SPUR May 30, Why Does Housing Cost So Much? (And what can we do about it?).

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1 SPUR May 30, 2017 Why Does Housing Cost So Much? (And what can we do about it?).

2 Land (Cost/Residual Value) Hard Construction Costs o Labor o Materials o Construction Type/Design Parking Costs o Number of spaces o Stackers o Construction type Soft Costs o Predevelopment o Construction Period o Sales/Lease up Period Governmental fees o Vary significantly What Contributes to Development Costs? Governmental Fees Soft Costs Parking Profit Land Hard Construction Costs Profit (Developer Margin/Returns) 2

3 Construction (Hard Cost Trends) Normalized Index Saylor Subcontractor Saylor Material/ Labor SF ENR BCI SF ENR CCI SF CPI - Urban Consumers 110 Historical Growth in San Francisco Construction Costs Compared to Inflation Index Year

4 PARKING PARKING PARKING 4

5 300 s.f. 350 s.f. 5

6 Illustrative Parking Cost Per Space Surface Podium Partially Below Grade Below Grade (1-level) Below Grade (2+levels) 6

7 Source: fibers.com and publicbikes.com 7

8 Housing + Transportation (H+T) costs may be better way to measure costs in San Francisco San Francisco CNT Score Source: CNT H+T Fact Sheet 8

9 Land Costs Based on Current Income Generation and Allowable Use 9

10 $900,000 Residual $800,000 Developer Margin/Profit Land $700,000 Construction Financing Value $600,000 $500,000 Other Soft Costs Including Selling Expenses Soft: Permits, Fees and Design (What a $400,000 $300,000 Funding Gap to Build Affordable Units Parking (Hard Costs) Developer $200,000 Construction (Hard Costs) Can Pay) $100,000 $0 Base Case More Parking 10% Higher Costs 5% Lower Sales Price Residual Land Value 10

11 Housing Affordable to Broad Spectrum of People 11

12 Illustrative Condominium Affordability Gap Market 150% AMI 135% AMI 120% AMI 110% AMI Affordability Gap Supportable Housing Cost 100% AMI 80% AMI 70% AMI $0 $200,000 $400,000 $600,000 $800,000 12

13 Illustrative Apartment Affordability Gap Market 120% AMI 110% AMI 100% AMI 80% AMI Affordability Gap Supportable Housing Cost 70% AMI 60% AMI 50% AMI 30% AMI $0 $100,000 $200,000 $300,000 $400,000 $500,000 $600,000 $700,000 13

14 WHAT IS A DENSITY BONUS? 14

15 Density Bonus Financial Considerations Height? Construction type? How many more units? Less or more parking? Will it be faster to process? Will design costs decrease? Will other costs decrease? How much more affordable housing will be required and at what target incomes? $900,000 $800,000 $700,000 $600,000 $500,000 $400,000 $300,000 $200,000 $100,000 $0 Developer Margin/Profit Construction Financing Other Soft Costs Including Selling Expenses Soft: Permits, Fees and Design Funding Gap to Build Affordable Units Parking (Hard Costs) Construction (Hard Costs) Residual Land Value 15

16 16

17 Money makes the world go around 17

18 Predevelopment: Time = Money 18

19 Capital Stack Equity Mezzanine or performing debt Developer co-invests Preferred and promotional return Target return and upside The value-add play pays out based on value creation Debt DCR LTV LTC Performance guarantees with recourse for: - Project completion - Cost estimates - Lease up 19

20 Typical Return Requirements Equity Mezzanine or performing debt Preferred 8%-12% Target 15%-20, higher for predevelopment Total potential 25% or greater Projected 20% or greater year amortization Debt 2-15 year repayment ( balloon ) 4.5%-8% interest 20

21 Waterfall of Equity Return Cash Flow after paying loans and costs Return of principal Preferred return (including developer co-investment) 1 st Dollars out 2 nd Dollars out Promotional return pari passu to investors to meet target total returns Some percentage distribution to developer 3 rd Dollars out Larger percentage return to developer Ongoing smaller percentage distribution to investors 21

22 Interest Rates, Cap Rates and Values Move Together A basic principle of finance is that prices are the present value of future expected cash flows. As interest rates fall, the rate at which the cash flows on commercial properties are discounted also falls, pushing commercial real estate prices up. é Commercial Real Estate and Low Interest Rates, John Krainer, FRBSF Economic Letter (4/22/13) 22

23 Historical Treasury Rates 16% 14% 12% 10-Year 3-Month 10% 8% 6% 4% 2% 0% Source: REIS, CBRE

24 Cap Rate is Indicator of Value/Market Strength Cap Rate = Project Value = Net Operating Income (NOI) Project Value NOI Cap Rate High cap rate indicates market weakness/high cost of financing Low cap rate indicates market strength/low cost of financing 24

25 Cap Rate Trends by Asset 12% 11% 10% 9% 8% 7% 6% 5% 4% 3% Apartment Office Industrial Retail Source: REIS, CBRE 25

26 X 8 Year Anniversary June 2017 Source: ULI Emerging Trends

27 Demand and Supply Imbalance 27

28 CA Jobs Growing Faster Than Nation ANNUAL PERCENT CHANGE California US CA 2.3% US 1.7% SERIES: Total Nonfarm Employment SOURCE: US Bureau of Labor Statistics, CA Employment Development Division Source: CAR

29 Employment Trends, San Francisco Metropolitan Division 2000 to ,400 1,300 Forecast 7.0% 6.0% 2016 San Francisco Metropolitan Division 1,200 1, % 4.0% 4% 4% 6% 0% 12% Employment (000) 1, Total Non-Farm Employment Total Non-Farm Employment Y/Y Change 3.0% 2.0% 1.0% 0.0% (1.0%) (2.0%) (3.0%) (4.0%) (5.0%) (6.0%) (7.0%) Employment Change (%) 3% 7% 7% 3% 12% 4% 13% Education & Health Services Professional & Business Services Leisure & Hospitality Construction Government Manufacturing Financial Activities Wholesale Trade Retail Trade Other Services (except Public Admin.) Transportation, Warehousing & Utilities Information Natural Resources & Mining 25% Source: Bureau of Labor Statistics; Moody's (updated May 2017); The Concord Group 29

30 Missing 65,000 New Units Annually Single Family Multi-Family Household Growth: 165,000/yr SERIES: California New Housing Permits SOURCE: Construction Industry Research Board Source: CAR

31 Underbuilding (New Jobs/New Permits) CA Underbuilding and Price Growth ( ) % -20% 0% 20% 40% 60% 80% 100% 120% -2 Price Growth (%) SERIES: Nonfarm Job Growth, New Housing Permits, Existing Median Prices SOURCE: CA EDD, C.A.R., Construction Industry Research Board Source: CAR

32 Most Underbuilt Counties in California 450, , , , , , , ,000 50,000 0 New Jobs vs. New Permits ( ) 381, , , , ,162 88,134 95,245 98, ,586 35,426 44,923 40,434 18,141 14,901 18,108 31,255 Jobs Permits 66,054 44,772 6,349 10,890 SOURCE: California Employment Development Department, Construction Industry Research Board Source: CAR

33 Residential Building Permit Issuances in San Francisco 1980 through March 2017 Building Permit Issuances 4,750 4,500 4,250 4,000 3,750 3,500 3,250 3,000 2,750 2,500 2,250 2,000 1,750 1,500 1,250 1, unit Multi-family 3-4 unit Multi-family 2 unit Multi-family SFD Remaining 2017 (Annualized) Source: U.S. Department of Housing and Urban Development; The Concord Group 33

34 Apartment Market Performance in Urban San Francisco, 1995 through ,000 Apartment Inventory & Vacancy Rate REIS Forecast 10.0% 80, % 70, % Apartment Inventory 60,000 50,000 40,000 30, % 6.0% 5.0% 4.0% 3.0% Vacancy Rate (Line) 20, % 10,000 0 Asking Rent & Vacancy Rate % 0.0% Inventory Vacancy Rate $4,000 Effective Rent & Effective Rent Change REIS Forecast 24.0% Effective Rent (Bars) $3,500 $3,000 $2,500 $2,000 $1,500 $1,000 $ % 8.0% 0.0% -8.0% -16.0% Change in Rent % (Line) $ % Effective Rent Effective Rent Change 34

35 Historical Home Sales and Price Trends in San Francisco 1988 through Q Ann. Growth 4% 9% 14% 15% 27% 7% 6% 6% 15% 14% 3% 5% -6% -14% 3% -6% 11% 17% 15% 16% 6% 4% 5% 3% 2% 6% 3% $1,400,000 Resale Median Home Price $1,200,000 $1,000,000 Median Home Price $800,000 $600,000 $400,000 $200,000 $ Q17 Urban San Francisco - New Urban San Francisco - Resale San Francisco County - New San Francisco County - Resale 35

36 If we can go to Mars, why can t we build a house better, cheaper, faster? 36

37 What can we do about it? Reduce construction costs Require less parking Streamline development process Encourage greater coziness (density) Test financial impact of new City requirements on development feasibility and modify as needed Build more housing as soon as we can! 37

38 Elizabeth (Libby) Seifel Seifel Consulting Inc. 38