Space Florida's rocket science financing
Some of the deals that spurred redevelopment of the Space Coast have involved creative use of tax incentives.
Some of the deals that spurred redevelopment of the Space Coast have involved creative use of tax incentives.
Around 9 a.m. the morning of Feb. 4, 2015, more than half a dozen attorneys and executives representing defense contractor Northrop Grumman and economic development agency Space Florida squeezed into a small conference room on the fifth floor of the Brevard County property appraiser’s office in Titusville.
The group included a former KPMG accountant who directed financial planning for Northrop’s aerospace systems sector; a Washington property law attorney; a New York incentive consultant; a former banking industry lobbyist who ran special projects for Space Florida; and a GrayRobinson lobbyist who had previously been general counsel to the property appraiser in neighboring Orange County. The conference room was so crowded that the group needed additional chairs.
At the time, Northrop was angling for a federal contract worth as much as $80 billion to build stealth bombers for the U.S. Air Force. The company had approached Enterprise Florida to begin looking for locations in Florida that it could judge against others in other states. That had led to negotiations with Florida economic development officials for an incentive deal under which Northrop would do the research-and-development work on the bombers at Orlando Melbourne International Airport, where the company already had a sizable presence. The Florida work, according to Northrop, could mean as many as 1,800 new jobs.
Company executives were looking for ways to cut the company’s potential costs. They wanted more than standard incentives like the typical 10-year property tax abatement program that would have exempted the company from paying city and county taxes but not school-related assessments.
So the company and Space Florida — whose CEO, Frank DiBello, once led the aerospace consulting practice at big-four accounting firm KPMG — developed a plan to create $500 million in property tax savings for Northrop by turning Space Florida into Northrop’s landlord.
The proposed deal posed the usual cost-benefit questions associated with incentives. The deal involved undeveloped, tax-exempt land — owned by the airport — that was, at least for the moment, generating no revenue for local governments or schools. But would the value of the jobs and development be worth the millions that the city of Melbourne, Brevard County and Brevard public schools would receive if the property were developed without incentives?
The strategy also involved walking a complex legal tightrope.
Working in Northrop’s and Space Florida’s favor was the fact that the strategy wouldn’t need approval from the Florida Legislature, whose leadership was growing more hostile to the use of tax incentives. But it would need the approval of Brevard County Property Appraiser Dana Blickley — who was being asked to sign off on an exemption unlike any she had ever granted before. “There was no model,” Blickley says.
Historically, Florida courts have taken a dim view of government agencies trying to help for-profit companies avoid paying property taxes. One such case involved International Speedway’s Daytona racetrack, which is built on government-leased land and which was told by the Florida Supreme Court that it must still pay property taxes.
Florida judges have consistently held that, when a government leases property to a private enterprise, the owner for tax purposes is the one who has the majority of the “benefits and burdens” of ownership — a government agency can’t, for example, simply buy property and lease it to a company in perpetuity for $1 a year on a tax-exempt basis.
Space Florida and Northrop Grumman hammered out a deal that, Space Florida says, required many “critical steps and negotiations.” In one of those steps, Northrop negotiated with the Melbourne airport authority, which owns the land, to consolidate most of its existing leases at the airport into a single master agreement. (The deal didn’t include all of Northrop’s leases, and the company continues to pay property tax on some of the land it occupies.)
Then, Northrop assigned its interest in the newly created master lease to Space Florida. A separate Northrop subsidiary then sublet a portion of the property back so it could build a new building for the work on the long-range strike bomber. Once construction was done, the building belonged to Space Florida. Northrop’s subsidiary canceled the sublease, and Space Florida immediately leased the new building back to Northrop for 40 years, with two five-year options.
After Northrop bought the equipment it needed for the new building, a separate Northrop subsidiary then lent Space Florida the money to buy that equipment. Space Florida then turned around and leased it back to Northrop. The lease called for Northrop to pay Space Florida the cost of the equipment over the first three years — which Space Florida would use to repay its own loan to the other Northrop subsidiary — and then $1 a year after that. Northrop must also keep commitments it made involving jobs and salaries.
Under the deal, Space Florida owns the building and equipment. As is typical in industrial leases and other Space Florida leases, Northrop has exclusive access to and use of the facilities, and the company has all liability from claims arising from any injuries on the property. It must insure, maintain and repair the property. The company won’t answer some questions pertaining to “ownership” — like whether it has taken any depreciation deductions on its income taxes for the building or equipment.
Among other provisions, the leases include two main provisions that enable the argument that Space Florida, rather than Northrop Grumman, owns all the buildings and equipment.
First, the leases — and there are several — run for terms that are shorter than the expected “useful economic life” of the assets that are being leased. So, in theory, everything Space Florida is renting to Northrop Grumman should still have value when Northrop’s leases expire.
Second, Northrop has the right to acquire any of the buildings or equipment at the end of its leases (or at any point if Northrop and Space Florida agreed on a sale). But it has to pay “residual value” for them; it can’t get them for free or a token amount, like $1.
Both of those questions — whether the company is leasing something for its entire useful life and who owns it at the end of the lease — have been important thresholds to appellate courts that have been asked to decide who the owners are in similar public-to-private leases.
Thorough vetting process
Blickley’s office was initially skeptical of the deal. Local economic development boosters pushed hard, believing Northrop’s work on the bombers — known then by its code name “Project Magellan” — could play a big role in reviving a regional economy that had been hit hard by the end of the space shuttle program. The Brevard appraiser brought in an outside attorney from Tallahassee to evaluate the deal, who gave her a legal opinion that the buildings and equipment could be exempted from tax.
Ultimately, Blickley’s office determined Northrop was entitled to the exemption. Northrop saved more than $2 million in property taxes last year alone. Representatives for Northrop, which turned a profit of more than $3.2 billion last year, did not respond to inquiries from Florida Trend.
Blickley says it was important her office thoroughly vet the deal because the request for one exemption would likely lead to others. “We were setting a precedent for 66 other counties,” she says.
She was right. Even as it was trying to help Northrop, Space Florida was working on a similar deal for another company: Embraer, the Brazilian jet manufacturer. Soon after Northrop applied for a property-tax exemption, Embraer applied for one of its own, too.
Embraer had just opened a 75,000-sq.- ft. Engineering & Technology Center at the Melbourne airport. Space Florida built the center, which Embraer uses primarily to develop the cabins on certain models of private jets, on land that Space Florida leases from the airport. Space Florida in turn leases it all to Embraer through a 20-year agreement — plus six additional five-year renewal options. Embraer doesn’t pay rent, but it must maintain a minimum number of jobs on site, and it provides other consideration to Space Florida, including royalties of the IP on sales of new products developed in the facility sold on the commercial marketplace.
Embraer applied for the same exemption Northrop had just received; a tax exemption worth an estimated $4 million over the initial 20-year term of the lease.
There is, however, another test that public-to-private lease deals must pass. In addition to being owned by a government, the property must also be used for what’s referred to as a “governmental, municipal or public purpose.” The Florida Legislature has defined that phrase broadly in statute, but courts have historically interpreted it narrowly, because the Florida Constitution restricts lawmakers’ authority to create property tax exemptions
Blickley’s office found Northrop was entitled to its tax exemption on the grounds that national defense was a public purpose. But the property appraiser denied Embraer’s exemption, arguing that work on luxury private jets was not.
With support from Space Florida, which sent three representatives to a hearing, Embraer appealed to the local Value Adjustment Board. The special magistrate assigned to the case ruled in their favor because the Legislature includes “aviation” work at an airport on the list of things that constitute a public purpose. “Luxury or not, the research and development directly relates to aviation,” Karen Wonsetler, an Orlando real estate attorney who served as the magistrate in the case, wrote in her ruling.
Blickley’s office opted not to challenge the decision in court, and Embraer got its exemption. The company saved more than $160,000 last year.
After the Northrop and Embraer deals, Space Florida struck a leaseback tax-exemption agreement with Blue Origin, which built a 750,000-sq.-ft. rocket factory near Kennedy Space Center. That deal saved Blue Origin roughly $1.8 million in property taxes last year.
More deals will follow. Dale Ketcham, a Space Florida spokesman, says the agency is working on similar leaseback agreements with Firefly Aerospace, which plans to build a rocket factory on the Space Coast, and with CAE, which has an aviation simulation training operation at Tampa International Airport. He says the agency is working on other agreements, which he declines to identify.
‘The phone started ringing’
For Space Florida, the leasebacks are a powerful economic development tool for several reasons. Because the arrangements rely on existing laws and don’t require any kind of appropriation, elected officials — whether the state Legislature or county commissioners — don’t have to make any potentially controversial public votes. And second, in a state where business taxes are low, the leasebacks target one of the levies companies most complain about now: The property tax.
Blickley says her office has received several inquiries from other property appraisers around the state who have been contacted by Space Florida. “Once Space Florida started showing up in other counties, then the phone started ringing,” she says.
To seed the ground in other counties, Space Florida this summer made a presentation on its deal-making at a Florida Association of Property Appraisers conference in Fort Lauderdale. “This is a rather nuanced application of state law,” Ketcham says.
Space Florida says it is confident that its agreements are on solid legal ground. There are some signs that the companies sense potential vulnerability. Blue Origin, for instance, insisted on getting a letter from Blickley’s office that its tax exemption would be approved before moving forward with its project. And like Northrop, neither Blue Origin nor Embraer is willing to talk about the agreements. “We are not commenting or providing any further details on our agreement with Space Florida,” says Embraer spokesman Daniel Bachmann.
To avoid antagonizing anyone, Ketcham says Space Florida only plans to pursue these kinds of deals on “public dirt” such as airports or seaports. Otherwise, he says, “then you start looking like you’re competing with private-sector developers.”
DiBello says Space Florida has been diligent in pursuing the mandate established by the Legislature, which created Space Florida and assigned it the task of “building a world-leading space and aerospace industry in the state.” New companies, he says, “bring capital investment in new infrastructure, thousands of new jobs with attractive salaries, families buying houses and spending in the local economy that all contribute to the economy and tax base of that community and the state. All parties in these partnerships for growth comply with legal mandates and exercise proper fiduciary responsibility in achieving this benefit for Florida’s future.”
Project Magellan: Costs and Benefits
Northrop Grumman’s Project Magellan was officially announced in May 2014. In exchange for an incentive package, the Falls Church, Va.-based defense giant will develop a site at the Orlando Melbourne International Airport where it will do the design work for the next generation stealth B-21 bomber — dubbed the Raider. (Most of the manufacturing will take place in California.)
What Did Florida Get?
- Space Florida says Northrop has already exceeded its first-phase commitments. The company has spent approximately $75 million to build and outfit a roughly 220,000-sq.-ft. facility (which is owned by Space Florida and leased back to the company). It has hired roughly 425 employees at an average salary of around $112,000 (it is contractually obligated to an average of at least $100,000).
- Altogether, airport executives say Northrop’s total footprint in Melbourne has grown to 2.2 million square feet from 1.8 million square feet over the past five years. (The company has had a longstanding presence at the Brevard County airport, where it runs a radar-surveillance system for the U.S. Air Force, among other operations).
- The operation is still ramping up — Northrop is building out the internal road network and other infrastructure at the airport — as the first B-21 Raider, which will cost an estimated $600 million each, isn’t expected to enter service until around 2025. But assuming the company continues to meet or exceed its projections for the program, economic development officials say Project Magellan could ultimately create up to 1,500 more jobs and another half a million square feet of facilities.
What Is It Costing?
- $500 million — Value of the total property tax exemption for its property and equipment over the next 40- plus years, according to the Brevard County Property Appraiser’s office.
- $20.8 million — Cash from the Quick Action Closing Fund that Space Florida says was used to pay rent to the Melbourne airport on Northrop’s behalf.
- $205,000 — Brevard County waived impact fees across the board for the period during which the deal with Northrop was consummated. The waiver wasn’t part of the Project Magellan deal, but Northrop benefited along with other companies.
Read more in Florida Trend's September issue.
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