Section Review

Financially struggling 40B projects may be altered after construction is complete

In a decision that may offer some relief for developers of financially struggling affordable housing projects permitted and constructed under G.L. c. 40B, §§ 20-23 ("Chapter 40B") prior to the market slow down, the Housing Appeals Committee ("HAC") has confirmed that it will approve changes to a comprehensive permit issued pursuant to Chapter 40B even after a project has been constructed and is operational. In 511 Washington Street LLC v. Hanover Board of Appeals, Permit Session Case No. 38149 (April 2, 2009), the Land Court affirmed a ruling of the HAC that a developer was entitled to lift an age restriction on an affordable housing project where the project as a "55 plus" rental community was operating consistently in the red due to a high vacancy rate.

Significantly, in its analysis of whether the developer was entitled to this project change, the HAC acknowledged that developers can and do make mistakes in the planning and execution of these projects and did not base its decision on whether the project's financial difficulties were the fault of the developer for originally choosing to permit the project with the age restriction or other alleged missteps in the conception and marketing of the project. The critical issue in the case was whether the project, in its current condition, was economic pursuant to 760 CMR 56.07(2), not who was to blame.

The age-restricted rental project

On March 29, 2002, 511 Washington Street LLC (the "developer") applied to the Hanover Board of Appeals (the "board") for a comprehensive permit pursuant to Chapter 40B to construct a project located on 3.88 acres in Hanover consisting of 74 age-restricted rental apartment units, including 19 affordable units. The board granted the comprehensive permit for the project, called North Pointe, on Jan. 21, 2003, which was subsequently amended in 2004 to allow the developer to change its subsidizing entity to the New England Fund. Condition 6 of the comprehensive permit memorialized the age restriction, requiring that at least one person who is age 55 or older occupy each unit. The project was constructed in 2004 and was marketed in early 2005.

The developer hired a professional real estate marketing company that included on-site staff at the project and extensive advertising and marketing efforts. Despite high traffic through the project by prospective renters over the course of several months, the project's market-rate units remained largely unrented. For example, in August 2005, only 30 of the project's 74 units were rented, and of the 30 rented, only 11 were market-rate units. The vacancy rate for market-rate units was 80 percent (11 of 55 market-rate units rented). As a rental project providing heat and hot water as part of the base rent for the units, the fixed costs - particularly those that were rapidly escalating as energy costs skyrocketed - and carrying costs pushed the project to the brink of financial ruin. At one point, the developer estimated it was losing as much as $50,000 per month.

Faced with this unsustainable financial reality, the developer sought to change the project in two different ways to increase demand, either by changing from rental apartments to for-sale condominiums or by lifting the age restriction on the rental project. Either of these changes required an amendment of the comprehensive permit by the board.

The notices of project change

The regulations implementing Chapter 40B provide a procedure for making changes to a proposed project. 310 CMR 56.07(4).1 Although the regulations do not directly address a change after permitting is complete, by practice, review of such proposed changes begins with the filing of a notice of project change ("NPC") with the local reviewing board, with appeals again going to the HAC. Generally, NPCs are filed prior to the completion of a project to allow developers to incorporate adjustments or alterations that arise during the planning and construction phases. In this case, however, the developer sought to amend a comprehensive permit for a project that had been completed and operational - albeit not successfully - for months.

The developer first filed an NPC with the board in August 2005 to convert the project from age-restricted apartments to age-restricted condominiums. The board denied that NPC, and the developer appealed that decision to the HAC. While that decision was pending, the developer filed an alternative NPC to lift the age restriction on the project but to leave it as a rental development. The board also denied that NPC in December 2006, and the developer appealed that decision to the HAC.

The HAC appeal

The HAC's rejections of the board's collateral arguments

Although both appeals were consolidated before the HAC, ultimately the developer only pursued lifting the age restriction (leaving the project as rental apartments) through the hearing. The developer argued that the failure to grant the NPC rendered the project uneconomic under the burden-shifting standards of 760 CMR 56.07(1)(c) discussed below. However, before addressing these substantive standards, the board raised two threshold questions. The board argued that because the developer had not challenged the condition imposing the age restriction at the time the comprehensive permit was originally granted, it had waived its right to do so in an appeal of the NPC to the HAC. Second, the board alleged that because the developer proposed the project with an age restriction, the age restriction was not "imposed" by the board within the meaning of 760 CMR 56.07(1)(c), notwithstanding that in the permit itself that the "Project shall be subject to an age-restriction …." However, the HAC dismissed these arguments, concluding that "our regulations clearly permit the developer to petition for changes without regard to whether the permit conditions or design parameters were imposed by the board, negotiated, or proposed by the developer." 511 Washington Street, Slip Op. at 6.

The board also attempted to dodge the HAC's substantive standards by arguing that the developer itself was responsible for the project's economic difficulties and that the HAC should not rescue the project and absolve the developer of its missteps by lifting the age restriction. The board claimed that the project's difficulties were a result of the developer's own choices, from the initial formulation of the project as an age-restricted development and a failure to adequately examine the market, to rents that were set too high and an insubstantial amount of time devoted to marketing the units. Essentially, the board argued the developer should be left to lie in the bed it made, regardless of the economic viability of the project, or, at the very least, should be forced to try for a significantly longer period of time to lease the units.

The HAC disagreed, concluding that where there is no allegation of fraud or other misconduct, which were not present here, a developer should not be prohibited from making changes to a project that has become uneconomic unless the board establishes there are countervailing local concerns in accordance with 760 CMR 56.07(2). Id. at 9.

The HAC acknowledged that the developer in this case bore some responsibility for the project's financial difficulties but concluded that was irrelevant, noting that in nearly every unsuccessful or struggling project, a combination of factors, including miscalculations by the developer, unforeseen construction difficulties, changing market conditions and overly restrictive permit conditions may be at play. Id. at 8-9. Such miscalculations, the HAC concluded, are "normal risks" associated with development as much as those market risks that are entirely outside a developer's control. Id. The HAC therefore disclaimed responsibility for apportioning fault in such cases. The HAC also noted that the alternative - to let a project fail - would not be in the interest of the town or its residents.

The board's denial of the NPC makes the project uneconomic

Having rejected the board's collateral arguments, the HAC addressed the age-restriction condition under its familiar burden-shifting analysis of 760 CMR 56.07(2). An applicant seeking to lift a condition imposed by a board - in this case, through the board's refusal to lift a condition - must demonstrate that the challenged condition renders the project uneconomic. 760 CMR 56.07(2)(a)(3). If the applicant satisfies its burden, the burden shifts to the board to prove first that there is a valid health, safety, environmental, design, open space or other local concern which supports such conditions, and then, that such concern outweighs the regional housing need. 760 CMR 56.07(2)(b)(3).

The developer presented the expert testimony of its real estate finance and development consultant regarding the return on total cost ("ROTC") for the project and comparing the return on the project with the age restriction to the return from a 10-year Treasury note. Under guidelines published by the Massachusetts Housing Partnership ("MHP"), a projected ROTC of at least 2.5 to 3.5 percent above the current yield on a 10-year Treasury note is required to fairly compensate capital investors for the risks associated with permitting, construction and operations. In this case, the developer's expert testified that while the MHP guidelines indicated a rate of 7.5 to 8.5 percent return would be economic, the project ROTC would be lower, ranging from 5.44 to 6.71 percent. Under the MHP guidelines, therefore, the project would be considered uneconomic, the developer argued.

The board challenged the economic analysis on a number of fronts, including rent levels and vacancy rates. However, even after these adjustments, the board's expert still calculated a ROTC of 6.6 percent, outside the MHP range. The board's expert then made the novel argument that, in fact, the acceptable return on the project should be lower than suggested in the MHP guidelines because the developer had already weathered permitting and construction risk, which the board's expert argued reduced the range by 1 percent to just 1.5 to 2.5 percent above Treasury yields. The HAC rejected this assertion, concluding that "[t]here is no indication in the MHP guidelines that pre- and post-construction risks are to be allocated within the overall risk of developing affordable housing. … The developer in this case should not be penalized simply because the risk that has materialized materialized after construction was completed." 511 Washington Street, Slip Op. at 14. Therefore, the HAC concluded that the project was uneconomic where the ROTC was below that indicated in the MHP guidelines.

Having found the project was uneconomic and that the board failed to raise countervailing local concerns that would favor the condition, the HAC issued a decision directing the board to lift the age restriction on the project. HAC Decision No. 06-05 (Jan. 22, 2008). The board appealed to Superior Court pursuant to G.L. c. 30A, § 14, and the case was transferred to the Permit Session of the Land Court at the request of the developer.

Land Court appeal

At the Land Court, the board sought a stay of the HAC's order pending the appeal, which was analyzed as a request for a preliminary injunction and ultimately denied by Judge Grossman. In both its motion seeking a stay and its cross-motion for judgment on the pleadings, the board sought to distinguish this case from the deferential standard applicable to administrative appeals under G.L. c. 30A, § 14, in which an agency decision may be overturned only if it is unsupported by substantial evidence, arbitrary and capricious, or otherwise based on an error of law. The board attempted to frame the questions raised in the appeal as solely legal ones subject to de novo review in which the HAC was entitled to no deference. The court rejected the board's view and adopted the well-established standard of review of agency action under G.L. c. 30A, § 14, where the court accords deference to an agency's findings of fact and interpretation of its own regulations. Under this deferential standard, the Land Court affirmed the ruling of the HAC in its entirety. Board of Appeals of The Town of Hanover v. Housing Appeals Committee, Land Court Permit Session Case No. 381349 (HMG), Slip Op. at 10, 20.

Although the board again argued that the developer could not pursue its claim because it had not challenged the age-restriction condition in the original comprehensive permit and the board had not "imposed" the condition, the Land Court agreed with the HAC that the genesis of the age-restriction condition was not relevant to whether it could be lifted through an NPC. The Land Court was similarly unpersuaded that the HAC had erred in dismissing the board's contention that the developer was at fault for the economic condition of the project and, therefore, without a remedy at the HAC. The Land Court agreed with the HAC that the sole question before it was whether the project was economic, regardless of what missteps the developer may have made that contributed to the current financial state of the project. Id. at 12.

As to whether the project was "economic," the court concluded the HAC's application of the MHP guidelines was within its express statutory authority and deferred to the HAC's reasonable interpretation of its own standards. Id. at 13-14. Further finding that there was virtually no testimony or other evidence of local or regional housing needs to support imposition of the age restriction, the court ruled the board failed to meet its burden. The court affirmed the decision of the HAC lifting the age restriction.

Notes

1.  The Department of Housing and Community Development promulgated renumbered and issued new regulations governing comprehensive permits effective February 22, 2008 at 760 CMR 56.00. These replaced prior regulations at 760 CMR 31.00. Although the project at issue in this case was permitted under the now-superceded regulations at 760 CMR 31.00, this article cites to the current regulations for ease of reference.

The Authors

Marc J. Goldstein is a principal in the Wellesley office of Beveridge & Diamond PC, an environmental, land use and litigation firm based in Washington, D.C. Goldstein specializes in permitting commercial and residential real estate projects and land use and environmental litigation in court and before administrative agencies.

Krista L. Hawley is an associate in Beveridge & Diamond PC's Wellesley office, specializing in land use and environmental litigation as well as permitting real estate projects, and is a former clerk of the Land Court. Goldstein and Hawley both served as counsel to the developer, 511 Washington Street, LLC, in this case.

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