Landlord lawsuit may upend New Castle County tax bills

A coalition of landlords and hotel owners has sued the state, New Castle County and its six school districts over the split-rate tax structures that legislators approved amid a wave of public outrage last month, moving more of the tax burden from residents to businesses.

If a judge ends up granting such an injunction – a hearing is scheduled for Sept. 23 – it would likely spell significant public confusion over where annual tax bills stand.

New Castle County is currently preparing new tax bills based upon the split rates approved by school districts that are due to be mailed out to residents within days, supplanting bills that were mailed out in July.

The coalition of plaintiffs include the Delaware Apartment Association, the Newark Property Association, the Delaware Hotel & Lodging Association, and the First State Manufactured Housing Association, which represents the interests of mobile home park operators.

They argue that state legislators overreacted to the public backlash, which was particularly heated in New Castle County where some residents saw their tax bills double or triple, while some major commercial properties actually saw tax reductions. 

That was due in part to the fact that school districts were not legally allowed to split their tax rates between residential and commercial properties, like the city of Wilmington and New Castle County were able to do.

It led the state legislature to a one-day August special session, where they passed a handful of bills, including House Bill 242, which allowed school districts in New Castle County to split their rates. Each of the six districts quickly followed suit, raising tax rates upward of 80% on commercial properties to move more of the overall burden away from homeowners.

“The School Board Defendants’ implementation of HB242 operates to shift tax burden away from wealthy and upper middle-class homeowners, whose homes have drastically increased in market value, primarily onto the owners of multi-family buildings and other “non-residential” properties who themselves had already sustained an increase in tax burden due to the reassessment,” the lawsuit states.

Tenants could be impacted

The plaintiffs warn that in order to avoid “financial ruin,” many landlords will have to pass these increased costs on to tenants, who are less likely to be able to bear the higher costs.

The Delaware State Housing Authority reported that nearly 40% of Delaware renters have incomes below 50% of the area median income – or $33,000 for a two-person household.

According to Apartments.com, the average rent in Delaware has risen 2.3% in the last year to reach $1,520.

“HB242 eases the tax burden on New Castle County homeowners by concentrating the burden on county residents who rent,” the landlords argue.

The lawsuit also details the testimony of manufactured home tenants Lorraine Burns and Evelyn Marshall, who say that even modest rent increases of $20 or $45 a month could require them to cut back on doctor visits, medications and “even food.”

Landlords seek to avoid foreclosure

The landlords explain that some apartment buildings have been “suffering from softening rental demand,” forcing them to reduce rents and invest in property improvements to try to cover debts. 

Most have loans on the properties that require them to maintain minimum debt service coverage ratios, which measure a debtor’s ability to generate sufficient income to cover its debts. Some also have maximum loan-to-value ratios, which calculate a remaining loan balance against a property’s value.

If either calculation exceeds its compliance levels, lenders could trigger defaults, requiring a landlord to repay their loan more quickly or all at once. Failure to repay the funds would result in a foreclosure and loss of the property.

“The unexpected, substantial tax increase under HB242 will affect both of these ratios for all properties,” the lawsuit said. 

“For some Plaintiffs’ members, it will be impossible to make the required payments. The properties that were already struggling cannot simply cover this expense by immediately raising rent to generate more revenue – they were already decreasing rent just to maintain occupancy. These members will likely permanently lose their properties to foreclosure,” the lawsuit stated.

The lawsuit specifically points out two apartment complexes – The Garrison in New Castle and Spring Crossings in Glasgow – that are at risk of foreclosure due to such provisions.

However, those properties mark two of the most heavily leveraged real estate deals in Delaware in recent years.

Goldcrest Properties, a New Jersey-based real estate investment firm, bought The Garrison for $30.6 million five years ago in what was Delaware’s largest apartment sale that year. A year later, New Jersey-based firm Capital Management acquired Spring Crossings for $56 million, marking that year’s largest apartment deal.

Each of those deals were made at the height of a buying spree on multi-family properties in Delaware during the COVID pandemic, where several investment firms topped $100 million in investments in northern Delaware.

Lawsuit argues split rates are unconstitutional

The plaintiffs present four arguments as to why House Bill 242 should be struck down, including that the Delaware Constitution’s Uniformity Clause prohibits split rate taxes. 

That clause states that “All taxes shall be uniform upon the same class of subjects within the territorial limits of the authority levying the tax.” 

They also argue that the Constitution forbids retroactive taxes on income, but the way that contractor Tyler Technologies assessed their properties would impose retroactive taxes on their income-producing properties.

When school boards amended their tax rates to introduce a split-rate structure, the plaintiffs argued that constituted an unconstitutional tax increase on non-residential property owners because it wasn’t approved in a referendum.

And finally, they argue that amending the rate structure so late in the process and therefore disallowing the landlords’ ability to appeal their overall assessment to lower their tax burden, resulted in a violation of their due process rights.