One of the biggest debates we have over development projects is whether or not a developer can afford to do more – more in the way of costly requirements, more in the way of affordable housing, etc. Time and time again, we are told by people who oppose a specific project, that the developer can do more and that we cannot simply rely on their representations about what pencils out.
The reality is that we actually have a fairly good idea of what pencils out and what doesn’t. We don’t have access to the exact costs and the exact rents – but then again, it’s a model and it is built on estimates and assumptions.
For example, the city hired Plescia & Company to do the feasibility analysis of the Nishi site (see the article here).
They noted: “This memorandum summarizes an initial development economic analysis of the currently proposed student housing project at the 47-acre Nishi site. The primary purpose of the initial analysis is to identify what amount of investment, if any, in off-site public infrastructure the project can feasibly support under an assumption that approximately 12 percent of the housing units are allocated for affordable housing.”
They concluded that “the requirement of payment for off-site infrastructure and provision of 12 percent of the beds for affordable housing suggests the developer will obtain a lower return on investment than is typically targeted for new development in Davis. Assuming the developer is willing to accept a lower return on investment, the proposed infrastructure and affordable housing requirements are reasonable.”
The pro forma from the Bay Area Economics (BAE) group that we reported on yesterday suggests we can make a whole lot of assumptions and calculations about both costs and income that help us determine whether a project is viable or not.
Some of the costs they project are costs for acquisition of land, costs for demolition (if it’s a redevelopment site), new construction costs, costs for parking (again, if it is downtown), infrastructure costs, and fees and permits. If it is a site like Nishi, there are costs for off-site public infrastructure and costs for affordable housing units.
And then they can project potential income.
The bottom line is the developers have to show that their project is viable in order for them to attract investors. For the downtown space, BAE established feasibility targets as 8.5 percent for income-producing projects and 10 percent return for for-sale projects.
For a project like Nishi, they might have to show about a five percent return.
There are two key takeaways here. The first is that, unless someone has done the analysis on the costs versus expected returns, they are not really in the position to state what the developer can and cannot take on. The second is that we can in fact come up with reasonable estimates on cost – that’s why the city contracts with firms like Plescia or BAE to do their fiscal analysis.
The findings from BAE are not exactly encouraging. As Matt Kowta of BAE pointed out in an email yesterday, “While variance from project to project could be significant, I think the financial analysis demonstrates that it will be challenging for developers to put together feasible projects in the downtown area, particularly if they have to acquire sites in the open market that most likely include an existing structure with some economic life left.”
This is one reason among many that larger projects are going to be more viable than smaller projects.
Mr. Kowta pointed out, “All other things being equal, if developers can increase the amount of rentable or sellable square footage that they can put on a site through increases in allowable density/intensity, this will help improve the economics in many cases, because it will allow them to better distribute the cost of site acquisition.”
BAE concludes: “These results indicate that under current conditions, it will be very difficult for developers to undertake projects similar to the prototype projects, with a few exceptions. As mentioned previously, it appears that a medium-sized mixed-use project incorporating high density for-sale residential units could be feasible.”
However, they do caution that “the pro-forma analysis models project feasibility strictly from the standpoint of investor/developers, and not from the standpoint of owner/users.”
They note: “For the owner/user, the evaluation of ‘feasibility’ may be influenced by considerations of establishing control of the premises where they operate their business…” They specifically cite the mixed-use office/laboratory over residential project on C Street between 2nd and 3rd Streets as well as the Coldwell Banker real estate office.
And they also identify ways that the city can positively influence development feasibility:
- Reduce project risk and project timelines by establishing clear planning guidelines for the desired development types and reducing or eliminating discretionary review processes;
- Allow increased densities, so that developers can achieve greater efficiencies of scale on the limited number of available sites, including better spreading the high cost of site acquisition;
- Limit requirements imposed on downtown development projects which would translate to increased costs that do not bring corresponding revenue increases; and
- Consider entering into public-private partnerships with developers to help put together feasible development projects that attract new businesses to downtown. This could include utilization of City-owned land on terms that help to bridge feasibility gaps where there is an expected return on the City’s involvement.
Some people took this all to mean that the answer is simple, we just don’t have developers and investor-initiated projects downtown.
The reality is that the owners and occupants are not going to develop the buildings downtown necessary to generate the type of economic development we need to improve the revenue and viability of our downtown.
There are three key takeaway points here. First is that we can reasonably estimate costs and viability. Second is that we are going to have challenges doing the type of redevelopment we need downtown. And third, the way we are going to overcome these challenges is by re-examining the processes and constraints we place on projects.
—David M. Greenwald reporting