Understanding the NJ PILOT Program | Opportunities, Risks, and Best Practices

Christopher Stoop:Alright, so in terms of today's agenda and overview, we're going to go through what is the New Jersey long-term pilot and tax abatement programs. Then we'll touch on the legal framework and statutes behind the program. We'll highlight the benefits both to municipalities and the developers operators. We'll go through the eligibility application and approval process, and then the compliance and reporting end. And then of course, we'll always leave question time for some q and a at the end. As we said earlier, you can take your questions in the q and a widget so we can cover those topics at the end. But it, I'll go to the next slide now and we're going to go through the background on what is the little long-term pilot and taxed programs covered by New Jersey here. So the payment in lieu of taxes, pilots for New Jersey, it's covered under the tax exemption law. But Tom, why don't you kind of go through this since this is your area of expertise?

Thomas Dolan:Yeah, just taking a step back in terms of why do we have pilots at all, what are pilots there? Just in the large sense, we have a half hour, so we're going to be moving quickly here. So I just want to set out at the outset we have our contact information. Everybody can reach out separately and with respect to the questions, if any time during the presentation, if you guys have questions, just pop them into the q and a box and if we have time as we're going through this, we'll address some questions if we have time or not. We'll do it just at the end, but it's always helpful for us to hear feedback as we go through. So just generally, what is a pilot program? It's a payment in lieu of tax program. It's an incentive program. We have it. Municipalities use this as an incentive to incentivize development in areas that normally don't have development.

So that's the general overarching purpose of the pilot program. And it's necessary for a, but for these pilot programs and incentives, the concept is they wouldn't be built and so we wouldn't have them. So they're necessary for projects to build and succeed. And it's really, overall, it's a partnership as we'll get into a little bit with the municipality and the developer. They enter into these agreements and they agree to do certain things and make certain payments. So it's a way municipality can control development in the city or the township, but it's also a way for builders to build in manners in which they would know otherwise be unable. So the legal framework of this, it stems from the constitution. The constitution permits these exemptions. There's a uniformity clause and property tax. So there's also a separate clause that allows for these specific exemptions in certain instances.

So based on the constitutional authority, there's statutory frameworks that have been put in place. There's several statutes for a long-term pilot. The one we're going to be talking about is the long-term tax exemption pilot, and that's NJSA 40, a 20 dash one. There's also a New Jersey, a long-term pilot for the New Jersey Housing and Mortgage Finance Agency that's under a different statutory program. And then the other one that comes up a lot is there's a five year program that's NJSA 40, a 20 dash 21 dash one, and that's for five years. So the long-term pilot, it can be up to 30 years in duration. And the way the program generally works is you make a payment based on your revenue. And we'll talk a little bit about that as we go further. And that's where Chris comes in and his team, they do the analysis. But the key features is there's a financial agreement in which, like I said, it could be up to 30 years under statute that's permitted, and that's a negotiable term.

The parties can negotiate how long it can be. If the project is very important to the city and they really want to do it, they'll give you 30 years. But I've seen them in the range of, they could be 10 years, somewhere between 10 to 30 years you make your payment, instead of paying regular taxes, you pay what's called an annual service charge. That's a percentage of your revenue for market rate projects, that's 10%. It can't be lower than 10%, but again, that's a negotiable rate. So I see them in the range of 10 to 15%, and that can be adjusted over the years and we will talk a little bit more about that.

So yeah, that's, that's the general overview of the program. In order to get the pilot, I should just say you have to be in an area, need a redevelopment, so that's a prerequisite. So when people call me about getting a pilot, long-term pilot, we have to check to see if the project is first in an area that is eligible for a pilot. If it's not, we can go back and get the area designated, but it's a longer process. So that's one of the first steps. The planning board has to have already designated the area and need redevelopment. It's part of the whole urban renewal process. Let me see what else I want to before I, I'll kick, we'll go to the next slide, Chris, about the benefits municipality. I think we cover over some of those.

Christopher Stoop:So from a municipality's benefits perspective, as Tom had mentioned, the purpose is to give some new spending new lifeblood to certain areas within municipality. And this is the municipality has the choice to target certain areas within their municipality that they say is open for redevelopment, open for new job spending, et cetera. So this can help revitalize some of those areas of plight, let's say, that might need some updating. There's also the job creation model that's going to happen during development and then subsequent, and then there's stable and predictable revenue streams that's going to come through the pilot agreement. But I think the biggest benefit to municipality, and I'll let Tom share any additional insight, is, but the municipality itself gets a larger share of the pie from pilot payments than they do under the traditional property tax value. The municipality itself will get to keep 95% of the proceeds that come from the pilot payments and 5% goes to the county where under traditional property taxes, there'll be, you'll split your property tax bill with school boards, fire library, et cetera. It's a big budget filler for the municipality. And it's a little bit more streamlined in terms of how much you're going to get because you have it under this long-term exemption program. But Tom, is there any other insight you want to touch on there?

Thomas Dolan:No, that's exactly right. When I do pilot projections for the municipalities and for clients to show what they would pay under a pilot as opposed to regular taxation, because the municipality keeps 95% of the tax revenue directly to the municipality and they have discretion to do with it as they please on a regular taxation, let's say they can get 50% or less of that usually sometimes they only get a third putting aside school budgets, but then the county gets a big chunk of that when we do the analysis for the pilot in terms of money going directly to the municipality, a lot of times, although the developer's paying less overall than regular taxation, the municipality sometimes is getting more or they get essentially the same amount directly in their pockets. So yeah, that's a big benefit that we always like to highlight to municipalities and obviously they're revitalizing areas they normally wouldn't.

Yeah. We have a couple of questions. Let me, somebody asked, as revenue increases, do taxes increase accordingly? Yes. Every year, and we'll talk about this, you do an audit. So if your revenue goes up every year, you pay a certain percentage based on that revenue. So if your revenue went up, your pilot payment would go up, but that's part of the stability that we talked about. And let's go to the next slide that goes to the developer benefits. So your taxes do go up, but it's always based on your revenue. So it's only based on what the revenue the developer's bringing in or the owner's bringing in. So it creates a stability and lenders love it because your project's never going to go underwater for taxes. So if you lose a fair amount of tenants, let's say on an income property, your payment is adjusted accordingly. So if you're losing rent, it's only based on actual income, actual revenue, every single year.

So that's a huge developer benefit. It brings stability to the project. Of course, it's financial assistance to bring the project to completion lenders, it's fairly common now, and lenders are always looking for properties that have pilots. It's very favorable. They like the stability, they like the fact that you won't go underwater due to the taxes, lower tax burden. Of course, the developer's paying sometimes half of what they would normally pay depending on the municipality. And then the way the program works is the improvements are exempt, and yet you get a credit for the taxes paid on land. So that's the traditional long-term pilot based on the statute. So you get an exemption on all your improvements, and in lieu of that, you pay the pilot payment. So there's a lot of benefits there.

Christopher Stoop:And I just want to jump in really quick. Certain towns in New Jersey will have the properties, reappraised or revalued every year, every five years, every 10 years. The benefit here is those improvements, being exempt, participating in the program, the value of the property going up has no bearing on what you're paying in your annual service charge because it's the contractual rate that was agreed upon between the developer operator and the municipality. So as Tom had mentioned, if you're paying 10% or 11% of revenue, you know exactly where you're paying. So it's contractually based. It has no bearing initially on the overall value of the unit.

Thomas Dolan:That's right. So as property values go up, but the taxes won't go up, only if your revenue goes up,

Christopher Stoop:Which helps from a modeling perspective too there. So if you're modeling out your occupancy trends and your annual rental rate growth, you can kind of more accurately predict what you're going to be paying in pilot. You don't have a huge variable on the property being reassessed. So I think it's easier for all parties involved to kind of model out what that predictable revenue streams are going to be to the municipality and then the pilot payment or expense for the operator.

Thomas Dolan:Right. Okay. I think we go to the next slide.

Christopher Stoop:So I'll have Tom kind of go through this. This is a very important process, but just Tom, why don't you walk the audience through the eligibility and application process.

Thomas Dolan:So I touched on a little bit. You have to be in the area, you need a redevelopment, so that's part of the initial requirement. So when a developer comes in, I check the location of the property. It is typically for fairly large projects, but it can be for some smaller projects. So a few key important points that sometimes it doesn't make sense depending on where you're on the project. So you have to apply before you break ground or before you start construction. That's standard in all municipalities. Some municipalities, and this is also a gray area, but I will say as a cautionary tale, you should always have your pilot approved before you start construction. And some municipalities require that be in stone and you certify to that. Some municipalities just allow you to apply before construction. But I would say by and large, most municipalities require you to have your pilot application fully approved before you start construction.

But you have to apply only after site plan because I have to know what the project is. So there's this period after site plan when we have to get the application in. And then you can't start construction, actual construction until you get the pilot approved. You can get your construction permits, et cetera, but you can't actually break ground. So it's sort of a compressed period. We try to get it done there. You apply to the mayor's office, sometimes they have a subgroup that handles it, an economic and housing development group, the BA sometimes involved, but it goes to the mayor first and then you have to submit a fairly detailed application describing the project, describing the benefits to the municipality, putting forth all your projected income and revenue. And actually that's a question somebody had. The pilot payment is based on the revenue, not on the income.

I just want to be absolutely clear there. Somebody thought there was ambiguity in what we said earlier, but it's based on the revenue. So you have to set forth all your projections, and these are all projections. And so what happens is you send that into the city and they'll look at it. They'll typically get their own financial consultants to crunch the numbers to see if it makes sense for them, and they'll come back to you and then you'll negotiate. I always ask for the most 30 years and 10% of revenue, and then we negotiate from there. And then after it's negotiated, then it's presented to the governing body, and then the governing body has to approve it separately and they approve it by an ordinance.

Yeah, and as part of the application, there's a draft financial agreement which has all the terms that govern everything. And just to address one of the questions on this point, if you have a financial agreement that's fully approved and executed, the city can't rescind it unless you breach it. And then there's terms in there to protect yourself. There's cure periods. So somebody had a question about can the city just take it away after they granted it? No, they can't unless you breach the agreement or there's some things that you haven't done. Actually, the other thing that is important here is you need to have an urban renewal entity, and Chris can talk a little bit about that.

Christopher Stoop:That's on the next slide

Thomas Dolan:There. It's on the next slide, you submit to the Department of Community Affairs for the urban renewal entity, and there's certain profit restrictions, but that's also, if you no longer are A URE, then that's the basis to terminate the pilot and you need that at the outset. So that's something we handle upfront.

Go ahead, Chris.

Christopher Stoop:I was going to say just for the urban renewal entity specifically, there is certain restrictions being an urban renewal entity. There's limited on profit restrictions. If remember the background, you applied for the pilot because it's an area of needed of redevelopment, some new life spending. So under each of the financial agreements, there'll be a term of allowable profit that's allowed to be generated under the project. And that's again, generally set at 12% of the project costs incurred during the development cycle. And that's the number that you cannot exceed over the entire life of the pilot agreement, which we're going to go under the assumption that this is a 30 year agreement, some are shorter, but overall, you're not allowed to exceed that allowable profit. It's very hard for the developer operator to exceed that allowable profit restrictions. Almost in a net operating loss carry forward method, you can carry forward losses from the beginning of the years before the properties were stabilized. So it would be rare for the developer to exceed that allowable profit assumption. But if the property is performing so well, the municipalities always has some additional protections there as an additional revenue stream for any taxes above. But honestly, I've never seen an operator go above that level profit method. That property would have to really be performing super strongly to trigger that requirement. But there is the annual audit requirement as well that we're going to touch on soon.

Thomas Dolan:Yeah, that's right. It's very rare, but it is something we have to advise our clients that there is a profit restriction and there's an annual audit every year that Chris handles that sets out what the pilot payment will be, plus it sets out whether there's been any excess of the profit requirement. And normally there's not, but that's a submission every year. And that takes us to our next slide, which is all the compliance and reporting requirements.

Christopher Stoop:So I'll touch to this. This is where the audit firms usually come into play. So this is a requirement under the statute. You're required to have an annual audit done. It's required to be done within 90 days of year end. So for most county year end companies, it's due by the end of March. And the audit has to be required on a US gap basis. So you cannot use a BOA or an income tax basis. It has to be done under US gap. And the developer will also have to submit upon completion of the project a certification, their total project development that's also defined under the statute. And then there's going to be this continuous audit monitoring of the allowable profit, which I touched on earlier over the remaining life of the agreement to make sure you don't go above that allowable profit roll. So the developer is going to be required to submit those audited financial statements, particularly when it's based off of revenue, because the municipality wants to make sure that the right number of revenue was reported.

Now, I saw a question pop up earlier about recoveries from a CAM perspective. Is it a pass through? Is it revenue? Is it excluded? So I think that's something that should definitely be negotiated during the application process because I've seen municipalities treat that differently depending on the municipality. So in my mind, it's a pass through. It's not true revenue, it's a cost recovery, and therefore I don't feel that it should be part of the pilot calculation in terms of what you're paying in terms of your annual service charge, that's definitely something that should be negotiated well upfront so that way all parties are on the same page. I think there is good standing that it's just a pass through, it's a cost recovery model. It's not true revenue, and therefore it should not be part of the pilot calculation. But I've seen certain towns say that those recoveries are subject to revenue since it's revenue on the financial statements, and therefore it's subject to pilot.

So again, I think that's part of the negotiation process during the application that should be covered. But the developer's going to be required to submit those annual audited financial statements within 90 days of year end over the entire life of the agreement. And from the municipality's perspective, they're going to have to review those annual audits, make sure that all the compliance and reporting provisions been followed, and they're going to have to enforce all the contractal terms that were laid out in the agreement. So the best practice, obviously what we'll touch on, but it's very important that we do this on the right foot to be in compliance. As Tom had mentioned earlier, one of the ways the municipalities can cancel the pilot agreement is if you're not in compliance with contractual terms. So it's important that you have these audits done and you work with your local accounting firm, your local CPA, Eisner ER to get these audits done on a timely basis.

Generally speaking, once we do one, it's relatively simple. The very first year we have to get comfort on the project costs that were incurred during development. And I'll say that the pilot usually kicks in if the property's being done in phases, the property might not even done yet. But once we start generating revenue, now we're paying pilot, and that's when the audit requirement would kick in. So if the property's being developed and there's 10 different buildings and we got cos on six of them and we're renting on those first six buildings, that's where the audit requirements going to kick in and we're going to start having the audited financial statements be submitted. But the schedule of allowable profit is not going to be required until the final end of the agreement once the project is finalized.

Thomas Dolan:Yeah, that's right. I mean, you'd be surprised the audits, how many people loan to the audit and sometimes the municipality doesn't ask for them and that becomes a mess later down the road because it's the basis to rescind the pilot. Or when people buy the property, typically that's when they do their diligence and they look and they say, well, this agreement and there's been no audit. And so that's always a very tricky situation.

Christopher Stoop:So from knowing that we only have a couple minutes left, I want to quickly just touch on challenges and issues. So as Tom mentioned, the financial agreement must be approved before the project begins, transfer and assignments upon sale. If the current operator is looking to exit, make sure, as we just mentioned, we want to make sure that all the compliance provision has been followed. So the purchaser is not inheriting a problem, defining the key terms. That was the question that came up earlier on the recoveries. Is that part of gross rental revenue or not? There has been some pushback and depending on the municipality, but because the municipality gets 95% of the proceeds, if it's a multifamily project and there's school aged children, well then there's a cost to educate those school aged children and we're not necessarily sharing with the school board. So that's something that could be negotiated time and application, but there could be a little bit of community pushback. There could be manipulation of revenue expenses by the operator, and that's why the audit requirement is there. And the municipalities also have to have that continuum of monitoring of the agreement over the entire life of the agreement. And certain towns have many pilots, certain have towns only have a few. So there could be some area of gray in terms of following all the contract rule provisions.

So in terms of best practices from the developers and operator's perspective, you always want to maintain transparency and timely reporting and communication with your municipal partners. You want to engage the experienced legal and financial advisors to make sure that the agreement has been executed correctly and that you're doing all the compliance reporting provisions. So you can kind of lock in the benefits of the long-term pilot program. And then you want to also plan for the long-term obligation beyond the pilot terms, as the pilot's starting to mature and that the end is near, there's things we can look at to have the property reassessed to kind of lower that tax burden once the pilot stops kicking in from municipality's perspective, they want to have that continuous analysis, make sure they're in compliance with all the contractual terms, and they can also negotiate benefit agreements. There could be some park space or affordable housing requirements that are part of the application. So those are all best practices, again, to be negotiated during that application process. Not after. It's a little bit harder to put the genie back in the bottle, so to speak, but I think those are some of the best practices. Tom, I don't know if you want to highlight anything else.

Thomas Dolan:No, I think you covered them, Chris. Those are the general best practices here. Obviously a lot with the programs we try to cover a lot in this truncated time. I dunno if you want to go over some questions.

Christopher Stoop:Yeah, yeah, we'll go to other Q&A now.

Thomas Dolan:So are they transferable? I think we covered that they are transferable, but you typically need municipal approval. All of this is covered in the financial agreement. It's a negotiated aspect of it, but typically they want to vet the new entity and make sure they approve it. I think we covered how revenue's defined, Chris. I dunno if you want to add more to that.

Christopher Stoop:Yeah, I was going to say the statute will define it on what they determine is gross revenue. Generally if you sell the property, that would be considered other income. That's not necessarily revenue. I think the biggest thing from a negotiation perspective there would be just negotiating those recoveries. That's probably the biggest part of the negotiation process, but pretty much any other form of revenue is going to be defined as revenue. And then therefore subject to pilot, you could also have an annual service charge, not based off of revenue. It could be as a percentage of your project costs, and that's generally 2% that you would pay in terms of the annual service charges. And then revenue would not be part of the calculation for your annual service charge. But I think that's rarer In my experience, most of the requirements that I've seen in my experience has been based off of revenue. But there is other models in terms of the annual service charge that you can pay. Again, that might be as a percentage of the project cost. And that's generally defined at 2%.

Thomas Dolan:That's right. Normally for non-income producing properties that don't have a regular revenue stream stream, we see 2% of project cost. But yeah, the standard one is a percentage of revenue, I guess. So anybody could reach out to either of us on some of these questions. Obviously we can't get specific on particular matters.

Christopher Stoop:Yeah, I was going to say there's a lot of specific questions. So for those we'll follow up after the meeting and we can touch base with each of you to answer those questions. It's hard to talk generalities because obviously every financial agreement specific, but we just wanted to highlight the background and benefit of the New Jersey pilot program, the long-term tax exemption, and we'll follow up with the specific questions that came in after the meeting.

Thomas Dolan:Right? Yeah, we're happy to follow up on anybody's questions. So there is one here about, one thing needs to be clear is it has to be part of a construction project. So if there's an existing property that's already done, you don't get a pilot on that. It has to be part of a redevelopment project. So I think somebody had a question about a building that already is in existence. Alright, I think we need to wrap up now, Chris, right?

Christopher Stoop:Yeah. Yeah. So Savanah, do you want to do the closing remarks?

Thomas Dolan:Great. Thank you everybody. Thank you all.

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