Journal of Tax Credit Investing


New Markets Tax Credits

2003 allocations to spur investment in 40 states

by Gary C. Perlow, CPA, Reznick Fedder & Silverman

On March 14, 2003, the Community Development Financial Institutions (CDFI) Fund announced the long-awaited awards of the first round of New Markets Tax Credit (NMTC) allocations. Sixty-six Community Development Entities (CDEs) were selected to receive $2.5 billion of NMTC authority.

This allocation enables the selected CDEs to issue $2.5 billion in qualified equity investments, which the investors in these CDEs can claim as tax credits equal to 39% of their investment over a seven-year period. The CDEs in return must invest substantially all of these equity investments in qualified low-income community businesses or nonresidential real estate in their designated service areas.

The awardees of this round, along with the proposed investments and geographical service areas, were very diverse. The average allocation award was $38 million, and allocations ranged in size from $500,000 up to $170 million. In total, six CDEs received allocations in excess of $100 million, and 24 CDE allocations fell below $10 million.

The CDE recipients anticipate making investments in 40 states plus the District of Columbia, with approximately 70% of the investments targeted at urban areas. The types of investments contemplated include:

  • loans and equity investments in real estate (not including residential housing) and businesses located in qualified communities
  • purchasing qualified low-income community loans
  • capitalizing other CDEs
  • investing in entities providing financial counseling to support low-income community businesses

Now that the allocations have been announced, the real work begins. The execution of the "Allocation Agreement" that effectuates the allocations is the first step. A draft allocation agreement released by the CDFI Fund prior to the announcement of the awards was considered too subjective and broad by many NMTC participants. The agreement left the CDEs and the investment community with many unanswered questions, especially about the potential impact on tax credit recapture and other penalties pertaining to noncompliance.

The CDFI Fund, in response to industry concerns, is currently revising this agreement to make it clearer, especially as it relates to events that could trigger recapture. The revised agreement should be sent to the CDEs by the end of April.

How will the credit be valued?

With all this excitement, the most important question remains unanswered. How quickly will the investor community respond to the allocation, and most importantly, how will the credit be valued?

Different than other tax credit programs, these investments, in addition to yielding tax benefits, will be expected to generate economic benefits. What this means is that the credit is just a piece of the investors' return. Therefore, pricing the transaction, rather than pricing the credit alone, will dictate how investments are valued. It is also unclear if investors will apply a discount rate in pricing the investment to account for tax credit recapture risk. Many in the industry believe that establishing an upfront, well-defined asset management and compliance program to prevent recapture will be necessary to attract investors.

Although real estate investments will account for a significant amount of the activity under this year's allocations, many CDEs hope to raise capital for other types of business investments. Many tax credit investors, having had experience only with real estate tax credits, have not been exposed to this type of transaction, and their appetite for other investment products may be tempered.

Therefore, we should see a new tax credit investor marketplace develop, with many of the investors being financial institutions and other investors that have previous experience in community investments and have an established comfort zone.

Other investor alternatives include structuring the investment as a debt-financed leveraged transaction, which will allow the tax credit and economics to be bifurcated so the tax credit investor will have nominal economic risk and will be relying primarily on the tax credit benefits. This type of transaction will allow the investor community to better assess the value of the credit alone.

This is a very exciting period for participants in the NMTC industry, and over time a more defined marketplace will evolve and standardized pricing will take shape. However, on this first allocation round, do not be surprised to see investors taking their time to fully assess how the program works, along with evaluating the best way to structure their investments.

Gary C. Perlow, CPA, is a principal with the national accounting firm of Reznick Fedder & Silverman, specializing in community development finance and various tax credit programs. Perlow can be reached at (410) 783-4900, or gary.perlow@rfs.com.

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