In 2020, a group of real estate investors approached the City of Larkspur with an idea: they wanted to buy a 342-unit luxury apartment complex called Serenity and convert it into affordable apartments for middle-income renters.

The deal would only work if the Larkspur City Council was willing to effectively exempt Serenity from property taxes. The investors promised the savings would then be used to set rents at levels that low- and moderate-income renters could afford.

Today, renters pay as much — and sometimes more — than comparable market-rate apartments, a Mercury News investigation found. Meanwhile, Serenity has been exempted from property taxes since 2020, costing the city $14 million.

Five years after it signed off on the exemption, the Larkspur City Council on Wednesday voted to begin rolling back the tax breaks, saying the affordability benefits to renters haven’t been enough to justify them. Stephanie Andre, Larkspur’s vice mayor, hopes the move will push other cities with similar agreements to do the same.

“Serenity has not met its goal of providing significant rent benefits to middle-income renters,” Andre said. Meanwhile, the project’s administrators and investors earned $7 million in fees in the five years since the property was acquired.

Serenity is one of 14 of these so-called ‘essential-housing’ properties around the Bay Area that were purchased by an obscure authority — the California Community Housing Agency, also known as CalCHA — which was created by a collection of real estate investors, bankers and attorneys who knew how to squeeze hefty fees out of the world of public finance.

Essential-housing deals work like this: a developer targets a property for acquisition, then approaches the city it’s located in and persuades officials there to join CalCHA. If they do, that allows CalCHA to issue bonds, or debt, which it uses to buy the property. CalCHA becomes the project’s owner, and because CalCHA is a government agency, the buildings are exempt from property taxes. Along the way, private real estate operators collect fees from brokering the deal and managing the asset. Bankers and attorneys get their cut from issuing the bonds.

“A significant portion of taxpayer dollars have been used to pay fees to expensive external advisors, rather than benefiting middle-income renters,” Andre said of Serenity, which is one of the biggest luxury complexes and most valuable parcels of real estate in Larkspur.

Taken together, Bay Area jurisdictions forfeit $21 million in taxes annually to participate in the program.

But many other cities don’t have the same recourse Larkspur has, because they signed agreements with CalCHA to remain a member until the bonds for their projects have been paid off, typically 40 years.

CalCHA, bondholders and real estate operators say that what happened at Serenity isn’t reflective of the entire essential housing program. They say their properties have provided rent-stabilized housing for middle-income renters who make too much to qualify for federally subsidized, low-income tax-credit housing, but may struggle to afford market-rate rents.

“There are a lot of tenants saving substantially on rent,” said John Drachman, co-founder of Waterford, which manages 14 essential-housing projects in the state, including Serenity. “This could have a really negative impact on those tenants.”

For Serenity, ending the tax-exempt status is likely to bring an end to the affordability provisions — but that’s unclear. Marin County, where Larkspur sits, is also a member of CalCHA, which could maintain Serenity’s tax-exempt status.

That’s a decision Marin County Assessor Shelly Scott will have to rule on, Andre said.

But if the assessor does determine that Serenity has lost its tax-exempt status, that could spell disaster for the bondholders. An appeal or lawsuit would be likely.

Serenity at Larkspur was already in financial straits, due in part to its massive debt payments (the project was 100%-debt financed). In August, Serenity defaulted on its debt after having spent most of its reserves. The project’s former property manager, Catalyst, blamed pandemic-era financial challenges and inflation.

Nine other essential-housing projects are also struggling to meet their debt payments and have tapped into reserves. Three other CalCHA projects — one in Santa Rosa and two in Antioch — are also in default for not keeping as much cash on hand as investors require.

The defaults — and Larkspur’s increased scrutiny of the project — spurred bondholders to intervene in Serenity. In March, the bondholders fired the former project administrator, Larkspur-based Catalyst and hired Waterford.

Bondholders have also been in talks to restructure the project’s $226 million debt. That would avoid selling Serenity, which would today fetch much less than the $223 million CalCHA paid for it in January 2020 because of a decline in real estate values.

Drachman said he was surprised by Larkspur’s decision to withdraw from CalCHA. After Waterford was appointed as the property’s new administrator, he told the city that he needed 60 days to come up with a turn-around plan. He had hoped Larkspur wouldn’t vote to leave CalCHA until they had a chance to present it next month.

But it was clear that, after months of back-and-forth with Catalyst and CalCHA, the City Council had reached a breaking point.

Andre scheduled meetings with CalCHA administrators in person and over Zoom to discuss Serenity, she said. Both times they cancelled the meetings and asked the city send their questions in writing.

“The way that this project has been managed is unacceptable,” Larkspur City Councilmember Scot Candel said. “I have no interest in rejoining CalCHA because it was a disaster.”

In a statement to this news organization, CalCHA Chair Doug Verboon wrote that CalCHA “will continue to evaluate its options and consequences associated with Larkspur’s withdrawal.”

“CalCHA has waived all of its fees and recently changed project administrators while actively working with bondholders to identify additional steps it can take to contribute to the project’s success,” he wrote.

Drachman remains optimistic that, with a restructuring and operational changes, Waterford can turn around the property and regain Larkspur’s trust.