 RTC Credit Rate 20% 20% NA NA Credits $ 588,226 $ 1,591,774 $ 8,087,652 $ 1,342,349 Basis Adjustment for RTC - - (1,591,774) No RTCs on Acq Adjusted Basis $ 6,495,878 $ 1,342,349 Basis Boost for QCT - - 1.3 Ineligible Basis Adjusted for QCT - - $ 8,444,641 $ 1,342,349 Credit Rate - - 9.00% 3.22% Annual Credits $ 588,226 $ 1,591,774 $ 760,018 $ 43,224 Years of Credits 1 1 10 10 Total Credits $ 588,226 $ 1,591,774 $ 7,600,177 $ 432,236 Price $ 0.94 $ 0.94 $ 0.92 $ 0.92 Equity $ 552,933 $ 1,496,267 $ 6,992,163 $ 397,657 Total RTC Equity $ 2,049,200 Total LIHTC Equity $ 7,389,820 Total Equity $ 9,439,020

Compared to Residential New Construction 40 Major differences: Predevelopment: Environmental (Loom City) Reconciliation of NPS with UBC and Going Green (Northern) Commercial needs - Who will your tenants be? Water capacity and Power loads for restaurants and other high users Accessibility for businesses vs privacy for residents Signage Budgeting and Contingency Preservation of historic fabric during contractor investigation of the building Estimating commercial lease rates and lease types (NNN Or Gross?) Local expectations regarding payment for tenant finishes Financing Understanding risks Communicating vision Commercial market and pre-leasing Cost allocations for accurate tax credit projections During Construction Contingency, contingency, contingency Marketing to commercial tenants

Compared to Residential New Construction Lease Up Knowledge of commercial brokers/leasing agents Negotiating Commercial Leases Clear direction re Historic and Environmental prohibitions Can t remove or destroy historic fabric Can t disturb contained hazardous materials Ex: asbestos in plaster or flooring Ensure resident non-disturbance Business tenants hours, noise, security etc. Commercial Lease Features Escalators, renewal options, CAM Charges, Gross, NNN, Fully Net, Percentage leases Compliance with Disqualified Lease regulations (RTC regulations) Tenant finishes Consistent with historic and other requirements Negotiating Shared costs Operations Calculation of NNN, utility, other shared operating expenses 41

Investment Not Made Due to Environmental Concern 42 Mixed-Use project over 10 years in predevelopment Over $2m spent on clean up under two Federal Grants Concrete shell - All interior materials removed But, developer out of predevelopment money to finish work required to finalize abatement budget Unable to close financing w/o matching Sources & Uses

Knock, Knock. Who s There? 43

44 Ballroom Woes

45 Needed: Tenant Buy-In Before Rehab: About half the units are now finished leaving tenants happy in fresh units in a growing area of the city 1920 Firehouse with watch tower Converted to apartments and office space in the 1980 s. Acquired by City through foreclosure Conveyed to a non-profit/for-profit team to put to put together and execute a redevelopment plan. Ten of 18 units occupied by original 1980 s tenants who were: - Weary of deferred maintenance, - Skeptical of a new owner and the idea of major rehab - Anxious about being temporarily displaced But the developers have worked closely with the tenants to put together a great rehab plan with numerous interior, exterior and energy efficiency upgrades

RTC and LIHTC Equity Worksheet 46 Total Equity = RTC Equity + Acquisition Equity + 4% or 9% Construction LIHTC Equity RTC 4% Acquisition Credit 9% or 4% Construction LIHTC RTC Basis 4% Acq. Basis (if applicable) Construction LIHTC Basis X 0.20 Cr Rate X Actual 4% Cr Rate (not 4%) - RTC (if applicable) Credits Annual Acquisition LIHTC New Basis X Price/$ X 10 Years X Applicable Fraction (% Affordable) RTC Equity Total Acquisition LIHTC X Applicable Fraction (% Residential) X Price/$ New Basis 4% Acquisition LIHTC Equity X 1.3 QCT or DDA Basis Boost New Basis X 9% or Actual 4% Credit Rate Annual Construction LIHTC X Price/$ Construction LIHTC Equity

47 Contact Us Training Technical Assistance Development Services Syndication Karen Garritson 303-475-7986 kgarritson@ndconline.org Erin O Neill 303-665-7068 (o) 720-985-7068 eoneill@ndconline.org