Tuesday, February 1, 2011

Case Study: Textile Mill Rehabilitation

Case Study:  Sale of tax credits in connection with the rehabilitation of an abandoned upstate textile mill into loft apartments provides equity financing for over 30% of total project costs.
As a primer on how tax credits can help finance development projects, I offer the following example in the form of a case study.  
A real estate developer proposed to rehabilitate and develop an abandoned historic textile mill in upstate South Carolina, into approximately 200 loft-style apartments.  The developer had completed many successful projects, but had not previously utilized tax credits to provide financing for a project.
The developer utilized federal historic rehabilitation tax credits, South Carolina historic rehabilitation tax credits, and South Carolina mill tax credits for this project. The federal historic rehabilitation tax credit is equal to 20% of the total qualified rehabilitation costs and can be used to offset federal income tax.  The state historic rehabilitation tax credit is equal to 10% of qualified rehabilitation expenses and can be used to offset South Carolina income tax.  The state mill tax credit is equal to 25% of qualified rehabilitation costs and can be used to offset South Carolina income taxes or property taxes.  Total estimated costs of the project were approximately $20 million.  The tax credit market and the amount investors are willing to pay for an allocation of such credits is subject to fluctuation.  An institutional investor contributed equity to the project in exchange for an allocation of the tax credits and and a modest cash return on their investment.
The transaction was structured to accomplish the following objectives:
  • To allocate the tax credits to the investor;
  • To allow the developer to maintain control of the project;
  • To pay a substantial development fee to the developer (approximately $2.9 million);
  • To allow excess cash flow to be retained by the developer when the project exceeded stated performance criteria;
  • To provide an exit strategy for the investor after 5 years at the lowest possible cost to the developer (to preserve the historic rehabilitation tax credits the investor must maintain its investment in the project for at least 5 years after completion);
  • To ensure that all requirements are met to receive the tax credits and avoid recapture.
The investor provided approximately $6.9 million in equity to help finance the project. The developer received a development fee of approximately $2.9 million over the life of the project, and the developer will be in a position to purchase the investor’s ownership interest in the project for a fraction of the investor’s equity investment (about 15%) 5 to 6 years after the rehabilitation is complete.  The combination of tax benefits and monetary returns provided an attractive outcome to the investor.

1 comment:

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