Developer wants to clear up ‘misinformation’
Kent Leach, developer of the Daugherty Building, said after the April meeting with the Clinton Historic Commission he is well aware of the commission’s concerns and he has no problem in addressing those concerns.
What is troubling to Leach, however, is the misunderstanding about what is being proposed for the building.
“There’s a lot of misinformation out there,” he said. “Maybe it’s miscommunication, but I never thought what we’re planning would cause so much … I don’t want to say, ‘hostility …’ but there is a lot of misinformation.
The following was written by Leach to address what he feels are points being misunderstood.
Daugherty Lofts
PILOT Explanation
The proposed Daugherty Lofts project has certainly caused a stir in Clinton since it was initially introduced to the public. Since its inception, the developers have planned to utilize the low-income housing tax credit (LIHTC) which is how the federal government now chooses to incentivize private development of affordable housing. LIHTC can be used to build newly constructed affordable housing, renovate older affordable housing units, or convert old spaces into affordable housing as is the case with the Daugherty Building.
The State of Tennessee administers LIHTC through the Tennessee Housing Development Agency (THDA), but the ultimate authority is the Internal Revenue Service. In all states, the developer submits a project to the state housing authority in an attempt to secure tax credits. The projects are typically scored and awarded credits based on how well they meet the requirements of the state housing authority. The Daugherty Lofts project won a large amount of LIHTC in 2020 and was awarded additional credits in 2022 due to rising construction costs. The total amount of tax credits awarded to the project is close to $11 million.
The credits are only of value to certain types of companies referred to as C corporations. Typically, these are large financial institutions and banks which incur significant profits in their businesses. The tax credits help them to offset large federal tax expenses that they incur due to their structure as C corporations. The credits function as a dollar-for-dollar rebate against any tax owed, so one can see they have significant value to these companies. Local banks that buy tax credits include Regions Bank, First Horizon, and Southeast Bank, and many others. Larger institutions include Chase Manhattan, Royal Bank of Canada, and Raymond James. Furthermore, the credits are sold at discount to these institutions to provide a small yield over the time period the credits are released.
The developers still must secure construction lending and permanent financing for their projects and the financials of the stabilized project must support the debt service of the eventual permanent loan. In 9% tax credit deals like the Daugherty project, over 75% of the total project cost can be derived from the funds created by the sale of the future flow of the tax credits. The tax credits are released from the IRS over a 10-year period which explains why the credits are sold at a discount. You will also see developers use “agency debt” created for affordable housing from government entities like Fannie Mae, Freddie Mac, HUD, and USDA. These government backed loans are the least expensive financing available, but do not dictate affordability as HUD did back in the 80’s.
With this understanding of how the credits are used to fund a development, now we must look at what the developer has to commit to and deliver to stay compliant and continue receiving the credits year after year. The key to affordable housing is keeping it affordable. LIHTC differs significantly from section 8 in that the developer sets rents within a certain range that is dictated by the average median income (AMI) for an area. The higher the AMI, the higher rents are allowed to be set. Anderson County is included in the Knoxville MSA and benefits from its higher-than-average AMI.
The average rent in the Daugherty Building will be $855 per month, with the larger three- bedroom units renting for $1,050 monthly. These rents are not changed based on the applicant and will be subject to yearly increases. While considered affordable, it is certainly not “free housing” and the tenants have to meet income verification standards and pass background and landlord reference checks. Residents will have to prove sources of income that are at least 2.5 times the amount of the rent being charged for the unit they are applying for. The income scale and rent that can be charged at Daugherty Lofts is as follows:
Two 1 BR units for residents making less than $30,525 for no more than $756/month.
Nine 1 BR units for residents making less than $36,750 for no more than $918/month.
Five 2 BR units for residents making less than $36,750 for no more than $918/month.
Eighteen 2 BR units for residents making less than $44,100 for no more than $1102/month.
One 3 BR unit for a resident making less than $42,450 for no more than $1061/month.
Four 3 BR units for residents making less than $50,940 for no more than $1273/month.
The problem that affordability creates is the limited amount of income produced by the apartments. The Daugherty Building will benefit from an injection of over $9 million in construction spending. The result will be 39 brand new desirable loft-style apartments that will be “rent restricted” for lack of a better term. If a developer were to build market-rate apartments with a $9 million budget, the average rents would have to be double what is being charged for rent at Daugherty Lofts.
The tax assessment of both properties would be the same, but the market- rate project enjoys a much larger rent income and is able to afford its high tax bill. This is why there has been very little if any new multifamily built in Clinton. Hopefully with the influx of new residents into Tennessee, a developer will soon take the risk of building a new market-rate apartment complex in Clinton, but rest assured the rents will not be considered affordable to the majority of Clinton’s population.
A Payment in Lieu of Taxes (PILOT) is a tool used to fix the taxes of certain developments for a pre-determined period of time. PILOTs can be for varying amounts, ranging from full abatement of the taxes up to the maximum taxes. PILOTs are frequently granted to industrial projects because of the jobs these developments bring into an area. It’s widely accepted that the new employment opportunities are a welcome commodity in any community and these developments are often granted the largest PILOT allowed by local statutes.
PILOTs are also awarded in the multi-family housing space as it is also a common thought that housing keeps the workers in the county they work in and builds the taxable base. Examples of PILOTs in housing can be found in Oak Ridge, where the Oak Ridge IDB voted to award a PILOT to the multifamily development known as the Main Street Project which is being developed on the former site of the Museum of Science and Energy. That agreement represented a reduction of taxes to approximately 25% of what the city and county would have collected if no PILOT were granted. Keep in mind that this was a market-rate project that was awarded a 75% reduction in taxes for the benefit it was bringing to the city of Oak Ridge.
A PILOT was also awarded to LHP Development when they purchased an older affordable housing development in Oak Ridge known as the Frank Callaghan Towers with the intent of injecting $5.8 million in renovations. That PILOT was designed to keep the current tax bill frozen with modest increases over a 15-year period. After 15 years, the taxes will average about $565 per unit. Had the building been reassessed including the $5.8 million in tax credits that it received for the renovations, the tax bill would have more than doubled to over $1,200 per unit.
The renovation of the Daugherty Building represents a truly unique situation. In essence, the developers are able to use tax credits to fund a top-notch restoration of a historical building while simultaneously providing affordable housing. The major difference between the Daugherty Building restoration and other projects is the quality of restoration that is required to meet the high standards of the National Department of the Interior and National Park Service. For instance, the windows must be repaired or replaced with similar windows that match and maintain the historic relevance of the building. The budget for windows alone is close to $500,000 in Daugherty Lofts. However, the developers cannot increase rent simply because of these increased costs. The rents must remain affordable when compared to the market and the residents will enjoy the unique loft-style apartments with high end finishes such as solid surface countertops, restored wood floors, stainless steel appliances, and yes – historically accurate, energy efficient windows.
The development team sat down with the Anderson County Tax Assessor, John Alley, to determine what the approximate tax bill will look like for Daugherty Lofts. He has collaborated with the state tax assessor and determined that without a PILOT, the combined city and county taxes for Daugherty Lofts will be approximately $42,000 but could be as high as $49,000.
The per unit cost of a $49,000 tax bill to Daugherty Lofts is over $1,250 per unit. The average tax paid per unit of every affordable project in Anderson County is $645 per unit. The projected per unit tax burden of Daugherty Lofts could be almost twice that of most affordable projects in Anderson County. That does not even take into account the economic and overall benefit that a beautifully restored Daugherty Building will have on the downtown historic district, the City of Clinton, and Anderson County.
The developers of Clinton Lofts plan to ask the Anderson County Industrial Development Board and the Anderson County Commission for a PILOT in the amount of $31,200 which is a per unit tax bill of $800 per door. This amount would remain fixed for the term of the PILOT request of 15 years. After this period expires the building will be reassessed and come back onto the tax roll. This request is reasonable and certainly smaller than the two previously mentioned PILOT requests that were approved within Anderson County. As the closing date comes into sight and the budget becomes finalized, the project can afford this amount without any sacrifices to the renovation budget.
This PILOT would allow the developers to size their permanent debt appropriately and fully fund the restoration of the Daugherty Building. With interest rates rising and without a PILOT, the debt will be sized smaller and require concessions from the rehab budget. Add in the fact that construction prices already skyrocketing, it is certain that this would impact the quality of the renovations and resident amenities. Locking the taxes at the requested amount allows the project to move forward with a healthy renovation budget that ultimately benefits the Daugherty Building and the surrounding downtown district.
Questions:
1. If the Daugherty Building is granted a PILOT, won’t the money just go directly into the developer’s pocket?
No, especially in affordable housing deals, the developer fee is fixed and in this case a majority is being deferred over 12-15 years. The PILOT will directly benefit the deal by reducing expenses and allowing it to maximize allowable debt.
2. How does not granting a PILOT just hurt the restoration of the building?
As mentioned previously, there are certain features of the building we must restore such as windows. These items will be restored or replaced with like kind replacements. But some features such as hardwood flooring restoration is very labor extensive, obviously more expensive, but not required. Other places to save money are the quality of cabinetry and fixtures. There are also features and areas of the building designed as common area that may be impacted.
3. I don’t like the idea of affordable housing in the Daugherty Building. Is this just like Clinton Towers?
No, LIHTC is very different from HUD project-based section 8 developments that were built in the 80’s. The government no longer is in the housing business like they once were. Today, they incentivize developers through tax credits to take on the risk of housing development. The state agency’s control the quality of the finished product through a scoring process.
To live in Clinton Tower or another Section 8 property, one need only pay 30% of their income, no matter how low their income is. It’s possible a tenant could have no income at all. The rents in Daugherty Lofts will be fixed, not tied to the resident’s income, and are very comparable with other apartment complexes around the county. Residents of Daugherty Lofts will be required to prove income equal to 2.5 times their rent. They will also undergo credit and background checks and landlord references will be required. In the future, you will see an increase of older section 8 properties that will apply for the use of LIHTC in order to fund renovations. These properties are grandfathered in and will remain section 8 despite their use of tax credits.
4. Who determines whether or not to award a PILOT to a development?
The Industrial Development Board and the Anderson County Commission are the bodies of government charged with making decisions regarding the award of a PILOT. The developer team has not yet approached these government bodies with its proposal. It is the developer’s desire that this report will provide answers to questions that elected officials might have before approving or rejecting a PILOT for market-rate or affordable housing.
5. Why can’t the Daugherty Building be converted into a hotel or high-end apartments?
Developers are always looking for opportunities, but opportunities must be able to provide a reasonable return for the risk involved. In order to convert Daugherty Lofts into a hotel or apartments, it would require a similar investment of $9 million into the restoration of the building. The return of that investment at a reasonable rate of return would require the rents and room rates to be double if not more due to the historic nature of the building. Clinton simply does not have any current developments that would support the idea of high- end multi-family housing, so lenders would likely balk at financing such a project. The building also lacks some features that typical high-end loft-style apartments and hotels have such as high ceilings and exposed brick walls. The top 2 floors at Daugherty were always designed to house workers from the surrounding area. This project will restore one of the Daugherty Building’s key original purposes – workforce housing.
