Phoenix gave illegal tax break to developer of downtown apartment complex, judge rules

Phoenix promised an illegal tax break to the developer of a 21-story apartment complex under construction in downtown Phoenix, a judge ruled last week.

The decision comes after years of legal proceedings related to the complex dubbed The Derby Roosevelt Row, a micro-unit apartment complex planned for Second and McKinley streets.

In 2016, the Phoenix City Council approved a popular tax incentive for the project, which would have allowed developer Amstar/McKinley to forgo property tax payments for 25 years. Under the agreement, the developer would have paid no property tax for the first eight years and a lesser tax for the remaining 17 years. 

This type of subsidy, known as a Government Property Lease Excise Tax or GPLET, are supposed to be used to encourage growth in blighted areas. But they're frequently used in downtown Phoenix and downtown Tempe — which have some of the highest property values in metro Phoenix. 

Phoenix officials often argue that GPLETs are still necessary tools to encourage high-rise development — which is substantially more expensive to build than standard midsize apartment complexes — even in more upscale areas. 

But others, most notably the conservative Goldwater Institute, which sued Phoenix over The Derby project, claim GPLETs are abused and no longer needed in high-dollar areas. 

After years of legal back-and-forth, a Maricopa County Superior Court judge sided with the Goldwater Institute, ruling that the agreement with The Derby developer violated the gift clause in the Arizona constitution, which prohibits governments from providing benefits to a private entity without an equal returned benefit.

Phoenix is contemplating an appeal, said Nick Valenzuela, a city spokesman.

“Phoenix is disappointed in the ruling issued by the Superior Court. We are still reviewing the decision and determining next steps," Valenzuela said. 

City approved tax break in 2016

The Phoenix City Council entered into an agreement with Amstar/McKinley LLC to develop a less-than-one-third-of-an-acre lot in downtown Phoenix in 2016.

According to the developer's proposal at the time, Amstar/McKinley LLC planned to build a $36 million, 19-story tower, with 211 furnished micro-unit apartments which would average about 400 square feet of living space. They were projected to rent for around $1,300 a month.

According to a news release from contractor Hensel Phelps, the new developer, Ascentris, has updated its plans to a 21-story high-rise featuring 222 residential units with an average of 350 square feet.

The developer asked for, and the City Council awarded, a GPLET which allows Amstar/McKinley LLC to transfer the property to the city for 25 years and lease it back. This will allow the developer to forego property taxes, since government-owned property is not taxable. 

For the first eight years, the developer will pay no taxes. For the remainder of the 25-year deal, Amstar/McKinley will pay an excise tax that is significantly less than typical property tax. Annual lease payments that escalate in amount start immediately, ranging from $10,000 to $250,000. After 25 years, the property transfers back to the developer, which is then responsible for full property taxes.

The Goldwater Institute filed a complaint in Maricopa County Superior Court in 2017, challenging the constitutionality of the deal on behalf of nearby property owners and businesses, including Angels Trumpet Ale House. The Derby is planned for the vacant lot adjacent to the restaurant.

Goldwater Institute attorney Jon Riches said that when the city awards tax breaks to developers, they overburden surrounding businesses that must make up the missing tax revenue.

He said GPLETS are no longer needed in downtown Phoenix, which is evident because of the plentiful number of large-scale developments going up in the area that did not get tax breaks. 

"The evidence was pretty overwhelming in this case that the public was giving up way too much and receiving way too little," Riches said. 

Developer's benefit outweighs city's

The lawsuit centered on the gift clause in the Arizona constitution and whether the city gave away taxpayer money, or in this case, forewent tax revenue, without receiving an equal benefit in return.

In his ruling, Maricopa County Superior Court Judge Christopher Coury compared the money the developer would save with the tax break to the amount of money the city would gain under the deal. 

In the judge's analysis, the developer came out on top — by a lot.

Coury found that the city's benefits would be about $5.8 million — which includes lease and excise tax payments —  and the developer would save between $20.5 million and $27 million. 

Attorneys for Phoenix argued that the court should take into account indirect benefits of the project, including anticipated sales tax generated by the future commercial tenants in the building and anticipated property taxes after the 25-year tax break is lifted. 

The judge found that it was inappropriate to include 'indirect" benefits and instead focused only on the direct payments by the developer to the city.

Coury wrote that the benefits to the developer are "grossly disproportionate" to the benefits to the city.

If the city decides not to appeal the decision, Phoenix will have to revoke the tax break it previously offered to The Derby project. 

Ascentris did not respond to a request for comment as to whether the development will continue without the tax break. 

The Derby broke ground in March. 

Has GPLET 'death knell' rung? 

Coury's ruling applied specifically to The Derby project and did not address the constitutionality of all GPLETs. 

That said, Coury noted that GPLETs may no longer be viable because Arizona law prohibits a city from providing "disproportional benefits" to a developer — but most GPLETs do provide a bigger benefit to a developer because they are, by nature, an incentive. 

"This judicial officer questions whether the death knell for the GPLET’s usefulness has rung," he wrote.

Riches said there may be some areas of Phoenix where a GPLET still makes sense, but cities never use them in those areas. He said GPLETs were intended to revitalize areas that were blighted or dangerous. The corner of Second and McKinley streets is neither of those things, he said.

"GPLET is obviously abused when it's used as a development tool in some of the most sought after areas in Phoenix," Riches said. 

Reach the reporter at jessica.boehm@gannett.com or 480-694-1823. Follow her on Twitter @jboehm_NEWS. 

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