Use Historic Tax Credits to Reduce Capital Costs

Trained as an architect and armed with an MBA from Cornell’s S.C. Johnson School of Management, Ryan Folger cut his teeth in Chicago on a project called "The Roosevelt Collection." Working as the Director of Construction, he oversaw the development of the 1,200 space three-level parking structure, 400,000 square feet of retail space, 342 condos, and the largest luxury cinema in Chicago featuring a cocktail lounge, VIP section, and 16 screens.

When the financial crisis slowed development in Chicago, Mr. Folger took a position as VP of Operations for Altisource Asset Management Corporation which, during his tenure, acquired a portfolio worth more than $1 billion. In 2016 Folger returned to Chicago and formed Anexis Development to specialize in identifying unique opportunities in underutilized locations while providing attractive returns to investors. His latest project, the Federal Street Lofts, is a 64,000 sq ft. loft conversion on the South Side of Chicago, a short walk from McCormick Place. With 12,000 square feet of office space and 24 residential units, the new development presents a tremendous opportunity for Anexis and its investors through the use of historic tax credits.

Riding the Wave of Commercial Development in Chicago’s McCormick Square

“I believe the newly named McCormick Square neighborhood is still being overlooked by developers in Chicago for two reasons. First, most developers prefer to stay in neighborhoods they already know well,” says Folger. “Second, many developers remain unaware of just how rapidly the area is changing. If you haven’t seen it for yourself in the past few months, it is easy to overlook. The city has been working for years to encourage the revitalization of this area, and I believe that the area is poised for very rapid positive change.”

New hotel development is leading the interest in McCormick Square; the new 1,205 room Marriott Marquee Hotel, slated for completion in late 2017, will alone bring over 400 jobs to the neighborhood. In addition, a new complex of Hilton branded hotels, adding an additional 466 rooms, has recently started construction. “The city is very focused on revitalizing Motor Row and turning it into an entertainment district,” Folger continued. “Unlike most neighborhood revitalization where residential development occurs first, and then restaurants and retail follow, the introduction of new hotels and restaurants are reshaping the neighborhood in a way that will make any residential to follow very attractive.”

Savvy and ambitious developers should be keen to join the city of Chicago’s push to revitalize the McCormick Square. Developers have worked hard to push amenity-rich residential buildings, effectively creating an amenity war throughout Chicago. The focus on amenities has in turn reduced unit sizes and driven rents per square foot sky high. These types of projects have appealed to affluent millennials who have grown accustomed to having 24-hour gyms, pools, and common areas in their apartment complexes. But upon reviewing the historic Federal Street building, Folger knew this model was not appropriate for the asset.

What was the Anexis team’s solution? First, increased unit sizes. Bucking the trend of shrinking units, Folger believes his target demographic is more likely to be older working professionals, for whom a shoe-box sized unit is less appealing. “Many of the units being built in Chicago today, while functional, are too small to be comfortable. We believe there is a market for a more comfortably sized unit for our target renter profile and that tenants will immediately see the value.”

The second strategy employed by Anexis was to fully utilize historic tax credits. Having identified the right property, Folger knew ”optimizing” the deep floor plate, common in older manufacturing buildings, with market sized units would lead to odd layouts that most prospective tenants would not rent. Unable to fight other complexes in the amenity war, the historic tax credits provided the opportunity to reduce the project equity cost of capital. With his sights set on a truly unique building, Folger would be able to provide a unique branding opportunity and remain differentiated from competing residential buildings in the area.

The speculative nature of the deal, however, presented a number of modeling problems, including estimating the time and complexity of filing for historic tax credits, as well as accurately estimating cash flows. In this case, using Lucro to model the deal enabled Anexis to “add an additional level of refinement and calculate those cash streams in a much more complex way,” according to Folger.

For Folger’s team, Lucro made it simple to manage the hundreds of documents necessary to support the deal from start to finish, typically a huge inconvenience for everyone involved. Aside from actually doing the financial modeling using a centralized platform enhanced the collaborative capabilities of all parties involved. Thus, Folger and his team were able to cater to different scenarios and requests made by all members of the deal quickly and effectively.

Structuring a Modern Commercial Real Estate Deal with Historic Tax Credits

The McCormick Square neighborhood boasts a rich history and the Federal Street Lofts building is no different. The exposed brick and concrete loft building was originally built to manufacture steel rollers used in printing presses. The original builder, The Rapid Roller Company, played a critical role in the rise of Chicago publishing. “In order to qualify for the historic tax credits," Folger begins, "the building had to have some very interesting history. [Owning] a building that appears historic is not necessarily sufficient for you to get approval.”

To qualify for historic tax credits, a building needs to be certified as a historic structure by National Park Service. This complicated process paid off in a major way for Anexis, with the Federal Street Lofts becoming eligible for up to 20% off the hard and soft costs associated with the development.

“Once you obtain the credits, you work in partnership with your historic tax credit investor,” Folger explains. “In the historic tax credit market, investors bid between 80 and 90 cents on the dollar. Essentially, if you have $1 million of tax credits, and an investor agrees to provide you 90 cents on the dollar, they will provide $900,000 in equity in exchange for the credits. This helps us reduce the equity gap from what the lender will finance. Basically, the historic tax credit is to your investor’s benefit and is a way of lowering the costs of your capital for the entire project.”

Redeveloping historic areas has been notoriously difficult for developers. Between navigating construction issues, securing historic tax credits, and dealing with the uncertainty surrounding the long-term growth of rapidly changing neighborhoods, most have made the case for pursuing projects elsewhere with little to no headaches. However, with the city of Chicago focused on helping restore neighborhoods like McCormick Square to their former glory, and technical solutions like Lucro facilitating the management of a tedious but rewarding process, it is likely that many more companies like Anexis take an interest in unique historic rehab projects.