MRED Paper

Valuation of the Historic Preservation Tax Incentive Program in California

Master of Real Estate Development Candidate, 2010
University of Southern California
Price School of Public Policy

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The financial valuation of historic properties is more art than science. Historic buildings have an inherent complexity that can create opportunities for success, and spectacular failure—these complexities are often beyond the grasp of the most thorough analysis. The rehabilitation process often contains unforeseen financial risk unaccounted for in the contingency budget of any economic model. This inherent risk is a primary premise behind the Federal Historic Preservation Tax Incentive program administered by the National Park Service. The tax incentive program was originally intended to reward private investment for rehabilitating income producing historic properties, and mitigate some of the risk of historic rehabilitation.

The goal of this paper is to review analytically the historic tax credit program, tracking the program with data spanning the thirty-two years of the program’s existence. First, this paper will perform an overview of the tax certification program within California since the program’s inception in 1977, analyzing the program against the value of new construction over the same period. Next this paper will review the location based trends of tax credit projects, looking at where these projects are located and why. Last, this paper will analyze market rents in San Francisco and Pasadena for both historic and nonhistoric properties, utilizing this data to assess the impact of age on the cost-per-square foot of properties.

[This paper appears in the Casden Economic Forecast of 2010]


Since 1976, the Internal Revenue Code has contained provisions offering tax credits for historic buildings rehabilitated for income-producing purposes. The historic preservation tax incentive program has been used throughout California to promote the reuse of historic buildings, and stimulate private investment in older structures. The National Park Service (on behalf of the Secretary of the Interior) jointly administers the program with the Internal Revenue Service (on behalf of the Department of the Treasury), in partnership with State Historic Preservation Offices of California. The Historic Tax Incentive Program provides a10% or 20% tax credit for qualifying hard and soft cost expenditures during the rehabilitation process (Internal Revenue Service, 1990). The 10% rehabilitation tax credit applies only to “non-historic buildings placed in service before 1936 and rehabilitated for non-residential use” (National Park Service). The 20% rehabilitation tax credit applies only to certified rehabilitation projects conducted on certified historic structures (defined as greater than fifty years old, or of exceptional significance). The 20% rehabilitation tax credit is available for properties rehabilitated for income producing purposes, specifically commercial, industrial, agricultural, or rental residential properties.

Tax credits vary widely depending on the scope and requirements of the qualifying hard costs, thus making valuation of the tax credit program difficult. The National Park Service defines qualifying hard costs as those expenditures on work that impact the historic integrity of the structure. However, qualifying hard costs are often difficult to quantify, and if often based on the opinion and analysis of the reviewing agency. The variance in the definition of qualified costs thus presents a challenge to an overall analysis of the tax credit program.

Last, prior studies have tried to quantify the monetary value and trends of the historic preservation program or historic buildings as an overall “asset class.” Redfearn (2008) suggests that, depending on the economic status of the community, residential inclusion in a historic district may have a positive impact on the value of historic residential dwellings. This paper focuses on the commercial sector within building rehabilitation, and is informed by a number of previous analyses of the Internal Revenue Code (Section 47 – Rehabilitation Credit).1 However, most research attempting to quantify the impact of an intangible asset such as “historic value” rarely grapple with the inherent complexity of historic preservation and the rehabilitation process. The current paper will present an analysis of a data set gathered to address a specific element of the preservation tax incentive program.

Preservation Equity

Since the program’s inception in 1977, the rehabilitation tax credit program in California has distributed over three and a half billion dollars to nearly 1000 certified projects.. The vast majority of the rehabilitation projects use tax credits to reduce the amount of developer equity needed to complete construction, obtain a construction loan, or repay a land/building acquisition loan. General partners can qualify for tax credits, but because they often have small income tax liability, they are typically unable to use the tax credits within their own business enterprises. In such cases, the general partner will enter into a limited partnership with a tax credit investor that “purchases” the tax credits. The process of syndication provides a significant gain in capital for rehabilitation projects, and is often integral to the revitalization of historic projects.

Figures 1 shows how the trend of tax credit distributions closely matches the movement of the market (US Census data) over the previous three decades. The data set reveals that the preservation tax incentive program is not a shelter to the movements of the market, an idea preservation advocates often present. Figure 1 demonstrates that the preservation tax incentive program is volatile, with a strong correlation to the overall real estate market. The relative increase and decrease in value over time indicates that the volume of tax credit allocations is a factor of the overall market for new development. The preservation tax incentive program does not “incentivize” new development, but rather creates an investment vehicle that may be appealing to some equity investors or general partners in times of strong real estate markets.

Owing to the inherent regulatory risk within the tax incentive program, developers often do not underwrite historic tax credits into an initial pro-forma. Interviews with developers of historic properties present a compelling reason for this. Often, developers will not pursue historic preservation projects unless the project will be profitable in the absence of the tax credit program because of the regulatory risk. Thus, the tax incentive program works as a “carrot” by which developers can achieve a higher internal rate of return. If the tax credits are withheld because of regulatory disagreements between the developer and the reviewing agency, the developer is not tied to the reviewer’s decision for the financial success of a project.

Figure 1
Figure 1: The total value of the historic tax incentive program in California since its inception, with both the total credit value at the time of investment and this same investment noted in present value at a 3.4% growth rate.

Figure 2
Figure 2: The number of projects within given hard cost ranges

The Centralization of Rehabilitation Projects

This research initially began as a test of whether historic preservation created positive externalities to nearby buildings or proprieties. These externalities would manifest themselves in higher property prices. Although a vast number of buildings have received tax certification, inadequate numbers of transactions prevented the identification of a correlation between tax certification and property values. The data show that owners tend to hold projects after completion of adjacent tax certified rehabilitations. A second, but less common phenomenon, was the consolidation of the ownership of historic properties into one project area, followed by an en-mass application to the tax certification program.

Figure 3
Figure 3: The agglomeration of approved historic tax credit projects in downtown Pasadena

Surprisingly, the presence of historic district status has little impact on the siting of tax credit properties. Prior inclusion in a certified historic district may reduce the requirements for approval of the Part 1 application, allowing only proof that the building is a “contributor” to the historic district. But an analysis of Los Angeles revealed that of 281 certified rehabilitation projects, only 4 fell within Historic Preservation Overlay Zones defined by the City of Los Angeles. Barriers to approval of a historic district and lack of commercial structures within existing historic districts explain this seeming anomaly. First, historic districts create an additional, and often significant, step in the approvals process for any project within the district. This barrier has a tangible, positive or negative, impact on the valuation of the building. Thus, to limit this potential for negative impact on the overall property value, commercial building owners often resist inclusion within a proposed historic district or individual listing on the National Register of Historic Places. Second, existing historic districts tend to be residentially focused or are lower density industrial areas. As a result, although tax credit projects cluster, they tend to cluster outside of existing historic districts.2

At this point, the Federal Tax Certification Program requires the properties to produce income. Although this may change (proposed Amendments to Tax Code Section 47, August 2009), the current rules limit the tax credit project to a specific subset of historic proprieties. The properties must be large enough to generate a cash flow able to sustain the debt, as well as covering the operating costs of a historic property. Thus, historic tax credit project tend to be in urban locations, and are often densely centered within a specific downtown districts or revitalization areas.

Figures 4 and 5
Figures 4 & 5: Approved tax credit projects by county since 1977

Historic Preservation and Commercial Rents

Preservation advocates often argue that the boutique nature of historic properties gives them an advantage in the marketplace. Although the boutique “appeal” may be tangible, in the current rental market, historic properties are generally classified as Class B Office rental space (with some notable exceptions such as the Ferry Building and One Market in San Francisco). Valuation of historic properties can often be difficult because some aspects of historic properties that do not lend themselves well to analytical research. In preservation parlance, this concept is referred to as “intangible heritage,” a theory that warrants further exploration outside of this paper (UNESCO, 2009).3 This analysis provides a valuation of historic buildings by examining rents, thus “quantifying” the intangible nature of historic buildings.

To get a first cut of the impact of historic preservation status on rent, we limit ourselves to leases with the following characteristics: they are for the downtown submarkets of San Francisco and Pasadena, the first through tenth floors of the historic and non-historic buildings (to eliminate the premium for views available in taller (newer) buildings), and for contiguous space of 5,000 to 12,000 square feet. This range of square footage tends to have a homogeneous user type, with similar characteristics and usage parameters. These controls allow us to have a reasonable set of comparables between historic and non-historic properties.

The analysis found that historic buildings had a rent discount of approximately 14% relative to their modern counterparts. The average annual rent per square foot for commercial office space in San Francisco during November of 2009 was $31.46 per square foot. This data was then split into those that qualify as historic (older than 50 years, or 1959), and those built after 1959. Commercial office space within historic buildings was offered at an average of $28.33 per square foot, as compared to an average cost per square foot for buildings built after 1959 of $33.03. The average rent per square foot for historic buildings included substantial outliers such as the Ferry Building (offered at $65.00 per square foot). This analysis suggests that the historicism of an existing building did not have a substantial positive impact on the cost per square foot of rent in San Francisco. Figure 6 shows a similar relationship for downtown Pasadena.

Rents are not the only determinant of the true worth of a building, particularly in a volatile market such as 2009. Owing to the complexity of leases (particularly full service leases with expense stops, the primary lease type analyzed) rents often do not reflect the true cost of occupying space. However, rents provide an insight as to how the market values amenities. Although this analysis found that historic properties did not achieve a premium pricing in commercial office space, significant rent price differences appeared to be specific to the location of the building. A characteristic unique to historic buildings is their relative placement on “prime” real estate of a given market.4 Historic buildings capitalize on their location, often charging rents that reflect a location premium not associated with the “intangible heritage” associated with historic structures. Thus, historic structures may have an even greater discount to rents than this research is suggests.

Figure 6
Figure 6: Rent value per-square-foot per-year of office space in the San Francisco Financial district

Figure 7
Figure 7: Rent value per-square-foot per-year of office space in downtown Pasadena


The historic tax incentive program can provide significant equity for the rehabilitation of a historic building for office or commercial usage. However, the historic tax incentive program does not necessarily spur development because of underwriting risk, rather provides a boost to the return on equity for a project that was modeled to be successful before taxes. The risks of the certification process may preclude underwriting of the tax certification process in the current market. These risks often depend on the location of a project, with projects in dense urban areas with previous historic tax credit projects having an advantage to those with no historic context. Last, we have no evidence that historic buildings command a rent premium. Historic buildings should be underwritten based on conservative estimates for rent prior to the restoration, with significant reserve available for the unforeseen complexities inherent in the rehabilitation process.

The historic tax credit program is on the verge of changes that will substantially affect the future of the program (Amendments to Tax Code Section 47, August 2009). A key element of the overhaul is that tax credits will now be available for non-income producing projects. Although this may have a substantial positive impact on preservation as a whole within residential neighborhoods, it has the likely outcome of increasing the review time and requirements of the State Historic Preservation Office and National Park Service. A substantial increase in the number of potential historic tax credit projects is likely on the horizon, which will inevitably lead to longer review times and potentially stricter requirements.


1 Additional studies have further expanded on this topic, including publications from the Getty Foundation (Research Report The Getty Conservation Institute, Los Angeles) and the Los Angeles Conservancy (The Los Angeles Historic Resource Survey Report).

2 This argument must also address the impact of planning review. Although historic buildings may not fall within the borders of a historic district, they are still under the purview of the California Environmental Quality Act, and are thus in the jurisdiction of the planning department. Additionally, many cities have adopted historic “conservation districts” within downtown areas. Although this is not a formal historic district, it serves many of the functions of certified historic districts.

3 For more information, see the United Nations Educational, Scientific and Cultural Organization (UNESCO) website, which provides a definition and explanation of “intangible heritage.”

4 For more information on the location based complexities of real estate, see Urban Economics and Real Estate Markets by Denise DiPasquale & William C. Wheaton, Chapter 3.