Why the NIZ Should Be Nixed

Most of the controversy over Allentown's Neighborhood Improvement Zone (NIZ) has focused on its negative tax implications in surrounding communities. Hanover, Bethlehem, Lower Saucon, Upper Nazareth and Bushkill Townships, along with the Borough of Hellertown are all upset to see their EIT grabbed to finance an arena and other improvements in Allentown. They've all voted to challenge the constitutionality of the special legislation creating the NIZ in 2009.  But even as Allentown Mayor Ed Pawlowski appears to be blinking on that issue, some other very big boots are getting ready to drop.

Bethlehem. Developers. And most of all, us. Let me explain it to you.

Back in 2009, when Pennsylvania lawmakers finally adopted a budget after a record-setting 101-day stalemate, State Senator Pat Browne slipped a little piece of language into the Fiscal Code update. Buried amid the definitions of "little cigars" and "cigarettes" was legislation that set aside twenty-eight million dollars  for something brand new - the "Neighborhood Improvement Zone. (NIZ)"  Most legislators thought they were voting for a budget. Shrouded in secrecy, that's how the NIZ was born.

Even its paternity is in dispute.

Hey NIZ, Who's Your Daddy? 

Both State Senator Browne and State Rep Jenn Mann claim they are the parents. But are they? I learned yesterday, from a highly placed official, that the real author of this legislation is none other than J.B. Reilly himself. He's the developer millionaire who hopes to become a billionaire on a NIZ that operates like a TIF on steroids. Reilly, and the tenants he selects, will be able to use state tax revenue, even cigarette taxes, to fund the cost of improvements within a 130-acre noncontiguous parcel in downtown Allentown and along the Lehigh River waterfront.

In crafting this legislation, Reilly greedily threw in everything he could. Because nobody really read the legislation, he never had to give anything away.

There is no obligation, for example, to require that tenants be drawn from outside of a certain radius, say 25 or 30 miles, so that other Lehigh Valley developers can still make an honest buck.

At least by their standards.

The legislation imposes It imposes no obligation to produce jobs that provide a living wage. There is no penalty or clawback if goals are never met.

Browne, more messenger boy than legislator, slipped special legislation into the Rules Committee that makes a NIZ available for any local government with a population between 106,000 and 107,000 in the 2000 census.  He reportedly left specific instructions to notify him immediately if anyone became too curious. But at that time, everyone was so worked up over a budgetary logjam that nobody seemed to notice that the NIZ could benefit one, and only one community.

Allentown.

And the Queen City had just been handed a tool that allows the Lehigh Valley to cannibalize itself.

Biggest Victim? Not the 'burbs

Meanwhile, the Christmas City has finally begun to turn the corner on a precipitous drop in its tax base. That happened in 1993, when it stopped making steel. (I'll have more to say about the good news in Bethlehem later this week). After years of juggling finances to keep taxes down, the City has finally stopped intragovernment borrowing. It was even able to end 2011 with a $650,000 cash surplus.

But the City still has some major development problems, not the least of which is an 1,800-acre brownfield left by Bethlehem Steel as a parting gift.

Bethlehem is also home to Martin Tower, tallest building in the Lehigh Valley and ... largely vacant.

Did you know that Martin Tower is located just one mile from the NIZ? How is that building's developer supposed to attract tenants when J.B. Reilly is offering rents of $5 per square foot just a stone's throw away?

Martin Tower's core area, that is the percentage of each floor's footprint taken up by things that don't generate rents (elevator shafts, hallways, fire towers, etc.) is around 40% or so. Modern office buildings, built by owners interested in more than providing corner offices for every mid-level executive in the company, restrict the core area to around 20%.

So this venerable building is already hurting, and the NIZ is a death knell.

Can you imagine what Mayor Pawlowski would be doing if the PPL building, another biggie, was vacant?

As you can see, the effort to "save" Allentown is not really regionalism, but cannibalism. Allentown is sucking the rest of the Lehigh Valley dry.

In Bethlehem, much of the land in that 1800-acre brownfield, especially along the Route 412 corridor, in intended as office space. But who will pay $20 per square foot there when they can get away with $5 per square foot inside the NIZ?

As you can see, one the biggest victim of this faux regionalism may very well be the Lehigh Valley's most successful urban core - Bethlehem.

PennCap Gets PennCrap

But as badly as Bethlehem loses, even worse hit are developers like PennCap. About this time last year, PennCap spent $124 million to buy 32 office complexes from Liberty Property Trust at Lehigh Valley Corporate Center, Stabler Corporate Center, the William Penn Business Center and Lehigh Valley Industrial parks.

PennCap will get Penncrapped as its tenants are lured away.

Absent "new" jobs being created, the market will have to absorb all the new office space in the NIZ by causing vacancies elsewhere. More office space (increased supply) with no corresponding increase in demand will lower rents across the board, even without the subsidies to the NIZ developers.

I can do graphs, too. 

Office building owners outside the NIZ get a double-whammy. First, they have to compete against artificially low rents in the NIZ. Second, they're in a market that already has a surplus of space available. The NIZ will only grow that surplus.

And it will do it locally. New Jersey is aggressively providing tax incentives to firms willing to grow their NJ "footprint." So the Valley's prime source of relocations has dried up.

The above diagram illustrates what the subsidy to the NIZ office owners does: more office space (outward shift of supply) comes into the market, causing a drop in the market clearing rental rate for office space (equilibrium price), and a corresponding fall in the market price of all office buildings.

If this does not kill the developer, it kills his bottom line.

In the late 1980s, we learned what happens when various tax credits and other government incentives make investing in commercial real estate artificially (and only temporarily) profitable for some.

It was called "The S and L Crisis" and cost taxpayers about $400 billion before the carnage was over after the commercial real estate markets collapsed.

The NIZ has the potential for creating a sequel to that crisis locally. Some office owners won't be able to generate sufficient cash flow to pay their mortgages. They'll simply hand the keys to their buildings to their lenders and walk away. Others will "tough it out" longer, bleed cash, demand lower property assessments, and attempt to renegotiate their loans. They'll also rent space to far less creditworthy tenants (some rent is better than no rent) which increases the risk profile of their buildings. Lenders will demand higher interest rates, making it even tougher for owners to pay their mortgages. Lenders will also pressure politicians to stem the carnage and threaten to "redline" the LV if relief is not forthcoming. Investment capital, on both the equity and debt side, will flee the Valley. The Valley will get a (justly deserved) reputation as a bad place to develop office space. Developers and their tenants (read "job creators") will flee for greener pastures. Stories will hit the national wires on the desperate circumstances in the Valley. The PA legislature will get the message, and pull back much of the NIZ goodies in an effort to help the Valley recover.

I've been told that another suit is coming, and this one will be filed by office landlords.

We're all victims!

When office landlords demand lower assessments, they will get them. This will mean less tax revenue to the counties, school districts and municipalities. There will be no choice but to increase taxes or make tough decisions about reducing services or programs.

The very people we were told this NIZ will benefit will actually suffer. By that time, J.B Reilly and Joe Topper will have already sold their equity interests to outsiders, and will spend their time counting their cash and laughing at the fools who made them obscenely rich.

Us.

Updated 11:00 AM: Martin Tower was reported as being 1 mile from the NIX. It is closer to 4 miles. It is about a mile from the Allentown border.