Dispelling 5 Common Misconceptions of the New Markets Tax Credit Program

While you may be unfamiliar with the New Markets Tax Credit (NMTC) program, you’ve almost certainly encountered its impact.

Created in 2000, the New Markets Tax Credit (NMTC) is a program that incentivizes private investment in community development projects located in economically-distressed communities. 

The credits are used for a variety of real estate projects, including health facilities, schools, manufacturing, arts and culture spaces, retail, hospitality, and more. In Missouri, for example, developers and organizations have leveraged more than $2.07 billion in NMTCs, according to the CDFI Fund. 

This credit not only ushers in vital services for communities, it also is a powerful multiplier of private investment dollars. On average, every $1 in tax credits generates $8 in private investment — a remarkable 8x boost, according to the U.S. Treasury Department’s CDFI Fund.

AltCap has been helping businesses and communities grow with this credit since 2008. We’ve facilitated more than $267 million in financing to fuel projects like the Linwood YMCA, Emmanuel Family and Child Development Center, The Lyric Opera of Kansas City, and many more. 

While it may seem like a straightforward tax-credit program, the program itself is often misunderstood. To help clear up confusion, we’d like to dispel a few common misconceptions we encounter when talking to folks about the New Markets Tax Credit program.

To learn more about the NMTC program or our comprehensive consulting services, reach out to Michael Bland, AltCap’s Director of Tax Credit Financing and Consulting Services.

Misconception No. 1 — NMTC financing is only for real estate projects.

While most New Markets Tax Credit transactions finance real-estate projects, they can also be used for operating businesses for working capital, inventory, or equipment purchases. An operating business is defined as one whose predominant activity does not include the development, rehab, construction, management, or leasing of real estate. 

The eligibility requirements remain the same for both types of businesses: 

• The business must be located in a low-income community.

• The business cannot be a farm, liquor store, massage parlor, casino, or residential rental property.

Misconception No. 2 — New Markets Tax Credits can’t be combined with other credits.

Part of the appeal of the New Markets Tax Credit is its flexibility. The New Markets Tax Credit is frequently combined with both state and federal historic tax credits. 

AltCap has used New Markets Tax Credit financing alongside historic credits for six projects totaling $80 million in total development costs. 

Our recent success stories of pair tax credits include the J. Rieger Distillery in Kansas City’s East Bottoms and the Wonder Lofts in the Beacon Hill neighborhood. 

Historic Tax Credits are a popular credit as they pair nicely with the New Markets Tax Credit and can provide a generous portion of the equity in the capital stack. Project developers interested in pairing historic credits should first check to see if the existing structure is on the federal and state historic preservation list. 

If not, the next step is to have the project added to both lists if possible. There are annual approval timelines from both the Missouri and Kansas historic tax credit programs as well as the federal program that will be relevant to a development’s timeline. These credits must be approved by state and federal agencies before beginning the New Markets Tax Credit closing. 

Misconception No. 3 — The New Markets Tax Credit financing can’t be used for housing developments.

The New Markets Tax Credit can be used for residential rental developments — so long as the development features a mixed-use component or supportive programming.

This is known as the 80-20 rule. It means that no more than 80 percent of project revenues can come from residential rental income. For example, if an apartment building has first-floor retail or a live/work component, this often satisfies the 80-20 rule. 

Another way to think about financing housing with the New Markets Tax Credit is to think of segregating or “condo-ing” out the use of funds. On AltCap’s WonderLofts project, the New Markets Tax Credit proceeds were not used for the residential units and instead were specified for the retail component. 

One final note, should you use the New Markets Tax Credit on housing units, 20 percent of the units must be affordable for residents earning no more than 80 percent of the area’s median income.

Misconception No. 4 — The New Markets Tax Credit financing has too many fees.

New Markets Tax Credit transactions frequently involve at minimum three parties: A project sponsor, a community development entity like AltCap, and a tax credit investor such as a bank.

Oftentimes there are source lenders and historic tax credit consultants as well. All these parties add to the transaction costs of a New Markets Tax Credit project. The bulk of the fees are upfront and can range depending on the Community Development Entity (CDE) involved and the complexity of the structure. These fees, however, are paid largely out of the New Markets Tax Credit subsidy provided by the tax credit investor.

Transaction costs are also standard irrespective of deal size, so the larger the project, the greater the subsidy. There are also ongoing fees during the compliance period, including loan servicing and asset management fees that are paid through interest-only, below-market rate debt service payments during the compliance period. New Markets Tax Credit projects will also be required to have annual audits and reimburse the CDE for its own audit expenses. Ultimately, a New Markets Tax Credit transaction — depending on size — can fill 15-18 percent of the total development cost of the project net all upfront and ongoing fees for the seven-year life of the deal.

Misconception No. 5 — New Markets Tax Credit projects must be $5 million or more.

In addition to the typical New Markets Tax Credit real estate loan, there are New Markets Tax Credit Small Loan Pools that offer loans anywhere from $500,000 to $4 million. 

These loans have many of the same terms as the larger New Markets Tax Credit loans such as higher loan-to-value, longer than standard interest-only payments, or lower debt service coverage ratio. The key difference is that the New Markets Tax Credit subsidy is not converted to project equity at the end of the compliance period and is instead paid back after 5 to 7 years.

Since 2016, AltCap has deployed two small loan pools that have invested $10.5 million into 14 small businesses.