Financing high-tech communications centers with tax credits

Real Estate Weekly, Jan 10, 2001 by Robert Plotka

The Internet revolution has revitalized the neglected downtowns of many American cities, while steadily reducing the commercial vacancy rates. As a result, the new-economy high-tech communications sites, also known as data centers, telecom hotels, and carrier facilities, have become a prominent and influential component of the commercial real estate industry.

High-tech communications centers tend to house the computerized servers where Internet-related companies store and manage data and switching devices that route telephone calls between long-distance carriers and local networks. Designed for around-the-clock business operations, they are outfitted with redundant power and telecommunications connections and specialized HVAC systems, as well as back-up generators and fuel tanks to lower the chance of an interruption in service. With no requirement for windows, these buildings usually have at least 13-foot high ceilings, heavy, load-bearing floors with the capability to support more than 250 pounds per SF, and large floor plates with wide spacing between columns. However, the greatest magnet for such buildings is the proximity to major fiber-optic back-bones and cables that reside along the railroad right-of-ways and under some highways and city streets.

In the race to meet the needs of these telecommunications and Internet-related companies, building owners are converting old commercial buildings in major metropolitan cities, such as former warehouses and distribution centers, into highly specialized high-tech facilities. This conversion activity is being spurred by the fact that old commercial buildings tend to be the ideal candidates for adaptive reuse because they generally offer the required high ceilings, reinforced floors, large floor plates, and nearby fiber-optic backbone access. In addition, because there are fewer human tenants, under-utilized elevators can be transformed into riser space for communication and power cables.

However, what building owners may not realize is that some of these conversions may be eligible for federal rehabilitation tax credits that can be converted into equity dollars to finance the rehabilitation project. Calculated as a percentage of qualified rehabilitation expenditures, federal tax law offers a 10% tax credit for substantial rehabilitation of non-historic, non-residential buildings built before 1936 and a 20% tax credit for substantial rehabilitation of historic buildings.

These tax credits can be either used to reduce the building owner's federal tax liability on a dollar-for-dollar basis or transferred to a corporate investor in exchange for additional equity capital that can be utilized for long-term financing of the project. Because the Internal Revenue Code's Passive Activity Rules and Alternative Minimum Tax Regulations severely limit and, sometimes, prohibit the use of tax credits by individuals, most building owners syndicate the tax credits to a third-party corporate investor who can utilize the tax credits. For example, $50 million in qualified rehabilitation expenditures would generate either $5 million in 10% rehabilitation tax credits or $10 million in 20% historic rehabilitation tax credits that, in return, could generate approximately $4.5 million or $9 million in equity financing.

For those building owners who are unfamiliar with the nuances of the rehabilitation tax credit and the highly structured, tax code intensive syndication process, the tax credit syndication process can be outsourced to an experienced rehabilitation tax credit financial advisory firm.

In conclusion, driven by the rise of the Internet and telephone deregulation, these new-economy companies need suitable building structures to house their expensive and sensitive equipment. To meet this demand, building owners can benefit from the federal rehabilitation tax credit program that was created to encourage preservation and adaptive reuse of the nation's old and historic buildings. For qualified rehab conversions, federal rehabilitation tax credits can serve as a viable secondary financing source for the transformation of old commercial buildings into high-tech communications centers.