AgdaPkt 2015-03-23 Closed and Joint SA PFA

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November 26, 2014 9.A. - Page 18 icentive Zoning/Community Benefits Program Page 2 typical project soft costs (e.g., architecture and engineering), land costs, and developer return on investment. The assumptions relied on by the analysis reflect EPS research, third-party data (e.g., CoStar Group market data and RS Means construction cost estimates), and correspondence with industry sources. When real estate value is sufficient to cover all project costs and provide additional value, the "surplus" value may be fully or partially capturable by an enabling entity (in this case, the City). This analysis finds that five of the six prototypes tested are likely to be financially feasible in the current real estate market and may offer surplus value for community benefits, if the City enacts an incentive zoning/community benefits program. In particular, mid-rise office and residential prototypes appear sufficiently valuable to offer community benefits over and above development of the project. Low-rise office/flex is found to be infeasible (i.e., values do not justify costs) in the current market, primarily due to the relatively low observed lease rates achieved by this product type. An obvious but critical finding from the pro forma financial analysis is that a project's financial viability is highly dependent on market conditions. When markets are strong there is project- derived value that may be used to fund community benefits. However, when the market falters, projects may fail to produce surplus value and may even cease to be financially viable, as was generally true for major projects nationwide during the depths of the last recession. A City incentive zoning/community benefits policy designed to capture real estate development value for community benefits should anticipate that market cycles will have significant effects on project value. A sensitivity analysis of financial feasibility exhibits the degree to which a weak real estate market diminishes the potential for project developers to fund community benefits. For all prototypes studies, if lease rates fall by 5 percent and capitalization rates climb by 25 basis points (0.25 percentage points), the potential for community benefits funding is eliminated.1 By comparison, if lease rates increase by 5 percent and capitalization rates decrease by 25 basis points, the potential for community benefits funding is increased dramatically. Figure 2 presents a summary of potential community benefits value capture by prototype, on a per square foot basis. Under current market conditions ("base" assumptions), estimates of surplus value range from negative $102 (-$102) to positive $52 per square foot. The following provides additional detail regarding the findings for the pro forma analysis, including sensitivity to market conditions: • Low-Rise Office/Flex development is financially infeasible in the current market. Even under a scenario in which rents improve and capitalization rates fall, new construction of this prototype is unlikely to occur (except potentially under a "build to suit" development arrangement for a company seeking highly specialized space). As shown in Figure 2 the analysis finds that this prototype is unlikely to contribute to an incentive zoning/community benefits program, with benefit value capture potential of negative $130 (-$130) to negative $72 (-$72) per square foot of development. • Mid-Rise Office Center development located in desirable downtown locations is financially feasible and, of the prototypes considered, the most likely to be able to create value for 1 The capitalization rate is equal to annual net property income divided by total property value. This market-based factor indicates the multiple of property income that a buyer will pay for a property. P:\141000s\141053RedwoodCity\Deliverable\Financial Analysis Memo 11 2614.docx