How Government Incentives Help Win Work

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By Brian K. Humes, CPA

Partner, CliftonLarsonAllen LLP

Economic development incentives are a fact of life in real estate development and construction. Governments package and promote their offerings in highly competitive bids to spark economic activity, create jobs and generate new tax revenues.

For most builders and developers, the challenge is not finding these incentives. The challenge is making sense of all that is being offered and determining what level of incentives, traditional investment and financing, will make a project viable and attractive to investors.

Incentives Reduce Construction Costs
Credit is still hard to come by in many markets, so builders and developers are still finding it difficult to launch new projects through financing alone. Using government incentives, developers can reduce the net cost of construction, which can be passed on as more favorable and competitive lease terms for tenants, or a lower cost per square foot for the end user.

State governments have been investing in economic activity for decades, and in many situations, they still dominate the universe of development incentives. Every state is different in the details, but certain programs consistently appear in development proposals:

· Tax Increment Financing (TIF) – TIF districts allow a municipality to effectively fund a portion of project costs and recover the investment through incremental increases in real estate or other taxes in the future.

· Transportation Development Districts (TDD) – TDDs are created to develop, operate, improve and/or maintain projects related to transportation infrastructure.

· Community Improvement Districts (CID) – CID financing is undertaken with an eye toward increasing property values in neighborhoods and communities.

Likewise, the federal government directly and indirectly supports economic development activities. Local and regional projects are made more affordable for builders, developers and end users thanks to federal dollars.

Some programs, such as New Markets Tax Credits (NMTC), are monetized at the point of new investment into projects within certain low income communities. The flow of funds from these qualified investments reduces the project’s net cost and increases the chances of success. The Tax Relief Act of 2010 extended benefits under the NMTC, which include a tax credit of up to 39 percent of the qualified investment in a Community Development Entity (CDE). The credit is claimed over a seven-year period; however, the investor makes an investment at the beginning of the project based on a negotiated amount that is less than the credit.

The Low-Income Housing Tax Credit (LIHTC) is a federal program administered by state commissions. It is designed to bring private investors into the affordable rental housing or low income residential housing market. A developer generates equity in a project by selling or syndicating transferable credits to investors, who are then able to utilize those credits to offset federal and state tax liabilities.

The Historic Rehabilitation Tax Credit allows a developer to recover costs incurred for rehabilitation of certain historic buildings. For purposes of the credit, rehabilitation includes renovation, restoration and reconstruction, but not enlargement or new construction. The percentage of costs that can be taken as a credit is 10 percent for buildings originally placed in service before 1936, and 20 percent for certified historic structures.

Sifting through the many options may require specialized financial modeling and analysis tools, but it is worth the investment since the ability to explore the short- and long-term impact of incentives on profitability puts builders and developers in a better position to secure the most favorable financing package. A number of incentives have the effect of reducing the cost of borrowed funds.

Maximizing the Benefits
There are several important keys to getting the greatest benefit from incentive financing:

· Make certain that all costs are considered, including land, construction costs and soft costs like development fees.

 · Look at all possible incentives and economic development programs at the federal, state and local levels.

· Consider special districts, such as transportation districts and community improvement districts, which can give rise to funds that reimburse the developer for certain site costs.

· Quantify incentives on their own and in conjunction with other offerings.

· Encourage incentive funders to compete against each other.

· Determine tax issues related to accepting incentives, and develop strategies to address them.

· Determine the best package for reducing costs and making the project viable.

Today, It’s All About Jobs
There has been a shift away from incentives that are "sold" to the public simply as revenue generators. Governments are more motivated than ever to boost revenue, but in times like these, the public wants to hear how incentives will strengthen the local jobs picture.

Employment is not just the end goal. Construction jobs make it a multi-stage process that injects cash into the local economy and creates revenue through sales and income taxes.

The reality of today’s marketplace is that, without incentives, many developments do not make financial sense. The developer asking for incentives is often viewed as wanting something for nothing, which in many, if not most instances, is not the case. Incentives simply allow the developer to manage and share, but certainly not eliminate, their risk.

If the developer doesn’t find what is needed from one jurisdiction, there are usually others willing to offer options elsewhere. As in the economy at large, competition is generally healthy and results in the most favorable cost structure.

 In the current political climate, there are always questions about whether government development incentives and grants are a good investment of taxpayer dollars. The fact is that incentives continue to encourage investment in low income communities. The NMTC is a good example: 594 awards have allocated $29.5 billion in tax credit since the program was established in 2000.

Today, if an economic incentive package can be shown to expand jobs, it’s going to enjoy greater public and political support, at least in the immediate future.