Historic renovation projects, like the ones shown here, offer different challenges and rewards from standard construction.

When, in the 1930s, John L. Lewis, leader of the United Mine Workers of America proclaimed, "I have pleaded your case from the pulpit and from the public platform—not in the quavering tones of a feeble mendicant asking alms, but in the thundering voice of the captain of a mighty host, demanding the rights to which free men are entitled," he was speaking on behalf of four million industrial workers. He fought hard for them and won for them, raising their wages over a billion dollars.

More recently, Summit Properties Inc., Charlotte, NC, pleaded the case for returning the historic building from which Lewis once addressed the nation, advised presidents and challenged corporate leaders, to its original stateliness. Located in the bustling McPherson Square area of Washington, D.C., the former UMWA building, originally built in 1912 as a private club for the local elite, with its ornate millwork, fireplaces and wood paneled offices will be preserved for apartment living, 105 units in all. Its grand salon with 24-foot vaulted ceilings and oversized French doors open to the Square's park will be transformed into an upscale restaurant.

When it comes to refurbishing timeworn buildings that sparkled in a bygone era, restoring their grandeur can be a wise choice. Those, like Summit Properties, who take on the chore of renovating historically designated property are rewarded for their creativity with a unique classic building, often in prime locations, and inexpensive capital through the sale of historic rehabilitation tax credits.

Tax Credits = Lower Cost Capital
"Without the historic tax credits this deal gets harder for us to do, economically," said Mike Schwarz, CFO, Summit Properties Inc., "But, with the credits it's going to be good for everybody."

Federal historic tax credits have been available for redevelopment since the 1970s, said John Leith-Tetrault, director community partners, Heritage Property Services, National Trust for Historic Preservation, Washington, D.C. The National Trust, through its fee-for-service initiative, Heritage Property Services, is an active syndicator/seller of historic credits. "[Historic tax credits are] a 20 percent credit against the cost of rehabilitation," he said. "That includes whatever it costs to fix the property plus any associated soft cost, i.e., architects, attorneys. It's a dollar for dollar reduction off of a company's income tax."

However, real estate companies that pursue historic redevelopment should keep in mind: The project must stay in business for five years or the tax credits will be subject to recapture. "You have to pick the deal that works," said Leith-Tetrault. While non-REIT public real estate companies can take tax credits associated with historic redevelopment projects against their income, REITs that want to develop these properties are faced with a unique challenge: finding a partner that will purchase the tax credits.

"You have to find an investor who can use these credits," said Schwarz. Once an investor is found, the REIT will form a partnership with that corporate investor after completing financial negotiations. That partnership, of which the REIT remains the general partner with a one percent interest, then owns the properties and the tax credits are purchased by, then passed to the limited partner or investor that owns a 99 percent interest in the partnership. Partnerships typically run five to seven years during which time the building must be a viable business and historic tax credits must be utilized. When the partnership is dissolved the REIT buys-out the limited partner who also participates in the property appreciation. The REIT then owns the building outright.

Master Realty Properties Trust is renovating both the Garment District and the River Market area in Kansas City, MO.[Click for larger image]

"From our perspectives, it's lower cost capital than we can otherwise source," explained Schwarz. During negotiations, REITs and investors work out pricing on tax credits which may be discounted anywhere from 80 cents to 90-plus cents on the dollar. Even though the corporate investor buys the credit at a discount, it still deducts the full dollar value from its income tax bill.

How much the investor pays for the credits is negotiated up front and since that money is used to refurbish properties, most REITs prefer to receive the funds early on. "It is cheaper than alternative capital," Schwarz added. "The later it comes in means you have to use other more costly funding."

Finding Value Where Others Don't
REITs, like residential developer Summit Properties, are finding that historic buildings in downtown areas are opportunities because their landmark designation prevents their demolition and they are often too small for today's office market. "If you want to invest in downtown residential housing you're always going to compete with office developers who have better economics than residential developers," said Baum. "As a result you don't find much housing mixed into downtown cores. But, we can come in and gain a competitive advantage with this type of building."

REITs in all sectors are finding choice historic sites to redevelop. In San Francisco, CA, Cornerstone Properties is refurbishing a historic bayside complex, and Madison Park REIT is turning old warehouse properties into live/work lofts in surrounding Northern California. In Kansas City, MO, Master Realty Properties Trust is reshaping two historic districts as they rehabilitate old warehouses into trendy mixed-use properties. And, FelCor Lodging Trust Inc. found that many guests are drawn to hotels with a bygone flair.

At the foot of Market Street on San Francisco's Embarcadero is the city's famous Ferry Building, now listed in the National Registry of Historic Places. In its 1930s heyday the Ferry Building, built in 1898 as a terminal for ferry services that served the Bay Area, was the most heavily traveled transit building in the world after Charing Cross Station in London, England.

Around 50 million people passed through its doors each year until the bay bridges were built in the late 1930s. Since then, it's had many uses, some of which caused its original architecture to be modified. Cornerstone intends to return the three-story building to its original design that features an interior concourse. Upon completion in 2002 it will be converted into 161,095 sq. ft. of office space and 55,459 sq. ft. of retail space. The anticipated net cost of the project is $57.5 million with $9.3 million in historic preservation tax credits that will be sold to an investor.

"[Tax credits are] a very competitive area and we will effectively bid the package when we get to that point," said Richard Springwater, vice president development. "We will offer it to a number of intermediaries and the one prepared to provide the most benefits will be selected."

Edison Capital Housing Investments, Irvine, CA, is one investor that is familiar with these kinds of projects. In a typical Edison Capital partnership the REIT would receive proceeds from the sale of the tax credit in the first year the property is placed in service. To maintain the limited partnership status the investor must participate in the underlying economies of the property: rent and appreciation. The cash flow participation that the limited partner requires in this structure is probably less than the equivalent of what the REIT would have had to pay if it borrowed on equity.

"The limited partner makes an equity contribution to the partnership because it is receiving the benefit of the tax credit," explained David Nahas, acquisition director. "For every dollar of tax credit [Edison Capital Housing Investments] receives, we pay 93 cents of equity into the partnership. The REIT gets the equity investment of 93 cents on the dollar up front and that pays [in part] for the cost of acquiring or rehabilitating the property. It ends up being a low cost form of borrowing for the REIT," said Nahas.

Gaining Credits
Tax credits don't come easy. For each project under redevelopment, the REIT or general partner must apply to the National Park Service to be awarded the tax credits. John Protopappas, Madison Park Real Estate Investment Trust, Oakland, CA, explains: "You have to register your property with the National Park Service and go through a three-step process. Part I is an application introduction on what you want to renovate and what you're interested in certifying. Part II is the actual specifics of construction and renovation, and, Part III is an inspection to insure that the work in Part II is completed. Once Part III is approved, you can obtain the federal tax credits."

Madison Park REIT sold approximately $2.1 million of tax credits earned in the rehabilitation of the Oakland Tribune Tower to First Union Capital Markets Affordable Housing Group through a limited partnership. The building, initially opened in 1907, received a 20-story tower in 1923. Madison Park re-opened it in 1999 with the Oakland Tribune newspaper as the major tenant, holding 93 percent of the space.

"There's no way this project would have made sense for us to do without this tax credit," explained Protopappas. "This policy encourages the renovation of historic properties in this country for an economic profit. It made a huge difference on this project."

Working With Investors
There are three ways that a REIT can work with an investor, according to Madison Park REIT investor First Union Capital Markets: as a mortgage lender, a partnership, or a sandwich lease. As a mortgage lender the REIT would finance the property, as a general partner the REIT would enter into a long-term lease of the land and building shell, and finally, as a sandwich lease, the REIT would lease the project from the partnership and then sublease to end-users.

"Assuming a property is generating $15 million in rental income, the general partner, or REIT, might want to become a tenant of the building and master lease the complex from the limited partner for $5 million, pay that to the partnership and keep the $10 million," said Rick Davis, director, equity investments, First Union Capital Markets Affordable Housing Group, Charlotte, NC. "In a sandwich partnership, the REIT would get the $5 million and share in operational profits from rental income."

In 1999, First Union Capital Markets Affordable Housing Group invested $86 million in historic properties. "If I can pay 85 cents for a credit that reduces my taxes by a dollar that's great for the corporation," said Davis. "As a bank, it's good for us to restore a landmark in a city or a town that a lot of people remember." Keeping History Alive
In some cases, restoring buildings in designated landmark districts makes sense for REITs. In Kansas City, MO, Master Realty Properties Trust, with a bonus 25 percent historic state tax credit, is reinvigorating the city's historic Garment District that was built between the 1890s and 1920s and the River Market that was built between 1860 and 1890, building by building. Overall, the REIT owns or controls 29 historic buildings of which 25 are finished projects and four are underway and are expected to be complete by 2001.

In River Market, on the banks of the Missouri River, Master Realty owns refurbished mixed-use buildings where Wild Bill Hickock once patrolled the streets as a U.S. marshall, a poorly disguised Jesse James strolled the neighborhood and actress Sarah Bernhardt performed at the Gillis Opera House.

While renovating the 1889 Builders and Traders Exchange Building in the historic Garment District that was once the second or third largest (depending on which historian you ask) clothing manufacturing center in the nation, Master Realty made an exciting discovery. Oftentimes, historic renovation uncovers extensive damage or environmental problems, but in this building hidden behind walls was a five-story atrium topped with a glass rotunda in the center of the building.

"When the contractor first started to cut into the wall, we didn't know it was an atrium building," said Thomas Trabon, executive vice president. "It was a pretty neat find."

Research showed that the construction trades used this building as a bidding center, according to Trabon.

"If, in 1905, you needed 1,000 running foot of board you'd go to this place and the dealers would display their wares in this atrium and the trades would start bidding," he said.

This building, along with an adjoining 1892 Burnham-Hanna Munger Manufacturing Dry Goods Co. warehouse and the 1895 Barton Bros. Shoe Company headquarters is now a Historic Suites of America.

Clearing the Hurdles
While tax credits make financing these projects economical, and their historic significance makes them fascinating, finding the right site and working within the historic preservation guidelines is often tedious.

Master Realty Properties Trust looks for buildings that meet their criteria. First staff look at the shape of the building and the floor plate (size of floor). Then, they consider the configuration of each floor to discern whether or not it can be adapted for residential use. Second, they consider the basic structural integrity of the building. And third, they consider the cost of the building.

"We have relatively low market rents in Kansas City," explained Trabon. "Our rent is 85 cents to 90 cents a square foot. We've had a lot of developers come in to Kansas City and they usually go home because they need $1.10 a square foot rent to put together a transaction. What helped us is the Missouri historic tax credit. It brought our cost down by 25 percent. That's brought us in line to where market rents work."

Once a building meets its criteria, the REIT moves ahead with the project, diligently working within the building codes that cover structures built years before building codes were developed. "When you renovate a historic building and your goal is to get tax credits, you have to do a rehabilitation that qualifies under the Department of Interior standards," he said. "They administer what you're doing and how you're doing it. It gets very complicated."

Recognizing the difficulty and prohibitive costs in taking current building codes and applying them to notable buildings, some cities have adopted historic building codes that are a little more liberal on certain construction issues. Kansas City is in the process of adopting such a policy.

With or without the historic building codes, one of the biggest issues facing historic building contractors is windows that cannot be altered. If windows need to be replaced, they must be duplicated and, depending on the building type, that becomes a very expensive and time-consuming process because they have to be custom built. And, since the windows cannot be moved, floor plans must be adapted to work with the window locations.

"These buildings were built 100 years ago," explained Roger Buford, vice president, Recon Development, Kansas City, MO, and Master Realty trustee. "Adapting them to code is the largest challenge that we face. It takes a city development and code staff, Missouri Department of Natural Resources staff, and Department of Interior staff all working together to be able to adapt a building to current codes."

Historic Chic
Oftentimes, historic buildings, once renovated, make for elegant hotels. "Historic property has a little more cache, class," said Thomas J. Corcoran, Jr., president and CEO, FelCor Lodging Trust Inc., Irving, TX. "I think there's something romantic about it."

FelCor owns three historic properties, which Corcoran said were acquired more by accident than strategy: The Mills House Hotel in Charleston, SC, where townspeople watched the flames of Charleston's 'Great Fire' sweep through the town in 1861, the Embassy Suites-Lofts in New Orleans, LA, a 100 year old building that was a sugar refinery in 1912; and the Allerton Crown Plaza in Chicago, IL. The latter property was once a residential "club hotel" for men in 1924 and home to the Tip Top Tap cocktail lounge where radio personality Don McNeill broadcast "The Breakfast Club with Don McNeill" in the 1950s.

"The leisure customer does enjoy the boutique-ness," said Corcoran. "You're treating someone special when you take them to a historic hotel. People are willing to pay a little bit more if it's truly a unique experience."

Whether it's an apartment, office building, or hotel, it's clear that historic buildings can be financially rewarding to REITs, and more. For some, it's more than the challenge. It's the "love of bringing a historic building back to life," noted Trabon.