Benefits and Pitfalls of PILOT Agreements for NJ Municipalities
By Keith S. Balla, CPA, PSA, ABV, CFF, CGMA, Partner
The tax abatement programs for all New Jersey cities date back to 1961. Beginning in the late 1950s, commercial and manufacturing employers in large New Jersey cities began an exodus from the cities, not only taking with them thousands of jobs but substantially eroding the city’s tax base. The most serious threat came when many large national companies announced tentative plans to leave the cities. For cities like Newark and Jersey City, this would have been catastrophic.
Newark, along with all major cities in New Jersey, needed a way to retain its large employment and tax base and to replace those businesses that had already either left or were in the process of relocating outside the city. The answer was the Fox-Lance Act.
Fox-Lance had a comparatively simple structure. Its goal was to eliminate urban blight, encourage redevelopment, maintain the viability of New Jersey’s large urban cities, and ultimately restore a solvent tax base to New Jersey’s deteriorating cities. Tax abatements were guaranteed up to 20 years for new or redeveloped construction. These long-term abatements could last 30 years from completion of the project or 35 years from the execution of the financial agreement. Payments were based on a simple formula of either 1.5% of annual revenue or 2.0% of total construction cost.
As a means of ensuring continued development within New Jersey’s cities, the Fox-Lance formula was generous to the entity (developer) but in reality may have been financially unfair to the cities. The municipality enters into an agreement with the developer which abates taxes that would otherwise be paid to the municipality including other entities such as county and school district taxes. The school district and county are not involved in the approval or selection process or the abatement award or financial agreement. For long-term tax abatements, there is a significant tax loss to the school district and county. Under the long-term tax abatement statute, the county receives 5% of the Payment in Lieu of Tax (PILOT) and the local school district receives nothing from the PILOT.
The Long Term Tax Exemption Act N.J.S.A.40A:20-1 (1991), together with subsequent amendments, attempted not only to remedy the unintentional inequity imposed on the city by the initial Act, but also provided a more detailed governing law relative to financial controls governing tax abatement.
Tax-Abated Development: Municipality Responsibility
Today, there are millions of dollars invested in the cities in tax-abated development. New Jersey municipalities which have significantly used abatements are: Atlantic City, Camden, Jersey City, Long Branch, Newark, New Brunswick, Paterson and Trenton. Each project is recommended by the Mayor and authorized by the Municipal Council under the specific conditions set forth and established by state statute and the city’s governing ordinances, resolutions, and financial agreements. Because of the need for continuing redevelopment and the financial considerations provided, it must be recognized that the municipality has a major stake in each development project in that:
- As the governing party to the financial agreement with the entity, the municipality has a primary responsibility to ensure that all provisions within the financial agreement, as well as all requirements established by law, are fulfilled.
- The municipality has a fiduciary obligation to safeguard the financial assets of the municipality including, but not limited to, all in lieu of payments (service charges) and other direct financial benefits that inure to the municipality as a result of the financial agreement.
- The municipality must have knowledge as to the specific ongoing financial and operational status of each project relative to its financial agreement with the entity.
Critical to the municipality’s ability to fulfill its oversight obligations is the review of annual audits that are required by state statute, local ordinance and the financial agreement. Many entities, however, have over the years been inconsistent in forwarding audits to the appropriately designated municipal agencies. Numerous entities which have developed properties in New Jersey municipalities have violated the terms of financial agreements with the municipality and have failed consistently to file copies of their audits with the governing body through the City Clerk as prescribed by both law and the financial agreement .
NJ Tax Abatement Governance
There are four controlling instruments that govern tax abatements:
- N.J.S.A. 40A:20, The Long Term Tax Exemption Act.
- The municipal ordinance (Title 10 Finance and Taxation; Chapter 11 Procedures of Tax Abatement Agreements) enabling the introduction of the Tax Abatement Act.
- The financial agreement with each entity.
- The specific municipal resolution authorizing the municipality to enter into a financial agreement with each entity.
Successful PILOT Agreements
Over the past 60 years, PILOT agreements between municipalities and developers have enabled cities with blighted areas to incentivize developers to take the risk and redevelop large sections of the communities. Looking at Jersey City, the early PILOT agreements which fostered the redevelopment of the waterfront have proven successful and have now become the Gold Coast of Jersey City. Newark‘s early PILOTs were the Gateway projects at Newark-Penn Station which have become the anchor for transportation, business and entertainment in the city. Cities like Jersey City and Newark have been successful in utilizing PILOT agreements to revitalize and spark the redevelopment the cities needed.
PILOT Agreement Negatives
The PILOT agreement funds all go toward the city budget with only 5% going to the county and no funds going to the school district budget. The city will actually garner more funds for the annual budget with the successful PILOT than under the old assessed value at the assessed rates.
The cities have over many years granted payment in lieu of tax (PILOT) agreements with various property owners wherein no tax is levied on the properties with PILOT agreements for the school tax of the cities. This creates a gap between education service requirements and related costs with no support by the property owners for the costs associated with education of students in the cities. As the real estate values and neighborhoods are revitalized, there would no longer be a need for future PILOTs. Often, the PILOT agreements have been extremely lucrative for the developers over time. Additionally, developers have often taken advantage of municipalities with creative contracts and operations to ensure the developer pays the lowest amount under the agreement.
Pitfalls and Problems of PILOT Agreements: Hands-on Experience
Over the past 35 years, working with New Jersey municipalities, we have seen the following pitfalls and problems related to PILOT agreements.
- Structure a master lease with an affiliated entity to artificially lower the revenue of the PILOT entity. The master lease affiliated entity then collects the higher rents from all of the actual tenants and the developer builds up additional profits in its affiliate by underpaying the percentage under the PILOT based on the artificially lower revenue paid by the affiliate.
- Set up management agreements with affiliates to overpay expenses for management and maintenance of the property to artificially lower the profits of the PILOT entity to underpay the city.
- Comingle expenses of multiple projects to overstate expenses of the PILOT entity thereby lowering profits and underpaying the city.
- Sell municipalities on entering into a PILOT when the area is not blighted or in need of redevelopment. Developers, in an effort to increase their profits, will pitch municipalities that a PILOT is needed when, in fact, the subject property is extremely valuable and maybe even one of the most lucrative development sites in a community; in effect, abusing the intent and spirit of the PILOT legislation to further enrich the developer at the detriment of the municipality.
- Did not comply with prevailing wage and minority hiring during construction to increase profits by having lower costs while knowing the municipality did not have the appropriate infrastructure to oversee audit compliance.
- Structure the operations with a lower base rent and separately invoice tenants for reimbursed expenses. The developer, then based on the definitions in the agreement for rent, exclude the reimbursed expenses from revenue to underpay the city.
- Did not comply with minimum wage laws and/or with submission of annual required audit reports.
We have also encountered during our assignments:
- Municipalities not ensuring that all required documents are received for construction projects and costs and supporting information.
- There are no consistent audit standards relative to what the municipality requires in order to consider an audit complete.
- There is only limited cursory review of audits by the municipality administration. There is a reasonable doubt as to whether this review is adequate because of a lack of in-depth professional accountants and auditors who are experienced and trained.
- Noncompliance does not result in any punitive action or penalty to the entity (developer) by the municipality.
- There are no outside or third party reviews conducted to ensure the appropriateness of submitted entity audits.
Although issued in August 2010, the report of the then New Jersey State Comptroller, A. Matthew Boxer, continues to underscore broad issues underlying tax abatements. It states:
The burden displaced to the neighboring municipalities can be large. For example, according to the county tax records previously referred to, Jersey City currently exempts approximately $2 billion of property value. In view of the city’s general tax rate of $6 per $100 of assessed value (6%), Jersey City is not collecting approximately $ 120 million in property taxes on the exempted property. In 2009, Hudson County received approximately 25% of the property taxes collected in the city. Using that as a baseline, the county did not collect approximately $30 million from Jersey City due to the city’s abatements. While the county still receives some amount through its 5% portion of PILOTs, it does not make up for that $30 million in lost revenue. Instead, the other municipalities in the county make up for those dollars.
Engage Experienced Professionals
While the PILOT programs in New Jersey have had many successes in a number of municipalities, there are numerous instances where municipalities have been underpaid and short-changed by developers. In addition, school districts have suffered due to the loss of tax revenues from PILOTs which is desperately needed for the schools. Municipalities and elected officials in considering entering into a PILOT with developers need to retain experienced professionals to assist in the evaluation of proposed PILOT projects to clearly understand the advantages and disadvantages to the municipality, as well as performing reviews of compliance once PILOTs are in effect.
If you have used our municipal services before and now have further need, please reach out to any member of your client service team, or if you are interested in requesting an engagement proposal, contact Keith S. Balla, CPS, PSA, ABV, CFF, CGMA at firstname.lastname@example.org or by telephone at 908.967.6813.