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WASHINGTON, DC-For the last nine months or more the use of tax credits to help finance development, namely New Markets Tax Credits and Low Income Housing Tax Credits, have been characterized by the following: The capital markets crunch has prompted more developers to look anew at these tools as good alternatives to bridging gaps in financing for projects. At the same time, the recession has significantly narrowed the option, by killing the demand for such credits. After all, banks have little need for tax credits when they are not making a profit against which to offset them.

There are signs, though, that this situation is about to change thanks to government measures, starting with the American Recovery and Reinvestment Act that passed in February. Included in that legislation was a clause that allows states to use these funds to cash in unused Low Income Housing Tax Credits.

Developers then will receive grants in lieu of, or in addition, to the tax credit program. As states receive stimulus funds, many housing agencies are now putting in place new tax credit programs based around grants instead of LIHTCs.

“This has been a big focus for developers and states – how to administer the grant program,” Greg Dahlgren, an attorney with DLA Piper’s real estate practice, tells GlobeSt.com. “Every state is coming up with its own program on how to use those grants.” He says the preference for many appears to be a combination of grants and credit, so there is some equity investment in the deal.

The need for grants instead of credits is clear: buyers of these credits have all but disappeared from many, but not all, markets. Besides the banks, Fannie Mae and Freddie Mac were key purchasers; they have all but ceased such operations.

“We do have some syndicated clients that have investors they work with, some mid sized banks that haven’t been touched the economic crisis, they are still making money and LIHTC satisfy community investment requirements,” Dahlgren says. “But the market is not good and prices are very down.”

This is not to say deals are completely dead. Tom Sestanovich, partner at Ervin Cohen & Jessup’s Real Estate Department, tells GlobeSt.com that LIHTC usage in California is still active. “The market and the prices change every day. There is still demand for these credits.”

A separate but related category are New Markets Tax Credits, which cannot be used for large scale residential projects, essentially if 80% or more of the income from a project comes from housing NMTC cannot be used, Lee Sheller, also a partner at DLA Piper, tells GlobeSt.com.

NMTC have garnered more interest from developers since the start of the crisis but paradoxically from a practical sense they have only been used by the strongest of developers, he explains. As it LIHTC it has been more difficult to tap outside investors for these projects. So developers have had to kick in more money themselves if they wanted to leverage these credits, typically structuring it as a loan to the investment fund that lends to the project, rather or in addition to taking an equity position in the deal.

At the end of May, though, the Treasury Department announced $1.5 billion in New Markets Tax Credit awards for 32 organizations throughout the country, awards that should ease some of the constraints for developers. The awardees announced in May are planning investments in renewable energy projects, charter schools, health care facilities, manufacturing companies and retail centers. Enterprise Community Investment in Columbia, MD, for instance, received $95 million in NMTC authority from Treasury last month. It will be using its new allocation to create a fund for sustainable commercial development.

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