HTC Insiders Upbeat about Market, But See Potential Problems

Published by Brad Stanhope on Friday, July 8, 2016
Journal thumb July 2016

The forecast for the historic tax credit (HTC) from industry insiders sounds a lot like a late spring day: sunny, with a few clouds on the horizon.

Compared to a few years ago, that’s great news. “I would say the market is as strong and robust as I’ve seen in recent years,” said Leigh Ann Smith, senior vice president and equity manager at Bank of America Merrill Lynch, who manages the bank’s national investment origination platform for HTCs. “There are a lot of developments in the pipeline. That lines up with what we’re seeing in the general real estate market.”

Smith gets few arguments.

“There’s more certainty now than two or three years ago,” said Merrill Hoopengardner, president of the National Trust Community Investment Corporation (NTCIC), a leader in tax credit syndication and redevelopment. “It’s settled down since the Rev. Proc. [2014-12] and there’s a fairly healthy stable of tax credit investors, even though there’s been an ebb and flow.”

Rev. Proc. 2014-12 was a landmark in the HTC industry. The guidance, released in December 2013, established a safe harbor under which the Internal Revenue Service (IRS) wouldn’t challenge partnership allocations. It came after the Supreme Court let stand a lower court’s ruling in Historic Boardwalk Hall versus Commissioner, in which it was determined that a partner must have a meaningful stake the success or failure of a business to receive the tax benefits.

“The most obvious comparison is to the post-Boardwalk time, when things got so tentative and we saw a slowdown,” said Bill MacRostie, senior partner in MacRostie Historic Advisors LLC. “Compared to that period, it’s much better. There are a lot of deals getting done … I’d describe it as very robust. It’s better than a year ago or five years ago.”

Tom Boccia, CPA, a partner in Novogradac & Company LLP’s office in Cleveland, said the improved overall economy has played a role in the growth of the HTC market. “The supply is starting to be a little more,” Boccia said. “We’re seeing a lot in the $1 million to $2 million size. I think there is an influx of investors who are different from a year or two years ago. We’re seeing the investor pool expand a little bit.”

But insiders say the HTC is a little bit stuck in the middle now: It’s after the IRS issued Rev. Proc. 2014, but the industry waiting for long-promised IRS guidance on 50(d) income, that results from master lease structured transactions.

Adjustment to Rev. Proc. 2014-12

In the 30 months since Rev. Proc. 2014-12 was issued, the industry adjusted. “The analogy I used is that what everyone hoped for was a recipe, instead we got a list of ingredients,” Smith said. “Through trial and error, we’re figuring out what to do. At this point, most people have a fairly documented set of standards, but there still seems to be some change based on conversations between law firms and the Treasury or IRS.”

Kandi Jackson, senior vice president and managing director of acquisitions and underwriting at NTCIC, said transactions build on each other. “I think there was a slowdown for a while as people figured out the tax structure on complicated deals,” Jackson said. “It doesn’t seem like every deal is being structured from scratch. That’s helping with timelines and with closing costs–people can be more nimble.”

Boccia agreed that the IRS guidance slowed the market until investors figured out the best way to address the issue. He said the wait for 50(d) guidance hasn’t had the same effect. “It takes longer for deals to close, but I haven’t seen projects go on hold because of the 50(d),” Boccia said. “They find ways to share the risk and there are a lot more single-tier structures.”

Boccia estimated that the market took three to six months to rebound after Rev. Proc. 2014-12. “By summer (of 2014), people figured out what they were going to do,” Boccia said. “There was some scrambling in the three to six months while investors figured it out.”

Hoopengardner also said there was a benefit to the ruling. “The safe harbor [ruling] took the mavericks off the table,” she said. “It brought us back to the same deal structures, where you don’t see investors trying different [risky] things. There are now fewer cowboys out there.”

What’s Hot(els)

While the entire market is doing well, one portion is particularly strong: hotels.

“They’re great historic projects,” Smith said. “But they’re also one of the riskier asset classes. There’s a lot of variability in them … We’re also seeing a lot of mixed-use projects that include hotels.”

Boccia said he’s seen more HTC developments involving hotels, something he attributes to the health of the economy, with increased business travel and demand for hotel space.

“The rental market is strong all over the country, so residential and hotels are both strong,” MacRostie said. “[But] hotels are probably the segment we think will slow down almost immediately, because it’s almost all built out.”

State Credits Crucial

While the attention is focused on the federal HTC, state-level legislation is important. “There’s a direct correlation to places with a state historic tax credit,” Boccia said. “You see a lot of activity if the state re-ups or if it didn’t have a credit before and gets one.”

Of course, everything is bigger in Texas, including its state HTC, which took effect at the start of 2015. “The makeup and character of state programs determine how much impact they have,” MacRostie said. “For instance, the state of Maryland’s credit for the past several years has a minimal impact because it’s a tightly capped program. But Texas is having a hugely dramatic impact on the number of deals and activity. Downtown Dallas is being transformed. And there’s everything between [Maryland and Texas].”

Waiting on a Ruling

Smith said waiting on the 50(d) guidance has held up some deals. “We like to issue proposals with what we believe is the correct treatment of 50(d) income, but to allow for a change to be made if there’s a deal,” Smith said. “Something is going to happen with 50(d) income … but obviously we’re [just] making our best guess. We go with the most likely scenario and the worst-case scenario [in negotiating agreements].”

Smith expects the 50(d) guidance to be positive. “It will help level the playing field and make deals easier to do,” she said. “[We’re aware that] anything that causes people to spend more time structuring deals takes money away … when you have an overly complex process, it dilutes the amount of tax credit value.”

Meanwhile, the industry waits. “I think obviously resolving the 50(d) issue will be an important event,” MacRostie said. “Hopefully it gets resolved and the market will figure it out.”

Boccia will be pleased when the 50(d) guidance comes out, since it will end some uncertainty. “The big question will be for deals that are in the pipeline or that aren’t in service yet, how will the rules affect them,” Boccia said. “They probably will create more certainty.”

Tax Reform Impact

Uncertainty concerning the upcoming national election and potential tax reform is a cloud on the horizon for the HTC community. “It’s an open question,” Smith said of the likely presidential race. “We know Sen. [Hillary] Clinton supported tax credits and Mr. [Donald] Trump is a partner in a historic tax credit project, so hopefully they’re supportive of the credit. But we don’t know.”

Hoopengardner, whose organization devotes 1.5 fulltime positions to lobbyists in Washington, D.C., said it’s a mistake to overlook tax reform. “[Tax reform] isn’t as big an issue as it should be,” Hoopengardner said. “We can’t rest on our laurels, as far as tax reform. HTCs were scheduled to be written out of the tax code in Chairman [Dave] Camp’s bill [in 2014]. People should be mindful of what could happen.”

MacRostie agreed. “[Tax reform] is always the cloud on the horizon,” he said. “Tax reform could be nothing, a modest impact or it could be an industry-killing event.”

Economic growth, IRS guidance, state credits and tax reform mean that it’s not simple. But the present, at least, is sunny.