Worcester's Junction Shops: $11MM Reasons Not to Demo the Building (or, Historic Tax Credit Financing 101)

In just one week from today, the demo delay currently in effect will expire and the owner of the historic Junction Shops on Beacon St. (circa 1851) will be allowed to apply for a demo permit. This is a big building, and I'm sure there are a number of environmental issues that would have to be addressed as part of any demo, so it is my hope that the significant cost of demo alone will be enough for the owner to continue along his current "do nothing" approach to the property. But I'm not willing to put all my eggs in this basket, so here's another reason that the buildings should not be demolished: demolishing this historic structure (or even just part of it, see story on Preservation Worcester's efforts to save the old Worcester State Hospital Clock Tower, which is all that remains of this once expansive collection of historic buildings) will eliminate the possibility of $11MM in historic tax credit equity that could be applied towards the redevelopment of these structures.

Demolition of the Former Crompton & Knowles Factory Complex at 95 Grand St. is Presently Underway, is the Historic Junction Shops Next on the Demo List? (Image from T&G)

Both the federal government and the Commonwealth of Massachusetts award tax credits to property developers who agree to preserve and/or restore designated historic buildings such as the Junction Shops. The National Park Service (NPS) administers the program in partnership with the IRS at the federal level and the Massachusetts Historical Commission (MHC) in partnership with the MA Department of Revenue administer the program in MA. In both cases the tax credit is equal to as much as 20% of the total costs spent on the historic building (anything spent on the building counts - windows, roofs, electrical and heating systems, etc., all count, but things outside of the historic building, such as a new addition or the cost for the parking lot do not count) and the design is subject to MHC and NPS review and approval both before and following completion of construction.

The federal credit is "automatic." In other words, if you satisfy the design requirements, you automatically earn a federal tax credit equal to 20% of your total actual costs spent on the historic building. For the MA credit, in addition to satisfying the design requirements, you must request an allocation of credits in order to earn the credits. For example, let's say you have a project with $10MM in qualifying costs which at 20% means you could potentially get a credit equal to $2,000,000. However, if MHC has only allocated your project $500,000 in credits, that's the maximum amount your project can use. MHC awards $50MM in credits annually, and applications are accepted three times a year.

Once your project has earned the credits, your almost there, the final step is to convert those credits into cash you can use to pay for the project's expenses. In bigger projects where the credits can climb into the millions of dollars, the typical arrangement is for the property developer to partner with a tax credit investor who agrees to "buy" the credits in exchange for cash. Typical buyers include large insurance companies such as UNUM and AEGON, and national banks such as Bank of America and others. Now these investors buy these credits at a discount, say $0.85 for every dollar worth of credits, so a project that generates $2,000,000 in credits will yield $1,700,000 that can ultimately be put towards the cost of the project. Yes, I know it's complicated. But when we are considering a net cash infusion of as much as $1.7MM into a $10MM plus project, it's well worth the hassles.

Following the above process, here's the math for the Junction Shops:

• The building is approximately 200,000 SF in size. Let's say hard costs (i.e., just construction costs) to rehabilitate the building are $150 per square foot plus an additional 20% of that number, $30 per square foot, for soft costs (i.e., lawyers, permits, taxes, insurance and interest during construction, etc) resulting in a total cost of $180 per square foot or $36MM.
• Of that $36MM, let's say 90% of that number, or $32.4MM, is for costs related to the historic building and not additions, parking lots, etc.
• Both the MA (for the purposes of this exercise let's assume we get a full 20% allocation from MHC) and federal credit are then calculated at 20% of this number or $6.48MM each or a total of $12.96MM in state and federal tax credits.
• Finally, we need to convert these credits into equity that we can use to pay project costs. Let's assume our investor, Acme Corporation, fresh off a banner year selling rocket powered jet packs to cartoon coyotes all across the west is facing a large tax liability. They agree to buy our credits for $0.85 per $1.00 of credit, which means they pay less in taxes and we realize about $11MM in equity that we can use to help cover project costs.

Assuming we paid $1MM for the property, that $11MM in equity will pay for 30% of the total development costs for this project, not a bad start in my book! That is, of course, assuming the building is still around to be redeveloped.