Five Tax Incentives That Can Juice Your Real Estate Returns

There are five primary real estate tax incentives that can boost returns in your real estate equity investment. Analysts should understand the mechanics of each so they can build effective real estate LBO models.

Tax Increment Finance (TIF)

Tax Increment Finance is a form of property tax rebate (refund) or an abatement (don’t have to pay) to the owner or developer in exchange for creating additional property tax value. The key term is “increment,” as these incentives are based on the increased property tax value created rather than the total value. TIFs are usually local, meaning a city approves and administers the incentive. But, the incentive may include contribution from the county or special taxing districts. TIFs target particular locations within a city, and the owner must demonstrate a need for the incentive. Depending on the state, the municipality may be able to issue bonds that are backed by the new property tax generated (revenue bonds rather than general obligation bonds). The net proceeds of the bonds are then paid to the developer/owner of the project to either return equity, or repay debt. TIF deals are very common and relatively simple to put together.

Sales Tax Rebates

Much like property tax incentives, sales tax sharing is permitted in some states. If a new project is expected to generate significant sales tax revenue, then the state or municipality may be willing to rebate some of those tax receipts over time. Also like property tax rebates, some states allow the municipality or the state to issue revenue bonds backed by these projected tax receipts. While not as common as property tax TIF incentives, sales tax programs are simple to put together, but do require more administrative work to document each year.

Federal and State Tax Credits

There are a number of state and federal programs that issue tax credits to projects that meet certain economic goals. Those goals could be preservation of historic buildings (Historic Tax Credits), creation of affordable housing (Low-Income Housing Tax Credits), development of rural areas or redevelopment of blighted areas (New Markets Tax Credits), cleanup and redevelopment of industrial brownfields (Brownfield Tax Credits), or job creation (Workforce Development Tax Credits). These credits against Federal or State tax can be retained by the owner/developer and reduce or eliminate taxes over time, but most often the credits are sold to other investors that have recurring tax obligations to offset. The purchase price varies, but is normally around $0.70-$0.80 on the dollar. Tax credit deals are usually the most difficult to put together, but make for a fascinating real estate investment case study.

C-PACE

Commercial Property Assessed Clean Energy is a relatively new program that aims to improve the energy efficiency of existing buildings, or encourage new buildings to maximize energy efficiency. If the owner elects to install energy efficient components beyond what the municipality requires (such as thicker roof or sidewall insulation, more efficient heating and cooling, etc.), then the cost of the upgrades may be reimbursed by financing that cost through a special property tax assessment on the building. C-PACE lenders will advance the funds to the owner and receive a virtually guaranteed annual payment through the special assessment. This program isn’t yet available in every state, and not all cities or counties are prepared to administer such a program. Because the payment comes through the property tax assessment, it is considered low-risk by investors backing the C-PACE lenders, and the interest rate is normally very competitive.

EB-5

EB-5 is a federal program administered by the US Citizenship and Immigration Service. “EB” stands for employment-based, and this program is the 5th category of “employment-based immigration.” In short, a foreigner desiring legal citizenship in the US can invest $500,000 directly into a business that creates 10 jobs (or through an intermediary called a “Regional Center”). The investor’s funds must be at-risk for at least two years. If the business is able to demonstrate that the 10 jobs were created, the investor will receive a green card. The advantage to the owner or developer is that these investors are most interested in a green card and preservation of capital, not return on investment. This is a lower cost of capital, and reduces the real estate equity investment by the owner. Interestingly, this program also exists in Canada, Australia, and other countries, so there is actually global competition for these immigrants. EB-5 has undergone several changes in recent years and the minimum investment will be increasing to $900,000 later this year.

Wrapping Up

Incentives can be the difference between a project that works and a project that earns a “Thanks, but no thanks.” Incentives often add more complexity, especially in the case of tax credits, but make for a challenging and rewarding real estate investment case study.