Historic tax credit fraud
How the latest scheme is affecting the Norfolk market
- July 30, 2012
Kathleen Kilpatrick, Virginia’s historic preservation officer, believes tough economic times lead to creativity — some positive, some criminal.
Unfortunately for Kilpatrick, director of Virginia’s Department of Historic Resources, criminal activity has taken the lead in recent years. In Richmond and Norfolk, developers in two high-profile, tax credit schemes were charged with defrauding taxpayers and investors of millions of dollars by inflating the costs to rehabilitate historic properties. This enabled them to receive more in tax credits, which investors purchased in exchange for the credits, prosecutors say.
Some real estate executives in Hampton Roads say fallout from the Norfolk case has had an impact on commercial real estate in downtown Norfolk, where partners George Hranowskyj and Eric Menden did several projects. Deborah Stearns, senior vice president with Harvey Lindsay Commercial Real Estate Co., says, “The Madison building [one of their projects] has had low occupancy and has skewed vacancies in downtown Norfolk to higher numbers than the true picture represents.”
The Norfolk developers are accused of bilking the state and a federal historic tax credit program out of $11 million, while pocketing about $8 million for their own use. The pair also was allegedly involved in a $41 million fraud that helped cause the collapse of the Bank of the Commonwealth in Norfolk.
In response to the two cases, the Department of Historic Resources has renovated its 15-year-old rehab tax credit program which gives developers a state tax break of 25 percent of a project’s renovation costs. Developers can also apply for a 20 percent federal tax credit. They can obtain additional funding by transferring those credits to investors.
Owners/developers sign a CPA-certified affirmative statement attesting to the accuracy of all information provided to the historic resources department. “Virginia is the only state that has those backstops,” Kilpatrick notes. “Those are strong prohibitions.”
But the process was not completely airtight. In 2009, historic department staffers suspected Richmond developer Justin French of inflating costs to renovate three dozen properties. The department worked with law enforcement to uncover his crimes, and French pleaded guilty to fraud. He was later sentenced to 16 years in prison.
A similar case unfolded this spring in Norfolk. Developer Hranowskyj was charged with 14 criminal counts that involved using taxpayer and investor money for personal purchases, rather than the rehab of the former James Madison Hotel and two other historic buildings. Since then, partner Menden has pleaded guilty to three federal felonies and agreed to testify against Hranowskyj whose trial is scheduled for November. Hranowskyj has pleaded not guilty.
Kilpatrick attributes the schemes to the tough economy combined with human nature. “Once the downturn in the economy started, a certain character emerged,” she says. “Human beings being human beings, some people are not going to tell the truth.”
The department implemented stricter vetting procedures. Staffers scheduled additional meetings with applicants, required extra documentation, increased site visits and mandated that engineers perform inspections. The department also can require a full CPA audit of developers’ expenditures. “It’s not a question of what we will be doing, but a question of what we have been doing going back more than three years,” Kilpatrick says.
She adds that investors, developers and lenders are vital to weeding out those trying to bilk the system. “They have a responsibility as due-diligence partners in the program. People have got to look behind the obvious and make sure they do business with people who are reliable.”
The safeguards paid off before Hranowskyj’s arrest. Due to the enhanced procedures, the department declined to certify two of Hranowskyj’s three projects, approving only the Madison Office Building (formerly the James Madison Hotel). Built in 1906, the eight-story hotel was once one of downtown Norfolk’s finest establishments. Purchasing the property for $5.1 million, Hranowskyj and Menden planned to convert it into condominiums but opted for a mixed-use concept when the real estate market collapsed. The $23 million renovation offers 81,932 square feet of space, with 60,000 of that office space.
Doug Aronson, a former vice president with S.L. Nusbaum Realty Co., which previously had handled leasing for the Madison, says that about 25 percent of the building was rented when he left the company last year. According to him, Hranowskyj and Menden have since assumed responsibility for leasing the Madison. Aronson says that as long as Hranowskyj and Menden remain owners of the building, potential tenants may be reluctant to sign a lease. “Tenants want to know who’s behind the management and ownership of a building.”
However, Aronson believes that the DHR’s stopgap measures will stem the impact of the tax credit fraud cases, especially as long as the department remains “diligent in making sure all the i’s are dotted and the t’s crossed.” Most historic tax credit program participants are honest, he adds, noting that “if you abide by the law, you don’t have anything to fear.”
Another Hranowskyj and Menden property in downtown Norfolk ended up in bankruptcy. This spring, a federal judge transferred ownership of the Wainwright Building to an investment group that plans to turn the historic property into apartments. However, Scott Adams, mid-South regional president for CBRE in Norfolk, thinks the Wainwright case could have a silver lining. “We expect the new ownership to convert the building to apartment use, which will be a positive to the office market because the current tenants will have to relocate and will absorb office space,” he says.
Meanwhile, as the tax credit program rebounds, Kilpatrick believes it will thrive under scrupulous creativity and oversight. “It’s critical that all involved understand the importance to hang onto this good tool for urban renewal and economic opportunity and all do our part to ensure its integrity.”