The full extent of the developer’s tax credit scheme is beginning to emerge, and the development community is still reeling from the upheaval it has caused. The Virginia Department of Historic Resources, meanwhile, has begun the process of rebuilding faith in its historic preservation program.
“The Department of Historic Resources profoundly regrets that an individual schemed to commit fraud,” said Kathleen Kilpatrick, the director of the agency. “I am proud that this agency identified a problem that went unnoticed by some pretty heavy duty companies and agencies and brought it to the attention of law enforcement.”
Kilpatrick said DHR first alerted law enforcement close to two years ago that something was fishy about French.
“It became a concern that things didn’t add up,” Kilpatrick said.
Before French came along, the program worked without any major issues. Virginia launched its rehabilitation tax credit program in 1997 to help preserve the state’s rich stock of old buildings while revitalizing urban areas.
The program has, for the most part, worked as intended. Property developers take a state tax credit of 25 percent of a project’s rehab costs, combine it with a 20 percent federal credit, and fulfill a large chunk of financing by transferring those credits to investors who want to lower their tax bills. As a result, urban areas are revitalized, jobs are created and historic building stock is saved from demolition.
In Richmond, the program took off. Long-abandoned tobacco warehouses were among the first buildings to be transformed into income-generating properties. Shockoe Bottom now has thousands of residents in buildings that were vacant in the 1980s. The program has been so popular here, in fact, that developers might soon run out of big projects to rehabilitate. Many have started to take on projects in Tidewater and the Shenandoah Valley.
In a few-blocks radius you can see its impact: Miller & Rhoads, CenterStage, Berry Burke, The National Theater and soon the John Marshall Hotel — all funded with the help of proceeds from historic tax credits.
But as with any system in which the government hands out money, temptations lurks.
Around 2005, French emerged on the local scene from seemingly nowhere, buying up old properties and jumping into the historic tax credit game. He could talk the talk, and with slicked-back hair, a fancy SUV and a svelte assistant, he walked the walk.
“He was friendly and courteous,” said Mimi Sadler, a preservation consultant and a principal of her firm Sadler Whitehead. “He dressed unlike anyone else in Richmond. His cuff links outdid anyone else’s, and his pocket scarves were bright red.”
Sadler said she came in on some past projects that French was involved in but never worked directly for him as a client.
“I declined to work on his projects because I didn’t like the approach he was taking,” she said. One reason was that there were too many units in his projects and not enough windows, she said.
French was known as much for his weekend jaunts to Las Vegas on his private jet and his bevy of young female underlings as he was for his work bringing new life to derelict properties in formerly industrial neighborhoods such as Manchester and Scott’s Addition.
A source close to French said that as time went on, his behavior became more erratic, agitated, egotistical and controlling. In recent times, he was hardly ever seen without his hired bodyguard close by.
As French grew his empire, some in Richmond started to wonder how he was able, or how long he would be able, to continue to maintain his lavish lifestyle — especially as the economy began to tank and the real estate market entered its darkest days in a generation.
“He was doing a ton of stuff in 2009 when most developers were on the sidelines,” said developer Bill Chapman. “It didn’t make sense.”
As it turns out, French made the numbers work by making them up.
On Jan. 24, French pleaded guilty to two felonies in connection with a tax credit scheme that defrauded the state and federal government of up to $20 million. French falsely reported the amount he was actually spending on his projects to get a juiced up tax credit in return.
Holes in the foundation
Since May 2009, Kilpatrick said, the Virginia Department of Historic Resources has stepped up its procedures by increasing site visits and meetings with applicants and back-checking supporting documentation. It also set a threshold for costs per square foot, which can tip off a discerning eye that a developer might be padding his numbers.
Kilpatrick said that the range varies by project type and that if a project’s reported costs go outside of that range it will trigger a closer look and a request for more documentation.
The next important step is for the department to finalize new guidelines for the certification process, which requires an accountant to review the costs when they exceed $100,000.
“To the best of my knowledge, we are the only state program in the country to have the extra step of certification,” Kilpatrick said.
An advisory board is working on those new procedures, which Kilpatrick said will require more backup documentation, verification of costs and a standardized reporting format.
“We are looking at strengthening the CPA certification as an integral part of validating costs, as it is intended to do,” she said.
Architects, developers, CPAs and consultants are welcoming the changes with open arms. Most say publicly that French was an isolated case and that fudging the numbers is not a widespread problem.
“It’s a great program in its current state. I can’t understand why someone would abuse it,” Chapman said.
Brian White, a developer with Historic Resources, used the program recently to turn the former Richmond Cold Storage building in Shockoe Bottom into apartments.
“I may be naive, but I was shocked to hear about what he was alleged to have done,” White said. “The program is a good program without cheating. You don’t need to cheat.”
But a few others have said French isn’t the only one to take advantage of the system — just the most blatant.
“As with any program, you can be sure there will be some people who are going to comply with the regulations to the extent that they know someone is looking over their shoulder,” said Mimi Sadler. “The Justin French example is just the most egregious.”
Bob Mills, principal of Commonwealth Architects, said there are definitely more out there who have bent the rules.
“We work for developers who are not abusing the system, and we’ve learned to sniff out the ones who abuse the system,” said Mills.
Mills said that perhaps French was able to get away with his scheme early on because of the amount of faith that DHR had in developers.
“There was a lot of trust in the system in that it was thought that all these developers were generally being fair and that all the costs broke down correctly,” Mills said.
The lucrative nature of the program, Mills said, made it is a target for abuse.
“Take the architecture fee for example: A developer can pump it up. We’ve heard about it before,” Mills said.
Mills said the soft costs, which refer to professional fees paid to architects, engineers, lawyers and consultants, are the most vulnerable to manipulation.
BizSense examined tax credits awarded to commercial projects in Richmond for 2008. Almost $59 million worth of credits were awarded to a total of 57 projects. The average cost per square foot was $188, slightly higher than the $80-$125 range several developers said they think is reasonable. Costs can go above that range depending on the size and condition of a building, the types of finishes, and whether there are any legitimate overruns.
French’s approved projects had costs far above the norm, going as high as $641 per square foot for a 1,120-square-foot duplex in Church Hill.
The CPA certification is supposed to discourage a developer from entertaining such greedy thoughts.
Developers say the CPA certification process is very detailed. Accountants look over invoices, partnership agreements and other information. One developer said the amount of material submitted to the CPA is several inches thick.
That didn’t stop French from manipulating those documents to beef up his end credits, according to Clive Morey, the CPA who certified his projects.
“The certifications were done with documents provided to me by French’s office. No audit verification is required by the state,” Morey said.
“The FBI said that my work papers were very good and that I was misled with the information I was provided,” Morey said, “That is as far as they went with me.”
Rebuilding from the rubble
Over the past five years, the tax credit program has helped spur $755 million in construction work in the City of Richmond. (That figure is from DHR from 2005 through 2009 and does not account for the cost of purchasing land or buildings.)
Now some developers are worried that their golden goose might be less forthcoming.
Mills of Commonwealth Architects said that banks got nervous when news broke about French’s scheme.
“It really affected banks,” Mills said. “All of a sudden, they were scared. Banks got more conservative looking at projects.”
Chapman, who founded and worked for Fountainhead Development, said the fallout affected projects he was working on at the time.
“We’ve seen much more due diligence from lenders, higher legal costs and overall more time and effort,” said Chapman.
“Banks and lenders don’t want to make the same mistake twice,” said Chapman, who now develops under a new company named Bill Chapman Enterprises.
And while banks are looking more closely at deals, DHR is doing the same, according to David Will, a CPA for Mitchell Wiggins.
“The bottom line is it takes longer to get approval now than before,” Will said. “DHR is doing more due diligence down at their end.”
But developers have not been discouraged from embarking on new projects. Although DHR is looking to toughen the application and review process, those affected say it will make the program stronger and prevent future abuse.
“If you complete a straight package with the appropriate documentation, there is no problem,” said developer Robin Miller.
“What this reemphasizes is that experience does count. Those developers with a long track record and positive results, none of us are having any kind of questions that I am aware of,” Miller said.
“I think it is a positive step, and I fully support DHR tightening down,” Miller said.
Coming tomorrow: a summary of the collateral damage inflicted by French.