Talking Heads: Chris Hite, President, Sugar Creek Capital
By Darryl Hicks
11 min read
The State Historic Credit Maze
State Historic Rehabilitation Tax Credits provide a valuable source of funding for developers who specialize in revitalizing older buildings. However, they also pose challenges for the uninitiated.
Unlike the Federal Historic Rehabilitation Tax Credit, there is no national template that states follow. There are currently 34 State Historic Tax Credits that differ by size and the rules that must be followed to claim them. Then there are the state legislatures that continually tweak, or worse, threaten to repeal their Historic Tax Credit programs. All of these issues and uncertainties add hurdles to finding investors who are willing to claim the tax credits and provide much-needed equity.
That’s why developers and syndicators often contact Chris Hite when they need help. Hite serves as president at Sugar Creek Capital, based in St. Louis, MO, which specializes in placing state credits with investors, both Low Income Housing Tax Credits and Historic Rehabilitation Tax Credits.
TCA sat down with Hite to discuss which State Historic Tax Credits are the most desirable.
Tax Credit Advisor: Why are State Historic Rehabilitation Tax Credits so important?
Chris Hite: Historic rehabs, by their nature, are expensive and time consuming and developers need all of the equity they can get. Especially given some of the restrictions on development in urban areas that add to the costs, it helps that the local jurisdictions, being the states, help supply a source of equity. A lot of times, you are getting similar amounts of equity that you would get from the Federal Historic Rehabilitation Tax Credit, so you are doubling up the equity on your deal. Construction costs seem like they are going up all over the country, and in some places spiking nearly beyond what the market could provide, so if you don’t have state tax credits you won’t be able to get your deals done.
TCA: Of the 34 states currently administering Historic Rehabilitation Tax Credits, which are the most useful and why?
CH: The one-year certificate with no recapture is probably the most marketable credit, while other states provide a bigger tax credit compared to what the Federal Historic Rehabilitation Tax Credit offers, which creates more equity. The Federal Credit gives you 20 percent of basis, but some states give you 25 percent to 30 percent.
TCA: Which states offer these features?
CH: Missouri gives you 25 percent of basis with a one-year transferable certificate. Very marketable. Texas has a program similar to Missouri’s. Louisiana has a 25 percent tax credit, but that will drop to 20 percent starting on January 1, 2018. Those are three of the largest.
TCA: For the State Historic Credit to be useful, does it need to be paired with the Federal Historic Rehabilitation Tax Credit, or can a developer get away with using just state credits to finance a project?
CH: Technically, a developer could get away with it in some states, but practically there won’t be enough money to close on the deal if you don’t claim both.
TCA: I imagine the pricing for State Historic Credits varies widely? Has the national debate over tax reform impacted pricing at all?
CH: Not directly. Ironically, if the value of depreciation (which is a factor in pricing of the Federal Credit) goes down because tax rates go down, then State Historic Tax Credit net pricing will go up because the taxes on the State Historic Tax Credit proceeds will go down. So that could make state credits more valuable if tax reform were to happen. There has been more pressure on State Tax Credit pricing because the Federal Tax Credit pricing has been reduced due to the threat of tax reform. So let’s say you’re a developer with $5 million of State Tax Credits and $5 million of Federal Tax Credits. Previously, let’s say you were getting $4.5 million for your federal credits and now you’re getting only $4 million because someone assumes they won’t get as much depreciation. Now you have a $500,000 gap and so you go to your State Tax Credit partner and ask how much of that gap can be made up. There’s more pressure on State Tax Credit pricing to offset the decrease in pricing for Federal Credits that is due to tax reform.
TCA: Is it harder to find investors for State Historic Tax credits, or do you generally find investors who are willing to buy both the Federal and State Historic Tax Credits in the same deal?
CH: It is very difficult to reliably find investors that are willing to do both the federal and state credits. The Federal Credit, of course, doesn’t depend on local geography or tax liability. It is also based off a 35 percent tax rate. The State Tax Credit is based on where your income is sourced and where you are headquartered and is often limited to a four to six percent rate. So in a typical state, even a megacorp with its tons of tax liability is only going to have one-seventh of that same amount that they would be able to offset with State Tax Credits. So it’s harder to find state tax credit investors and typically you’re doing a lot more transactions at a smaller dollar volume per transaction when you’re talking about the amount of investors per deal.
TCA: Who are the major investors of State Historic Rehabilitation Tax Credits?
CH: Commerce Bank and U.S. Bancorp are two big investors and we also work with a lot of insurance companies. For a long time, the market was driven by high net worth individuals. They are still a good chunk of the market, but not a majority.
TCA: Has there ever been a national effort to create a model program, as opposed to having 34 distinct programs?
CH: If you look at draft legislation in Nevada, Michigan or Kentucky—and in states, like Colorado, Oklahoma and Texas that recently created programs—there are certain commonalities that exist. Very rarely does a state legislator say ‘this is my idea, let’s create a Historic Tax Credit program.’ Usually, a legislator says, ‘I want to increase development’ and then a developer says, ‘here is one way to do that.’ The developer reaches out to a State Tax Credit expert and asks them to provide the legislative language. Groups, like the National Trust for Historic Preservation, sponsor these efforts and have developed model legislative language that includes elements from Missouri’s program, which is generally considered to be among the best.
TCA: What makes a certificate, such as the kind offered in Missouri, so valuable?
CH: Because it is freely transferrable, so in other words you don’t have to have a significant ownership interest in the deal. You can come in just for the State Tax Credits.
TCA: I understand that Missouri’s governor is not a fan of the State Historic Tax Credit and that supporters are battling to save it. How is that effort going? What’s the governor’s ideological rationale for getting rid of the credit?
CH: The last two governors have appointed commissions that attacked tax credits. The first was appointed by Governor Jay Nixon, a Democrat who served from 2009 to 2017, and the second by current Governor Eric Greitens, a Republican. Missouri is facing fiscal problems due to all sorts of things, including tax cuts that were larger than expected. And so they are seeking ways to find revenue so they can balance the budget. We have seen growth in State Historic Rehabilitation Tax Credits—34 states have programs and more are considering them-—but two-thirds of state legislatures and more than 1,000 legislative seats have switched to the Republican Party since 2008. Republicans don’t hate tax credits, but they do like tax cuts and 49 states have some sort of balanced budget requirement. If you’re going to pass tax cuts, which reduces your revenue, and you have a balanced budget requirement, and your spending doesn’t go down, you have to find revenue from somewhere. So the elimination of tax credits is, while politically painful, an alternative policymakers are considering. Unfortunately, cuts to credits will also mean cuts to economic development.
TCA: I guess I am trying to rationalize why states would consider repealing Historic Rehabilitation Tax Credit programs when they create jobs and spur urban revitalization.
CH: Kansas City grew by 28,000 people last year. If you fly into Kansas City, you would see an urban core that is incredibly vibrant. The Crossroads and Westport neighborhoods, the waterfront and the downtown all have tremendous historic building stock that has been rehabbed in the past five years due to Historic Tax Credits and led Kansas City, MO to become one of the nation’s fastest growing urban markets. And yet the governor is looking at repealing or reducing a critical tool behind this revitalization. It just shows you the difficult financial straits that the government finds itself in.
TCA: Does the Missouri legislature need to sign off on any such repeal?
CH: Yes, the governor has no power to limit the size of the program, as that office only controls the administration of it. There is support for the Historic Tax Credit in the legislature, so at the end of the day it will be very hard to pass new legislation that limits or repeals the program. However, we will need to defend cuts of any size
TCA: Besides Missouri, which other State Historic Tax Credit programs are in danger of being repealed? What can our readers do to help save these programs?
CH: The programs most under threat will be in states that recently passed tax cuts. Oklahoma actually proposed a moratorium on redeeming tax credits, which is much more irresponsible than just cutting the program, because what you do is devalue the promise of the state of Oklahoma. Investors will not put their capital in Oklahoma if they don’t believe the state will honor its promises. Some states are talking about cutting back the size of their tax credits on a prospective basis, but Oklahoma is seriously looking at doing it retroactively. The best thing that TCA readers can do is get legislators to your projects and show them the good work that has resulted from having Historic Tax Credits. Some of these states are governed by rural lawmakers. Historic Tax Credits don’t just revitalize urban neighborhoods. There are plenty of downtown areas in rural America that are historic. It’s hard to justify, because of low rents, any sizable capital improvements in these rural areas absent a meaningful program, like the State Historic Tax Credit.
TCA: Do you see any states adopting new Historic Rehabilitation Tax Credit programs in the coming year? What other noteworthy trends are you seeing in the Historic Rehabilitation Tax Credit market?
CH: Legislative efforts are underway in Nevada, Michigan and Kentucky, but I don’t know how successful they will be. Only time will tell. As far as trends, I’m seeing a lot more creative tax structures where general partners claim a one-year credit is allocated (meaning the equity is not taxed) at the project tier, yet the state credit partner treats the credit as a certificate (more valuable credit) at the upper tier. The IRC Section 707 regulations seem to indicate that relying on allocation treatment at the project tier is especially risky when considering a one-year credit that may not be subject to recapture. Federal investors will not take the tax risks associated with such a structure. Developers who need more net equity in a deal—which is almost every single developer-—are going to have difficult choices ahead regarding the risk they want to undertake on these tax structures. There are investors who will allow the partnership to take aggressive tax positions, but it all usually comes down to a guaranty by the developer. So a developer says, ‘all right, if you will allow this unconventional State Tax Credit structure, I will guaranty that the federal investor won’t bear the cost if that tax structure doesn’t hold up under review.’”
Story Contact:
Chris Hite
President, Sugar Creek Capital
[email protected]
