Leveraged Breakdowns

Real Estate Private Equity Model 101: Other Incentives

There are five primary tax incentives in real estate private equity 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. Two of these incentives have been covered already: Property Tax Incentives and Sales Tax Incentives.

Federal and State Tax Credits

There are a variety of state and federal programs that issue tax credits to projects that meet certain economic goals. Those goals could be development of rural areas or redevelopment of blighted areas (New Markets Tax Credits), preservation of historic buildings (Historic Tax Credits), creation of affordable housing (Low-Income Housing Tax Credits), job creation (Workforce Development Tax Credits) or cleanup and redevelopment of industrial brownfields (Brownfield Tax Credits). These credits against Federal or State tax can be retained by the owner/developer and offset taxes over time, but most often the credits are sold to other investors that have recurring tax obligations they prefer to reduce or eliminate. The purchase price varies based on the type of credits and whether they are state or federal, 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 phenomenon designed to address green initiatives and sustainability. The program aims to improve the energy efficiency of existing buildings, or encourage new buildings to maximize energy efficiency. If the owner or developer elects to install energy efficient components beyond what the municipality requires (such as thicker roof or sidewall insulation, higher quality windows, more efficient heating and cooling, etc.), then the entire cost of those upgraded components may be financed 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 or semi-annual payment through the special assessment. This program isn’t yet available in all states, and even in states that have approved the program, not all cities or counties are prepared to administer it. The interest rate to the owner/developer is very competitive because the payment comes through the property tax assessment. As a result,  it is considered low-risk by investors backing the C-PACE lenders.

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 $900,000 directly into a business (or through an intermediary called a “Regional Center”) that creates 10 jobs in a Targeted Employment Area (TEA). Projects outside of a TEA require investment of $1.8 million. The investor’s funds must be at-risk for at least two years following approval of their citizenship application. As long as 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 changes effective in 2019 raised the minimum investment to $900,000, and requires an update to the minimum investment every five years.

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 can be a very lucrative investment. As an analyst, they make for a fascinating real estate investment case study.

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