The Peerless Lofts/Alice Building Project

A.        Providence’s Commercial Tax Rate

For more than a decade, Providence has segmented its residential and commercial property tax rates, allowing commercial rates to rise to higher levels in order to keep taxes affordable for homeowners.  By 2005, Providence had the third highest tax rate according to a national study.  With these rate increases, development in Providence dropped precipitously, with many developers citing the commercial tax rate as a major factor in their decision not to build.

B.        The Tax Stabilization Agreement (“TSA”) Program

In response, the General Assembly enacted legislation allowing communities to offer incentives to developers to build. Under a “tax stabilization agreement” (“TSA”), a community is provided the flexibility to postpone the date on which it increases the assessed value of a parcel to reflect the investments and improvements added by a developer.  In this way, the developer is allowed a period of years (known as the “stabilization period”) in which to recover an initial investment prior to paying full taxes.  If the parcel would not be developed absent the incentive, a TSA effectively allows the City to be  “held harmless” in the sense that the tax revenues for the property do not decline below the “no development” alternative.  To my knowledge, over the past decade, Providence has seen very little major development unless one of these tax stabilization agreements is offered and accepted.

C.        The Goals Of Tax Stabilization Agreements

While a city cannot thrive without development projects, it is important to for Providence to gain more from TSA’s beyond development for its own sake.  For me, the most important TSA goal is to expand the City’s tax base.  For that reason, we need restrictions on stabilize properties to prevent sales or transfers to tax-exempt owners.  Another important benefit is jobs, both in construction and in some cases operation of developed properties.  TSA’s should therefore contain terms encouraging the employment and/or training of City residents without making the achievement of the first goal impossible.  TSA’s can help accomplish urban planning goals; for example, Providence used TSA’s to create vital downtown residential district that is attracting entrepreneurs and “creative class” members to move into the City.  Other ancillary goals of TSA’s can include neighborhood improvements and environmental protection

D.        Providence’s Experience With Tax Stabilization Agreements

Providence has experimented with different forms of tax stabilization agreements to accomplish these goals.  Earlier this year, the Internal Auditor and City Solicitor compiled information about existing agreements you can review by clicking on this link: Report.  Measured by this standard, several prior agreements have fallen short.  Some have offered terms that were more generous than needed to encourage development.  In others, the City attached conditions (regarding the employment of City workers or union workers) that were difficult to monitor.  In early agreements, the assessment remained very low during the entire “stabilization period”, jumping up to full value only in the last year or two.  This model did not cause developers to focus with enough attention on the importance of meeting the goal of full taxation within the stabilization period.  Also, the process of “case by case” review of these agreements by the administration and the City Council has induced an atmosphere of horse-trading, in which developers sometimes feel the need to add extra amenities to win the support of particular elected officials in the decision proces

E.         Protecting The Taxpayer Against Unnecessary Giveaways

In 2011, the Gilbane Development Company approached the City Council with plans to build student apartments at 257 Thayer Street.  The developer negotiated a proposed tax treaty with the City that would postpone for twelve years the imposition of full taxes.  The developer provided a pro forma data sheet to justify its request.  When I reviewed the data sheet, I calculated that the revenue projections were based on anticipated rents of $900 per bed per month, even though the developer had told the media that the expected rate was between $1,200 and $1,500.  Using those figures, the Internal Auditor calculated that a discounted tax was not necessary, and that the proposed treaty would cost the City between $1.9 million and $3.5 million over the life of the proposed treaty.  The developer maintained that the project would not be built without a treaty.  Despite this, the City Council did not approve the treaty, and the development is scheduled to open in January.

There are risks in playing this type of “high stakes poker,” but the data was sufficiently compelling to justify this risk, which paid off for the City.  From my own study of the issue since that time, it appears that the 257 Thayer project was a rare exception to the general rule that developers will not build without TSA’s.  In the case of 257 Thayer, the key factors appear to have been that the location was one of the most attractive in the City, and the developer was demolishing the existing buildings to permit less expensive “new construction” costs rather than the higher costs of renovation.

F.         Improving Tax Stabilization Agreements Going Forward

During hearings earlier this year, the City Council reviewed the tax stabilization process, and soon will be producing a report with findings.  Though I have not seen the final report, I will support changes that standardize tax stabilization agreements to remove some of the loopholes that impaired previous ones, including the following:
*          There should be a standard agreement that offers a fixed “stabilization period” of between 10 and 15 years that brings the incremental increased assessment in equal annual increases.
*          The standard template should include a restriction on transferring the property to nonprofits within a certain number of years of reaching full taxation, as many current agreements have no such restriction, presenting a major potential loophole.
*          The template should clearly state that no extensions will be granted.
*          The standard agreement should be available administratively without further approvals, removing the horse-trading that discourages development under the current program.  This creates a potential risk that a project such as 257 Thayer, which can be built without a TSA, will gain an unnecessary tax break; however, the cost of occasional subsidies that are not needed is offset and exceeded by the benefits of facilitating more development that meets the requirements of a “template” TSA with clear requirements written into it.
*          To protect the integrity of the tax base, there should be an annual limit on these agreements until we have more experience with which to optimize the template.

G.        The Alice Building/Peerless Lofts Projects

The Alice Building and Peerless Lofts projects before the City Council were early examples of TSA’s.  In addition to introducing new development, they accomplished other important goals.  The projects supported residential living downtown, which has been instrumental in attracting a new group of “creative class” and affluent residents.  Also, the projects advanced the goal of historic preservation, as they called for the reconstruction of dilapidated downtown buildings without tearing them down.  As part of this effort, the developer also acquired State historic tax credits.  As the project moved forward, however, it ran into problems.  First, the cost of renovation proved to be larger than expected; by the time the project was finished, the construction costs amounted to approximately three times the real estate value added to the buildings.  Also, the real estate market proved to be weaker than predicted.  With that said, the structure of the TSA postponed these problems, because rather than building the assessed value steadily from 0% of the improvements to 100%, the TSA remained fixed at a low value.  To further postpone the “day of reckoning”, the developer obtained a blanket extension from the State prior to seeking the 5-year extension now before the City Council.

The proposed extension will move the assessment from 25% to 95% over five years, and 100% thereafter.  It will incorporate new restrictions on transfer to tax-exempt properties, and the assessment value will float based on future revaluations, rather than be fixed.  The Internal Auditor prepared an Analysis that estimates the lost tax revenues at $1.6 million over the five-year extended stabilization period.

In hindsight, this project was an extremely inefficient investment of private and City funds, as the developer’s financial information suggests that the ratio of construction costs to added value is approximately 3:1.  (This disparity results from the fact that property value for this building is based on the income it generates from rentals, which is market-based.  Also, the construction costs are greater because the project involves renovations based on historical preservation goals, rather than demolition and new construction.)  With that said, it would be detrimental to the City’s downtown development and long-term tax base were this project to fail.  Within this analysis, a further revenue loss of $1.6 million appears to be the least expensive and most prudent course.