Shawnee Landing TIF Project City of Shawnee, Kansas Need For Assistance Analysis December 17, 2014
Table of Contents 1 EXECUTIVE SUMMARY... 1 2 PURPOSE... 2 3 THE PROJECT... 3 4 ASSISTANCE REQUEST... 7 5 RETURN ANALYSIS... 9 6 CONCLUSIONS... 13 7 QUALIFYING STATEMENTS... 14 Mission Statement Springsted provides high quality, independent financial and management advisory services to public and non-profit organizations, and works with them in the long-term process of building their communities on a fiscally sound and well-managed basis.
Executive Summary 1 1. Executive Summary The City of Shawnee retained Springsted to review the need for assistance for the proposed Shawnee Landing commercial retail development to be located at the southwest corner of Shawnee Mission Parkway and Maurer Road, to determine if the proposed project would not reasonably be anticipated to be developed without the adoption of the requested financial assistance. The project consists of the development of retail development containing a 50,000 square foot anchor space, an additional 94,600 square feet of inline retail and junior anchor space, seven pad sites containing 33,100 square feet of building, and necessary site work and infrastructure improvements (the Project ). The developer is SMPW Fund I LLC, (the Developer ). The measurement index to determine the need for assistance is the return on investment given similar developments, termed the internal rate of return, (the IRR ). Springsted reviewed Project costs, operating revenue and expense information, and the requested assistance revenues to determine the Project s need for assistance. Springsted reviewed ten-year cash flow projections provided by the Developer, and tested the revenue and cost assumptions prepared by the Developer. The testing compared the Developer s representations to industry benchmarks. We determined the following: The projected IRR without assistance to the Developer falls below the current range expected within the marketplace, and the Developer s own return expectation. Based on the projected level of return without assistance we conclude the Project is unlikely to be undertaken without the requested public assistance. The development would have to realize either savings in project costs, increases in project revenue, or a combination of the two for the Project to be undertaken without the requested assistance. The base return without assistance is illustrated in Table A below, along with the rate at which assumptions would have to change for the Project to be considered feasible without assistance. Table A Internal Rate of Return (IRR) Return Analysis Analysis Change Necessary to be Feasible* Return without Subsidy Base Developer Return N/A 1.94% Decreased Costs 34% Decrease 8.28% Increased Project Revenue 56% Increase 8.22% Combined Cost Savings & Increased Project Revenues 21% Decreased Costs 21% Increased Revenue 8.30% * Feasibility defined as an internal rate of return of 8.23% per the Korpacz/Price Waterhouse Cooper Real Estate Investor Survey.
Purpose 2 2. Purpose The City of Shawnee has retained Springsted to review the application for a redevelopment project located generally at the southwest corner of Shawnee Mission Parkway and Maurer Road. The project proposes the development of the site into a commercial retail development. Additionally, the Developer is proposing necessary street, sanitary sewer, stormwater, and utility improvements; along with private site work as part of the development. The Developer is requesting the City Council approve financial assistance in the form of Tax Increment Financing (TIF) and a Transportation Development District (TDD). The City has requested this analysis determine the Project s need for the requested TIF and TDD assistance, based on the Project cost and operating pro forma information provided by the Developer. The analysis that follows will examine the determination that the proposed Project would not reasonably be anticipated to be developed without the adoption of the requested financial assistance. We have approached this determination based on the proposed Project s plans regarding development costs, outcomes, financing sources, and timing, to develop a measure of the Developer s expected return when compared to the amount of risk. If a project is owned and operated as an investment, a measure of return is calculated considering the time value of money, and involves an assumed sale of the property at a price appropriate in the market place: this analysis is termed internal rate of return. The final determination is based on whether or not the potential return is reasonable without the requested assistance, within the current marketplace and at the present time. The assistance requested is in the form of TIF revenue generated by statutorily available ad valorem property tax revenue and sales tax revenue. The Developer has requested that 85% of the revenue generated by the City s 1% general sales tax be captured as sales tax TIF, along with 100% of the statutorily available ad valorem property tax revenue. Additionally, the Developer has requested the creation of a Transportation Development District and the application of a 0.5% special TDD sales tax rate applied to purchases within the District. The Developer has requested TIF assistance in a principal amount $10,843,866 and TDD assistance of $4,496,000; for a total amount of $15,339,866 plus interest on the TIF portion. The request is to be reimbursed on a pay-as-you-go basis. The Developer will also be seeking reimbursement for interest expenses incurred on the TIF principal amount based on the rate actually incurred up to a maximum interest rate which is yet to be negotiated. For purposes of this analysis we have utilized the Developer s assumption of a 5.5% interest rate.
The Project 3 3. The Project The Project contemplates the redevelopment of the site into a commercial retail development. Specifically planned is the construction of a 50,000 square foot anchor space, 94,600 square feet of junior anchor/inline retail space, and seven pad sites with a total of 33,100 square feet of building space. The total development is approximately 177,700 square feet of space developed on approximately 25.97 acres of property. The Developer estimates starting construction on the development in 2015 with completion of the 50,000 square feet anchor space, 49,000 square feet of the junior anchor/inline retail space, and two pad sites with 9,100 square feet of building. Anticipated to be completed in 2016 is the remaining 45,600 square feet of junior anchor/inline retail space and two pad sites with 11,600 square feet of building. The development is projected to be completed in 2017 with the construction of the remaining three pad sites with 12,400 square feet of building. The Developer anticipates constructing and operating the anchor, the junior anchor/inline retail, and four of the retail pad sites, for a total square footage of 160,300 constructed and operated by the Developer. The project anticipates that three pad sites will be sold and developed by third parties with a total building square footage of 17,400. In addition to the commercial component of the development, the Developer is also anticipating undertaking necessary improvements to the development site related to street improvements, sanitary sewer, stormwater improvements, and utility improvements in addition to onsite private improvements. The Developer has provided a preliminary project budget as part of their TIF application containing categories for land acquisition, site work and infrastructure, vertical building construction, and soft costs. The Project costs for each category are illustrated in Table B: Table B Cost Category Total Cost Reimbursement Request Land Acquisition $6,250,000 $4,500,000 Site Work & Infrastructure $14,700,000 $10,275,726 Vertical Building Construction $22,605,000 - Soft Costs $12,800,000 $564,140 Grand Total $56,355,000 $15,339,866 Table C breaks down the Developer s estimated cost and requested reimbursement amount for the land acquisition category. Table C Land Acquisition Cost Reimbursement Total Costs $6,250,000 $4,500,000 The Developer indicated they are either under contract or are in contract negotiations to purchase each of the eight parcels that comprise the 25.97 acre development site.
The Project 4 The Developer indicated their cost assumption is based upon contracted purchase prices and the anticipated results of ongoing negotiations. The anticipated cost of acquiring the site equates to a $5.52 per square foot purchase price. However, the Developer has indicated given the difficult nature of the property they would assign a market value of $1.50 per square foot if the site were available as a single tract of property in its current state. The Developer is seeking reimbursement of $4,500,000 to offset the difference between the cost of acquiring the site and their projected market value of the land. Table D breaks down the updated site work and infrastructure line-items as prepared by the Developer. Table D Site Work & Infrastructure Cost Reimbursement Demolition & site clearing $100,000 $100,000 Grading, retaining walls & erosion control 8,300,000 3,878,726 Private utilities storm sewer, sanitary sewer, and water 700,000 700,000 Private utilities electric, gas, and phone 50,000 50,000 Storm water detention/bmp s 350,000 350,000 Parking lots, drives, and sidewalks 2,250,000 2,250,000 Landscaping and development signage 350,000 350,000 Public grading 350,000 346,000 Public utilities storm sewer, sanitary sewer, and water 600,000 600,000 Public utilities electric, gas, and phone 150,000 150,000 Utility relocations 125,000 125,000 Maurer Road improvements & traffic signal modifications 400,000 400,000 New public street and sidewalks 925,000 925,000 Bell road cul-de-sac improvements 50,000 50,000 Total Costs $14,700,000 $10,275,726 Costs the Developer has identified as public in nature are shown in italics above. City engineering staff have reviewed the proposed cost estimates and determined them to be reasonable.
The Project 5 Table E breaks down the projected Developer incurred costs for the building improvements category. Table E Vertical Building Construction Developer Cost Reimbursement Anchor Space 50,000 square feet $5,000,000 - Junior Anchor/Inline Space 94,600 square feet $11,005,000 - Pad Site Buildings 33,100 square feet $6,600,000 - Total Building Costs $22,605,000 $- The anchor space cost estimate equates to a cost of $100 per square foot. The junior anchor/inline retail space cost estimate equates to a cost of $116 per square foot. The pad site building cost estimate equates to a cost of $199 per square foot. The projected total building cost of $6,600,000 includes $3,469,486 of vertical building costs incurred by third parties in the development of lots 1, 3, & 5. The net developer incurred costs for pad site buildings is $3,130,514. To analyze the projected vertical construction line-item assumptions we compared the cost estimates to the RSMeans Quickcost cost estimator for estimated construction costs for the proposed building types in the Kansas City metropolitan area. The RSMeans data provides a range of cost estimates from low, medium, and high for the construction of vertical building improvements. The Developer s cost assumption for the 50,000 square foot anchor space is approximately $100 per square foot. The RSMeans estimate for this type of space is $109.26 for the low estimate. The Developer s cost assumption for the 94,600 square feet of junior anchor/inline retail space is approximately $116 per square foot. The RSMeans estimate ranges from $109.50 for the medium estimate to $136.88 for the high estimate. The Developer s cost assumption for the 33,100 square feet of standalone pad buildings is approximately $199 per square foot. The RSMeans estimate for fast-food restaurants ranges from $190.21 for the medium estimate to $237.76 for the high estimate. The RSMeans estimate for sit-down restaurants ranges from $195.50 for the medium estimate to $244.37 for the high estimate. Based on this review the Developer s vertical building cost assumptions appear reasonable.
The Project 6 Table F breaks down the Developer s projected costs for the soft cost category. Table F Soft Costs Total Cost Reimbursed Architectural, engineering and surveying $1,150,000 $200,000 Geotechnical, environmental, and special inspections 250,000 75,000 Legal and accounting 550,000 - Leasing and sales commissions 1,250,000 - Project management 475,000 - Bonding, permitting, and fees 300,000 - Financing fees 325,000 - Construction interest 2,500,000 - Developer fee 1,750,000 - Contingency 4,250,000 289,140 Total Soft Costs $12,800,000 $564,140 The total soft costs of $12,800,000 equates to approximately 23% of the total development cost. The largest of the soft costs is the contingency line item of $4,250,000; which equates to approximately 7.5% of the total project costs, which is a reasonable estimate. The construction interest expense is the next largest soft cost category at $2,500,000. This amount equates to an annual interest expense of approximately 5.5% incurred on the total project cost. The soft costs include a developer fee expense of $1,750,000 which equates to approximately 3.1% of the total project cost. The leasing and sales commission line item expense of $1,250,000 equates to approximately 2.2% of the total project cost. The architecture and engineering line item expense of $1,150,000 equates to $6.50 per square foot. In the Return Analysis section of the report we discuss the sensitivity of the rate of return to changes in the project costs, and the effect on the return of a decrease in project costs.
Assistance Request 7 4. Assistance Request The assistance requested is in the form of TIF revenue generated by statutorily available ad valorem property tax revenue and sales tax revenue. The Developer has requested that 85% of the revenue generated by the City s 1% general sales tax be captured as sales tax TIF, along with 100% of the statutorily available ad valorem property tax revenue. Additionally, the Developer has requested the creation of a Transportation Development District and the application of a 0.5% special TDD sales tax rate applied to purchases within the District. The Developer has requested TIF assistance in a principal amount $10,843,866 and TDD assistance $4,496,000; for a total assistance amount of $15,339,866 plus interest reimbursed on the TIF principal amount. The TIF request is on a pay-as-you-go basis with interest expense to be reimbursed on an as incurred basis, subject to a cap on the maximum eligible interest rate yet to be negotiated. For the purposes of this analysis we have assumed reimbursement on the TIF principal amount at an anticipated a rate of 5.5%. The TIF eligible project costs would be funded initially by the Developer, who would then receive reimbursement for eligible costs as TIF revenue is generated. The TDD revenue stream is based on the total amount of revenue generated by the TDD, as the reimbursement of operating interest expenses is not an eligible use of TDD revenue. The net present value of the TDD revenue stream when calculated at 5.5% is approximately $2,408,715. The net present value of the combined TIF and TDD revenue streams when calculated at 5.5% is approximately $13,252,581. The Developer will be funding their portion of the Project costs through a mix of Developer equity and private debt. The Development pro forma estimated an equity contribution of 20% of project costs, with the remaining 80% financed by permanent debt. The Developer projected private financing terms of 5.5% interest over a term of 20-years. The final terms of the Developer s anticipated debt and equity requirements have not been determined, however the preliminary assumptions provided in their pro forma are reasonable. The Developer will be responsible for initially privately financing the $15,339,866 of expenses that will ultimately be reimbursed by TIF and TDD.
Return Analysis 8 The Developer is anticipating Industrial Revenue Bonds (IRB) will be issued in conjunction with the development, resulting in project cost savings as a result of the sales tax-exemption for the portion of the development finance with IRB bonds. The anticipated savings as a result of the IRB issue is $1,215,155. The total project budget also included third party costs of $3,469,486 for the construction of buildings on pad sites 1, 3, & 5. As a result the net costs funded by the Developer through private debt and equity is $51,670,359. Table G Sources: Permanent Financing 1) (80%) $41,336,287 Developer Equity (20%) $10,334,072 Total Sources $51,670,359 1) The revenue from the TIF and TDD will be provided on a pay-asyou-go basis -- revenue received would be used to offset the private equity and debt of the Developer.
Return Analysis 9 5. Return Analysis Utilizing the operating pro forma prepared by the Developer we evaluated the need for assistance for the proposed development as a whole by comparing the potential return with and without assistance. The Developer provided a 10-year operating pro form for the development, which included the build-out, and operating revenue and expense assumptions. The Developer demonstrated the potential return through a leveraged internal rate of return (IRR) calculation, to illustrate the potential return with and without assistance. The return realized by the Developer is a result of the assumptions used in the creation of the operating pro forma; therefore a number of steps must be performed to analyze the reasonableness of the assumptions used. The first step in analyzing the return to the Developer is to determine if the costs presented are reasonable. We have discussed a portion of the costs above and have commented on the mechanics whereby cost savings on the private side could occur. If cost savings for the Developer s share occur absent any other changes, the Developer would realize a greater return than projected. In the sensitivity analysis below we examine the impact of cost savings on the projected rate of return without assistance. The second step in calculating the return to the Developer is to determine if the operating revenues and expenses are reasonable. The Developer has assumed the following average per square foot triple-net retail lease rates by product type: o Anchor - $14.00 o Junior Anchor - $12.00 o Inline Retail Space - $20.50 o Standalone buildings $26.33 The Developer has projected a 5% vacancy factor, and assumed rental income will increase by 5% in year 7, the 5 th stabilized year. The Developer anticipates selling lots 1, 3, & 5 as build-ready lots to third party developers. The sale prices per square foot are $9.71, $17.22, and $15.94 respectively. We examined various retail lease rate listings in the Kansas City area market. Our conclusion is that the projected lease rates, pad sale prices and vacancy assumption are reasonable. In the sensitivity analysis we examine the impact of increased lease rates on the projected rate of return without assistance. The third step in analyzing the return to the Developer is to determine if the assumptions for a sale of the asset are reasonable. The return analysis to the Developer should factor in a hypothetical sale of the asset at the end of ten years of operations. A critical assumption when valuing the asset at the time of the hypothetical sale is the capitalization rate. The available net operating income
Return Analysis 10 divided by the capitalization rate results in the assumed fair market value of the asset. The Developer has used a capitalization rate of 7.5% for the project to calculate the hypothetical sale value. In reviewing historical cap rate trends for commercial retail developments, we feel 7.5% is a reasonable assumption. Table H illustrates the Developer s base pro forma with the rate of return with and without assistance, on a leveraged basis. Table H Base Developer Pro Forma Without Assistance With Assistance Leveraged -14.13% 9.66% To provide a comparison of the Developer s return without assistance to an industry benchmark the Developer s submitted pro forma was modified to include the IRR analysis on an unleveraged basis. An unleveraged IRR calculation is performed in order to compare the potential return to the Developer based on the Price Waterhouse Cooper (PWC)/Korpacz Real Estate Investor Survey, Third Quarter 2014, which provides a market comparison on which project feasibility can be judged. Table I shows the Developer s base pro forma with the rate of return with and without assistance, on an unleveraged basis. Table I Base Developer Pro Forma Without Assistance With Assistance Unleveraged 1.94% 8.57% To evaluate the rate of return a project of this nature would require to be considered feasible we consulted the Korpacz/Price Waterhouse Cooper Real Estate Investor Survey prepared for the third quarter of 2014. This survey provides a resource for comparing the Developer s rate of return to a market benchmark to help determine feasibility. According to the developers surveyed, the typical unleveraged market return necessary for them to pursue a project of this nature falls in a range from 6.25% to 11.00%; with an average return of 8.23%. In order to answer the question is the development likely to occur without public assistance we analyzed the without incentive scenarios, using the base developer pro forma without assistance as the basis of the assumption. We performed a sensitivity analysis in order to understand the magnitude at which project costs would have to decrease, or conversely project revenues would have to increase, for the project to be considered feasible. For this sensitivity analysis we are using the average market return from the Korpacz Survey of 8.23% as our target for a feasible project.
Return Analysis 11 To understand the impact of the project cost assumptions, we have performed a cost sensitivity analysis to determine the rate at which costs would have to be reduced for the projected rate of return to be in excess of our feasibility benchmark without assistance. Table J illustrates the development would need to realize a 34% reduction in project costs in order to be feasible without assistance. Given a 43% reduction in costs the project would have a rate of return of 8.28%. However, the City may choose to verify the final actual project cost before reimbursement. Table J Project Costs Sensitivity Reduction in Project Costs Rate of Return without assistance 34% 8.28% To understand the impact of projected lease rates and pad sale assumptions, we have performed a sensitivity analysis to determine the rate at which project revenues would have to be increased for the projected rate of return to be in excess of our feasibility benchmark without assistance. Table K illustrates the development would need to realize a 54% increase in project revenues in order for the project to be feasible without assistance. Given a 54% increase in project revenues, the project would have a rate of return of 8.22% which falls into the reasonable range. Table K Project Revenue Sensitivity Increase in Project Revenue Rate of Return without assistance 54% 8.22% As a final step in the sensitivity analysis, and to understand the impact of a combined change in project costs and project revenues, we have performed a sensitivity analysis to determine the rate at which these areas would have to change for the projected rate of return to be in excess of our feasibility benchmark without assistance. Table M illustrates the development would need to realize a combined 21% decrease in project costs and a 21% increase in project revenues for the project to be feasible without assistance. Given these changes in assumptions the project would have a rate of return of 8.30%. Table L Combined Sensitivity Rate of Reduction in Project Costs Increased Project Revenues Return without assistance 21% 21% 8.30%
Return Analysis 12 The three tables above (Tables J, K, and L) indicate the magnitude at which project assumptions would have to change for the project as a whole to have a rate of return in excess of the 8.23% feasibility benchmark used in the sensitivity analysis. Absent changes of the magnitude outlined above, the project would not have a sufficient enough return to draw market investment. Only by assuming either increases in project revenues, decreases in project costs, or a combination of the two does the return increase to a feasible level without public assistance. However, we project changes of the magnitude outlined above are unlikely to be realized, which indicates the proposed project, when viewed as a whole, would not likely be completed through private enterprise alone.
Conclusions 13 6. Conclusions This Project involves the construction of a commercial retail development. The Developer will bear all the risk until project completion and permanent financing is in place, and continued operating risk thereafter. This level of risk demands a positive return with a comparable national market range of 6.25% to 11.00%, with an average of 8.23% as indicated in the PWC/Korpacz study. As detailed above, the projected IRR to the Developer without assistance, falls below the current range expected within the marketplace and in comparison to the return with assistance. Therefore, Springsted concludes that the proposed Project, without assistance would not likely be undertaken at this time without the requested assistance.
Qualifying Statements 14 7. Qualifying Statements The above conclusions are reliant on preliminary information regarding many assumptions. These assumptions include the total cost to construct the project, the timing of Developer equity, the projected income and expenses during operation of the development, and the projected offsetting tax revenue. We did test the project cost and revenue assumptions, and noted the level at which project assumptions would have to change for the project to be considered feasible. However, actual project costs and revenues differing from the initial assumptions would result in changes to the rate of return realized by the Developer. The above conclusions are based on projected tax increment and TDD revenue generated by the project. The Developer is requesting funding of $15,339,866 (plus interest on the TIF portion) provided on a pay-as-you-go basis for additional eligible expenses. The purpose of this analysis is to illustrate the project without assistance is unlikely to occur. The specific amount of assistance necessary to make the project feasible should be analyzed separately.