by William Harla, Esq.
and Michael Caccavelli, Esq.
As if the current economy does not present enough challenges for new apartment development, New Jersey's budget woes and the accompanying reductions in State aid to local municipalities will merely exacerbate that ever present impediment to development and bane of the project pro forma: property taxes. Decreases in State aid will drive the State's municipalities to squeeze every tax ratable dollar possible out of what little new construction comes on-line. In such an environment, a new apartment development may appear very appetizing indeed to the hungry local tax assessor.
The best means by which to achieve a fair, stable and predictable property tax bill is to take advantage of any available payment in lieu of tax ("PILOT") programs. The chief advantages of a PILOT are that (1) the amount of taxation is stable and predictable over the term of the exemption and (2) the PILOT payment generally is less than what would be paid via regular taxation. This second advantage emanates from the fact that a PILOT agreement removes the property in question from regular taxation and diverts nearly all revenue from the PILOT to the municipality, which revenue is shared with the local school district and the county under regular taxation. Since PILOT revenue goes predominately to the municipal government, this almost always results in the municipality realizing substantially more revenue from a PILOT. In the current fiscal climate, this consideration should not be overlooked and may serve as a powerful inducement for a municipal governing body to grant a PILOT.
The most widely-available PILOT program is the Long Term Tax Exemption Law ("LTTEL"). The LTTEL permits municipalities that have declared areas in need of redevelopment to enter into PILOTS for new construction for a maximum period of 30 years. The amount of the PILOT is based on either a percentage of annual gross revenue (not more than 15% for low and moderate income housing, nor less than 10% for everything else), or a percentage of total project cost (not to exceed 2% for low and moderate income housing, and not less than 2% for other types of projects). The greatest advantage of a PILOT under the LTTEL is that the payment is fixed for the term of the PILOT which as a general rule of thumb is about 1/3 less than taxes under regular taxation. LTTEL PILOTS are subject to a number of restrictions including the requirement that the entity owning the project is subject to annual dividend limitations and must pay excess profits to the municipality. Despite this limitation, the excess profit formula contained in the statute possesses some fairly generous deductions that make the restrictions much more palatable.
In municipalities that have established areas in need of rehabilitation, the Legislature has provided an alternate, short-term PILOT program known as the Five-Year Exemption and Abatement Law ("Five-Year Law"). As the name implies, the Five-Year Law is limited to a maximum term of five years. The Five-Year Law permits PILOTS for either the rehabilitation or conversion of existing improvements, or for construction of new improvements. There are certain limitations on the total amount of exemption for rehabilitations and conversions. In any case, the amount of the PILOT, similarly to the LTTEL, may be predicated on a percentage of project cost or gross revenue. In addition, the PILOT under the Five-Year Law may be based on a percentage of taxes other wise due over a five year phase in period with no taxes due in the first year, 20% of tax otherwise due in year 2, 40% of taxes otherwise due in year 3, 60% of taxes otherwise due in year 4, 80% of taxes otherwise due in year 5, and cessation of the exemption and subjection to 100% taxation in year 6. The chief advantage of a Five-Year Law PILOT is the elimination of any payment in the first year following completion of the project which is very attractive to the developer in the lease-up period.
A third, less common, PILOT program is available only if the developer finances the project through the state's Housing and Mortgage Finance Agency ("HMFA"). HMFA financing permits the local governing body to grant a tax exemption for a term equal to the duration of the initial HMFA financing, which loan term may be a maximum of 50 years. The HMFA PILOT is based on a percentage of the project's annual gross revenue for expenses that is negotiated with the municipality up to a maximum PILOT amount of 20% of annual gross revenue. Limitations to a HMFA-based PILOT are it (1) is subject to the availability of HMFA financing; (2) comes with fairly strict on-going regulatory requirements and restraints on the ability to sell or transfer the project; and (3) imposes certain profit limits.
If a PILOT program is not available, there are still steps that should be taken. Accepting the fact that taxation is certain, the better practice is for the apartment developer to be proactive and engage the local tax assessor as early as possible. By engaging the tax assessor, the developer can provide project specifics such as the size, type and composition of units, construction details and fit-out, projected operating costs, projected rents and lease-up and occupancy projections. While providing this information certainly cannot guarantee a fair added assessment based on true market value, it can preempt a badly flawed assessment based on the assessor's "best guess" from being imposed. At the very least this proactive approach will give the developer some advance warning of the tax burden that is likely to result upon substantial completion. If the developer does not engage the assessor prior to the imposition of the added assessment, the developer loses a unique opportunity to provide input into that added assessment to ensure that the added assessment is based on accurate facts and a fair market value of the project.
Mr. Harla and Mr. Caccavelli are partners at the law firm of DeCotiis, FitzPatrick, Cole & Giblin, LLP. Mr. Harla is a member of the Firm's Management Committee and an Associate Counsel of the New Jersey League of Municipalities. Mr. Caccavelli is the head of the Firm's Local Property Tax Department