Housing USA: Making NMTC More Flexible for More Housing

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New Markets Tax Credits (NMTC) can be used for a variety of real estate types. They benefit developers building everything from grocery stores to clinics to manufacturing facilities, in areas deemed underserved. They’re bought by financial institutions, who become eligible for a five to six percent tax credit across a seven-year span. They’re syndicated through community development entities (CDEs), which can be either for-profit, nonprofit, or government-run. However, housing developers have somewhat restricted access to this financing tool. While NMTC has been used to build many a mixed-use residential project, the program can be inflexible, particularly regarding the “80/20 rule.”

NMTC recipients must demonstrate that more than 20 percent of their revenues are derived from non-housing uses. The rule is designed to bring economic diversification to these distressed communities. One common example is grocery stores; they are placed into NMTC pro formas to address the “food desert” problem.

According to the Tax Policy Center, mixed-use projects made up only 17 percent, and residential four percent, of NMTC-financed projects from 2003 to 2015. These numbers may be even smaller today. Two sources I interviewed—Bobby Maly, CEO of The Model Group, and James Howard, principal shareholder of Dudley Ventures—both say that mixed-use developments are a relatively small proportion of NMTC recipients.

“I don’t think that there are as many mixed-use projects using new markets….even before COVID,” said Maly.

Both developers have, however, constructed mixed-use projects using the credit. The Model Group, which works primarily in Ohio, Indiana and Kentucky, constructed two housing-oriented projects in Cincinnati: Broadway Square and Paramount Square. The Broadway Square renovation upgraded 103 residential units to LEED standards, half of which were affordable to people making 80 percent of area median income (AMI). Paramount Square was a rehabilitation of 81 apartments. In both cases, the properties include (per the 80/20 rule) a wide range of retail and other commercial uses. Dudley Ventures, which operates nationwide, has built similar projects: Halsey 106 in Portland, OR, and Crosstown Concourse in Memphis both have significant mixed-use components.

But, as I’ve explained in previous articles about Low Income Housing Tax Credits, having commercial space requirements may be inefficient, given the tenuous future of retail and office. This is particularly the case in the distressed areas where NMTC is deployed; the lack of existing commercial services in these neighborhoods is a market signal that they’re not in heavy demand, and that housing may be the primary need. A mandate for 20 percent commercial means space used for that can’t be used to build more affordable housing, even though there’s a nationwide shortage of the latter. In the worst case scenario, this 80/20 mandate discourages developers from pursuing certain projects altogether.

Making NMTC more flexible by reforming or ending the 80/20 rule would be a good way to spur more affordable housing, but it would have tradeoffs. Howard argues that it is important to provide financing for mixed-use projects, particularly those that incorporate social services, as distinct from housing-centric programs, such as LIHTC. After all, these services are considered necessary for the people that NMTC targets.

“From my perspective, the rule works effectively in that you’re encouraging mixed-use. The type of mixed-use that you see tends to incorporate social service activity” as well as “minority or not-for-profit businesses…where the leases are below market.”

Halsey 106, for instance, included below-market rate leases for a homeless support non-profit and a city-owned business incubator space for minority businesses. Howard notes that NMTC is a housing tool but housing is “not the predominant focus,” and making the funds housing-centric could eliminate the capacity for other dynamic options.

For now, adds Howard, particular housing types are in fact incentivized by the rule.

“When you look at the fact that there’s a slightly lower level of affordability at 80 percent, that really allows you to look at [options like] workforce housing,” as opposed to more affordable projects (such as those supporting rents for people under 60 percent AMI, as is common with LIHTC). Recent NMTC workforce housing projects of this nature have been completed in Newark and Baltimore.

Maly supports tweaking the rule in a context-specific manner: “I would love to see New Markets have greater flexibility around the 80/20 rule in urban areas with respect to having more projects be residential than commercial.”

He believes that in dense and low-income neighborhoods, projects with 20 percent or more commercial space can be challenging to underwrite. A “90/10” rule—that is, decreasing the minimum commercial revenue threshold to 10 percent—would increase the number of projects eligible to receive NMTC support.

An exception to the 80/20 rule concerns housing that is being sold, not rented. An analysis by Nixon Peabody notes that for-sale properties that set aside 20 percent of available units as affordable at under 80 percent of AMI can be financed using NMTC.

Another constraint with NMTC is that it can’t be combined with LIHTC. This prevents a more fully-developed capital stack from being formed for challenging projects. Howard notes, however, that the two credits can be combined if a project is segmented into separate entities, which he did by making some units in Halsey 106 into condos.

Greater flexibility may be especially necessary now, with COVID-19 creating uncertainty for the retail and commercial sectors. Meanwhile housing demand, particularly for affordable housing, is likely to increase in coming months as the economy recovers.

The bottom line is that if the federal government wants tax credits to enhance affordability, economic development, and quality of life in underserved markets, it must listen to market signals about where the needs are most acute, and balance them with business diversity goals. NMTC has clearly added to that diversity in underserved neighborhoods, but affordable housing may still be the more critical need, and the best way to leverage NMTC. Moving to a “90/10” rule, at least in neighborhoods with lagging commercial real estate sector interest, might be a more realistic use of NMTC. And then maybe from there the Department of the Treasury can consider a special “100/0” NMTC program.

This features additional reporting by Market Urbanism Report research staffer Ethan Finlan.

Story Contacts:
Bobby Maly, CEO, The Model Group, [email protected]

James Howard, Founder and Principal, Dudley Ventures
[email protected]