For a real estate private equity beginner, layering sales tax incentives into a real estate private equity model may sound intimidating. Like other incentives, however, accurate modeling comes down to understanding how the incentive is calculated and the timing of receipts. Sales tax incentives are not allowed in all states, but there are enough that do permit it that it warrants separate treatment.
Sales Tax Incentives
Unlike property taxes, sales taxes aren’t paid by the owner; they are paid by consumers during the ordinary course of business. Naturally, then, you won’t see sales tax incentives on multi-family properties, industrial properties, or office properties, but rather on retail properties. As an incentive to spur investment in under-served or targeted development areas, Cities, Counties, or States may agree to rebate a portion of the sales tax receipts collected at the subject property to the owner. These rebates are usually paid semi-annually, but may be quarterly or annually.
One wrinkle in modeling sales tax rebates is the fact that there is a market for them. There are funds and investors that will buy the projected revenue stream. This monetization can provide an influx of cash early in the project’s life cycle and eliminate the reliance on future sales tax receipts, which are uncertain, as a part of the profitability of the project. As you can imagine, there is usually a significant discount applied to the future revenue streams, but that may depend in part on how risky the project is to begin with, the tenant mix, demographics, and the quality of the projections.
The Real Trick
Whether you opt to collect the sales tax rebates over time or monetize them, the real trick to incorporating sales tax rebates into an LBO model is the assumptions behind the calculation. Most retail tenants will not share their projected sales for a store because that would be giving away information that could hurt them in lease negotiations. You’ll have to be more resourceful. Publicly traded retailers file annual reports (10k) with the Securities and Exchange Commission (SEC) (filings can be found on EDGAR) that include the number of stores open and operating, the average square footage of their store fleet, and total sales for the fleet. You can then calculate an average sales per square foot and apply that to your tenant specifically. You may want to make adjustments for the demographics of your location specifically.
Many retailers are privately held, but there are some online sources or brokerage firms that may have estimates available. Your firm may also experience within its portfolio that can serve as a guide. Or, you may just have to make an educated guess. In any case, a separate tab in your model that shows your assumptions and calculations will be critical in arriving at a value for the incentive, and conducting sensitivity analyses on the assumptions built into the incentive.
Sales tax incentives are not as common as property tax incentives (read more here) but you will likely run into them at some point in your career. As a real estate private equity beginner, building your familiarity with various incentives will serve you well. When you do have the opportunity to incorporate incentives into your real estate private equity model, you won’t be starting from ground zero. Explore more of the content available at Leveraged Breakdowns, including free quizzes and coursework that will help you conquer your REPE career!