Factors Affecting the Value of State Historic Tax Credits

Novogradac Journal of Tax Credits |
July 2019 | Volume X - Issue VII

By: Albert Rex

It has been more than 30 years since states started creating their own historic tax credit (HTC) programs.

Over this time, the value of the credits has become even more important to the capital stack as both hard and soft costs increased and the availability of debt changed after the 2008 crash in the market, requiring developers to have more equity in their deals.

Most state programs started to further incentivize the rehabilitation of historic buildings and increase the use of the federal HTC program. Now state HTCs are an essential financial component of most HTC projects and often are the “but for” element of project funding that makes or breaks a project. This is apparent in states such as Georgia, where several projects are stalled due to the depletion of their state HTC funds.

Not all state HTCs are created equal and there are a number of factors that go into determining pricing for these credits in each state. The No. 1 factor is whether the state credit is bifurcated from the federal HTC. Bifurcation is important, as the pool of investors that are interested in state credits are often different from that pool of investors interested in federal credits.

Different States, Different Markets

The investor pool changes from state to state based on the tax laws. For instance, Texas has no state income tax, but it does have state franchise tax and insurance premium tax, which the Texas Historic Preservation Tax Credit program offsets. Other states, such as Massachusetts, allow their credit to offset all state income tax, which creates the opportunity for individuals as well as corporations to participate in the marketplace.

Although the pools might be different from state to state, a typical investor profile for a state HTC programs includes tax directors for large C corporations, insurance companies and financial institutions. There are also large demands for state tax credits by high-net-worth individuals in several states where the state credits are certificated. They are simply investing in the credit to reduce their overall state tax liability, unlike the federal credit where there are additional benefits related to their return on investment.

If the state credit is bifurcated from the federal, the next important factor is whether the credit is allocated or certificated. Allocated credits are much like the federal HTC in that the investor must enter into the transaction in some form of partnership. This adds time and cost to the state HTC transaction and reduces the pool of investors, as many of the typical players in the state markets don’t want to be involved in a real estate transaction for a number of reasons. A certificated credit can be sold like a stock certificate and therefore can be a much more efficient transaction, usually with a simple purchase agreement connecting the end user to the developer. This eliminates the entanglement of some form of partnership.

Not all certificates are created equal. Some can only be transferred once while others can be transferred multiple times. The number of allowable transfers can affect pricing. The more transfers allowed, the larger the investor pool and competition for credits, which can increase pricing as multiple transfers can allow in an investor to sell credits if there is a change in their tax requirements. Limiting the transfer to only one entity shrinks the pool of end users and does not allow for certain efficiencies in the sale, such as the participation of a nonprofit partner.

If the credit is certificated, another consideration for the investor is the recapture rule. Many states followed the five-year federal recapture rule, with 20 percent of the credit burning off each year. Some states, like Massachusetts, have the same five-year period but the burn off is calculated on a daily basis. Other states, such as Rhode Island, have shorter recapture periods, or no recapture at all, such as Texas.

Another way of trying to attract users of state HTCs, but perhaps depress investor opportunity, is to make the credit refundable. Rhode Island had its original program close and then reopen in 2013 with a program cap of $34.5 million and a 3 percent application fee based on the amount of qualified rehabilitation expenditures. The new legislation required projects to apply and then be put in a queue. One of the interesting changes to the revised program is that nonprofits can now participate and the credit became fully refundable. The changes can affect the credit transfer marketplace, as some developers will seek the refund versus selling the credits making less credit available and potentially impacting pricing.

Prices Going Up

“State historic tax credit pricing has been steadily increasing over the past several years with investors becoming more familiar with the programs,” said Scot Butcher, a principal at Tax Incentive Finance. “Lack  of supply and increased demand are simple economic principles that influence pricing to rise. States with certificated tax credit programs and limited recapture exposure, like Massachusetts and Texas, see pricing in excess of 92 cents, depending on size of the transaction and structure of the state tax transaction.”

State HTC pricing is trending in a positive direction, especially in comparison to the federal HTC that were impacted both by Rev Proc 2014-12 and the modification of the credit under the 2017 tax reform legislation that requires the credit to be taken over five years versus just one.

In many ways, the maturing of state HTC programs could not have come at a better time. With the depression of federal credit pricing due to this change and increased construction costs across the country, developers are looking for every penny of equity they can find to make their project work.

Troubling Trends

Unfortunately, not all the news is good. Some longstanding state programs are under threat legislatively or have struggled to recover from changes to their state HTC programs.

A bill was introduced in the Louisiana legislature this past session to extend its HTC program to 2026. The program is set to sunset in 2021. A $150 million program cap was tacked on to the bill by the Louisiana House, but the Senate killed the measure altogether, leaving the sunset date in place and the program in limbo until next legislative session. Likewise, Missouri had their overall project cap lowered from $140 million to $90 million last year. From a supply-and-demand perspective, this does not negatively affect the pricing and in the short term can actually create a price increase, due to competition for a small credit pool. In the longer term, changes in caps and not extending sunset dates can be destabilizing in a marketplace not dissimilar to the threat of tariffs and their impact on certain segments of the economy.

New York is another program that is seeing devaluation of its state HTC on the investor market. Now one of the most active HTC states in the country, legislation to make the state credit transferable failed in the legislature this spring. Since the credit cannot be freely transferred and must be allocated within the partnership, per-credit pricing tends to be under 70 cents, making it much less efficient than states where the credit can be transferred and pricing is closer to 90 cents on the dollar.

Despite turbulence in various state programs, the state HTC market is at the height of its maturity. With a deep field of investors and syndicators to serve them, pricing is at an all-time high with several markets seeing investors paying more than 90 cents and most markets in the mid-80 cent range, which makes the programs incredibly efficient by helping developers to realize funding needs and get projects off the ground.

After 30 years of refinement, there is a much greater understanding of what makes a strong and sustainable state HTC program and that can and should inform smart policy decisions. Strong pricing and an efficient market place make HTC programs more competitive in the crowded and sometimes stormy world of state subsidies.;

 This article first appeared in the July 2019 issue of the Novogradac Journal of Tax Credits.

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