After sitting empty for twenty odd years this abandoned department store was in need of a total transformation. The property had a solid foundation, a beautiful facade, and held rich memories for the locals, but behind the broken/boarded up storefront was a building begging for a wrecking ball. The building lacked plumbing, electrical service, required fire safety, or even a safe way to get to the upper floors (ie no elevator or internal stairs)! To get to the upper floors of this 5 story building you had to climb a dilapidated fire escape.
The amount of investment required to redevelop this historic landmark would clearly exceed the cost of new construction on a suburban green field. This harsh reality helps explain why so many North Carolina downtown buildings remain empty and why Federal and State historic tax credit programs have been created to encourage private investment into core properties like this one.
The first challenge in taking advantage of the Historic Tax Credits in our department store example was the size of the building. As an estimated $3m project (with roughly $1.4m in available tax credits), it was too large to find high net worth investors that could advantage of the tax credits individually. If the investors don’t have at least $700k worth of federal tax liability each year they wouldn’t be able to get the maximum value out of the tax credits.
Unfortunately, a tax credit deal of this size is also a bit challenging for private corporations to take advantage of as well. Large banks/utility companies which buy the majority of tax credits have huge tax liabilities and as a result usually focus on large (greater than $5m) deals on which to spend their time/resources. The legal/closing costs for completing small tax credit deals are similar to those required for much larger deals. In the interest of efficiency, these companies prefer to invest in larger deals.
This is the scenario I faced in my first project as I launched a development company called Greenfire Development that went on to acquire and redevelop over 20 distressed properties in downtown Durham. To get past this tax credit challenge I had to find a midsize company that had significant North Carolina operations (ie tax liabilities) that was familiar with the program and interested in our specific deal. In order to maximize the tax credits, we needed to create an “income producing” property. Market research at the time indicated that the highest and best use of the space was to create a mixed-use property with residential units above retail space. Based on this information I took the common approach of building apartments that could later be converted to for-sale condos after we the tax credits had been used up.
The approximate sources and uses of funds for this project were as follows:
|Tax Credit Equity||
|Hard Cost (construction)||
|Soft Costs (everything else)||
After the build out was complete, the residential units and commercial space leased up better than projected. The project generated positive cash-flow for the tax credit required 5 year hold period. At that point, the property was converted to condos and was recently sold to new buyers. In total, the property sold for roughly $4,000,000, generating a healthy $1,000,000 return on the original $250,000 investment.
Generating these returns would not have been possible were it not for taking advantage of the Historic Tax Credits. Although they can be complicated to understand/use, the tax credits not only led to significant private investment in a dilapidated property, but there are now approximately 20 proud new property owners/investors in a formally abandoned downtown area.
Michael Lemanski is the founder of Greenfire Development and now serves as the Director of the Development Finance Initiative at the UNC School of Government.