Thursday, November 19, 2009

Census: Small US cities lose luster in downturn

Associated Press Financial Wire

November 16, 2009

BY HOPE YEN and FRANK BASS, Associated Press Writers

America's small cities are losing some of their traditional appeal to upwardly mobile families seeking wholesome neighborhoods, a stable economy and affordable living.

A review of newly released census data shows, for example, that cities of between 20,000 and 50,000 residents have lagged behind their larger counterparts in attracting higher-educated residents in this decade.

In 2000, small cities, which include remote towns and the distant suburbs known as "exurbs," ranked at the top in the share of people with college diplomas. They slipped to No. 2 last year with 30 percent holding degrees in between medium-sized cities, which had 31 percent, and big cities, at 29.8 percent.

Poverty is growing in the small cities, fueled partly by population growth, although average median income of $60,294 in those communities is still higher than other places.

Small cities looking more and more like bigger cities over the decade ranged from places like Hobart, Ind., and Mount Pleasant, Mich., to Anniston, Ala., and Greenville, Miss. Compared with previous years, they had smaller incomes, higher housing costs, longer commutes, more poverty and more single-parent families.

Demographers attributed some of the shifts to the housing downturn and a spike in gasoline prices, which has hit residents in the far-flung exurbs harder. Many families in smaller towns also are looking for jobs in larger cities because of the current recession and are rethinking the wisdom of a lengthy commute to work.

Some small cities may have become victims of their own success. As their local economies boomed mid-decade, many places grew rapidly and attracted lower-income residents needed to build roads, schools and other public works projects. Some of these areas have shot up in size and are now medium-sized communities.

"Small towns have a certain appeal to people, and their quality of life there is backed up by the data," said Mark Mather, associate vice president of the nonprofit Population Reference Bureau. "But as more people move in, small towns start to lose the qualities that attracted people there in the first place."

The shifts are notable in the ranks of the educated.

According to census data, smaller cities in California, Texas, Florida, Michigan and New York had declines in the share of residents with bachelor's degrees, ranking among the lowest in the nation. They included Bell, Calif.; San Benito, Texas; Jasmine Estates, Fla.; Hamtramck, Mich.; and Newburgh, N.Y.

North Potomac, Md., posted some of the highest shares of college graduates in the nation. Still, its share fell in the last decade, from 75 percent in 2000 to 70 percent. Other highly educated towns that saw brain drains were East Lansing, Mich., North Druid Hills, Ga., and Greenbelt, Md.

The findings come as President Barack Obama has pledged to upgrade mass transit and other urban priorities in inner cities and their close-in suburbs. That could create additional shifts in residential patterns to larger-populated areas, especially for younger couples and small families who more readily move.

The AP review found both extreme poverty and wealth in smaller-sized cities.

For example:

Poverty has risen in small cities, from 10.8 percent in 2000 to 12 percent. In big cities, poverty declined slightly, from 17.7 percent to 17.6 percent.

Homeownership costs in small cities are growing less rapidly, partly a reflection of the housing collapse in many exurbs. In 2000, big cities trailed small cities when it came to the share of residents with monthly costs of more than $1,000 56 percent to 61 percent. By 2008, 82 percent of big-city residents were paying the high costs, compared with 78 percent for small cities.

Carbondale, Ill., had the lowest median income, at $17,508, followed by small cities in New York, Louisiana, Alabama and Ohio. Darien, Conn., topped all other cities with the highest median income, at $188,823.

"There are lots of small towns and rural areas that are struggling," Mather said. "Many were struggling before the current recession, so it might take more than a dose of stimulus funds to put them on the road to recovery."

The data, from the American Community Survey, represent three-year averages covering 2006 through 2008, providing a snapshot of every community with at least 20,000 residents. Medium cities are defined as having 50,001 to 150,000 residents, and big cities have more than 150,000.

Thursday, November 5, 2009

Letters Of Intent And Avoiding The Unintended

Article by Michael Szlamkowicz and Alex Radetsky

Letters of intent or memoranda of understanding are frequently used in private equity transactions to evidence the preliminary understanding of a potential transaction before the parties commit significant time and resources to the transaction. Often such documents are prepared and negotiated by deal professionals based on the precedent from the last deal or another similar deal with limited or no review by outside counsel. A recent case suggests that this approach is not without risks and that careful drafting of letters of intent and memoranda of understanding is important.

In the case of Vacold LLC v. Cerami, a decision by the United States Court of Appeals, 2nd Circuit, the court held that some preliminary agreements, such as letters of intent or memoranda of understanding, may bind the parties and require them to complete the contemplated transaction even if the parties are unable to reach agreement on definitive documents for the transaction. The court considered the language of the agreement, the context of the negotiations between the parties, and the existence of open terms in determining whether the preliminary agreement in question was binding on the parties. The court concluded that a preliminary agreement that clearly manifests the intention of the parties to be bound will obligate the parties to fully proceed with the transaction.

The court presented several factors that, if present, could result in a preliminary agreement binding the parties to complete the transaction, including:

* the failure to draft an expressed reservation of the right not to be bound in the absence of a definitive written agreement;

* the partial performance of the agreement;

* the parties reaching agreement on all of the material terms of the transaction; and

* the transaction is the type that is usually committed to a more formal and definitive agreement.

As a result, when drafting a letter of intent, memorandum of understanding or other similar preliminary agreement it is imperative for private equity sponsors to always consider that such an agreement may bind them to more than they may have intended if they are not vigilant when negotiating and drafting the documentation.

The following are tips for private equity sponsors to consider when preparing letters of intent, memoranda of understanding or other similar documents in order to mitigate the risk that they will become bound to complete a transaction when it was not the sponsor's intention to do so:

* Use unambiguous language for the title of the document. Use a title for the preliminary agreement containing words such as proposal, letter of intent or memorandum of understanding. A document entitled "letter agreement" may be interpreted as manifesting the intent of the parties to be bound. However, one should not rely alone on the title of a document to manifest the intent of the parties not to be bound by such agreement.

* Include a conspicuous disclaimer that the document is not intended to be binding. In order to strongly indicate the intention of the parties not be bound by a preliminary agreement, a conspicuous disclaimer within the document should indicate that the understandings contained therein are for discussion purposes only and do not constitute a binding agreement (except, of course, with respect to certain provisions which the parties may intend to be binding, such as exclusivity and confidentiality) but merely express a summary of current discussions with respect to the transaction and that any terms discussed in the document shall only become binding upon the negotiation and execution of definitive agreements.

* Indicate terms that remain open. Including a list or a discussion of terms that remain open strongly indicates that the parties do not intend for the preliminary agreement to be definitive or binding and that a definitive agreement is necessary in order to bind the parties to complete the transaction. It is recommended that parties include clear and unambiguous language that specifies that the parties do not intend to be bound until (a) the private equity sponsor completes the due diligence process to its satisfaction, (b) the investment committee of the private equity sponsor approves, in its sole discretion, any potential transaction and (c) the parties enter into a definitive written agreement to complete the transaction.

Letters of intent, memoranda of understanding and similar preliminary documents are important components of private equity deals. However, sponsors need to be aware of the risks that such preliminary documents may be deemed binding. There is also a risk in some jurisdictions that a court may impose a good faith duty of negotiation on the parties and require them to work together to negotiate definitive agreements for a transaction. By following the practice tips identified above and having counsel carefully review all preliminary documents, private equity sponsors can lay out the intent of the parties while still avoiding the unintended.

Huge Tax Savings Available Through Cost Segregation

Cost-Segregation Solutions

These studies can provide tax advantages even after property sales.

By Harvey Berenson

Cost segregation is an accepted Internal Revenue Service method of allocating the purchase price paid for real estate property. Generally, cost segregation enables owners to increase the depreciation deductions from their properties, providing substantial present value benefits by reducing income taxes during the initial years of ownership.

Although most cost-segregation studies are completed when the taxpayer acquires or constructs a building, the IRS allows owners to complete cost-segregation studies for buildings they have sold. This can generate significant tax savings in the year of sale — and owners do not need to amend prior tax returns.

A cost-segregation analysis breaks down construction and acquisition costs, allocating the costs to specific categories: tangible personal property, land improvements, and real property. Under the applicable tax rules, a substantial percentage of a typical building’s cost often qualifies for shorter cost recovery periods, generating tax savings from accelerated depreciation.

How Does It Work?
The following example illustrates the cost-segregation concept. An owner buys a commercial property on January 1 of year one for $10 million; $2 million is allocable to land and $8 million to the building. A cost-segregation study is not performed. The owner is entitled to $196,580 of depreciation (11.5 months under the applicable rules) in year one.

Now consider the benefits if a cost-segregation study were performed. The cost-segregation expert allocates 10 percent ($800,000) of the building’s original $8 million tax basis to five-year property depreciation and 5 percent ($400,000) to land improvements qualifying for 15-year depreciation.

The cost-segregation study effectively converts $1.2 million of the tax otherwise depreciable over 39 years into property that will be depreciated over five or 15 years. As a result, the owner deducts $347,100 of depreciation in year one, which is $150,000 in additional deductions. If the owner is in the 35 percent federal tax bracket, he saves almost $53,000 in taxes.

The owner will continue to enjoy larger depreciation deductions for the next several years.

After a Sale
An owner is never precluded from benefiting from a cost-segregation study, even if the study is done after the owner sells the property, as illustrated by the following example.

The owner sells the property on the first day of year six for $10 million. Except for depreciation and gain on sale, the owner does not have any taxable income or loss from the property. Prior to sale, costs were not segregated.

Based on a 39-year life for the building, the owner deducted a total of $1,026,600 of depreciation during the period he owned the property. The depreciation deductions reduce the basis of the property from $10 million to $8,974,400 at the time of sale.

In year six, the owner deducts $8,500 of depreciation and recognizes $1,025,600 of gain (equal to the prior depreciation deductions), which will be taxable at a maximum federal rate of 25 percent. If the owner is in a 35 percent federal tax bracket, the owner pays $253,400 in net tax in year six.

What would be the outcome if the owner commissioned a cost-segregation study for the building following the sale? Assume that, as of the date of purchase, the owner’s depreciable basis should have been allocated in the same manner as set forth above: $800,000 to five-year property, $400,000 to 15-year property, and $6,800,000 to 39-year property.

Based on the study, the owner recalculates the depreciation deductions he should have taken for years one through five, which total $1,769,100 instead of the $1,017,100 actually deducted.

In year six, the owner is entitled to a deduction of $752,000 to make up for the depreciation that he did not take in the first five-year period. This deduction offsets the owner’s ordinary income, subject to a 35 percent federal tax rate.

In addition, for the short period that the owner had the property in year six, he is entitled to depreciation of $65,900, which also reduces his ordinary income.

The owner deducts $817,900 of depreciation in year six, as compared with $8,500 before the cost-segregation analysis — without affecting the deductions he took in earlier years.

The property’s tax basis is now smaller because the owner has taken more depreciation. When the owner sells the property for $10 million, he will recognize $1,835,000 of gain because the property’s tax basis has been reduced to $8,165,000.

The federal tax on the owner’s gain is a more-complex calculation than in the simple case where his only depreciable asset was a 39-year property. Under the tax rules, any gain (up to the amount of the owner’s prior depreciation deductions) on the five-year property or the 15-year property will be subject to a 35 percent tax rate. At the same time, it may be possible to convert a portion of the gain, which otherwise is subject to a 25 percent tax rate, into gain treated as long-term capital gain that is subject to a 15 percent federal tax rate. The owner’s tax cost from the sale of the property thus depends on the relative value of the various components of the building.

Assume that the owner determines at the time of sale that the value of the five-year property is $200,000 (25 percent of original cost) and the value of the land improvements is $270,000 (two-thirds of original cost). In this case, $233,100 of gain will be taxable at 35 percent, but $730,100 of gain will be taxable at 15 percent; the balance of $871,800 will be taxable at 25 percent. Because not all of the additional depreciation deductions resulting from the property’s reclassification as a five-year property or 15-year property are recaptured on sale, this excess amount ($730,000) is taxed at 15 percent even though the owner received a 35 percent tax benefit from the prior depreciation deductions.

Substantial Tax Savings
The owner’s net tax bill in year six is reduced from $253,400 to $122,650, a savings of more than $130,000. (See chart "Cost-Segregation Tax Savings" below.)

As the values allocated to the five-year and 15-year property decrease, the owner’s tax savings increase. For example, if the five-year and 15-year properties are sold for their tax book value, the federal tax on the gain decreases from $408,950 to $362,500, and the owner saves more than $168,000 in 2009 federal tax liability by undertaking the cost-segregation study. The owner does not amend his earlier tax returns. He is simply required to include the required information in his year six tax return.

Cost-Segregation Tax Savings

Year of sale, No cost segregation study, Tax benefit (liability), Cost-segregation Study, Tax benefit (liability),

Depreciation deductions ($8,500), $3,000, ($817,900), $286,300,

Gain on sale $1,025,600, ($256,400), $1,835,000, ($408,950)

Total tax: ($253,400), ($122,650)