This article is part of the Under the Lens series
Shelter in a Federal Storm: State and Local Housing Solutions for a Time of Federal Hostility
The city of Chattanooga, Tennessee, was between a rock and a hard place. Sustained population growth, accelerated during COVID, drove steadily rising demand for rental housing. The private sector responded: Since 2021, developers have permitted more than 9,400 new units in a city of roughly 82,000 households. But the city had no tools to ensure that a share of those new units would be affordable.
New development in strong markets was market-rate, while affordable housing was limited to a handful of Low-Income Housing Tax Credit projects in weaker markets where land was cheap. To maintain a place for long-time residents as neighborhoods grew and changed, we needed new development to include affordable units. However, most of the regulatory “sticks” that can compel developers to include affordable units are preempted by state law. And as a city in a low-tax-revenue state, Chattanooga has limited discretionary funding to offer “carrots.”
Against this backdrop, tax abatement emerged as one of the city’s most powerful local tools for incentivizing mixed-income housing. But to unlock its potential, we had to hone the blunt instrument. In March 2024, Chattanooga made a first-of-its-kind change to its long-standing affordable housing PILOT program: it directly tied the amount of tax abatement to the cost of providing affordable units. While it may seem obvious, this marked a fundamentally new way of using tax incentives to fund mixed-income housing development.
What Is a PILOT?
PILOT stands for Payment in Lieu of Taxes and refers broadly to any agreement between a tax-exempt entity and a local government to make an annual payment that compensates for lost tax revenue. In Tennessee, PILOTs offer a legal mechanism to grant property tax abatement to private property owners. Here’s how it works: a privately owned property is deeded to a public agency and leased back to the owner. Because the public agency is tax-exempt, there is no traditional property tax bill. Instead, the owner makes annual payments in lieu of taxes, which are typically lower than what the property’s tax bill would be.
In practice, a PILOT is a negotiated discount on property taxes offered in exchange for a public benefit. While PILOTs are often associated with economic development and job creation, here we are talking specifically about their use as a local funding source for affordable housing.
How Does a PILOT Help Affordable Housing?
Multifamily housing is financed based on net operating income: rental income minus operating expenses like property taxes, insurance, maintenance, and staffing. That monthly income must be high enough to repay the loans and deliver a return on the equity that finances construction. If the income is too low relative to the cost of construction, the project cannot attract enough private financing to be built and will require subsidies.
This creates a fundamental challenge for mixed-income development. Lowering rents to create affordable units reduces income, but it does not reduce expenses. Without an offsetting subsidy, the project has less income to repay its lenders and investors. In strong markets with wide profit margins, this cost can be absorbed by a decrease in profits. In many markets today, however, high interest rates and construction costs have pushed projects closer to the viability threshold. Even small reductions in income can stop projects from moving forward. Therefore, if cities want to accelerate mixed-income housing production, they must find a way to fund it.
Tax abatement is a tool for doing that. Property taxes are a significant and ongoing operating expense. By reducing that expense, a PILOT functions as an ongoing operating subsidy that can offset the income lost from affordable rents, allowing projects to be financed with conventional market financing.
Like a tax credit, a PILOT subsidizes affordability by using foregone future tax revenue rather than a direct appropriation from the budget. Cities can secure affordable units in market-rate developments without needing upfront subsidies, even when the market is not generating big enough profit margins to sustain uncompensated inclusionary zoning. For Chattanooga, the question was never whether to use PILOTs, but rather how to most efficiently and effectively translate public investment into affordable units. While state law typically establishes the legal framework for tax abatement, cities often set affordability requirements. Therein lies the real challenge of PILOTs: rightsizing the tax abatement.
The Limits of a One-Size-Fits-All PILOT
In theory, a PILOT should reduce a project’s property taxes by the same amount as the income loss from affordable units—ideally a little more to create an incentive. In practice, like many cities’, Chattanooga’s existing PILOT was a blunt instrument. Developers received tax abatement in exchange for a fixed percentage of units at a fixed affordability level. In our case, the threshold to receive it was 50 percent of units affordable to households earning 80 percent of the area median income (AMI). The problem was that the value of the tax abatement was rarely enough to make up for the rent loss from the affordability requirements.
As a result, the PILOT functioned primarily as a gap-filler for LIHTC and nonprofit developers, who layered in other subsidies to make the numbers work. Meanwhile, a wave of market-rate development was underway, and the city had no effective carrots or sticks to bring affordable units into those projects.
Our first instinct was to adjust our affordability requirements: maybe 20 percent of units at 60 percent AMI would pencil for market-rate developers, or maybe 10 percent at 50 percent AMI. But when we tested these scenarios against pro formas from proposed developments and existing PILOT projects, the results varied widely. The city would pay vastly different prices for the same nominal public benefit, with no consistent relationship between the developer’s actual rent loss and the value of the tax abatement.
The problem was partly geographic. In weaker submarkets, the difference between affordable and market rents is smaller, so the rent loss was lower. In higher-rent neighborhoods, the difference was much larger, so the same PILOT fell far short of offsetting the loss. A one-size-fits-all structure would inevitably oversubsidize affordability where rents were already low and fail to incentivize affordable units where market pressure was highest.
This misalignment created two broader challenges. First, developments in the high-opportunity, amenity-rich neighborhoods where the city most wanted mixed-income housing were the least likely to use the PILOT. Second, the lack of a clear link between public investment and public benefit made the program difficult to explain. There was no simple answer to the basic question, How much is the city investing, and what is the developer giving in return?
That lack of transparency mattered. In Chattanooga, PILOTs require city council approval on a project-by-project basis. When the value of the incentive and the cost of affordability are opaque, public scrutiny increases, elected officials become more cautious, and the city’s ability to use PILOTs to invest in affordable housing is undermined.
Flipping the Script
So, we flipped the approach. Instead of asking developers to meet fixed affordability requirements and hoping the numbers would work, we tied the value of the tax abatement directly to the lost income from affordable units. This makes the exchange of public investment for public benefit clear and transparent, and it gives any new development a fair and attractive incentive to include a share of affordable units.
The approach is based on a simple formula:
Tax Abatement = (Market Rent – Affordable Rent) x Incentive
This formula calculates the tax abatement for each affordable unit. Market Rent minus Affordable Rent captures the income loss, and it is multiplied by an incentive factor so the value of the tax abatement is slightly greater than the lost income. The result is that a project’s net operating income increases when it includes affordable units.
Here are the variables:
- Market Rent. Market rents are estimated using the Department of Housing and Urban Development’s Small Area Fair Market Rents (SAFMRs), which provide ZIP-code-level rent estimates. To better approximate market rents for new construction, we apply a multiplier: currently 110 percent. This multiplier is updated annually to ensure that the adjusted SAFMRs still approximate rents across different submarkets.
- Affordable Rent. Affordable rents are based on HUD’s AMI-based rent limits. We offer incentives for units that are affordable at 50, 60, 70, and 80 percent of AMI. Deeper affordability results in greater income loss and therefore a larger tax abatement. These figures are updated annually as new HUD data become available.
- Incentive. The incentive is what makes the program a “carrot,” ensuring the value of the tax abatement exceeds the rent loss and covers the cost of compliance. The incentive is currently set at 10 percent and is revisited annually in response to market conditions.
Putting these together, the formula becomes:
Tax Abatement = (110% SAFMR – AMI Rent) x 110%
We use this formula to generate a schedule of annual tax abatements by unit size (0–4 bedrooms), affordability level (50 percent–80 percent AMI), and ZIP code in our publicly available PILOT calculator. A developer enters their project ZIP code and receives a custom table of annual tax abatements. By inputting their unit count, current property value, and hard costs, a developer can estimate both their property tax bill and maximum eligible abatement.
Developers can test different scenarios by adding affordable units of different sizes and affordability levels to offset their tax liability. They may include just a handful of affordable units and earn a partial abatement or commit enough units to offset their full eligible tax bill. What is ultimately written into the PILOT agreement is the percentage of abatement the project has earned, so the dollar value of the abatement grows as the property value increases over time.
The calculator cuts straight to the questions developers care about: What am I giving up? What do I get in return? When we walk through it with them, the response is consistent: “I’m shocked it makes this much sense.” We’ve spoken with many developers who don’t “do affordable housing,” but they immediately recognize that the PILOT makes financial sense for their project, especially in a tight market where every dollar of operating income matters.
From a policy perspective, this structure delivers several advantages. Because the incentive is calibrated to actual rent loss, a 60 percent AMI unit in a high-opportunity neighborhood receives a larger abatement than the same unit in a weaker market. Larger units and deeper affordability give a bigger boost to the project’s income because the incentive is a share of the rent loss. Developers can mix and match unit types and affordability levels, stacking abatements in ways that fit their projects while delivering a clearly priced public benefit. At the same time, the program remains fully workable for affordable housing developers, who qualify for the maximum abatement.
In October 2025, we proved the concept with the first PILOT issued under the new structure: a 278-unit Class A development on Chattanooga’s riverfront, in one of the city’s most amenity-rich neighborhoods. The developer does not typically build affordable housing, but the 69 percent tax abatement helped the project close in a tight equity market. The brownfield site that previously generated just $9,000 in annual taxes will now produce more than $340,000, even with the abatement. And the project will include 32 units affordable at 60 percent AMI and 10 units at 80 percent AMI in a neighborhood that currently has no income-restricted housing. It is precisely the type of development this tool was designed to reach.
More broadly, this experience underscores the power of tax abatements as a local housing tool. For cities without large housing trust funds, or whose markets limit the use of inclusionary zoning, abatements of future property taxes offer a way to make long-term investments in affordability without significant up-front public spending.
Chattanooga did not change the PILOT mechanism itself; instead, we changed how affordability is priced. When designed with precision and transparency, tax abatements can stand on their own, leveraging private development capacity to deliver mixed-income housing in high-opportunity neighborhoods without relying on federal subsidies—and transforming a blunt instrument into a reliable, scalable incentive.
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3 thoughts on “How We Rewrote a Tax Incentive to Encourage More Affordable Housing ”
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Thank you for another explainer on how you’re flipping the script! Question: How long do these PILOTs last? Can they be revisited and, if yes, at whose initiative? I.e. can the city change the terms, can the owner opt out?
Thanks for your question. In Chattanooga, projects are eligible for a 15 year PILOT and have the opportunity to apply again for a 15 year extension at the end of the PILOT term, for a total of 30 years.
The terms of the PILOT agreement cannot be renegotiated within a PILOT term, but are renegotiated at the extension.
The owner can exit the agreement before the end of the term, but there is an associated penalty based on 150% of the full tax liability. When the PILOT lease ends, the property returns to full taxation. Affordability requirements are coterminous with the incentive, and there is no ramp up period.
This is a fantastic idea – simple and easy to explain to participants and the public, elegant with the incentives directly tied to the desired outcome, and scalable in that it rests on a property tax system that exists everywhere in the country. Kudos!