Industry Insights

In a sign of today’s challenging real estate development market, public-private partnerships are capitalizing on anticipated market preferences for tax-exempt bonds. While traditional private capital markets have all but closed to developers, the public sector is increasing bond financing volumes to provide capital for desirable projects.

Because income tax rates are expected to climb steadily over the next several years, investors are migrating toward tax-exempt bonds for superior after-tax returns and the relative safety of government-sponsored development. Public-sector infrastructure investment can generate an increased tax base for the community, providing funding sources to repay the bonds issued for the infrastructure investment.

These partnerships sometimes draw on creative financing structures. A new idea is Build America Bonds (BABs), in which the federal government subsidizes taxable state or local bonds with separate credits or payments to reduce the rate to the equivalent of tax-exempt rates. (Click here for more information about the BAB program.) While BABs are slated to expire after 2010, President Obama’s 2011 budget proposed to permanently extend this program and allow tax-exempt 501(c)(3) organizations to issue these taxable bonds.

This proposed law change would give BABs equal footing with an old but resurgent financing technique, 63-20 Bonds. These tax-exempt bonds are issued by a nonprofit to construct public facilities and infrastructure. Under a 1963 IRS Revenue Ruling, Rev. Rul. 63-20, the nonprofit economic development entity issues the tax-exempt bonds, the government agency leases the project until the bonds are retired, and a construction company provides a guaranteed maximum price for the project. When the bonds are repaid, the nonprofit agency transfers ownership of the facility to the government agency for a nominal fee. This structure avoids regulatory burdens that typically come with government projects. Because a nonprofit, rather than the government, issues the tax-exempt bonds, restrictions such as prevailing wage can be avoided.

Opportunities for nonprofit community development corporations using 63-20 bonds—or BABs if the enabling legislation moves forward—should be significant. Developers who have been unable to finance projects in this environment will find a new source of financing in partnership with nonprofit agencies and government lessees.