|March 2011, Volume II, Issue III||Published By Novogradac & Company LLP|
Alexis DeTocqueville described Cleveland in his famous 1830 work, Democracy in America, as a sophisticated society amidst a heavily forested landscape. The nickname "Forest City" has stuck with Clevelanders, and the city's legacy is reflected in its verdant "Metro Parks" system. Cleveland is also the home to world class institutions such as the Cleveland Orchestra (ranked 7th in the world) and the Cleveland Clinic (ranked 4th on US News' Honor Roll of U.S. hospitals). Anyone my age who has a national perspective on community development also recognizes that Cleveland is a powerhouse and creative center for community development finance.
It all started when Ronald Reagan passed his first federal budget in 1981, cutting U.S. Department of Housing and Urban Development (HUD) funding by 50 percent and famously stating, "Government isn't the solution to our problem, it is the problem." Observing from my position at the time with the Enterprise Foundation (now Enterprise Community Partners), Clevelanders seemed to take the Reagan challenge to the city's future seriously. In the ensuing years, downtown corporate interests formed Cleveland Tomorrow (now the Greater Cleveland Partnership); the philanthropic community, including the Cleveland and Gund foundations, and BP formed Neighborhoods Progress Inc.; and the Cleveland Housing Network (CHN). These institutions were bolstered by a strong community organizing base that spawned an exceptionally talented set of community development corporations such as Detroit Shoreway CDO, Ohio City CDC, University Circle Inc. and the Famicos Foundation.
Homegrown investors including Sherwin Williams, Key Bank and National City Bank (now PNC Bank) stepped forward to provide loans and equity investments. In this environment, it was no coincidence that two Cleveland-based developers, The Ferchill Companies and Forest City Enterprises, grew to rank among the largest national developers of historic properties. NRP Group is now one of the country's highest volume developers of low-income housing tax credit (LIHTC) properties. MRN Ltd. and the Coral Company have also become highly sophisticated in the use of all types of tax credits. While I'm sure it never was as coordinated and organized close up as it seemed from a distance, Cleveland nevertheless stood out as an American city that could make things happen in downtown and neighborhood development.
Defining the Concept of Private Sector Leveraging
With less direct funding from HUD, Cleveland adopted the new community development mantra of "leveraging" private sector financing. It was a novel concept in the early 1980s and Cleveland played a major national role in defining what it meant. One example of Cleveland's leadership was how community development corporations, financial institutions and city government worked to perfect the concept of "linked deposits," public funds deposited in financial institutions at below market rates to induce low-interest lending for affordable housing and economic development projects. While today's community development industry has largely forgotten this tool, Cleveland groups continue to use it. The Cleveland Restoration Society (CRS), a local partner of the National Trust, uses linked deposits from multiple governmental sources to borrow low-cost capital from banks for its historic home improvement loan program. Over the past 18 years, CRS has closed on more than 800 such loans for a total volume of more than $30 million at interest rates as low as 1.5 percent.
Another Cleveland-invented private sector leveraging tool was the use of conservation easements to generate an additional layer of financing for historic property transactions. Cleveland law firms, accountants and investors were the first to figure out a way, under Internal Revenue Code (IRC) section 179(h), to monetize deductions for the donation of façade easements and lost development rights. While this type of financing has resulted in considerable IRS audit attention in recent years, at some point there will be a meeting of the minds among appraisers and IRS policy makers, and this creative tool will ultimately come back as a useful way to close financing gaps on historic rehab transactions.
Master of Tax Credits
Where Cleveland has really excelled is in the tax credit arena. At every step—from the enactment of the federal historic tax credit (HTC), LIHTC and new markets tax credit (NMTC) to the passage of Ohio's state HTC and new markets program—Cleveland has been a veritable vacuum cleaner. "Cleveland has developed a strong core of legal, accounting, architectural, developer and investor expertise in how to put together complicated tax credit transactions," said Mark Lundine, the Ohio Department of Development's urban revitalization coordinator. "When developers outside of Cuyahoga County look at tax credit transactions, many times they look to Cleveland professional service providers to get deals done."
The statistics that speak to this point are compelling. According to National Park Service quarterly transaction data, since 2002 alone, Cleveland's for-profit and not-for-profit developers have closed on 74 separate federal HTC transactions with estimated total development costs of more than $568 million dollars. Again, according to Lundine, Cleveland projects have used 43.3 percent of the state HTCs allocated over the past three rounds, a total of $106 million in credits out of the $245 million awarded. On the NMTC side, Cleveland has three strong locally-based community development entities (CDEs), Cleveland Development Advisors (Cleveland New Markets Investment Fund), Cuyahoga County Port Authority (Northeast Ohio Development Fund) and University Circle Inc. that have received an aggregate of $137 million in NMTC allocations. Cleveland CDEs also were awarded $5 million of the $10 million allocated in the first round of Ohio's new NTMC program.
Economic Drivers of Cleveland's
Tax Credit Transactions
Unlike many other cities that make productive use of tax credits for community and economic development, Cleveland has achieved a good balance between downtown redevelopment and low-income neighborhood projects. In the neighborhoods, CHN has been highly creative in its use of LIHTCs to finance a single-family lease-purchase program. Beginning in the 1980s, CHN began acquiring and rehabilitating vacant homes and leasing them at affordable rates to low-income households. Families were offered the option to purchase the units after the 15-year LIHTC compliance period. I can remember thinking at the time, will the tenants stay long enough to exercise their option, and will they feel like homeowners in the interim? Rob Curry, executive director of CHN, confirmed recently that 25 years later, CHN continues to use this unique LIHTC model. Incredibly, 90 to 95 percent of maturing units were successfully acquired by the tenants prior to the Great Recession. Post recession, CHN has maintained an 80 percent success rate with the help of a seller financing mortgage pool. Approximately 650 units with an average sale price of only $16,000 have been acquired by tenants and fully one-third of the sales have been to original tenants.
On the commercial side, historic and new markets transactions have been concentrated in historic commercial and cultural centers. An early initial signature project was the historic rehab of the iconic Terminal Tower. The Gateway Warehouse District was another early magnet for federal historic tax credit investing. More recently, the 4th Street entertainment district has benefited from federal and state historic and new markets financing. The latest concentration of tax credit driven real estate development has been the University Circle or "Uptown" neighborhood.
A noteworthy catalyst project in Uptown, pictured on the cover of this issue, has been the McCullough Center at the Cleveland Institute of Art (CIA). The McCullough Center is the conversion of a 175,000-square-foot former Ford Model-T assembly plant into classroom, faculty, administrative, meeting and artist studio space. The CIA, known nationally for its industrial design program, enrolls approximately 500 students and the new center will help it meet its goal to expand to 650 students. The rehabilitated facility and planned 80,000-square-foot Phase 2 addition are also part of a plan to centralize the campus on Euclid Avenue. The McCullough Center finished construction in December 2010, and the Phase 2 addition is scheduled to break ground later this year. The scope of work included the installation of energy efficient windows and high efficiency HVAC. The air conditioning system will enable the CIA to offer summer sessions.
Federal and state HTCs and federal NMTCs were combined to make the project feasible. Financing partners on this $47.6 million transaction included US Bancorp (new markets debt and equity), a Key Bank/PNC Bank construction loan, and a Key Bank/PNC term loan. Other sources include capital campaign donations and a one-day loan to facilitate NMTC enhancement of initial pre-closing construction costs. NMTC allocations totaling $23 million were provided by National Trust Community Investment Corporation and the National New Markets Fund.
Al Zvosec, vice president and chief financial officer at the Cleveland Institute of Art, said that the McCullough Center has generated a lot of positive publicity for the visual arts school and an equal amount of excitement among the faculty, students and artists who have begun using the new space. Chad Arfons, an attorney specializing in tax credit transactions at the full-service law firm of Roetzel & Andress said that the McCullough Center has extended new development to the eastern boundary of University Circle and generated additional real estate activity in the immediate vicinity. These projects, many of which have also benefited from tax credit financing, include the planned $25 million Museum of Contemporary Art Cleveland; a $44 million MRN Ltd. sponsored mixed-use project that includes 102 market-rate residential units and 56,000 square feet of retail; and the planned 50-unit New Circle Vistas maximum accessibility housing.
John Leith-Tetrault has 32 years of experience in community development financing, banking, community organizing, historic preservation, training and organizational development. He has held senior management positions with Neighborworks, Enterprise Community Partners, Bank of America and the National Trust for Historic Preservation. Mr. Leith-Tetrault is the founding president of the National Trust Community Investment Corporation and serves as the Chairman of the Historic Tax Credit Coalition. He can be reached at (202) 588-6064 or email@example.com.