Housing PILOT Tax Break Program in Chattanooga

The HOUSING PILOT Program in Chattanooga/Hamilton County

Helen Burns Sharp for ATM

How the Program Works

Chattanooga and Hamilton County occasionally award property tax breaks to certain housing developers by using a tool called Payments-in-Lieu-of-Taxes or PILOTs.

Here is how a City Internal Audit report in 2010 described the housing PILOT process:

“Tennessee State Law provides exemptions from ad valorem tax for property owned by housing authorities and property of a Tennessee nonprofit corporation used for permanent housing of low-income persons with disabilities, low income elderly or handicapped persons (T.C.A. 67-5-207) provided, that, they agree to make in lieu of tax payments for services, improvements or facilities furnished by the local governments...Through a City ordinance, the City delegates to the Health, Educational and Housing Facility Board the authority to negotiate and accept payments in lieu of ad valorem taxes (PILOTs)...The structure of this type of PILOT agreement includes the assumption of a property ownership by the Board and an accompanied lease of the property to the operating business. Typically, the business makes commitments outlined in the PILOT agreement...and in exchange, the local governments abate a percentage of the companies ad valorem taxes related to the real and personal property investments. Both the City and County governing bodies must approve the PILOT agreement.”

The program has succeeded in rewarding developers by providing tax breaks that represent millions of dollars in lost revenue to local government. The program has failed in several important respects, raising significant public policy questions for the City and County. The past few years have seen improvements to the program and offer hope for future positive changes.

The 2002-2014 "River City" Housing PILOT Program failed.

It failed in helping low-and-moderate-income persons with their housing needs, which is the sole justification for the program under state law. There is no documentation that any low and moderate-income persons benefited.
It failed by not requiring the closing fees government was initially going to receive so it could administer a viable affordable housing program.
It failed to include meaningful “claw back” provisions in the agreements to protect the public in the case of non-performance. Examples include "low-mod" compliance and the (non) building of a parking structure at Walnut Commons.
It failed by creating a system where a private non-profit (the River City Company) controlled recruitment and monitoring for the first 12 years of the program with no oversight by the city, allowing businesses to capture a government function and creating opportunities for the appearance of conflicts-of-interest.
It failed by awarding two PILOTs at a time when the City did not have a program on the books (2012-2014).

Fundamental Issue: The Affordable Housing Disconnect

State law allows local governments to use the PILOT housing tool to help low and moderate-income citizens with housing costs. This is the "public purpose" enabling the tax break. In Chattanooga, this program turned into a tool to give tax breaks to developers.

Cities and counties are not required to have housing PILOT programs. But if they choose to have them, they must conform to the enabling legislation in state law regarding the definition of a "project." That did not happen here.

In an analysis of tax incentives in Tennessee, attorney Mark Mamantov (Bass, Berry & Sims) writes: "Health, Education, and Housing Facilities Boards are authorized to own and lease only certain specified types of projects...HEHBs generally are permitted to own, lease, and finance facilities used by educational institutions, hospital facilities, and housing facilities to be occupied by persons of low or moderate income."

In presentations before the City Council, County Commission, and bond board from 2002 to 2014, neither the River City Company nor their attorney mentioned the requirement that low- and moderate-income persons must benefit from the program.

River City (Kim White) told the County Commission in 2012: "We are not creating low- and moderate-income housing downtown."

Attorney Alfred Smith (Miller & Martin) represented River City. (Mr. Smith also represented almost all of the private clients that received PILOTs). While he acknowledged that a project must qualify under the state (low- mod) statute for the bond board to take title to the property, Mr. Smith said that prospective tenants do not have to provide their income.

How did the City and County know if low- and moderate-income persons were benefiting if no one asked for and verified income? In research done by a bond board committee in 2016 for an annual report, no documentation surfaced to demonstrate that a single low or moderate-income person benefited from a housing PILOT from 2002 to 2016.

The reason the low-mod requirement matters goes beyond compliance with state law. It affects people. Housing affordability is a very real issue in Chattanooga.

A study by the Brookings Institute says that city poverty has grown faster here than the national average. Our city’s poor and working families bear the brunt of skyrocketing housing costs.

Housing PILOTs could have been an important component of an affordable housing program.

In 2016, the City made some changes to the program. The City

Increased the percentage of units that must be set aside for low/mod from 20 to 50 percent;
Added stronger clawback language to address what happens if a developer does not meet the commitments made to get the PILOT;

Added a small developer fee at closing for staff time to enforce all PILOT commitments and to build a program;

Increased application fee to reimburse the city for staff time;

Strengthened language on assignability if a PILOT developer sells the project while the agreement is in effect;

Added a provision that a PILOT agreement shall terminate if ground is not broken within two years of PILOT approval;

Changed the eligibility footprint from downtown to city-wide, and
Brought administration of the program inside city government rather than delegate it to a non-governmental entity, such as River City or the Chamber of Commerce.

ATM Recommended Changes to Current Program

1) Affordability. ATM recommends that units be set aside for persons with an annual income that does not exceed 60 or 70 percent of area median income (AMI) as defined by HUD. The AMI percentage in the previous PILOT and in the current program is 80 percent, which allows rent in 2020 of up to $1017 per month for a single person with an income less than $40,700. ATM believes that this rent is not affordable to many low-moderate income people in Chattanooga. ATM believes that allowable rents based on the current 80 percent AMI might approach or exceed market rent in many locations, thus making it difficult for most taxpayers to see the "public benefit" of the large PILOT tax break. ATM also recommends that the City clarify that the basic rent for these units must include water, sewer, and basic internet.

2) Accountability. The City's Comprehensive Annual Financial Report (CAFR) in its section on Housing PILOTs states that; "Currently there are no recapture provisions when terms are not met...." In 2019 the City and County did pursue enforcement action against the developer of the Market City Center apartments downtown when they announced plans to convert a number of their apartment units into vacation rentals.

3) Size of Units. Most of the units that the housing PILOT program has subsidized over the years are small one-bedroom and studio units, some smaller than 400 square feet. What about families? Should the program require a certain percentage of one and two-bedroom units?

4) Transparency. ATM recommends that the City Council and County Commission hold public hearings on PILOT applications so members of the public would, for the first time, have a designated time to comment. Current practice is to allow PILOT applicants, but not the public, to speak before the Council's Economic and Community Development (ECD) committee.

ATM asks that a public hearing requirement be added, either at ECD or at the regular Council meeting and at the County Commission meeting. It would help with public trust. Many perceived the previous program as a tool to help developers get a tax break rather than to provide public benefit. Not having a public hearing perpetuates this perception. ATM hopes that the City and County will establish a "home" on their websites for all information about the housing PILOT program. This would include the resolution with policies and procedures, the application, and the project review criteria.

5) Community Benefits Agreements. A Community Benefits Agreement (CBA) is a project-specific agreement between a developer and the local government (or a broad community coalition ) that spells out the project’s contributions to the community and helps with community support for the project. CBAs allow a win-win approach to development: meaningful, up-front communication between the developer and a broad community coalition decreases developers’ risk while maximizing the positive impact of development on local residents and economies.

The developer benefits from active community support of the project, and community members gain when the project responds to their needs. The community benefits terms from a CBA may be incorporated into an agreement between the local government and the developer, such as the Payment-in-Lieu-of-Tax (PILOT) agreement or lease. That arrangement gives the local government the power to enforce the community benefits terms.

The terms of the CBA would be project-specific, depending on the neighborhood. Here are some possible examples of what developers might be asked to do:

commit to at least 20% of construction workers being targeted employees
provide $ for job training programs for residents
seek partnerships between local industry and residents for addressing employment needs
provide on-site space for a child care center as part of an apartment complex
contribute $ to project/program at the neighborhood Recreation (YFD) Center
contribute $ to project/program at a nearby school
increase lighting in the neighborhood
improve existing sidewalks or construct new ones
contribute x towards the goal of securing a grocery store in the neighborhood

6) Fee at Closing. In 2002, the River City Company (Ken Hays) told the Health, Education and Housing Facilities Board (HEB) that incentives were needed to encourage downtown housing. Mr. Hays said that the City of Memphis had success by using a tax freeze tool (PILOT). Mr. Hays said that River City hired the law firm of Miller & Martin (Alfred Smith) to develop a program to encourage downtown housing in Chattanooga. It was to be modeled on the Memphis program.

The City Council and County Commission passed resolutions prepared by Mr. Smith to establish the Downtown Housing Initiative. Several months after passage of the original 2002 resolutions, Mr. Smith asked the city and county to delete Section 6, which had provided the funding source, a fee at closing, that would enable the bond board to hire staff to administer an effective affordable housing program.

In explaining why he was proposing this amendment to the County Commission, the minutes reflect Mr. Smith gave as a reason that his private clients objected to paying a fee at closing. The Memphis bond board has continued to collect this fee. It has enabled them to hire staff to run a program that has assisted thousands of low and moderate-income persons with their housing needs. From 2002 through 2016, there is no documentation that any low and moderate-income persons benefited from Chattanooga's program.

ATM recommends that the City and County return to the fee that Memphis did and does collect, a closing fee of one percent of the total project cost, plus applicable attorney fees and filing fees.

6) Term and Percentage of Abatement. The current program provides a complete abatement of taxes on the value for all improvements for the first 10 years. This total abatement is followed by a graduated phase-in period that may last four more years. The tax break schedule for businesses under the Jobs PILOT program is usually a declining abatement (100%, 75, 60, 50). Is a total abatement appropriate? Is a phase-in period necessary?

7) Prohibit Vacation Rentals. Make clear in all housing PILOT agreement that conversion of units to short-term vacation rentals voids the agreement. The provision in state law enabling local governments to approve housing PILOTs references housing units to be occupied by low and moderate-income citizens.

Approved Projects

2002-2012 (January)--The HEB approved six housing PILOTs from 2002 until the program expired in January 2012. Four involved rehabilitation of existing buildings. Two involved new construction (Walnut Commons and Frazier Place.) None of these PILOT had to go to the City Council or County Commission for a vote. See Walnut Commons section below to learn why ATM views it as the poster child for how badly this program failed.

2012 February--2014 (July)--The “original” downtown housing PILOT program expired in January 2012. River City was not able to persuade the City Council to reauthorize in 2012. Councilors raised questions about the impact of PILOTs on the city’s revenue base. When the Council did reauthorize in 2014, their resolution contained a recital acknowledging that the old program expired in January 2012.

In December 2012, the City Council approved two in-lieu agreements abating city taxes, even though there was no authority for the City to grant a housing PILOT. The projects were UTC Two and UTC Three. The applications stated that the average rent would be over $1,000 per month, an amount well above what a low or moderate-income person could be asked to pay.

In August 2014, the City Council reauthorized the Downtown Housing Initiative, which had expired in January 2012. The County Commission had reauthorized it in August 2012. Five projects were approved in 2015, representing about $10 million in property tax revenue to be forgiven over the duration of the agreements. Two involve rehabilitation (the Maclellan Building at 721Broad Street and a hotel building at the Choo Choo); the others are new construction at 728 Market, 1400 Chestnut, and 500 Lindsay Streets.

2016, Under the "new" program, the City and County approved ECG Chestnut at 2108 Chestnut St., the (Jaycee) Riverview Towers (Wishrock) at 500 W. MLK Blvd., and Standard Coosa Lofts. Each of these projects apparently involves federal low-income-housing tax-credits (LIHTC), meaning the rents will be lower than the standard "downtown" PILOT.

2017, Flats at 58 was approved by the City. It has not been approved by the County.

2018, The City and County approved the Ridgeway PILOT on Poplar St. on the Westside. It is a LIHTC project, meaning that a percentage of residents are 60% AMI or less and that the State will monitor for compliance. In December the City approved a PILOT, also LIHTC, for Patten Towers for low-income seniors. The County Commission approved in January of 2019.

The City's Economic and Community Development Department, where the Housing PILOT program is currently housed, has begun presenting an annual report on PILOTs to the Health Education and Housing Facilities Board. This is a positive development.

Walnut Commons: Poster Child

The 2010 Walnut Commons PILOT is the poster child for how the 2002-2015 housing PILOT program failed and how the city government has remained unwilling to address non-compliance.

But/For Test: Walnut Commons is a successful, upscale apartment complex located in a prime location near the Tennessee River. It is the beneficiary of a several million dollar property tax break and yet the developer acknowledged in the Times Free Press that it is "the underlying market, interest rates and rent" that make projects like this worth doing. "Traditionally, the [tax breaks] have just been the icing on the cake."

Low/Mod Compliance: The resolution passed to approve the PILOT referenced the state law definition of low and moderate-income and yet there is no documentation or claim that a percentage of units have ever been set-aside and rented to this demographic. Rents for all units have always been higher than the PILOT program would have allowed for those set aside.

Parking Garage: Both the PILOT agreement and Lease agreement reference a parking garage. A garage was never built. This, in addition to benefit to low and moderate-income persons, was part of the public benefit consideration in granting the tax break.

No School Taxes: Walnut Commons is the only PILOT since 2008 that was not required to pay the school portion of property taxes. Why?

Assignment: The local developers sold the property shortly after it was completed. The membership interest was purchased by a Nebraska REIT; in 2017 it was flipped to a corporation in South Carolina. The tax break went right along with it, with no one at the City apparently checking to see if the project met its responsibilities relative to low/mod and the parking garage. Developers continue to use our tax dollars as a bargaining chip to increase their profits when they sell.

Lost Opportunities: In 2016 and 2017 the Health Education and Housing Facilities Board (HEB) and the Chattanooga Downtown Redevelopment Corporation (CDRC) passed on opportunities that could have resulted in about $1.5 million more money for the public by getting the apartment complex back on the tax rolls for future years when the land sold.

The developer's decision to exercise the option to purchase the property from the CDRC (rather than make lease payments) re-opened the 2010 PILOT deal. The CDRC agreed to sell the land for less than what the formula in the 2007 Land Lease Agreement called for. No city staff member or board member gave a reason why it was in the public interest to accept less.

The Health Education and Housing Facilities Board (HEB) had the opportunity to get Walnut Commons on the tax rolls for future years. Sadly but predictably, they did not do so. How many times do you get a chance to say no and still say yes? ATM speculates that the lender may have insisted on a resolution because they wanted affirmation that the board was going to continue the PILOT. Even the bank may be surprised by the board's "generosity."

Deaf Ears: ATM continued to bring up the commitment to a (never built) parking structure in the PILOT agreements and a representation by the original developers about a set-aside for low and moderate-income. ATM requested a special work session to get all of the facts and perspectives on the table: the board did not acknowledge that request.

It became even more clear that Alfred Smith, the local private attorney representing the developers, continued to hold sway with the city attorneys and thus with the board.

On November 16, 2016, the HEB had the opportunity to take action that could have led to placing this property on the tax rolls. They chose not to do so. With little discussion and no written staff report, the Board followed the lead of Walnut Commons LLC attorney Alfred Smith and Deputy City Attorney Phil Noblett, the two attorneys who presented the PILOT application to the Board in 2010.

The Board voted to execute a special warranty deed for the Walnut Commons (WC) project to give the HEB fee simple title, thus enabling WC LLC to continue the PILOT tax break another nine years. Approximately $1 million in taxes had already been waived.

ATM hired an attorney to examine the land lease and PILOT documents dating back to 2007 and to provide an opinion. Attorney John Konvalinka gave legal reasons to support ATM's contention that what the HEB Board was asked to do in 2016/2017 was a “new deal.” It was not one they were obligated to do. ATM requested that the HEB exercise the right choice and place the property on the tax rolls for future years.

The ATM attorney identified examples of non-compliance with language in the lease. The attorney concluded that--due to these breaches--there appears to be no enforceable obligation which obligates the HEB to sign the Lease Termination and Release of Memorandum of Lease.

As for Mr. Smith's contention that "a deal is a deal," Mr. Konvalinka said that "whoever subscribes to this theory must believe only the HEB is bound to anything by the documents and not Walnut Commons LLC."

He addressed "what was the original deal" based upon the documents. He said that Walnut Commons, LLC was to make rent payments unless the company chose to exercise the option to purchase and terminate the lease. This choice would require Walnut Commons to pay taxes rather than rent. In 2016 they decided to purchase the land and quit paying the rent payments.

But the owner did not want to pay property taxes either.

This is a different deal than the original deal in that there is no payment of rent or taxes. This arrangement appears to be just fine with the City. Perhaps Hamilton County government might have viewed it differently, but apparently the city never brought the county into the discussion, even though both school taxes and county general taxes continue to be abated.

Accountability for Taxpayer Money-Chattanooga
~Helen Burns Sharp

February 2021