It is anticipated that the Community Development Financial Institutions Fund ("CDFI") will announce $5 billion in New Markets Tax Credit ("NMTC") allocation awards within the next several weeks. These awards will be in search of a broad range of projects located in highly distressed rural and urban areas throughout the United States, resulting in job creation, revitalized neighborhoods, a boost to economic opportunity, and the improvement of the lives of those residing in distressed communities. Projects which focus on specific community needs, employment, healthy foods, community services, health and wellness, agriculture, technology, education, and manufacturing will be the beneficiaries of private capital they could not otherwise obtain. The significance of NMTCs can be measured by outcome. According to the CDFI, over the past 20 years NMTCs have generated $8.00 of private investment for every $1.00 of federal spending, resulting in the financing over 5,400 businesses, the development of 178 million square feet of retail, office, and manufacturing space, and the creation of over one million jobs in all 50 states, the District of Columbia and Puerto Rico.

NMTCs are designed to increase the investment of private capital for community redevelopment and economic growth in distressed communities through the use of federal tax credits. Considered "gap financing," private capital will bridge the gap in the project's capital stack which will allow for the underwriting of a wide variety of metro and rural projects, from the acquisition, construction, and major rehabilitation of commercial, industrial, community facilities, and mixed use developments to the support of new and existing operating businesses. With $5 billion of NMTC allocation available, projects now need to be positioning themselves in the best light to attract this valuable resource. Below is a checklist which may prove helpful to projects in search of a NMTC allocation.

  1. Qualified Census Tract. First and foremost, if a project is not located in a qualified low income census tract, it will not qualify for NMTCs. NMTCs can only support activities located in Low-Income Communities (LICs), which are defined by statute as population census tracts with a poverty rate of 20% or greater or a median family income at or below 80% of the applicable area median family income (26 USC §45D(e)). Over 31,000 of census tracts in the U.S. qualify for NMTC investments. The "location" requirement is straight forward. A project is either in a qualified census tract or is not - there is no gray area in this determination. The CDFI has created an online mapping tool to provide prospective applicants with the ability to search by address, census tract and other geographic areas of interest to determine program eligibility for NMTCs. In recent years, NMTCs have been heavily deployed in projects located in "severely distressed" census tracts. To the extent a project is located in a severely distressed census tract, it may have a leg up on other qualified projects.
  2. The "Sin" Businesses. In order to use NMTCs as part of a project's capital stack, the project must constitute a trade or business for federal income tax purposes. This is a fairly easy requirement to satisfy; however, there are a number of businesses which are explicitly prohibited. These are known as the "sin businesses" which include the leasing of unimproved real property, an endeavor predominantly engaged in the development or holding of intangibles for sale or license, golf courses, country clubs, massage parlors, tanning salons, racetracks or other gambling facilities, and stores with the principal purpose of which is the sale of liquor for off-premise consumption. If a project falls within one of these categories, it will need to look elsewhere for financing. It is worth noting that residential rental projects can qualify so long as annual rents from such activity does not exceed 80% of the operation's annual total revenue.
  3. "Demonstrable and Substantial Community Impact". The community impact or benefit of a project is critical. The sole purpose of NMTCs is to target distressed and underserved communities which means a project must display a demonstrable and substantial community benefit to the individuals that work or reside in the qualified low income census tract. Projects will be evaluated by "outputs" which are measurable units that are easy to quantify. These "outputs" include such factors like (i) the number of jobs created, (ii) the square footage of a new mixed-use development, (iii) the number of visits by patients to a primary healthcare facility, or (iv) the number of people served at a health and wellness center, which will be used to establish whether a project achieves the broader objectives of increased employment, local economic vitalization, and/or improved public health and education. It is often worthwhile to obtain some type of third-party feasibility study, economic impact analysis, or community impact assessment which analyzes the direct and indirect economic effects. The results will serve to demonstrate whether a project's proposed impact will reach those in the underserved community.

    Impact projects typically seek to achieve the following community benefits:

    (a) Jobs. Economic growth of a distressed community will begin with the creation of quality jobs that are accessible to low-income people. A quality job is viewed as full time, permanent, paying a living wage with benefits, with training opportunities and the prospects for advancement.

    (b) Community Services. The focus is on the community. How will a project's goods and/or services reach those in the economically distressed community? Active endeavors that focus on healthy food outcomes, healthcare, education, social welfare, early childcare and senior care, family services, and vocational training usually have strong appeal. In addition, greater levels of products or customers served draw significant attention.

    (c) Minority- & Women-Owned Businesses. Minority- and women-owned entrepreneurs struggle to access capital while their counterparts typically rely on traditional financing and/or private capital to build or expand their businesses. On top of this, commercial financing rarely ventures into underserved communities. For whatever reason, conventional lenders and investors often don't have the interest in, or the expertise to service, underserved communities. Consequently, NMTCs, as an economic development tool, determinedly pursue economic development in minority communities as a result of this.

    (d)     Energy and Environmental Sustainability. Energy is a prime example of utilizing NMTCs to support a diverse portfolio of energy sources which, in turn, encourages economic development, strengthens investments in renewable energy sectors, and enhances lower energy consumption. Much too often business endeavors are unable to meet conventional underwriting requirements primarily due to technology risk and the startup nature of such technology. The creation of a grid-scale, solar and battery energy storage facility, the conversion of forest waste into feedstock to produce electricity, or a state-of-the-art clean energy generation technology used in an anaerobic digestion facility, are a few examples of NMTCs past involvement in the development of alternate sources of power which conserve natural resources and reduce harm to the environment.
  4. Community Development Entities - Your Next Best Friend. A community development entity (CDE) is an intermediary vehicle that provides loans, investments and financial counseling to residents in low-income communities. Being certified as a CDE allows an organization to compete annually for the NMTC allocation awards from the CDFI. Unlike other federal tax credits that deliver a direct federal subsidy to projects, CDEs are required to sell these NMTCs to private sector investors and use the sale proceeds to make debt or equity investments in projects located in qualified low-income communities. Securing NMTCs is a very competitive and time consuming process. For example, in 2019, the 73 CDEs that received NMTC allocation awards were picked from a group of 214 applicants. With awards in hand, CDEs will be in search of impactful projects that satisfy NMTC qualifications and further their particular mission. CDEs are often set up to address the needs of a specific geographical area, by creating a local, state, regional, or national footprint. Others CDEs concentrate on specific business themes such as community services, real estate, manufacturing, energy, education, and healthy foods. Some deploy their awards in only rural areas while others will look to finance operating businesses in the inner city. Consequently, a project will likely be required to conduct considerable due diligence in order to find those CDEs whose profiles fit their project. In 2019, project needs exceeded the credit allocation by six times. Consequently, obtaining a commitment for a particular project from one or more CDEs is a formidable task.
  5. Minimum NMTC Allocation. To make it worthwhile, the rule of thumb is that a project should not entertain NMTCs unless it is looking for an allocation of at least of $5 million or more. This means the project budget must be at least $5 million since a project cannot receive a NMTC allocation in excess of its project budget. The net cash benefit of a NMTC allocation to a project will be determined by the following elements: (i) the pricing of the NMTCs; (ii) the fees and reserves associated with a NMTC allocation and required by the CDE; and (iii) the transactional costs which include professional fees. For example, a $5 million project with a $5 million NMTC allocation, based on today's pricing with customary fees, reserves, and transactional costs will generate somewhere between $700,000 and $1 million of cash for the project. Keep in mind, however, this is not money out of the project's bank account; all of these costs are paid out of the capital paid to secure the credits. The end result is that it simply lowers the amount of cash available to the project.
  6. Project Readiness. Equally important to a project's success in obtaining NMTCs is its "shovel readiness." A project that has confirmed community benefit outputs is valuable, but it's not enough. To secure NMTCs, a project must by ready. This means it must have all of its financing lined up, in cash, and ready to go, and it must have completed the necessary due diligence so the project can commence within a short period of time after closing its financing. With respect to financing, a project will need to have all the "leverage funds" available, in cash, at closing. This means, for example, a $5 million NMTC allocation, with the NMTC pricing at $0.73 per credit dollar, will generate cash in the amount $1,432,500 for the project. This means in order to close on the financing, the project must come up with its own funds in the amount of $3,576,500. This amount is known as the "leverage source" and is required from the project's sponsor with all funding sources, such as equity, debt, and/or grants, identified and committed. To the extent that bank financing is involved, it is to the benefit of the project that the lender has prior experience with NMTC financing. The completion of the project's due diligence is equally important. Depending on the type of project, all aspects need to be in order to close. If the project involves real estate construction for example, title work, survey, environmental, complete plans and specifications, insurance, zoning, building permits, and signed tenant leases or letters of intent will all need to be in final form in order to close.

There is no question that the U.S. economy is floundering in uncharted waters due to the presence the COVID-19. With the uncertainty and complexity created by high unemployment and severe economic disorder, everyone from federal and state governments, businesses, nonprofits, and individuals are trying to grasp just how deep this impact will go. Economic tools such as NMTCs, with the objectives of job creation and economic revitalization, are proving as critical as ever. Stites & Harbison has the depth of understanding, perspective, and substantial experience working with projects to finance their development using NMTCs. Our typical role is to coordinate the efforts to secure the NMTC allocation from one or more CDEs, secure a NMTC equity investor, assist in structuring the financing transaction, and help with the coordination of the final documentation and closing process for the financing.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.