Business owners exploring financing options for projects in low-income communities quickly encounter the New Markets Tax Credit (NMTC) Program as a potentially valuable resource. However, one of the most common questions that arises during initial exploration concerns the actual amount of funding available through this program. Understanding what percentage of my project cost can be covered by New Market Tax Credits is essential for determining whether NMTC financing makes sense for your specific situation and for planning the overall capital stack that will bring your project to fruition.
The Fundamental NMTC Financing Structure
Before answering what percentage of project costs NMTCs can cover, it’s crucial to understand that NMTCs are not grants or direct subsidies. Rather, they are tax credits provided to investors who make Qualified Equity Investments (QEIs) in certified Community Development Entities (CDEs). These CDEs then use the invested capital to make Qualified Low-Income Community Investments (QLICIs) in operating businesses or real estate projects located in designated low-income census tracts.
The tax credits equal 39% of the QEI amount, claimed over seven years by investors. This credit structure incentivizes investors to accept below-market returns on their investments, effectively subsidizing the cost of capital for qualifying businesses. The economic benefit to project sponsors comes not from receiving the full QEI amount as usable capital, but from accessing financing at significantly reduced interest rates compared to conventional alternatives.
Typical NMTC Coverage Percentages
In most NMTC transactions, the program can cover approximately 20% to 40% of total project costs, though this range varies significantly based on transaction structure, project characteristics, and market conditions. Understanding what percentage of my project cost can be covered by New Market Tax Credits requires examining how the typical NMTC transaction is structured and how that structure affects usable proceeds.
A standard NMTC transaction involves a leveraged structure where the CDE receives a QEI from an investor, then combines that investment with a leveraged loan to create the total investment in the qualified active low-income community business (QALICB). A common structure might involve a 75% leveraged loan and a 25% equity-equivalent investment, though ratios vary.
For example, consider a $10 million project. The business might receive a $5 million NMTC allocation structured as follows: a $3.75 million leveraged loan at market rates and a $1.25 million equity-equivalent investment at zero or minimal interest during the seven-year compliance period. However, the usable proceeds to the business after accounting for transaction costs, reserves, and investor compensation might be approximately $4 million to $4.5 million, representing 40% to 45% of the total project cost.
The remaining 55% to 60% of project funding must come from other sources, which might include conventional bank financing, equity contributions from owners, other public incentives, or subordinated debt from various sources. This capital stacking is standard in NMTC transactions and requires careful coordination among multiple financing sources.
Factors Affecting Coverage Percentages
Several factors influence what percentage of my project cost can be covered by New Market Tax Credits in any specific transaction. Understanding these variables helps businesses set realistic expectations and plan appropriately.
Project location significantly affects NMTC availability and terms. Projects in highly distressed areas or communities with severe economic challenges often receive more favorable treatment, potentially accessing larger NMTC allocations relative to project size. CDEs with specific mission focus on particular geographies may offer better terms for projects aligned with their target markets.
The type of project matters considerably. Real estate development projects, particularly those involving commercial or mixed-use properties, often achieve higher NMTC coverage percentages than equipment purchases or working capital needs. This stems partly from the ability to secure additional collateral and from CDE preferences for projects creating lasting community assets.
Business financial strength and creditworthiness affect leverage ratios and overall structure. Stronger businesses with solid financial projections and experienced management teams can support higher leverage, potentially allowing larger total NMTC investments relative to project costs. Conversely, riskier ventures may require more conservative structures with lower leverage and smaller total NMTC allocations.
Transaction size plays a role, with larger projects often achieving economies of scale that allow higher net proceeds as a percentage of total costs. Transaction costs represent a relatively fixed burden, so they consume a smaller percentage of larger deals. Projects under $3 million often struggle to achieve attractive NMTC coverage percentages due to the disproportionate impact of transaction costs.
Market conditions and CDE capacity influence available terms. During periods when NMTC allocation authority exceeds demand, businesses may negotiate more favorable terms, potentially accessing larger allocations or better pricing. Conversely, when allocation authority is constrained and competition is intense, terms may be less favorable.
The Leverage Loan Component
The leveraged loan portion of NMTC financing typically represents 70% to 80% of the total NMTC investment. This loan carries market or near-market interest rates and must be repaid according to negotiated terms, usually over 20 to 30 years. While the leverage loan provides significant capital, its market-rate pricing means it contributes less to the economic benefit than the equity-equivalent investment.
Understanding what percentage of my project cost can be covered by New Market Tax Credits requires recognizing that the leverage loan functions similarly to conventional financing, providing capital but at conventional costs. The primary benefit comes from accessing this capital as part of a package that includes the below-market equity-equivalent investment.
Some transactions use external leverage, where a conventional lender provides the leveraged loan directly, while others employ internal leverage, where the investor provides both the leverage loan and the equity investment. The choice between internal and external leverage affects transaction economics, closing complexity, and the ultimate percentage of project costs covered.
The Equity-Equivalent Investment
The equity-equivalent investment, typically representing 20% to 30% of the NMTC allocation, provides the core economic benefit. This investment usually carries zero or minimal interest during the seven-year compliance period, dramatically reducing debt service requirements and improving cash flow.
At the end of the compliance period, most transactions include put-call provisions allowing the business to purchase the investor’s interest for a nominal amount, often $1,000 or less. This structure effectively converts the equity-equivalent investment into a zero-interest loan that disappears after seven years, maximizing the financial benefit to the business.
The size of the equity-equivalent investment relative to total project costs significantly affects overall benefits. A larger equity-equivalent component means more capital at zero interest, increasing the percentage of project costs covered on favorable terms. However, larger equity investments require more investor capital and thus larger NMTC allocations, which may not always be available.
Transaction Costs and Net Proceeds
A critical consideration in determining what percentage of my project cost can be covered by New Market Tax Credits involves accounting for substantial transaction costs that reduce net usable proceeds. As discussed in previous analyses, NMTC transactions involve fees for legal counsel, accounting advisors, CDE services, syndication, and various other expenses typically totaling $750,000 to $1.5 million or more.
These costs are usually paid from the NMTC proceeds before funds reach the operating business, reducing the net capital available for project expenses. For a $5 million NMTC allocation with $1 million in transaction costs, only $4 million remains for actual project funding, representing 80% of the nominal allocation amount.
When calculating coverage percentages, businesses should focus on net proceeds after all costs rather than gross allocation amounts. A $5 million NMTC allocation funding a $10 million project might appear to cover 50% of costs, but if transaction costs consume $1 million, the actual coverage is 40%. This distinction is crucial for accurate capital planning.
Maximizing NMTC Coverage Percentages
Businesses seeking to maximize what percentage of project costs can be covered by NMTCs should consider several strategies. Right-sizing projects to align with available NMTC allocation while maintaining operational viability helps optimize coverage. Oversized projects may struggle to secure adequate NMTC funding, while undersized projects pay disproportionate transaction costs.
Demonstrating strong community impact through job creation, blight remediation, or essential services provision makes projects more attractive to CDEs, potentially enabling larger allocations. Projects that clearly advance community development missions receive preferential treatment in the allocation process.
Structuring projects to minimize costs and maximize efficiency improves the relationship between available NMTC funding and total project needs. Value engineering, phased development approaches, and creative design solutions can reduce total costs, allowing NMTC funding to cover larger percentages.
Combining NMTC financing with other public incentives, including historic tax credits, opportunity zone benefits, state tax credits, or economic development grants, can dramatically improve overall project economics. These layered incentives may allow NMTC allocations to cover smaller percentages of total costs while still making projects financially viable through the combined benefit package.
Realistic Capital Stack Examples
Consider a $8 million mixed-use development project in a low-income community. A realistic capital stack might include:
- NMTC financing: $3.5 million (44% of project cost), consisting of a $2.6 million leveraged loan at 6% interest and a $900,000 equity-equivalent investment at zero interest
- Conventional senior debt: $2.5 million (31% of project cost) at 7% interest
- Owner equity: $1.5 million (19% of project cost)
- Historic tax credit equity: $500,000 (6% of project cost)
After accounting for $800,000 in NMTC transaction costs, net NMTC proceeds available for project expenses are $2.7 million, representing 34% of total project costs. Combined with historic tax credits, public incentives cover 40% of the project.
For a $15 million manufacturing facility expansion, the capital stack might look different:
- NMTC financing: $7 million (47% of project cost), structured as $5.25 million leveraged loan and $1.75 million equity-equivalent investment
- Equipment financing: $4 million (27% of project cost)
- Owner equity: $3 million (20% of project cost)
- Subordinated state loan: $1 million (7% of project cost)
Net NMTC proceeds after $1.2 million in transaction costs equal $5.8 million, covering 39% of total costs. The larger transaction size allows better cost efficiency and higher net coverage percentage.
When NMTC Coverage Is Insufficient
Some projects discover that what percentage of project costs can be covered by NMTCs falls short of what’s needed for financial viability. In these situations, businesses must either scale back project scope, seek additional funding sources, or reconsider whether the project should proceed.
Gap financing from various sources can bridge shortfalls between NMTC proceeds and total project costs. Economic development authorities, philanthropic organizations, and mission-driven lenders sometimes provide subordinated debt or grants that complete capital stacks for worthy projects with public benefit.
Phasing project development allows businesses to complete initial stages with available NMTC funding, generating cash flow that finances later phases. This approach requires careful planning to ensure early phases create viable operations capable of supporting debt service and additional investment.
Understanding Allocation Limits
The Community Development Financial Institutions (CDFI) Fund allocates NMTC authority to CDEs through a competitive application process. CDEs can only invest up to their available allocation authority, creating practical limits on what percentage of project costs can be covered in any given year.
Individual project allocations typically range from $2 million to $15 million, though some larger projects receive more substantial allocations. CDEs generally limit allocations to ensure they can serve multiple projects and maintain diversified portfolios. Projects requiring allocations exceeding individual CDE capacity may need to work with multiple CDEs, adding complexity but potentially accessing larger total funding.
Conclusion
Understanding what percentage of project costs can be covered by NMTCs requires recognizing that typical coverage ranges from 20% to 40% of total costs, varying with transaction structure, project characteristics, and specific circumstances. The economic benefit stems not from the nominal allocation amount but from accessing below-market financing that reduces debt service and improves cash flow throughout the seven-year compliance period.
Successful NMTC-financed projects typically require multiple funding sources carefully coordinated into comprehensive capital stacks. By understanding realistic coverage percentages, planning accordingly, and working with experienced advisors, businesses can effectively leverage NMTCs as part of broader financing strategies that enable impactful projects in underserved communities.