UC Real Estate Professional Development: Financing Tools

Financing ToolsNew and Bedrock Tools of Development Finance

UC Real Estate Professional Development Series

Presented by Susan E. Thomas

Matt Staarmann, CFAMarch 24, 2015

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AboutPort of Greater Cincinnati Development Authority

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Private Sector Practices

• Risk Tolerance

• Market Focus

• Sense of Urgency

Public Sector Tools

• Resources / Tools

• Credibility

• Long Term Perspective

Value Creation

• Jobs

• Property Values

• Residents

PLANNING

STRATEGYSTEWARDSHIP

Our Strategy: to be the most sought after development partner

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Finding the Right Tools

Stage of Growth and Risk Profile

DesperateStart-UpEstablished and Looking to Grow

Port Authority Tools

Port Authority tools are primarily debt related Reduce Cost of Capital or Construction Costs Access to Capital on More Attractive Terms

Commercialize

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Development Bond Financing

$539 million for 15 financing projects

Red Bank Village

Queen City SquareOakley Station

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AboutRoss, Sinclaire & Associates

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Ross, Sinclaire & Associates, LLC

• Regional broker-dealer founded in 1989

• 14 offices in 10 states – headquarters in Cincinnati

• Local Projects of Interest:Hampton Inn (3000 Vine Street)

Vernon Manor Offices

USquare @ the Loop

Broadway Square

Wilmington College – Center for Sports Sciences

Sanctuary – Education Matters and Community Matters

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8 Historic Tax Credits

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Historic Tax Credits

• Federal Rehabilitation Tax Credit (IRC Section 47)

• Tax aspects administered by the IRS

• Preservation aspects jointly administered by the National Parks Service and State Historic Preservation Offices (SHPOs)

• Many states offer additional tax credit incentives

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HTC – Federal Credit Types

• Old Buildings – 10% of QREs• Placed in service before 1936

• Non-historic and non-residential

• Historic Buildings – 20% of QREs• Listed in National Register of Historic Places

• Located in a Registered Historic District and is listed as being of significance to that district

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Qualified Rehabilitation Expenditures (QREs)

• Amounts incurred by a taxpayer in connection with the rehabilitation that are capitalized to the building

• Generally includes:• Hard costs

• Architecture and engineering fees

• Interior demo

• Development fees (must be reasonable)

• Construction period interest and taxes

• Generally excludes:• Acquisition costs

• Site work

• Personal property and FF&E

• New building construction (enlargements)

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Earning the Credits

• Must be a “building” – i.e., enclosed space within walls and usually covered with a roof

• Building must be “substantially rehabilitated”

• Rehabilitation must meet the standards of the NPS

• Building must be depreciable

• After rehab, the building must be used for income-producing purposesfor five years

• Building owner earns the credits

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HTC Structures and Compliance Period

• Attracting investor capital more favorable than sponsor use of credits:• Partnership structure

• Lease pass-through structure

• 5-year compliance period following placed-in-service• Recapture reduced by 20% per year

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HTC – Other Considerations

• Non-profit, tax exempt users – additional complexity

• IRS Rev. Proc. 2014-12 – safe harbor guidance

• Transaction costs and economies of scale

• State Tax Credits:– Ohio

• Competitive application process – semi-annual rounds

• Up to 25% of QREs or $5 million

– Kentucky – max of $400,000

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Project Example – QRE Calculation

Budget % QRE QRE

Acquisition Cost 1,500,000 0.0% -

Sitework 400,000 0.0% -

Hard Costs 6,250,000 100.0% 6,250,000

Architecture & Engineering 350,000 90.0% 315,000

Other Soft Costs 500,000 50.0% 250,000

Developer Fee 1,000,000 85.0% 850,000

Total 10,000,000 7,665,000

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Project Example – HTC Calculation

QRE 7,665,000

Federal HTC % 20%

Federal Credits 1,533,000

Investor Allocation 99%

Investor Price 1.00

Investor Contribution 1,517,670

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Project Example – Sources of Capital Comparison

Conventional HTC Deal

Senior Debt 7,000,000 7,000,000

HTC Investor Equity - 1,517,670

Developer Equity 3,000,000 1,482,330

Total 10,000,000 10,000,000

• No Free Lunch: HTC structures provide up-front capital to help close

financing gaps, but tradeoff is that HTC investor receives some operating

cash flow until investor exits deal after compliance period

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18 Structured Lease

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Structured Lease

• Port Authority is not required to pay state and local sales tax on construction materials – even if the project is for economic development purposes

• In order to use this incentive, the Port Authority must have an ownership interest in the project even if those properties are leased to private entities

• Property transfer and lease arrangements are madeon a case-by-case basis

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Structured Lease – Examples$25 million new construction project (hard costs)

• Assume 50% of hard cost is for construction materials

• Hamilton County tax sales tax of 6.75%

• Goal: 80% of savings retained by client post transaction fees and expenses

• Total Savings to client: $675,000

$5 million new construction project (hard costs)

• Add on to projects where the Port Authority has another role

• Assume 50% of hard cost is for construction materials

• Hamilton County tax sales tax of 6.75%

• Goal: 80% of savings retained by client post transaction fees and expenses

• Total Savings to client: $135,000

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Structured Lease – Bond Financing Option

• Port Authority specific financing option – capital or operating lease

• Port Authority purchases or constructs the facility. Port Authority leases the facility to a master lessee who makes lease payments sufficient to cover debt service on the bonds that financed the facility

• Master lessee can be a developer or an end user

• The bondholder has recourse only to the lease payments made by the lessee or any guarantor or to the asset leased or financed

• Lease bond financings are credit dependent

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Lease Bond Financed Projects

303 Broadway

Queen City Tower

$259 million lease revenue bonds$ 64 million TIF bonds

• Port Authority owns landand buildings

• Capital lease to affiliate of Western-Southern

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23 Greater Cincinnati EB-5 Program

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EB-5 Program Overview

• Created by the Immigration Act of 1990• Foreign nationals can receive Permanent US Green Card if they

invest in new or troubled US businesses

• Investor must create at least 10 jobs within 2 years per $500,000 invested (if in a targeted employment area)

• Provides access to a diverse, stable, and patient capital source• Well suited for real estate construction and stabilization

• Works with a variety of asset types

• Partners well with TIF, New Market Tax Credits, and other financing sources

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Investment Models

Direct Investment• Primarily equity investment

• Only direct jobs count towardsjob creation

• Requires active managementby the investor

Regional Center• Allows for pooling of investments

and various types of financing• Can count both direct

and indirect jobs• Permits passive management

through Limited Partnership

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Regional Center ModelRegional Center most common in EB-5 investments

• Over 90% of EB-5 applications go through Regional Centers

• Investors invest in the Regional Center, which then makes an investment in the project,

rather than direct investment into projects or companies

• Operates within a defined geographic region, although does not have exclusivity

to any given region

Benefits:

• Can do other types of financing (i.e. flexible, senior debt, and mezzanine financing).

• Can use Economic Modeling to estimate job creation, counting both direct and indirect jobs

• Can aggregate funds to do larger scale investments

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Job Creation Calculation

• EB-5 Investment Capital requires Job Creation• Amount of EB-5 investment a project can support is based on job

calculations

• Multiple allowable techniques to calculate jobs• Direct jobs (head count) difficult to track, limits investment size• Economic modeling using development expenditures to

determine direct, indirect, and induced jobs

• Typically can finance 25-30% of total project costsCan count expenses and revenues for entire project,not just EB-5 funded portion

• Project certainty very important

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EB-5 for Development Finance

Works best as a portion of the capital stack• Senior debt at higher LTV and/or lower interest rates than traditional debt

• Mezzanine Debt to fill a financing gap

• Works with a variety of asset types

• Projects with public sector participation more significant to foreign investors

• Can be combined with TIF, New Markets Tax Credits, and others

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$65 million office development:• Maximum EB-5 Investment of $16-20 million• Mezzanine Debt, as opposed to

Equity position

$125 million mixed use development:• $30 million Hotel• $55 million Office• $25 million Residential• $15 million Parking Garage

• Maximum EB-5 Investment of $31-37 million• Could direct all EB-5 investment to components that are more difficult to

otherwise finance

Examples – EB-5

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Port Authority EB-Program: CiF PartnershipPort Authority• Market program locally• Pipeline generation• Preliminary due diligence• Offer bond financing to EB-5 projects when appropriate

Regional Center (CiF)• Loan and EB-5 underwriting• Solicit foreign investment• Manage investors and immigration process• Program compliance

u Start with the Port Authority

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Port Authority Program Requirements• Minimum $30 million project• Located in a Targeted Employment Area (TEA)– Anywhere in Hamilton County, urban areas of Hamilton and

Middletown

• Job coverage ratio• Strength of the developer or end-user• Public involvement• Senior Mortgage or Mezzanine Debt• 5 Year Term, Interest Only• Complete capital stack• Certainty of execution• Ability to refinance EB-5 debt

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EB-5 Investment Process

ProjectPort

AuthorityCiF

Foreign Investor

• Initial point of contact• Review project and

evaluate EB-5 potential

• Project underwriting and due diligence

• Advance term sheet

• Solicit foreign investment• Manage investors and

immigration process

• Provide equity investment into single asset LLC

• File for visa with USCIS

• Provide debt capital to the project

• Administer ongoing compliance

Project CiFForeign Investor

Workflow

Cashflow

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EB-5 Borrower Process

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Case Study: The Flats East Bank

Centered on the construction of the Ernst & Young office tower, attached Aloft Hotel, and space for retail and restaurants. Phase 1 completed in 2013.

Total EB-5 Investment: $45 million Total Project: $275 millionEB-5 Investors: 90 Job Creation: Estimated 1,800+ Status: Closed | Fully Funded

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Case Study: Westin Hotel

Total EB-5 Investment: $36 millionTotal project: $80 millionEB-5 Investors: 72 Job Creation: Estimated 850+ Status: Closed

Renovation of an existing building into a luxury Westin Hotel with a prime location. The new Westin offers 484 upscale rooms, a fitness facility, a spa, a steakhouse, and meeting and event space.

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Case Study: University Hospitals

Part of University Hospitals $1.2 billion expansion and renovation effort. EB-5 investors financed construction of state-of-the-art Ahuja Medical Center and the SeidmanCancer Center (shown).

Total EB-5 Investment:$60 million Total project: $1.2 billionEB-5 Investors: 120 Status: Closed | Fully Funded Job Creation: Estimated 3,400+

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37 New Market Tax Credits

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NMTC Overview

• The New Markets Tax Credit (NMTC) Program provides an incentive to attract investment of private capital over 7 years into distressed communities

• The incentive is a 39% tax credit, taken over a 7-year period, on Qualified Equity Investments (QEIs) into Community Development Entities (CDEs), which invest the equity proceeds into Low Income Communities (LICs)

• Its purpose is to provide an incentive that stimulates investment which facilitates economic and community development outcomes in distressed LICs

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Community Outcomes

The CDFI Fund expects that significant quantitative and qualitative outcomes will result from CDE investments. Some common examples most applicable to real estate:

• Job creation

• Quality of jobs

• Jobs accessible to low-income persons or residents of low-income communities

• Commercial goods or services to low-income communities

• Community goods or services to low-income communities

• Healthy food financing

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What are Low Income Communities?

Census tract criteria:

• Greater than 20% poverty

• Less than <80% of the Metropolitan Statistical Area’s (MSA) or State’s

Higher distress:

• Unemployment 1.5X national average

• Non-metropolitan county

• Federal Economic Development Zone

• State/Local Economic Zone

• Brownfield

• Food Desert

• Medically Underserved

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What are Community Development Entities?

• Certified by the CDFI Fund of the U.S. Treasury

• Primary mission of serving Low Income Communities

• Maintains accountability to residents of LICs through a governing or advisory board

• Apply for NMTC allocation

• Local CDEs that have received allocation:• Cincinnati Development Fund

• Cincinnati New Markets Fund, LLC (3CDC)

• Uptown Consortium, Inc.

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Ineligible Businesses

• Residential rental property with >80% income from residential units• Any rental property without substantial improvements• Farms with >$500,000 in assets• Development of intangible assets for sale or license• Others

• Golf Courses• Gambling Facilities• Country Clubs• Race Tracks• Liquor Stores• Massage Parlors/Hot Tub Facilities/Suntan Facilities

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NMTC Basic Rules

Investors make Cash Qualified Equity Investments (QEIs) into qualified Community

Development Entities (CDEs) that make Qualified Low Income Community Investments

(QLICIs) by investing Substantially All of the cash proceeds into Qualified Active Low

Income Community Businesses (QALICBs)

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NMTC Leveraged Structure - $10 million

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Structure and Compliance Items

• Loans from CDEs are interest only for 7 years• Possible to structure for amortization

• Forbearance required by NMTC lender

• 80/20 rule for mixed-use residential

• Unwind with a put-call option agreement

• Recapture risk is 100% for the full 7 years• QALICB stays a QALICB; CDEs remain compliant

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NMTC – Other Considerations

• Location is a prerequisite, but LIC outcomes are what drive credits to a transaction

• Scarce resource and ultra-competitive market

• Long lead times

• Securitization requires credit

• Complexity is unavoidable– Requires creativity and sophistication amongst the sponsor entity and all professionals

involved in the transaction

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Project Example – Wilmington College

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Project Example – Wilmington College

• Total Cost at Project Level = $10,300,000

• Extra Cost Attributed to NMTC = $550,000

• NMTC Capital to Project = $3,050,000

• Net NMTC Capital = $2,500,000– Approximately 25% of capital stack

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Southwest Ohio Regional Bond Fund

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Southwest Ohio Regional Bond Fund• Cooperative Arrangement with Dayton Port Authority

• A credit-enhancement vehicle supported by a system of common program reserves and designed to achieve an investment grade rating.

• The fund can be used to provide unrated but credit-worthy businesses, both large and small, access to long-term, low cost, fixed-rate financing to fund expansions and create jobs.

• Additionally, Tax Increment Financing (TIF) backed infrastructure bonds of less than $6 million could become financially viable if issued to the fund.

• Partners well with other Port Authority Bond Funds and the Ohio Enterprise Bond Fund.

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SORBF: Eligible Borrows and ProjectsEligible Borrowers:

• Industrial or Commercial Companies including manufacturing, distribution, housing, and education

• Infrastructure Projects (TIF & Special Assessment Projects, including PACE)

• Non-profit or 501 c(3) entities

• Governmental

Eligible Projects: • Acquisition and/or Renovation of Existing Buildings

• Construction of New Buildings

• Acquisition of Land

• Purchase and Installation of Equipment

• Financing Costs and Soft Costs

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52Tax Increment Financing (TIF) & Special Assessment (SA)

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Tax Increment Financing• TIF is a tool for local governments to finance capital projects in support of

economic development

• State programs vary– Local variations within each state

• TIF enables a sponsoring municipality, or designated authority, to capture the increase in taxable valuation generated by new development or redevelopment to pay (the debt service on bonds issued) for project expenses

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Tax Increment Financing

$

TAX

AB

LE A

SS

ES

SE

D V

ALU

E (T

AV

)

BASE TAXABLE ASSESSED VALUE (BTAV)

attributable to all taxing districts

Incremental TAV captured by

TIF Authority to pay project

cost

New TAV

attributable to

all taxing

districts

5 10 15 20

Issuance Maturity30 Year TIF

TIME

Increased TAV from

Development activities

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TIF in Ohio

• Counties, townships, or municipalities establish TIFs:– Pass legislation to designate parcels in TIF

• Project TIF or TIF District (up to 300 acres)

• Property owners make payments in lieu of taxes (PILOT), also known as Service Payments

• 30 year limit

• Incremental revenue directed to special fund– School district approval and agreement

• TIF used to pay for public infrastructure– Residential development in blighted areas

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Structuring TIF Bonds

• Property tax cycle increases risk exposures– Lag in collection timeline

– Assess Valuation unknown

• Project type and credit profile– Projections – valuation and growth?

• Security features:– Debt Service Coverage

– Debt Service Reserve Fund

– Minimum Service Payment

– Tax Lien

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TIF Bond Timeline$5MM

Yr 0

$1MM

$2MM

$4MM

$3MM

Yr 1 Yr 3 Yr 5 Yr 10 Yr 20

Yr 30

$0MM

Bond Debt Service Payments

TIF Revenues

Excess Revenues (DSCR)

“Absorbtion”

Risk must be

addressed

Yr 30

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TIF – Other Considerations

• TIF and abatements don’t mix

• Triple Net Lease – what valuation will the market bear?

• Bond market has a fickle past:• Credit / security enhancements:

– Private sector enhancements – Letters of Credit

– Municipal enhancements – Cincinnati Non-Tax Revenues

– State – SW Ohio Regional Bond Fund or State Infrastructure Bank

– Special assessments

• Developer purchased bonds

• Reimbursement

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Special Assessments

Charges against property (not owner) to pay costs of improvements or services that benefit the property.

Not property taxes, but are included as a separate line item on the real estate tax bill.

Assessments can be for improvements such as streets, sidewalks, water and sewer, or services such as lighting and litter removal.

The county auditor keeps an accounting of these assessments.

Process can be either: Determination of necessity of improvement by a municipality

Petition by the property owner

Multi-step approval process.

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TIF Deal Examples

• Linden Pointe – City of Norwood – Special Assessment

• Vernon Manor – State of Ohio Enterprise Bond Fund– Special collateral from Build Cincinnati Development Fund

• USquare – City of Cincinnati – Non-Tax Revenues

• Keystone Parke II – State of Ohio Infrastructure Bank– City of Cincinnati Non-Tax Revenue Pledge

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Case Study: Oakley Station

Oakley Station

74 acre mixed use development$6.835 million in TIF and SABond proceeds used to fund public infrastructure

Assessments: 24 years

$ 6.835 million principal

$15.95 million total estimated installments

TIF: 30 years

LEED abatement can supersede TIF

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Case Study: Cincinnati Mall

Cincinnati Mall

80+ acre mall

$18 million in TIF and SA bonds

Bonds used to acquire and repair public infrastructure including parking garageAssessments: 30 years

$18 million principal$40.8 million total estimated assessments

TIF Base Value: approx $60 millionCurrent Value: approx $8 million

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Property Assessed Clean Energy (PACE)

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Public Finance: PACE - Clean EnergyWhat is PACE?

• Property Assessed Clean Energy (PACE)

• Innovative financing program to support energy efficiency and renewable energy upgrades

• Property requests assessment on property tax bill to raise capital for improvements

Benefits• No net out-of-pocket expense

• 100% of project costs can be financed

• Debt terms extended to 15 years, making it possible to achieve positive cash flow on retrofits

What type of Project qualifies?• Projects that demonstrate cost savings through reduced energy consumption

or energy generation

• End-of-Life cycle equipment replacement

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Source: Setting the Pace: Financing Commercial Retrofits; Institute for Building Efficiency; Feb 2013 citing Energy Efficiency

Indicator Survey, Institute for Building Efficiency, Johnson Controls, 2012.

Barriers to Upgrading

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Audits

Coordinate with contractors to perform energy audits

Evaluation of audit findings with property owner

Determination of potential energy savings

Pre-Certification of contractors

Coordinate with energy audit findings

Assist in development of scope of work

Revolving Loan Fund

PACE bonds

Grants

Direct bank loans

Post-issuance debt compliance

Special assessment servicing

Evaluation of energy savings

Contracting Financing Monitoring

Port Authority / Energy Alliance

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1st PACE project inHamilton County

ADDRESS: 1682 Seymour Avenue, Cincinnati, OHFOCUS AREA: Bond Hill / RoselawnSPECIFICATIONS: 25,000 square feet Former furniture warehouse gets energy efficiency upgrades with PACE• $250,000 in upgrades• NOW AVAILABLE

PACE Project:

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68 Combining Financing Tools

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Combining Financing Tools

• Hampton Inn – TIF and NMTC

• Vernon Manor – TIF, HTC, and NMTC

• USquare – TIF and NMTC

• Broadway Square – City 108 Loan, HTC, and NMTC

• Sanctuary – HTC and NMTC

• Queen City Square – TIF, Lease

• Oakley Station – TIF and SA

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Sanctuary Structure Diagram

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MATT STAARMANN, CFAManaging Director, Structured Finance513-381-3939Ross, Sinclaire & Associates, [email protected]

SUSAN THOMASVice President, Public FinancePort of Greater Cincinnati Development [email protected]

Thank You