Economic Analyses in Development Agreements · For hotels, furniture, fixture & equipment (FF&E) Parking • Soft Costs Professional fees (e.g., A&E) City permits & fees City impact

Economic Analyses in Development AgreementsPlanning Commission Study Session November 7, 2012

Economic Analyses & Development Agreements PC Study Session | 11.07.2012

Purpose of Discussion

• Respond to request from Planning Commission

• Review policy‐based framework to evaluate community benefits

• Identify issues with content and preparation of economic analyses

• Propose modifications in approach to economic analyses


1. New Affordable and Workforce Housing

2. GHG Emissions and Future Congestion Reduction

3. Community Physical Improvements

4. Social, Cultural and Educational Facilities

5. Historic Preservation

LUCE Priority Categories of Community Benefits


• Obligations of the project (e.g. taxes)

• Project design or feature• Zoning Code requirements based on adopted plans such as: LUCE Open Space Element Creative Capital Urban Forest Master Plan Bike Action Plan Housing Element

Identifying “Significant Project Features”


• Five LUCE categories establish priority “Community Benefits”

• Refined Through Community Involvement Project Community Meetings Development Agreement Float‐Up Process Area and Specific Plans (Downtown, Bergamot, and Memorial Park)

Identifying Community Benefits


• Relationship to achieving LUCE goals May vary by area, mix of uses, and project type

• Prioritize and address community needs identified through Specific and Area Plans Establishes realistic expectations about magnitude of benefits

Evaluating Community Benefits

Combine financing mechanisms and individually negotiated DAs to achieve overall vision

• Using economic analyses to inform decisions


• Does the project advance the LUCE community vision for the neighborhood in which it’s located?

• Does the project protect and enhance the neighborhoods?

• Does the project contribute to the City’s overall traffic reduction and management strategy?

• Does the project contribute to future open space and community gathering spaces?

• Does the project contribute to the City’s long‐term sustainability?

Community Benefits Should Help Answer Key Questions


• Identify Community Benefits LUCE Priority Categories Direction from Area and Specific Plans Direction from Planning Commission and City Council float‐up Confirmed through community involvement

• Evaluate Community Benefits Relationship to LUCE goals Address community needs

• Prepare 4 types of economic analyses to inform decisions Fiscal Impact Analysis Economic Impact Analysis Value Enhancement Analysis (Residual Land Value) Financial Feasibility Analysis

Summary of Current Approach to Community Benefits


Where are the DAs located?


• Studies submitted by developer• Peer reviewed by City

• Only 3 have been reviewed through public process

• Handful more submitted in draft

Preparation of Economic Analyses


• Inconsistency in format• Differing assumptions• Cost to City missing from Fiscal Impact Analyses• Broad range for land value• Appropriate base project• Multiple financial feasibility metrics and return measures

• Overemphasis on financial feasibility analysis above all others

Key Peer Review Issues


TIERED STRATEGY WITH A LOWERED BASE HEIGHT

• Base: A project can build to an established base height

A project will receive a height bonus above the base height with required affordable housing units

• Tier 2: Additional height and FAR may be requested

Community benefits provided

• Tier 3: Request up to maximum allowable height and FAR requires Development Agreement

Additional community benefits individually negotiated

LUCE Community BenefitsTier Structure

Base

Tier 2 and 3


• Fundamental LUCE principle is that new development should contribute to the community

• Estimate the value enhancement created by increments of height and FAR established in LUCE tiers

• Consider other forms of economic analysis• What is an appropriate frame of reference? Residual Land Value Analysis

General Approach


• General Economic Impacts Analysis City‐specific estimates of direct and “multiplier effects” jobs, worker

compensation and output (construction and annual operation at completion)

Utilizes IMPLAN input‐output model of the City’s economy

• Fiscal Impacts Analysis City‐specific estimates of tax and other revenues Estimates of City service costs and net fiscal impact Utilizes City‐specific taxes, rates and formulas for revenues Utilizes averages cost approach to services (residents and “resident‐

equivalents” for employees/visitors) Required by Development Agreement ordinance

Economic Analyses Used in Considering Community Benefits Requirements


Economic Analyses Used in Considering Community Benefits Requirements

• Value Enhancement Analysis Compares the financial performance of a project under Tier I vs. Tier II

or III development standards to estimate value conferred by City with more generous development standards

Typically has used change in Residual Land Value as an indicator of value enhancement

• Financial Feasibility Analysis Required for some CEQA alternatives To date, has typically used a financial performance indicator other

than Residual Land Value But, the same analysis technique could be used to measure both Value

Enhancement and Financial Feasibility


• Calculation approach, calculation factors and analysis metrics vary by: Development product and product mix particulars Location in the City (e.g., rents; hotel room rates) Timing relative to multiple market cycles Developer’s financing specifics (equity and debt)

• Variety of “rate of return” measurements used to determine feasibility Return on total development cost in the first stabilized year – Net Operating

Income/Total Development Cost , including actual land value Residual land value in the first stabilized year –project value (i.e., capitalized

NOI) minus TDC, without land cost to generate supportable land value Internal rate of return (IRR) – Discounted Cash Flow over a holding and sale

period; with or without leverage (i.e., financing); pre‐ or post‐income tax Others (e.g., return on equity; profit margin)

Issues in Preparing Value Enhancement/Financial Feasibility Analysis


Regardless of measurement technique, a project is feasible, or achieves enhanced value, only if

completed project value exceeds development costs

Source: Strategic Economics


Components of Value Enhancement/Feasibility Analysis – Development Costs

• Land Cost (except in Residual Land Value)

Acquisition price or value Acquisition charges (e.g., legal, closing costs)

• Hard Costs (construction) Site work Off‐site requirements Building shell and core For retail, tenant Improvements

For hotels, furniture, fixture & equipment (FF&E)

Parking

• Soft Costs Professional fees (e.g., A&E) City permits & fees City impact fees & other

requirements Marketing & leasing costs Taxes & insurance Developer’s management fee

• Financing Costs Construction loan interest Construction and permanent loan

fees


Components of Value Enhancement/Feasibility Analysis – Project Value

• Project Operating Income Gross rental income Less: vacancy and collection

loss Effective Gross Income

• Project Operating Expenses Varies by product type (e.g.,

different profile for hotels vs. apartments, office and retail) and leasing approach (e.g., full‐service gross vs. NNN)

• Income – Expenses = Net Operating Income (NOI)

• Project Value = NOI / Capitalization Rate

• Developer profit either derived or assumed, depending on feasibility method


Components of Value Enhancement/Feasibility Analysis –Additional Information for “Feasibility” Conclusion

• Internal Rate of Return approach requires additional assumptions (dynamic vs. static analysis) Inflation rates for income and expenses over time Sale year capitalization rate Discount rate Required detail and implied accuracy may be inconsistent with

level of project information at the entitlements stage• All feasibility measures require benchmarking against

industry standards Third‐party real estate industry data sources Comparable transactions, if available Experience and judgment


Single Analysis Technique for Value Enhancement and Feasibility – Residual Land Value Example

Total Development Cost w/o Land(Construction Costs + Soft Costs + Financing Costs)

minus

Project Value(Gross Income ‐Vacancy allowance ‐Operating expenses) / Capitalization rate ‐ Developer profit margin

Supportable Land Cost/ValueProject is “feasible” if:1. Positive value; and2. Derived land value is

within range of actual land sales


• Economic analyses are one dimension of broader policy‐based approach for evaluating community benefits Rooted in LUCE policies, area/specific plans, public process

• To better inform decision‐making, modify approach for content and preparation of economic analyses Clarify role of the analyses Preparation of Value Enhancement Analysis, Fiscal Impact Analysis, and Economic Impact Analysis

City‐prepared studies• Potential for greater consistency for similar projects in same geographic area (e.g. Downtown)

Summary


• Confirm policy‐based framework for consideration of community benefits

• Identify other review issues to be addressed• Feedback on modified approach to content and preparation of economic analyses

Discussion Points

Documents

Economic Analyses in Development Agreements · For hotels, furniture, fixture & equipment (FF&E) Parking • Soft Costs Professional fees (e.g., A&E) City permits & fees City impact