The favorable financing from NMR is possible because a bank or corporation will pay to purchase federal tax credits (New Markets Tax Credits, or NMTCs) from an entity (Community Development Entity or CDE) formed by NMR for financing purposes. The credits are equal to 39% of the equity investment made in NMR's financing entity. The credits are realized by the bank or corporation at a rate of 5% of the equity investment in years 1-3 and 6% in years 4-7 (in total, 39% over seven years). The up-front cash paid by the bank or corporation for the future tax credits may be 30% to 33% of the total cash loaned or invested by the CDE into the project. This up-front cash delivers economic benefit to the owner of the real estate project by virtue of a low interest rate and other favorable terms of the NMR financing.
In addition, a bank or other lender must be willing to make a seven-year interest-only loan for the real estate project. Instead of making the loan directly to the project owner, the bank makes the loan to an investment fund, owned by the buyer of the tax credits. The investment fund makes an equity investment in a subsidiary CDE (the financing entity) formed by NMR. This equity investment gives rise to the tax credits, which flow through to the bank or corporation which owns the investment fund. In some cases, the bank making the seven-year loan is the same bank that buys the tax credits (and owns the investment fund).
NMR (through the financing entity) makes a low interest rate loan or loans to the owner of the real estate project, and sometimes an equity investment as well. The debt service on the loans is calculated at a level which together with distributions attributed to the NMR equity investment allows the NMR financing entity to distribute cash to the investment fund sufficient to pay interest on the seven-year bank loan. Because there are no principal payments for seven years, and because the distributions required for the NMR equity investment are very modest, the interest rate on the NMR loans will be significantly below market.
NMR's loans mature in seven years. At that time the project owner must refinance. However, the NMR financing includes an agreement giving the project owner the ability to purchase the investment fund at its fair market value if the fund hasn't first "put" its interest to the project owner at a pre-agreed price. The effect of this agreement is to give the project owner the opportunity, under certain specified circumstances, to effectively increase its equity and arrange its refinancing on very attractive terms.