Public Finance and Tax Incentives Fuel Cleveland's Development
Cleveland has gone through quite the makeover in recent years. Since 2015, the real estate development market in the downtown area has boomed, with dozens of projects utilizing private and public financing tools to create new multi- use properties. Examples of these large-scale construction projects include the Flats East Bank, which turned a once dilapidated area of the Flats into a residential and commercial center of the city, and the planned construction of the NuCLEus Project, which will further transform Cleveland’s Gateway District near Progressive Field and Rocket Mortgage FieldHouse (which itself is completing a $140 million renovation). Large skyscraper, multifamily apartment complexes such as the Beacon Apartments near the East Fourth District, the One University Circle apartment tower near the Cleveland Clinic and University Hospitals campuses, and the Lumen Tower Project in the Playhouse Square District are likewise utilizing the financing and investment tools offered through both public and private means. In keeping with this surge of downtown development, the city of Cleveland has turned its eye to renovating its outdated justice center complex, which houses the county jail, the Cuyahoga County Court of Common Pleas, the Cleveland Municipal Court, the county prosecutor and the sheriff ’s department. While plans are preliminary at this time, it is likely that the renovations will include some portion of private and public finance.
What caused this increase in real estate development in the downtown area? Public financing toolsandfederal andstatetax incentives that offer substantial enticements to real estate developers and investors is certainly a significant reason for the trend. These options have been used to varying degrees, but have continued to be a substantial portion of the financing and investment obtained for the revitalization of downtown Cleveland.
Perhaps the most significant public entity to promote high-end real estate development in Cleveland is the Cleveland-Cuyahoga County Port Authority. A port authority is a quasi- governmental organization created for the express purpose of, in part, engaging in activities that “enhance, foster, aid, provide, or promote transportation, economic development, housing, recreation, education, governmental operations, culture, or research within the jurisdiction of the port authority.” Ohio Revised Code § 4582.01(B) (1). Port authorities have specific powers provided by statute, which include the ability to “acquire, construct, furnish, equip, maintain, repair, sell, exchange, lease to or from, lease with an option to purchase, convey other interests in, or operate real or personal property, or any combination thereof, related to, useful for, or in furtherance of” anyoftheabovenotedauthorized purposes. Ohio Revised Code § 4582.06(A)(1).
In addition to these powers, port authorities may issue bonds or notes for the acquisition, construction, furnishing or equipping of real or personal property for the above noted authorized purposes. Ohio Revised Code § 4582.06(A)(3).
There are several benefits to utilizing port authority financing, including tax-free interest for the purchasers of bonds in instances of construction of public improvements. Perhaps the largest benefit, at least for large real estate development projects, is the Ohio sales tax exemptions that a developer may obtain for construction materials. Port authorities are generally exempt and not required to pay “any taxes on property, both real and personal, or any combination thereof, belonging to any port authority that is used exclusively for” any of the above noted authorized purposes. Ohio Revised Code § 4582.20. This, in turn, provides the key for significant savings for real estate developers through the use of the port authority’s tax exemption, when financed via the portauthority’s issuance of bonds or other debt instruments.
Typically, construction materials amount to approximately half of the expenses of large scale development projects. On the real estate side, as part of port authority financing, the port must retain a requisite ownership interest in the project to qualify for the sales tax exemptions. This can include the port authority owning the property in fee simple and leasing the property to the developer under a capital lease. In such case,
the developer receives all ownership benefits for federal tax purposes, and under the capital lease, the developer has the right to purchase the property at the end of the term. Alternatively, the developer can retain fee ownership of the project site, lease the underlying ground to the port authority via a ground lease, and the port leases back the project site to the developer via a capital lease. In either of those structures, the port authority, by retaining a requisite ownership interest in the underlying land (either in fee simple or through a ground lease), is able to provide tax exempt status regarding the construction materials of large scale development projects. The port authority, as an administrative fee, will receive a certain percentage of the sales tax savings provided to the developer. In utilizing port authority financing, developers realize significant savings.
Another tool heavily used for real estate development in downtown Cleveland is state and federal tax credit incentives. Tax credits may be taken by real estate developers themselves or other third party investors and institutional lenders in such projects. As an example, the federal Historic Tax Credit and Ohio Historic Preservation Tax Credit programs have attracted significant investment in development projects in the downtown area. With both programs, in order to be eligible for tax credits, the historic buildings for renovations must be listed in the National Register of Historic Places or otherwise belocatedwithin ahistoric district anddesignated by the National Park Service as a structure that retains historic integrity and contributes to the historic character of the district. Given that downtown Cleveland has many historical buildings with ornate facades and structures, it is no wonder that these tax credits have been put to good use.
Future development may also be on the horizon with the proposed “transformational mixed use development credit,” which recently passed the Ohio Senate by a 32-1 vote, and is now with the Ohio House of Representatives to consider. In order to qualify for tax credits, the project must constitute a “transformational mixed use development,” which means it must:
- Have a transformational economic impact within the project area approved by the Ohio director of development services
- Integrate some combination of retail, office, residential, recreation, structured parking, and other similar uses
- Include at least one building that is 15 or more stories in height or has a floor area of at least 350,000 square
The program allows the developer to sell the tax credit to obtain financing for the project, and is specifically catered toward insurance companies as the ultimate beneficiary of the tax credit as the investors in the project. It remains to be seen whether the transformational mixed use development credit will be passed into law, but in the event that it does you can expect additional large projects to be financed by the program in the coming years.
The above are just a few of the public finance and tax incentives offered to induce real estate development in the city of Cleveland and the state of Ohio. Finding attorneys who can navigate the complex processes and requirements for these programs is key to successfully developing real estate with significant cost and tax savings.
David Hales is the co-chair of the McDonald Hopkins Real Estate Practice Group, and is an accomplished real estate attorney with over 20 years of experience. David has been a member of the CMBA since 1997. He can be reached at (216) 430-2010 or dhales@ mcdonaldhopkins.com.
Alec Davidson is an Associate at McDonald Hopkins specializing in public finance, real estate finance, leasing and acquisitions, and asset- based lending transactions. Alec has been a member of the CMBA since 2015. He can be reached at (216) 348-5741 or adavidson@ mcdonaldhopkins.com.