Finance and Budget Begins Their Process of Evaluating ARC

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The Finance and Budget Commission met for over three and a half hours on the Aggie Research Campus (ARC) on Monday night, listening to a consultant presentation, asking dozens of questions and taking nearly one and a half dozen public comments before deciding to push further discussion off for later in the month after a subcommittee has a chance to ask questions and further evaluate the fiscal impacts of what was described as a key project.

Consultant David Zehnder from EPS (Economic & Planning Systems) Consultants explained that “this project is I think a very important regional project for not just Davis, not just Yolo County but for the entire region—we believe it’s a well founded leveraging of UC Davis’ longstanding investment in not just Davis, but the entire region.”

This taps into the university’s economic spinoff potential in a region that is starting to diversify to be more resilient and more robust.

“This project leads the way in that regard,” he said.

One of the key concerns that many commissioners and members of the public expressed was the lack of analysis of COVID-19 and the current downturn.

David Zehnder called this period “unprecedented” and acknowledged “we don’t know what the next six months holds.”

But he noted that they were looking at 20 markets, they have evaluated many projects, and “this is right up there with the most innovative and important that exist today.”

One of the downfalls of the Mace Ranch Innovation Center (MRIC), he said was, “We look back and it really struggled because it was really a single-use center.  That is the antithesis of what we see in today’s market, the trend’s fully toward integrated multi-use projects.”

The 2015 work, he said, “it came up short in terms of financial feasibility and a big reason for that was, it was a single use project and it really didn’t adhere to the best practices in the industry.”

Overall, he noted, the project should diversify the economy.

“It provides a means by which there can be predictability in the market,” he said, with the current problem in Davis being a lack of land assets available to commercial interests looking to move Davis.  “This project would go a long way toward providing more certainty.”

Land and space constraints have led to “volatility with the periodic loss of large tenants” but the city in general faces low vacancy rates and higher rents compared to the regional averages.  University Research Parks in isolated and small college towns suffer from low demand, however, Davis has the added benefit of a strategic location along the I-80 corridor between the dynamic Bay Area and growing Sacramento economy.

He was asked about the ability of the ARC to repair and replace its own infrastructure.

David Zehnder explained that the combination of the two line items takes you to $220,000 per year at buildout, which he said “is absolutely sufficient in our opinion to cover those types of road maintenance and pavement management expenditures.”

In explaining the difference from 2015 to now, he noted the addition of Measure Q, which wasn’t in place before.  However, they did also attach “a somewhat higher sales per square assumption in this version.”

In 2015, they had $175 per square foot, which in 2015 “that mirrored the average for the city.”  Now they believe “retail is going to be pretty current state of the art, should command better than average result.”  So they made the decision “to bring those numbers up a bit.  That’s reflected in some of the higher numbers you see.”

It was also pointed out that they have both Nishi and West Davis Active Adult Community, where they have negotiated tax-sharing agreements to guide the assumptions here, “whereas in 2015, we didn’t have those numbers at that time.”

There were also questions about the pricing for the real estate and the “significant premium that’s included here that’s not consistent with current regional reporting.”

As Commissioner Ezra Beeman pointed out, “If the actual development value is significantly below the estimate, then that will have a significant impact on the property taxes.”

David Zehnder explained of the average office R&D rent, “our numbers are coming in higher than that.”  He said, “This is going to be state of the art space so we’ve modeled both the cost and rent assumptions based on state of the art projects.”  He argued this was the most appropriate comp that’s available.

Not the top of the market, “but the top 20 percent.”

He was also asked about the assumption that 25 percent of operating costs for the city are fixed costs.

Zehnder explained that there are both fixed and variable costs.  They looked at both 100 percent variability—which he saw as being out of line with costs in other cities.

“It was determined that there was likely a fixed price component here based on the fact that certain aspects of the operation aren’t going to be affected,” he said.  He called this “a judgment call that we’re always engaged in.”

There were a number of questions about the impact of COVID-19.

“Is there a risk that if the project moves forward and values are lowered due to COVID and the present reduced demand, that could have an effect on the ongoing financials for the project as a whole?” a commissioner asked.  The idea being that with lowered property values “we would end up with an ongoing reduction in revenue just because the building that was $1 million… is going to be $900 due to the effects of COVID.”

David Zehnder responded, “There’s no way that we can say with any certainty about what the effects of COVID are with where we stand today.

“There’s just so many unknowns that it would be folly for me to just sit here and say that there would be no impact,” he said.  He acknowledged, “How we emerge from this crisis is going to have effects on every project across the US and across the world.”

Ashley Feeney added, “With COVID, we likely see this project remain as it stands today—continuing farm operations until it makes sense to move forward with the project.  I don’t see them building and financing a project and infrastructure and doing that kind of investment…  We’re talking about the opportunity to zone land… for future business use.”

But David Zehnder noted that the sectors most resilient right now “are both included in this plan.”  Multifamily and tech industrial.

Chair Michelle Weiss asked the question about market demand and sensitivity.  “We just assume that there will be the demand for this at a very good market rate,” she said, and wanted to know the sensitivity on that.  “Everything is a bit rosey.”

David Zehnder explained, “We did not seek to come in high or low on this, we aimed for what we thought would deliver.”  He said they matched that to current development.  “We did not do extensive sensitivity analysis in a formal sense,” but he said they could do that in response to the current discussion.

Ashley Feeney added that the key here is that these assumptions result in “a very positive fiscal benefit.”

He argued, “If it was right on the margins of neutrality, I’d say we’d want to learn a lot more about sensitivity.”

He added, “When we do a model for fiscal analysis, we are really looking at is it positive, is it neutral or is it going to be a drag on the city in terms of costs and services.”

—David M. Greenwald reporting


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About The Author

David Greenwald is the founder, editor, and executive director of the Davis Vanguard. He founded the Vanguard in 2006. David Greenwald moved to Davis in 1996 to attend Graduate School at UC Davis in Political Science. He lives in South Davis with his wife Cecilia Escamilla Greenwald and three children.

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15 thoughts on “Finance and Budget Begins Their Process of Evaluating ARC”

  1. Matt Williams

    In 2015, they had $175 per square foot, which in 2015 “that mirrored the average for the city.”  Now they believe “retail is going to be pretty current state of the art, should command better than average result.”  So they made the decision “to bring those numbers up a bit.  That’s reflected in some of the higher numbers you see.”

    A question that I was surprised was not asked by the FBC members or the public was that the professed target market for ARC … high tech startups … do not generally have the financial where-with-all to pay high monthly rents.

    I would have liked to have heard David Zehnder and Tom Martens thoughts on whether the higher assumed rents would be an impediment to getting tenants from the start-ups that spin out of UC Davis.

    1. David Greenwald Post author

      Part of the answer for that is that it gets at too low a level of analysis.

      That said, the way around cost of rent for start ups are things like co-space like Pollinate. One of the possible landing spots for ARC is an incubator that would solve the issue for start ups. Keep in mind as well there is space in Davis for small start ups. What is lacking is space for larger companies and move ups.

    2. Richard McCann

      A question that I was surprised was not asked by the FBC members or the public was that the professed target market for ARC … high tech startups … do not generally have the financial where-with-all to pay high monthly rents.

      Matt, the SF office market has been fueled by these high tech start ups. They seem to focus on being in an agglomeration center to enhance learning and innovation (as I discussed yesterday.)

  2. Alan Miller

    “this is right up there with the most innovative and important that exist today.”  One of the downfalls of the Mace Ranch Innovation Center (MRIC), he said was, “We look back and it really struggled because it was really a single-use center.  That is the antithesis of what we see in today’s market, the trend’s fully toward integrated multi-use projects.”

    It’s very important to rename projects that were innovative, give them a fresh new name, and call them now ‘most innovative’ and integrated multi-use projects.  Lord I believe!

     

      1. Bill Marshall

        What Alan quoted, as to “what he said” is either correct or false… based on your “reporting”… the rest of his post was either opinion, and/or a jab…

        You’re ‘out of line’, in my opinion, with replying,

        That’s not what he was saying.

        Based on your reporting, the quote is correct… Alan’s ‘saying’ is also what he said… unless, in the first case, it was not accurately ‘reported’…

        Read Robert McCloskey’s famous quote…

        I know that you believe that you understood what you think I said, but I am not sure you realize that what you heard is not what I meant. — Robert McCloskey

        In this case, what was said, appears to have been said… now, what was “meant” is a separate matter… but you focus on what was “said” in your response to Alan M… in tennis, that would be a ‘foot fault’… IMO

         

        1. David Greenwald Post author

          What the consultant is pointing out here is that the MRIC project was too one-dimensional and struggled because it was single-use and out of alignment with the direction that these projects are going. The new project is multi-faceted and keeping up with best practices and industry standards.

        2. Bill Marshall

          Non-reply to the foot-fault, and somewhat pretentious as to the consultant’s meaning… perhaps the consultant could clarify, rather than an apparent clairvoyant…

  3. David Greenwald Post author

    My view is that the analysis itself was fairly conservative. The differences between the original and this one have to do mostly with objective changes – the passage of Measure Q, the change of the ERA, the passage of the TOT tax. That’s okay – you actually want fiscal analysis to be conservative.

    1. Alan Pryor

      The differences between the original and this one have to do mostly with objective changes – the passage of Measure Q, the change of the ERA, the passage of the TOT tax.

      David – Stick with Political Science. Economics is obviously not your bag.  Measure Q, the change of the ERAF, and the passage of the TOT tax  positively impacted the analysis but the main changes were the huge increases in assumed lease rates far greater than regional averages leading to increased assessed valuation leading to increased property taxes and the huge increases in sales/sq ft in the retail and commercial components far greater than regional averages leading to increased sales tax income.

      What the consultant is pointing out here is that the MRIC project was too one-dimensional and struggled because it was single-use and out of alignment with the direction that these projects are going. The new project is multi-faceted and keeping up with best practices and industry standards.

      What spin, David! What the consultant actually very clearly said without mincing words (and had the numbers to prove it) was that MRIC was not profitable enough for the developers to do it and they dropped that project because there was no housing fueling their profits. Now that there is housing at ARC, lo and behold, the project came back and “pencils-out” in terms of leveraged and unleveraged ROI for the investors. The leveraged/enleveraged ROI for Phase 1  was 14%/22% and 17%/28% for Phase 2 but only when the housing units are scheduled to be built. However, once the housing units are in, the  leveraged/enleveraged ROI drops to about 9%/12-15% for Phases 3 & 4 which is below the acceptable industry ROI threshhold.

      Ezra Beeman correctly pounced on that and very clearly articulated that if Phases 3 &4 are not profitable enough in terms of ROI on a stand-alone basis, then why would the investors even bother to build out Phases 3 & 4. They would probably just sit on the land unbuilt until another opportunity came along or they could go back to the voters in 20 years and try to change it and add housing.

      EPS tried to backtrack and blurted out that the entire project in total was profitable enough “as a whole” but Ezra would have none of it. He doubled down at the end of the meeting  stating that if the future returns of Phases 3 & 4 were not sufficient then any reasonable investor would simply just stop at Phases 1 and 2 (with the housing already built) and reap those rewards with avoid further sub-par returns on the commercial buildout on Phases 3 and 4 .

      The only way to make sure this does not happen is to slow down the rate of housing unit construction such that to build out the remaining units, commercial construction in Phases 3 & 4 also has to be done. This can be easily accomplished simply enough just by only allow one dwelling unit per 3,000 sq ft of commercial construction (850 units/2.6 M sq ft of commercial space) instead of one unit every 2,000 sq ft as the developer has suggested. Doing so allows the entire project to still well exceed the minimum ROI threshhold AND ensures Phases 3 and 4 are actually built. Otherwise we will likely end up with 850 units in Phases 1 and 2 with far less of the commercial space ever completed in Phases 3 & 4.

      But what do you think the chances that our “take-any-lousy-deal-that-comes-along” City Council will require that?

      1. David Greenwald Post author

        Says the guy who thought people were going to wait four hours to enter the highway.

        “why would the investors even bother to build out Phases 3 & 4. ”

        The build out as they noted last night is going to be drivin by whether companies want to move in and as we saw with Aggie Square, there is a huge demand for such space.

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