Tax incentives for distressed real estate investment


Authored by RSM US LLP

Key takeaways

  • There are far more tax incentives than the handful of federal programs that developers typically know about, including local utility incentives and job creation incentives.
  • Tax increment financing can be an extremely useful addition to a developer’s capital stack, but it takes an intimate knowledge of a jurisdiction’s regulations.
  • Especially for larger value-add acquisitions, tax incentives can make projects more feasible by lowering the long-term operational costs of development.

While sponsors may rightfully be focused on sourcing deals and raising capital, they should not overlook the impact of tax incentives on the deals they choose. While tax programs may not turn a bad deal into a good one, they can significantly lower long-term development costs and drive higher yields on projects with slim margins.

New Markets Tax Credits, which incentivize development in underserved areas, function similarly to very cheap senior debt in a capital stack. Because the loans do not require principal to be paid for the first seven years, they allow developers to more quickly see higher cash flow on their projects and pay down more expensive pieces of their debt, lowering debt service costs over the lifetime of the project. After seven years, the debt from the third party is forgivable, offering a significant benefit on the back end, said RSM US Senior Manager Debbie Singer.

Tax Increment Financing, or TIF, programs can also make it easier to create new developments by lowering property taxes and other long-term costs for a project. But getting approval for a TIF district requires a strong relationship with the city in question, and every city's TIF approval process is unique, Singer said.

“A lot of the sponsors of big projects will know about TIF, but knowing about it is entirely different from navigating it,” Singer said. “You need buy-in from local officials and residents.”

Beyond these programs, though, there are often dozens of local programs to incentivize new development, including discounts on utilities and incentives for job creation, some of which can provide cash directly to developers, rather than just lowering their costs. Especially for developers making acquisitions in new markets, working with a professional who lives and breathes incentives can unlock new value in their projects.

Utility benefits vary across the country, however they frequently come in the form of utility tax reductions or rate reductions. For example, projects within the geography served by the Tennessee Valley Authority can access tax credits related to expanded operations. The TVA also offers performance grants for certain new and expanding companies in the region.

Because of their focus on community revitalization and new redevelopment, tax incentives will likely play their most important roles in large-scale projects that rethink the highest and best use of assets. They are less important for recapitalization deals, Singer said, than they are for a deal that brings a new manufacturing facility to a graying industrial area, or brings a grocery store to a food desert.

“These incentives are most crucial for projects that are creating and retaining jobs and providing benefits to a low-income community,” Singer said. “That’s where the world of distressed acquisitions and the world of social impact can be one and the same.”

Tipping point: Tax incentives are likely to be able to boost yields on properties that developers already believe in, but they usually won’t turn a bad deal into a good deal.

This article was originally published in partnership with Bisnow.