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French Lick

The possibility of widespread fraud involving historic tax credits has the development community running scared.

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The plethora of badges and pistol holsters descending on Shockoe Slip generated a sidewalk frenzy the morning of Aug. 5, with reporters and passers-by inquiring about the fuss and blue lights in the city's cobblestone creative district.

It was the beginning of a dramatic saga, a story of a flashy developer with a little-known history of gunrunning and drug dealing, caught in the web of a wide-reaching investigation involving the Federal Bureau of Investigation, the Internal Revenue Service, state police and the U.S. Marshals Service.

Still much is unknown about the raid of French's offices on Cary Street, but one thing is clear: The case building against French threatens to stymie a widely praised historic tax credit program that has been perhaps the single biggest force behind the city's revival during the past dozen or so years.

The Virginia Historic Rehabilitation Tax Credit Program was created in 1996 to encourage real estate developers to invest in rehabilitating and preserving historic buildings. This wasn't a terribly novel idea. Similarly used federal historic tax credits have been around since the 1950s. But the addition of the state tax credits, and their relative transferability, sparked a sea change. Suddenly a developer could combine the state and federal tax credits, worth 25 percent and 20 percent, respectively, to finance major construction projects that otherwise would be too costly.

The tax credits don't just make the projects themselves attractive. The value of receiving 45 percent in credits, to offset state and federal income taxes, can be sold to investors and corporations for up to 80 cents on the dollar — creating instant capital.

“This subsidy is a wonderful subsidy, and it is the grease that makes these deals go,” says Kurt Maggette, a real estate lawyer who does about 30 tax credit deals every year. “Most developers are using that as a material part of their equity.”

For example, a developer might plan to spend $5 million to convert a former warehouse in a historic district into loft apartments. The tax credits could be used to get about $1.8 million in an infusion of cash, Maggette explains. The project must qualify, and the architectural and construction plan must meet approval from the state Department of Historic Resources, which oversees the state tax credits, and the National Park Service, which oversees the federal tax credits. But the credits, which are sold to investment groups once approvals are met, essentially become the collateral to secure the construction loans, along with the property itself. The developer, in turn, converts the warehouse into apartments and puts up little to no equity. (Technically, tax credits can't be bought and sold in Virginia, but the state allows tax credits to be awarded to partnerships, wherein investors buy into the partnership in exchange for a share of the credits. For more about how the process works, click here).

The program is viewed as win-win for all involved — the warehouse is preserved in its historical context, the construction creates jobs, the developer's investors get their tax credits and the developer walks away with a highly profitable apartment complex. Even better, developers don't risk much, if any, of their own money.

The promise of tax-credit infused capital sparked a widespread renewal of historic structures in Richmond, and across the state. Communities such as Church Hill and Jackson Ward, long pockmarked with vacant, dilapidated houses and buildings, quickly became magnets for developers and homeowners. In 1998, two years after the state tax credits became available, Cleveland-based Forest City Enterprises purchased five warehouses in Tobacco Row, converting them into loft apartments and creating a template for other developers throughout the city.

About that same time, French began putting down roots in Richmond. He'd just completed a federal prison term of less than two years for firearms and cocaine trafficking while living in Arlington and attending law school at George Mason University. After release in August 1996, he moved to Richmond to live with his grandparents, Ernest and Suzie Hazelwood. Within a couple of years, French was dabbling in the real estate business and in 1999 purchased a house in the 2700 block of Monument Avenue. By mid-2002, French began his foray into historic rehabilitation projects.

During the next few years French developed scores of apartments and restaurants, including the higher profile apartment projects off Summit Avenue and Norfolk Street in Scott's Addition, now the subject of a multimillion-dollar lawsuit. The lawsuit, filed Aug. 6 by the Bank of Hampton Roads, charges that an architect for French submitted requests for work that wasn't completed, ultimately defrauding the bank of $15 million. The federal and state investigation has been looking into French's use of state and federal tax credits, sources say — namely whether French was submitting to Historic Resources fraudulently inflated renovation expenses, which are the basis for determining the amount of the tax credits.

“Allegations of outright fraud are unprecedented,” says Kathleen Kilpatrick, the department's director. In 14 years, it's the first time the department has contacted federal authorities seeking an investigation. The department also has never had to undergo a formal “recapture” of the tax credits after they've been awarded.

The prospect of high-profile fraud involving the tax credits could undeniably cast a pall over the program, some observers say. Kilpatrick worries that the program will unjustly be tainted. There are appropriate backstops — including an expense report certified by an accountant for all projects that cost more than $100,000 — but if someone attempts to defraud the program there's little her department can do, Kilpatrick says: “We are not a law enforcement agency.”

There's still much to unravel in the French case. His first hearing following last month's arrest is in early November. In the meantime the development community will sweat out anxious state regulators and banks that may tighten lending on tax credit projects — at least in the short term. Bigger political implications will have to wait until the details emerge from the French investigation.

“What an investor needs in order to invest is certainty. If there is uncertainty out there whether or not that tax credit will be respected, that creates uncertainty about the number of people that are willing to invest,” real estate lawyer Richard W. Gregory says. “And the problem is there used to be lots of certainty.” S

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