Structuring, Closing HTC TransactionsMODERATOR PANELISTS

Mike KressigNovogradac & Company LLP

Eric BrubakerFoss & Company

Fred MillerLathrop & Gage LLP

John DaltonBryan Cave

Thomas StephensDentons

John TessHeritage Consulting Group

Working with the National Park Service and the States

Novogradac 2017 Historic Tax Credit ConferenceDenver, Colorado

September 28-29, 2017

John Tess, PresidentHeritage Consulting Group

Review Process

Local, State and Federal Design and Program Approvals

Working through the mazeLocal, State and Federal design and Program Approvals

Understand the Players and their

Roles

The roles of each reviewing body and the process

• Local (Local review authority and maybe advisory to State)

-- Local Historic Preservation boards -- Certified Local Governments

• State (State decision making authority and is Advisory to Federal agencies)

-- State Historic Preservation Offices-- Conduit for all federal programs

• Federal (National Park Service, Advisory Council on Historic Preservation-- Final decision makers)

-- Part I, Part II and Final Certification-- Section 106, Federal undertakings

Where to start?

LocalLandmarks

State Historic preservation Office

National Park Service

Local

FederalState

Multi-directional Process

Landmarks Commission

State Historic Preservation Office

National Park Service

Design Standards

Secretary of the Interior’s Standards for

Rehabilitation

Understanding how the Standards are interpreted

• The interpretation of the Standards is a subjective process.

• Local, State and Federal authorities may differ on the interpretation.

• Interpretation is generally done on a case by case basis depending on many factors.

• Interpretation can vary from one reviewer to the next.

How to get through the process?

Putting the right Team together

Why do you need a Team

• Heightened level of sophistication of deals

• Competition for resources

• Time

• Credibility

• Specialties needed

Who are some of the team players

• Developer

• Attorney(s)

• Accountants

• Preservation Consultant

• Contractor

• Architects and engineers

• Other Consultants

The Other Team MembersThe Review Bodies

• Neighborhood

• Local review bodies

• SHPO

• NPS

Result of Bringing the right team together

“Peace of Mind”

Peace of mind is attained in any historic deal by;

• Putting together the correct project team

• Identification of issues

• Early consultation with all team members

• Continued team work throughout the project

Avoid Common Mistakes

How to Avoid Common Mistakes

• Put together an experienced team, down to the architect and general contractor.

• Follow-up on all conditions in a conditional approval.

• Hold off on demolition until after the Part 2 has been reviewed.

• If proposing a rooftop addition, anticipate an extra level of scrutiny.

Novogradac 2017 Historic Tax Credit ConferenceDenver, CO September 28-29, 2017

Approvals Granted

Local

FederalState

Material Rev. Proc. 2014-12 Considerations• “Bona fide equity investment” – value is contingent on partnership’s operations.

– Investor must share in economic upside and economic risk of underlying operation.

– Return cannot be fixed.

• Reasonably anticipated value commensurate with overall percentage.– Investor’s interest must be in substance what it purports to be in form. For example, if it is

a 99% interest flipping down to 5%, it should have a value consistent with such an arrangement.

– The interest is not required to have any particular pre-tax value.

• The value of the Investor’s interest may not be reduced through fees, lease terms or other arrangements that are unreasonable as compared to such arrangements for non-HTC deals.

– Developer fee amounts and lease arrangements must be reasonable.

– All related party arrangements must be reasonable.

– Reasonableness opinions are used to support these conclusions.

– Related party subleases (sandwich leases) are deemed unreasonable unless mandated by a third party.

Reasonableness Opinions• Used in support of developer fee amounts and other related party arrangements.

• Amounts paid do not necessarily need to equal those paid in non-HTC deals, but must be reasonable in comparison, taking into account any differences in transactions.

• The reasonableness opinion should address the work to be performed in the particular transaction by the developer and the developer’s experience and capacity with respect to such work.

At-Risk Rules: Developer Fee

• Credit base must be reduced by “nonqualified nonrecourse financing,” even where a master lease credit pass through structure is used, to the extent that the owners of the landlord are subject to the at-risk rules.

• Applicability of the at-risk rules and characterization of the debt is done at by looking through to the ultimate owners of the landlord.

• Deferred developer fee may be viewed as “nonqualified nonrecourse financing” requiring a reduction of credit base.

– Credit attributable to the reduced portion will be allowed as the deferred developer fee is paid. The recapture period for such credit remains the initial recapture period.

Tax Credit InvestorManaging Member

TenantTenant Tenant

Landlord (Property Owner)

Lender(s) Developer

Equity99% Profit and Loss, HTCs, and Cash Flow

1% Profit and Loss, HTCs, and Cash Flow

Equity

Construction/Perm Debt

Debt Service

Leases and Rents

Development Services

Developer Fee

Single Tier or Partnership Flip Structure

Managing MemberOn Flip Date, sharing percentages flip from 99/1 to [5/95]

Tax Credit Investor

Managing Member

SubtenantSubtenant Subtenant

Master Tenant Landlord (Property Owner)

Lender(s)

Developer

Equity 99% Profit and Loss, HTCs, and Cash Flow

1% Profit and Loss, HTCs, and Cash Flow Equity Equity

[10]% Profit and Loss, Cash Flow

Master Lease, Pass-Through of HTC

[90]% Profit and Loss, Cash Flow

Equity and Master Lease Payments

Construction/Perm DebtDebt Service

Leases and Rents

Development Services Developer Fee

Master Lease Pass Through Structure

Choosing a Structure

Single Tier

• Simplicity (fewer entities, fewer documents, reduced costs)

• Basis reduction = 100% of HTC– Fewer depreciation deductions

– More gain/less loss on sale of building

– No 50(d) income to investor

• Investor receives most of residual cash flow pre-flip

Master Lease Pass Through• SNDA more palatable to lenders than standstill

• Easier to manage cash generated by the project

• Fewer losses to investor, sponsor retains greater share of cash and losses

• Reduced value of investor interest at exit

• Some investors prefer to be one step removed from ownership of real property

• 50(d) income to the investor

Tax Equivalency Payments• Investors generally require payments to cover phantom income

• Paid from cash flow– Limited to cash available for distribution?– Payable after flip?– Unpaid amounts accrue? With interest? – Offset against preferred return or other distributions? – Applicable tax rate – highest combined corporate federal, state and local

• 50(d) income – not a partnership tax item– Investors may nevertheless require TEP to cover 50(d) income

Conditions Precedent to Equity Pay-In

• Term sheets seldom provide sufficient detail (e.g., calculation of required debt service coverage ratios)

• Cannot negotiate documents as part of term sheet process, but it’s important to understand exactly what is required to obtain funding

• “Catch-all” provisions

Conditions Precedent to Equity Pay-In

Representative conditions precedent to investor equity funding

– Part 1 and Part 2 approvals– Real Estate and Construction Due Diligence– Appraisal– Closing on other sources of funding– Opinions

– Unconditional Part 2 approval (if investor closed on conditional Part 2)– Substantial Completion – Placement in Service– Preliminary Cost Cert– Submission of Part 3 to SHPO

– Part 3 approval– Final Cost Cert– Tax returns/K-1s– Stabilization

Prepaid Rent Under Master Lease

• Generally, HTC Investor equity in the Master Lease structure has been transferred from the Master Tenant to Master Landlord by:

(i) equity contributions (requires Master Tenant ownership in Master Landlord), or

(ii) loans from Master Tenant to Master Landlord (needs to be structured as true debt)

Prepaid Rent Under Master Lease• A third method of getting HTC Investor equity to the Master Landlord is

by prepaying rent under the Master Lease• Used separately or in conjunction with other methods.• However, this method makes the HTC Investor equity taxable to the

Master Landlord as rental income and potentially imputed interest.• Section 467 Lease Treatment

-- Method to reduce income hit from prepaid rent. -- Proportional Rental Accrual Method – Rent Allocated for Period multiplied by ratio of PV of Actual Rent Payments to PV of Fixed Rent-- However, depending on the structure of the exit, a big COD income hit to Master Landlord may result on exit due to deemed forgiveness of the Section 467 prepaid obligation.

Prepaid Rent Under Master Lease• Developer Lesson: Not only do you need to

evaluate the pricing the HTC Equity and the timing of HTC Equity installments, you need to evaluate the economic impact of how the HTC Equity enters the structure.

• Engage accountants early. Run alternate projections based on different investment structures.

Exit Considerations• Rev. Proc. 2014-12 prohibits the Principal and

Partnership from having call options with respect to the Investor’s interest in the Partnership.

• Rev. Proc. 2014-12 permits the Tax Credit Investor to have a Put Option with respect to its Interest in the Partnership so long as the put price does not exceed the Fair Market Value of the interest at the time the put option is exercised.

Exit Considerations• Developer Concern: “Will Investor put its

interest in the Partnership?”– Even before Rev. Proc. 2014-12, this was a

Developer concern as the put right is discretionary rather than mandatory.

– Reputational Pressure of Investor to Put

Exit Considerations• Put Price Calculation

– The FMV of Investor’s Partnership Interest is the ceiling for the put price (the “Put Price Ceiling”)

– Put Price is generally the lesser of (i) FMV of Investor Interest and (ii) a percentage of Investor’s aggregate capital contributions plus certain additional items

– Examples of additional items include unpaid Investor loans, unpaid Priority Returns and unpaid Special Tax Distributions.

Exit Considerations• Utilizing Flips of Partnership Interests

– Rev. Proc. 2014-12 permits flips in interests in the Partnership provided that the Investor interest does not flip below 5 percent of the Investor’s largest pre-flip percentage interest in each material item of Partnership income, gain, loss, deduction and credit.

Exit Considerations• Flip Benefits:

-Reduces the FMV of Investor’s interest thus the lowering the Put Price Ceiling.--Shifts more of the economic benefits back to the Principal even if Investor does not exercise its put right.

Exit Considerations• Timing of Flip

--Typically the later of (i) the end of the Recapture Period and (ii) the date various other items have been paid to Investor (Special Tax Distributions, Investor Loans, etc.)

• Factors such as Investor’s required Cash on Cash return can limit the size of the flip.

Structuring, Closing HTC TransactionsMODERATOR PANELISTS

Mike KressigNovogradac & Company LLP

Eric BrubakerFoss & Company

Fred MillerLathrop & Gage LLP

John DaltonBryan Cave

Thomas StephensDentons

John TessHeritage Consulting Group