Amazon recently announced its selection of Nashville for its Operations Center of Excellence, ultimately bringing 5,000 jobs to the city. While not Amazon HQ2, this selection is certainly a nice consolation prize. Combine that with the relocation of Alliance Bernstein's New York City headquarters to Nashville and the city’s number five ranking of top U.S. real estate markets to watch in the U.S. in the ULI/PwC Emerging Trends in Real Estate report, and it’s no surprise that interest from out-of-state investors continues to rise.
With this increasing interest in mind, below are five issues sponsors, investors and developers need to be aware of prior to coming to Nashville.
Tennessee franchise and excise tax
Tennessee’s lack of a state income tax on wages makes it an attractive relocation option for employees and businesses. Given the state’s tax-friendly reputation, the Tennessee franchise and excise tax often comes as a surprise to uninformed out-of-state investors, and it is especially burdensome for owners of real estate. The tax is imposed on all entities doing business in Tennessee that provide their owners with limited liability protection, including limited partnerships and limited liability companies. The excise tax is imposed at a rate of 6.5 percent on the entity’s net earnings. The franchise tax is imposed at the rate of $0.25 per $100 of value of the greater of (i) the taxpayer’s net worth or (ii) the depreciated book value of property owned or used in Tennessee. Given that, in many cases, tenants with leverage resist including these taxes as permissible pass-through charges under their leases, franchise and excise taxes can have a significant impact on net operating income for a project. However, there are several exemptions from the franchise and excise taxes that should be discussed with a tax professional when structuring the ownership of a real estate project in Tennessee.
Tennessee does not impose a state property tax. Property tax is, however, imposed by cities and counties. To encourage development, cities and counties can offer one of two property tax incentives: payment in lieu of taxes (PILOTs) and tax increment financing (TIFs). Cities and counties can offer a PILOT incentive that allows a property owner to make a reduced PILOT payment instead of the standard property tax that would apply to the real estate and personal property owned by the property owner. The PILOT payment is typically calculated as a percentage of the standard tax that would otherwise be paid. Cities and counties are also able to offer a TIF incentive that allows a developer to use the real and personal property taxes payable on its property (and, in some cases, other impacted property) to offset development costs, typically through a TIF loan.
In Nashville, PILOTs must be approved by the city’s governing body—the Metropolitan Council. TIFs must be approved by (i) either the Metropolitan Development and Housing Agency (MDHA) or the city’s Industrial Development Board, and (ii) the Metropolitan Council. Currently, a moratorium is in place on MDHA TIFs. Investors should also be sure to consider projects in the city’s “opportunity zones,” as this federal tax incentive is bringing additional interest to parts of the city that have already seen significant investment in past years.
Construction and development issues
As is the case in most states, a developer should not commence site work on a project until it consults with a local attorney and its title insurance company to ensure priority of the mortgage securing its construction loan over mechanic’s liens. In Tennessee, a potential lien attaches at “visible commencement of operations,” which is the first actual work of improving the land or the first delivery to the site of materials that remain on the land until actually incorporated into the improvement. Although demolition, surveying, excavating, clearing, filling or grading, placement of sewer or drainage lines or other underground utility lines and the erection of temporary security fencing by statute do not trigger visible commencement of operations, these items should still be reviewed by the developer’s title insurance company prior to beginning work.
Developers must also ensure that their project’s contractors, subcontractors, architects, engineers, construction managers and consultants are licensed in Tennessee, including any person or entity that constructs, supervises, oversees, schedules, directs or assumes charge of a project valued at $25,000 or greater. A developer’s acceptance of a bid from an unlicensed contractor is a class A misdemeanor and could subject the developer to fines and penalties. Additionally, when contracting with a project’s contractors, retainage cannot exceed 5 percent of the contract price, and where the amount of the prime contract is $500,000 or greater, retainage must be held in a separate, interest-bearing escrow account with a third party.
Much of downtown Nashville is zoned Downtown Code, which permits a broad spectrum of uses and does not include a parking requirement. However, the Code divides downtown into several subdistricts, which include distinct design and building regulations. Properties may be further subject to overlay districts with additional regulations and required approvals. Of note, much of downtown Nashville is located within redevelopment districts administered by the MDHA. For properties in a MDHA redevelopment district, project plans and signage must be submitted and approved by the MDHA Design Review Committee for compliance with the design guidelines of the applicable redevelopment district. A local design and engineering firm should be consulted early when considering a new project in a redevelopment district.
While developers and investors bring their lenders to Nashville to finance projects, Nashville is home to many local and regional banks with sophisticated lending practices. The lending environment remains competitive, and new banks continue to enter the market. Given their familiarity with project sites and the market in general, local banks are often more nimble and responsive when presented with an appropriate opportunity.
Mike Stewart is a member of the law firm Bass, Berry & Sims PLC. He advises developers and investors on commercial real estate projects throughout Tennessee and across the country. He can be reached at [email protected].