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HomeMy WebLinkAboutStaff Report 3959 City of Palo Alto (ID # 3959) City Council Staff Report Report Type: Action Items Meeting Date: 9/16/2013 City of Palo Alto Page 1 Summary Title: Preliminary Public Benefit Economic Analysis for 395 PMR/3045 Park Title: Review of Preliminary Economic Analysis Report for a Planned Community (PC) Rezoning to Accommodate: 1) Four-Story Office Development at 395 Page Mill Road and; 2) Three-Story Public Safety Building with Attached Six-Level Parking Structure Located at 3045 Park Boulevard From: City Manager Lead Department: Planning and Community Environment Recommendation Staff recommends that the Council review and provide comment on the Public Benefit economic analysis for a proposed Planned Community development at 395 Page Mill Road and 3045 Park Boulevard. The proposed Planned Community project would consist of an office development at 395 Page Mill Road and a Public Safety building and parking garage at 3045 Park Boulevard as described below. Background The project applicant, the Jay Paul Company, is proposing to construct two (2) four-story office buildings totaling 311,000 sq. ft at 395 Page Mill Road. The proposal would retain the existing three-story 219,377 sq. ft. office building on the same site (AOL’s current location). A total of 1,170 parking spaces would be provided in basement garages and in an above grade parking deck. The second part of the proposed development includes a new 44,420 sq. ft. Public Safety Building and 579 on-site parking spaces. 388 spaces would serve the development at 395 Page Mill Road, and 191 secured parking spaces would serve the Public Safety Building. A complete description of the project is provided below. The applicant is proposing that the development be approved as part of a Planned Community (PC) zone. A Planned Community Zone may be approved if the following findings are made: City of Palo Alto Page 2 (a) The site is so situated, and the use or uses proposed for the site are of such characteristics that the application of general districts or combining districts will not provide sufficient flexibility to allow the proposed development. (b) Development of the site under the provisions of the PC planned community district will result in public benefits not otherwise attainable by application of the regulations of general districts or combining districts. (c) The use or uses permitted, and the site development regulations applicable within the district shall be consistent with the Palo Alto Comprehensive Plan, and shall be compatible with existing and potential uses on adjoining sites or within the general vicinity. In summary, PC zones allow for consideration by the City Council of the standard zoning regulations to be exceeded in exchange for a public benefit. Of course, the project also must meet many other conditions and mitigate impacts as determined by the Council. In this case, the primary exception being proposed by the developer is an increase in overall floor area. In other words, the developer is proposing a building that is larger than would typically be permitted in the existing zoning district. In exchange for this increase in floor area, the developer is proposing to construct and give the City a new Public Safety Building and associated land. The building would include tenant improvements, except for IT cabling and furnishings. In the past, PC zones did not undergo a specific public benefit economic analysis. However, earlier this year the City Manager gave direction to staff to incorporate an economic analysis as a standard part of all Planned Community review processes. The purpose of this review is to quantify the private gain/increased value associated with the land use changes requested under the PC zone, in order to better understand the adequacy of the proposed public benefit. This project is the first to be reviewed under this new policy. Several months ago the City hired Applied Development Economics (ADE) to complete this analysis. ADE is expert in fiscal impact and pro-forma analysis. ADE conducted fiscal analysis on behalf of the City for the Stanford Development Agreement and for updates to the Comprehensive Plan. ADE has met with staff on several occasions and with the developer once to verify several assumptions made within the analysis. The analysis is attached to this report and described below. To date, the project has been the subject of: a Prescreening Hearing by the City Council; four meetings of the Planning and Transportation Commission (PTC) for Initiation and Scoping of the project and EIR, and twice discussed by the Council Infrastructure Committee to discuss the Public Safety Building component of the project. Staff reports and available minutes for these meetings can be found on the City’s Project webpage at http://www.cityofpaloalto.org/news/displaynews.asp?NewsID=2269&TargetID=319. The Planning and Transportation Commission initiated the Planned Community Zoning process in City of Palo Alto Page 3 May. This additional “check-in” point, where the Council will review public benefit analysis, is not a typical part of the review process. Given the scope of this project, however, the Council requested this additional step. The preliminary (draft) traffic study, which was also tentatively scheduled to be reviewed, will now be reviewed in early 2014. Staff was concerned about a number of assumptions made in the traffic report, and therefore did not believe it accurately described potential impacts. If the Council chooses to move forward with this project, the full review by the ARB, PTC and Council will be required. Additional community meetings will be also be scheduled. Project Description Over the past year, this project has been the subject of extensive staff review and multiple public hearings. After receiving direction from staff and at these hearings, the applicant revised the development plan and public benefit proposal, as described below: 395 Page Mill Road The components of this project include:  Construction of two four-story R&D/ Office buildings totaling 311,000 square feet of floor area;  Retention of the existing three-story 219,377 square feet of R&D/Office (AOL) building;  1,329 on-site parking spaces provided on three levels, including a basement level and one above-grade parking deck. A total of 388 parking spaces for the R&D/Office uses would be provided off-site at 3045 Park Boulevard;  Setbacks of up to a 100 feet along Ash Street;  Stepping the 3rd and 4th stories back 10 feet from the stories below;  Significant setback along Olive Avenue for storm water retention and useable open space. The applicant is proposing to provide the following public benefit(s): 3045 Park Blvd  Complete construction of an approximately 44,500 square foot Public Safety Building with 191 dedicated parking spaces. The Public Safety Building would be located on the southern portion of the site. A 388 space parking structure in six above--grade levels providing the parking required for 395 Page Mill Road tenants would be located on the northern portion of the site. The two structures would be connected by two levels of underground parking. The City would only be responsible for the cost of furniture and IT equipment/cabling. City of Palo Alto Page 4 Discussion of Pubic Benefit Economic Analysis The pro-forma analysis memo written by Applied Development Economics (ADE) is attached to this report. This memo was created using a number of assumptions that are based on market research, ADE’s knowledge of the Bay Area real estate market, meetings with City staff, and a meeting with the Jay Paul Company. While the fluid nature of development markets makes it difficult to predict the future with complete precision, the analysis provides a solid framework for determining the adequacy of the proposed public benefit. The City Council is not bound by the analysis and could request more in public benefit. But this third-party analysis provides a beneficial perspective to inform the City’s review and ultimate decision. In addition to outlining the assumptions, the analysis discusses the adequacy of the proposed public benefit. The memo also includes a “sensitivity analysis” which details what public benefit could be expected if the project were reduced in size. Overall, the memo concludes that the current proposed public benefit is reasonable from a financial perspective and would allow the developer to obtain a return on investment (ROI) consistent with market standards. There are, however, a number of variables that could change, reducing the developer’s return on investment and the proposed public benefit. For example, if interest rates were to rise (long- term rates are currently rising) or if extensive CEQA mitigations measures were required, the developer may not be able to obtain an adequate ROI to support the proposed public benefit. On the other hand, should interest rates, lease rates, or other factors increase beyond the assumptions, the public benefit level could grow. Furthermore, due to initial foundation and overhead (sunk) costs that are less variable, reducing the project size could disproportionally reduce the possible public benefit. These are important factors for the City and developer to consider as review of the project moves forward. Staff suggests that the Council and public review the attached six-page memo, particularly the summary, conclusion and sensitivity analysis which can be found in the first two-pages. Data and an explanation of the underlying assumptions follow these pages. Obviously, the conclusions that can be drawn are dependent upon the assumptions. Attachments:  Attachment A: Pro Forma Analysis for 395 Page Mill Project (PDF) 255 Ygnacio Valley Road, Suite 200  Walnut Creek, CA 94596  Tel 925.934.8712 2320 Broadway, Sacramento, CA 95818  916.454.1537 www.adeusa.com MEMO TO: Joe Saccio FROM: Doug Svensson CC: Aaron Aknin, Lalo Perez DATE: September 3, 2013 SUBJECT: Pro Forma Analysis for 395 Page Mill Project The pro forma analysis is based on the plans for the 395 Page Mill Rd. project submitted by the Jay Paul Company, dated 5/22/2013. The analysis is structured to determine the amount of time and cost needed for the developer to build the proposed project and recoup that investment as well as the added cost of the proposed public benefit, which is the construction of the City Public Safety Building (PSB) and related parking structures. SUMMARY We have assumed that the construction period for the two office buildings would be 18 months and that it would take six months to fully lease up the properties. Given current market conditions, we expect the developer to be able to lease up to 98 percent occupancy. The PSB would be built during year 2 of the construction period and has been incorporated into the developer's overall construction cost. Table 1 shows the pro forma through the construction and lease up period (Years 1-3), the first stabilized year of full operation (Year 4), the first year with a positive cumulative cash flow (Year 18) and at subsequent Years 20, 25 and 30. As indicated at the bottom of Year 2, under the financing scenario we have portrayed in this analysis, the developer would need to invest $122.6 million in equity to get the project started, including the sunk cost in the sites for the new office buildings and the construction of the PSB. The project would require a sustained financial investment of about $88 million, which eventually is recouped in Year 18, although the net present value (NPV) of the investment is not positive until year 28 (assuming a 5 percent discount rate). By year 30, the NPV profit is about $15.7 million, for an Internal Rate of Return (IRR) of 6.0 percent. Calculated as a return on the developer’s long term investment in the project of about $88 million, the NPV profit of $15.7 million equates to a 17.4 percent return on equity. CONCLUSION The proposed project would potentially cover the cost of the PSB and still return a profit of about 17% on the equity investment in the project over a thirty year period. While this appears to be a healthy return on investment, it should be considered a best case scenario, since there are a number of risk Page 2 | Applied Development Economics factors and unknown costs that could reduce this figure when the project is actually implemented. Of particular concern are mitigation costs that maybe identified in the CEQA process and further escalations in construction costs by the time the project is actually built. Increases in interest rates would also have a big impact on the cost to build and operate the project. Interest rates have been at very low levels but are beginning to rise. In addition, there is risk related to the market for office leases and the long term vacancy rates in the market. This analysis assumes the project can achieve a two percent vacancy rate, but most areas within the market currently continue to report double-digit vacancy rates. For these kinds of reasons, developers typically require a pro forma result in excess of 20% IRR so there is a margin to cover inevitable cost increases when projects are actually developed. SENSITIVITY ANALYSIS In order to understand the tolerance of the project for changes in the proposed intensity of development, we have run two scenarios with reduced project sizes to see what public benefit, if any, could be supported. Two major cost categories are relatively fixed and affect the ablity of the project to absorb size reduction: the cost of the land, which is now a sunk cost, and the cost of site development, which will be complicated under any development scenario due to the superfund issues with the property. If the project were reduced by 25 percent, the public benefit potential would need to be reduced to about 6o percent of the level currently proposed in order to achieve the same return on investment as the full project described above. The public benefit amount would be about $26.9 million rather than the $49.3 million currently estimated. However, if the project were reduced by half, there would be no possibility of any public benefit contributions and still achieve the same rate of return. A p p l i e d D e v e l o p m e n t E c o n o m i c s | P a g e 3 Table 1 Summary Pro Forma for 395 Page Mill Rd. (Current Dollars Except NPV) Year 1 Year 2 Year 3 Year 4 Year 18 Year 20 Year 25 Year 30 Project Costs Land $30,447,961 Land Holding Costs $2,906,770 $400,663 $408,676 $416,850 $550,024 $572,245 $631,805 $697,564 Building Construction $137,509,307 $70,379,991 Other costs $17,830,530 $8,917,319 Const. Loan Finance $6,058,254 $3,092,595 $144,888,008 Operating Costs $5,806,355 $8,129,510 $8,292,100 $9,338,252 $9,338,252 $9,338,252 $9,338,252 Debt Service $9,343,823 $9,343,823 $9,343,823 $9,343,823 $9,343,823 Total Costs $194,752,821 $88,596,923 $153,426,194 $18,052,773 $19,232,099 $19,254,320 $19,313,880 $19,379,639 Project Revenues Construction Loan Proceeds $100,970,894 $43,917,114 Lease Revenue $7,981,376 $21,562,658 $21,993,911 $29,020,499 $30,192,927 $33,335,431 $36,805,009 Mortgage Proceeds* $171,852,020 Annual Cash Flow ($93,781,928) ($36,698,432) $39,988,483 $3,941,138 $9,788,400 $10,938,607 $14,021,551 $17,425,371 Cumulative Cash Flow ($93,781,928) ($130,480,360) ($90,491,877) ($86,550,739) $6,140,059 $27,436,474 $91,256,261 $171,440,688 Net Present Value ($93,781,928) ($122,602,682) ($88,059,126) ($84,816,742) ($33,661,430) ($25,439,848) ($4,711,461) $15,706,158 Annual IRR -51.4% -45.9% 0.6% 2.1% 4.6% 6.0% Page 4 | Applied Development Economics DISCUSSION OF DATA AND METHODOLOGY LAND The property records for 395 Page Mill indicate that Whisman Ventures LLC in partnership with Jay Paul Co. bought the property in May 2006. The land value is assessed currently at $38.08 million ($88.66 per sq.ft.). Based on the proposed addition of 311,000 sq.ft. of building space to the existing 224,000 sq.ft. building, we have allocated 60 percent of the land cost to the proposed project. In addition, the site across the street at 3045 Park Blvd. would house the City Public Safety Building and a parking garage for the 395 Page Mill site. This property was purchased in September 2011 for a reported sale price of $7.6 million. However, it is currently assessed at $4.9 million, with $3.2 million for land ($54.81 per sq.ft.). We have included the entire purchase price of this property as a land cost for the proposed project. Since this site will house parking for the 395 Page Mill offices as well as the PSB, we have included it as a cost of the office development. Land holding costs are estimated at 1.2% annually and escalate by 2% per year. We have accumulated holding costs from the purchase dates for each site, 2006 and 2011, respectively, into the first year of the pro forma. Year 1 of the pro forma is assumed to be 2014. CONSTRUCTION COSTS We used the most recent available edition of the Commercial Square Foot Building Costs manual by Deloitte and Saylor Publications to estimate the construction costs of the office building and parking garage.1 The costs in this manual reflect 2009 prices and we escalated the costs to 2014 using the Engineering News Record (ENR) building cost index for the San Francisco area. The manual uses San Francisco as its base location for costs. The office costs are for precast panel construction with steel frame, and include architects fees (6%) and builder’s overhead and profit (30%). We added a $20 per sq.ft. allowance for tenant improvements and an additional cost of $18.3 million for site grading and excavation of the basement parking areas. The site is an EPA superfund site and will require special treatment during the excavation and disposal process, as well as ongoing dewatering treatment. The hard construction costs and site development for the office buildings is estimated at $594.00 per sq.ft. (including cost of basement parking and other parking structures) for a total of $184.8 million. SOFT COSTS Since architects fees and builder’s profit are included in the hard construction costs, additional soft costs include City fees and allowances for accounting, legal, and marketing functions. Table 2 presents our estimates of City fees and permit costs. We did not attempt to estimate electrical, mechanical or plumbing permit fees, but we did include an allowance of $250,000 for an EIR. Also, any other mitigation costs that are identified through the CEQA process would need to be added when they are available. 1 Horvath, Jim, Stychaz, Stan, Haigh, Ian, and Kimmel, Matt. Commercial Square Foot Building Costs, Deloitte and Saylor Publications.2010. A p p l i e d D e v e l o p m e n t E c o n o m i c s | P a g e 5 The allocations for accounting and legal are $3.00 per sq.ft. each plus $15.00 per sq.ft. for marketing expenses and $1.50 for other miscellaneous expenses. The total soft costs, excluding financing, for the project are $23.8 million. In addition we have assumed the developers would secure a construction loan for 65% of the development cost at an interest rate of 4% plus a 1% fee. The total cost of this financing for both office building plus all the parking would be $8.1 million. The total development cost of the project, excluding land, would be $216.7 million. This creates a cost basis for the office space, assuming the parking space is ancillary and not counted in the building size, of $697.00 per sq.ft. Table 2 Palo Alto Permit and Development Fees Type Estimated Total Fee Per SQFT Per Project Building Permit application $54 $54 Building Permit Fee $937,482 $3.01 SB 1473 Fee (Bldg. Stds. Admin.) $1,443 $0.00 Elective Plan Check $262,495 $0.84 Grading Permit $3,682 $0.01 Fire and Life Safety Plan Check $421,867 $1.36 Zoning Plan Check $281,245 $0.90 Public Works Plan Check $112,498 $0.36 SMIP Fee $30,231 $0.10 Comp Plan fee $79,176 $0.25 Outside Verification Review $865 $865 Architectural Review (Major Project) $3,712 $3,712 Environmental Impact Assessment (EIA) $1,738 $1,738 Development Impact Fees Parks $1,405,098 $4.52 Community centers $79,305 $0.26 Libraries $75,573 $0.24 Housing $5,734,840 $18.44 Traffic Impact - Stanford Research Park $3,445,880 $11.08 Total $13,478,196 $43.32 $6,369 OPERATING COSTS AND REVENUES For an operating cost profile, we were able to obtain two years of operating cost data for a major 176,000 sq.ft. Class A office building in Walnut Creek. Table 3 shows the sq.ft. cost factors derived from that data. Page 6 | Applied Development Economics Table 3 Annual Operating Costs Cost category Per sq.ft. Annual for Proposed Project Management $ 1.63 $ 505,921 Maint./Repairs $ 3.04 $ 946,694 Utilities $ 3.79 $ 1,177,448 Operations $ 1.89 $ 589,236 Insurance $ 1.12 $ 349,235 Landscape $ 0.36 $ 110,450 In addition to these costs, we included property tax at 1.1% of market value reserves at 5% of revenue, which may be used for capital replacement costs at longer term intervals. Annual debt service is assumed to reflect a 70% loan-to-value ratio, a 30-year term, and a 3.5% fixed interest rate. The pro forma uses an office lease rate of $5.40 per month. Other data range from as low as $3.32 up to $5.50 as indicated below, but the higher rates appear to reflect more specific conditions in Palo Alto and the Stanford Business Park. We have also assumed $80 per space in parking income. Reported Rental Rates o Kidder Mathews, Real Estate Market Review, Northern California, Santa Clara and Alameda Counties, first quarter to fourth quarter of 2012. - $5.60 (Palo Alto) o Marcus & Millichap, Office Research Market Review - $3.23 (PA/Mtn Vw/Los Altos) o Colliers International, Silicon Valley Research and Forecast Report - $5.17 (Palo Alto) o Cresa, Tenant’s Guide, North American Markets - $5.50 (Stanford Park) PROJECT CAPITALIZED VALUE Cassidy Turley has reported office sales transactions for the first quarter of 2013.2 Sales occurred in San Francisco and in Silicon valley but not on the Peninsula. The average capitalization rate for all sales was 5.8%, ranging from 4.8% in San Francisco to 7% in Silicon Valley. Jay Paul Company is reported to have purchased an office building in San Francisco at an average price of $1,489 per sq.ft., while the average transaction in San Francisco was $582 per sq.ft. and $353 per sq.ft. in Silicon Valley. For this analysis, we have used the regional average of 5.75%, which translates to a per sq.ft. value of $789.40 and a total value of $245.5 million. 2 Cassidy Turley, Investment Market Snapshot, Bay Area, First Quarter 2013.www.cassidyturley.com.