Trust but verify proper expenditure of impact fees

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While the development community has expended a great deal of time and money reviewing DIF studies and adopting ordinances, there hasn’t been much oversight applied to the actual monitoring of the fees’ expenditures.

Carter Froelich
Carter Froelich, CPA
Managing principal, mountain and southwest regions, DPFG, Phoenix

Ever since jurisdictions began collecting development impact fees to fund public infrastructure, the development community has been concerned with these fees being fair and equitable, having a “rational nexus” between growth and the supporting infrastructure, and having a “rough proportionality” between the impact fee and benefit received.

While the development community has expended a great deal of time and money reviewing DIF studies and adopting ordinances, there hasn’t been much oversight applied to the actual monitoring of the fees’ expenditures. As the excess infrastructure capacity that was constructed in the run up to the Great Recession continues to be eroded by new growth, more scrutiny is being applied to DIFs. There has been tremendous demand from the homebuilding and development communities to perform audits of jurisdictions’ DIF accounts; the results have been sobering.

For example, a recent audit indicated that a city in question had misappropriated approximately $7.2 million in development impact fees.

The city utilized approximately $935,000 to fund debt service related to the construction of a fire station; however, the study indicated that the fees were to be used exclusively toward the construction of three new fire stations.

Second, the city utilized approximately $15.1 million of its water fees collected to fund a water treatment plant; however, only approximately $11 million should have been used for this purpose. This misallocation of the DIF resulted in a shortfall of approximately $4.1 million in necessary funds to construct water distribution lines to serve new residential growth.

Lastly, the city expended approximately $2.2 million of sewer fees collected to fund a water reclamation facility; however, these funds should have been used for the construction of sewer collection lines. As a result, there were insufficient funds in the DIF accounts to support new growth with additional sewer transmission lines.

The DIF audit supported the local homebuilder’s association is requesting that the city use approximately $7.2 million of its funding to replenish and rebalance the accounts depleted from improper expenditure. As of the date of this writing, the issue remains unresolved and could potentially lead to litigation in the near future.

The example above is not unique and, in our experience, this type of misappropriation occurs quite often. One of the major reasons for the misappropriation of funds is the result of a miscommunication between those preparing the studies and those responsible for expending the impact fees. These mistakes led to the development community not receiving benefit for the impact fees for which they are paying, as well as the lack of infrastructure necessary to support new growth for which the impact fees were intended.

Given the amount of funding involved in the collection and expenditure of DIFs, much greater oversight on the public sector from the private sector is warranted. For these reasons, it is important to audit jurisdictional impact fee accounts routinely in order to ensure that funds are being expended for public improvements as outlined in the DIF studies and supporting municipal ordinances. While these audits are not necessarily performed in accordance with generally accepted accounting and attestation principles, they should be performed by certified public accountants who understand DIFs, DIF studies and the concepts of “rational nexus” and “rough proportionality.”

As jurisdictions more than likely will be reluctant to open their books for DIF audits, it sometimes may be necessary to amend a state’s DIF-enabling legislation to require DIF audits by independent third parties.

In 2011, the homebuilder’s associations in Arizona tightened the DIF statues (Arizona Revised Statute 9.463.05) to outline the methodology to be performed by Arizona jurisdictions. This tightening helped to ensure that the tenants of “rational nexus” and “rough proportionality” were being properly addressed. The law change also required biennial audits of jurisdictional impact fee accounts by an independent third party in instances where an advisory committee of homebuilders and real estate representatives did not directly assist in the preparation of the DIF study.

Given the detailed steps required by the law change for municipalities to charge DIFs, a number of Arizona jurisdictions stopped collecting impact fees all together. The biennial audits also are providing the homebuilder and development community with comfort that DIFs are being expended in accordance with the DIF study.

While it is our experience and opinion that the development community supports DIFs, they should only do so if the fees are fair and equitable, and are being expended for the appropriate infrastructure, which supports new growth. To this end, and in the immortal words of Ronald Regan, the building industry should “trust but verify” that jurisdictions are properly using development impact fees for the infrastructure for which they were intended.

Featured in CREJ’s May 17-June 7, 2017, issue.

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