development economics for planners and other land use professionals
DESCRIPTION
Presentation made with TIm Youmans of Economic Planning Systems, Inc. for the annual conference of the California Chapter of the American Planning Association on September 25, 2008TRANSCRIPT
Development Economics for
Planners
How the MarketplaceAffects Planning
Outcomes
APA-CA 2008 ConferenceSeptember 23, 2008
Development Economics• Why should Planners care?
– Old School – We just set the standards – making money is the developer’s problem
– New School - Plans that don’t work are a waste of resources and public involvement
– Public-Private Partnerships – Win/Win (not surrender)
• Financial Markets – capital is a global commodity essential to community well-being
• Lost in Translation - planner speak vs. developer speak
Development Economics• Public Facilities Financing Plans and
Fiscal Impact Analyses– Ensuring development pays its own way for
public infrastructure and services- “Community Benefit”
• Economic Development / Redevelopment Project Feasibility Analysis- Determining need and magnitude of subsidies
or incentives
• No Free Lunch – Who Pays?– Public objectives have real costs (clean air,
water, affordable housing, schools)
Basics of Development Economics
• Market Research– Purpose– Objectives
• Linkage between Market Research and Financial Feasibility
• Financial Feasibility– Purpose– Case Studies
• Risk/Return/Time Value of Money
Market Study Objectives• Creation of a Land Use
Plan or Building Project consistent with current trends
• Validation of a Development Project– Justify debt or equity
financing
• Market Creation Strategy– Identify the basis for new
projects or products that cannot be justified by current trends
Types of Market Studies• Long-range planning (5-20 yrs)
– Regional plans – City General Plans– Specific Plans – Community Plans
• Site Plans (2-10 yrs)– Residential subdivision– Commercial center
• Buildings (6 months–2 yrs)– Residential– Non-residential (Retail, Office,
Industrial, Mixed Use)
Linkage Between Market and Feasibility Analyses
• Market analysis provides technical assumptions for feasibility analysis
• Feasibility analysis tests market assumptions to develop viable project– Sales prices– Supportable square feet of development
Financial Feasibility Analysis• The “Pro Forma”
– Identify key variables through market research• Sales prices• Construction costs• Fees• Land Values
• Test sensitivity to changes in marketconditions
• Evaluate conditionsnecessary to achievereturn requirements
Residual Land ValueFinal Sales Price
• Market Derived
minus
Development Costs
equals
Residual Land Value
• Market comparables
• Estimated Dev. Costs
• Impact Fees
• Backbone Infrastructure & Mitigation
• Site Development Costs
• Building Construction Costs
• Contingencies
• Builder’s Profit
Hypothetical Project Alternatives
Project A Project BItem (20 units/acre) (60 units/acre)
Concept Lofts TowerLand Area (Sq. Ft.) 217,800 290,400Stories 3 15Total Residential Units 100 400Average Sq. Ft. per Unit 1,100 950Floor Area Ratio (FAR) 0.60 1.50Parking Surface StructuredConstruction Cost Per Sq. Ft. $125 $175
Analyzing Density for New Transit-Oriented Development
Financial Feasibility:Current Market Conditions
Target:$40-$50/
land sq. ft.
Target:$90-$100/land sq. ft.
Project A Project BItem (20 units/acre) (60 units/acre)
Revenue (Sales Price) $350,000 $325,000
CostsDevelopment Impact Fees $20,000 $20,000Unit Construction/Site Development $147,500 $176,250Structured Parking $0 $30,000Financing, Marketing, Builder Profit $67,250 $69,375Total Costs $234,750 $295,625
Residual Land Value Per Unit $115,250 $29,375Per Land Sq. Ft. $53 $40
Financial Feasibility:Break-Even Conditions
No adjustment
required
Increased$42k toachieve
feas.
Project A Project BItem (20 units/acre) (60 units/acre)
Revenue (Sales Price) $350,000 $367,000
CostsDevelopment Impact Fees $20,000 $20,000Unit Construction/Site Development $147,500 $176,250Structured Parking $0 $30,000Financing, Marketing, Builder Profit $67,250 $75,675Total Costs $234,750 $301,925
Residual Land Value Per Unit $115,250 $65,075Per Land Sq. Ft. $53 $90
Fee Breakdown
Project A Project BItem (20 units/acre) (60 units/acre)
City/County FeesProcessing/School Fees $8,500 $8,500Development Impact FeesWater $1,000 $1,000Drainage $1,000 $1,000Sewer $2,500 $2,500Transportation/Transit $1,800 $1,800Park $1,500 $1,500Public Works $500 $500Fire/Police $500 $500Community Facilities $2,500 $2,500General Government $200 $200
Total Fees (Rounded) $20,000 $20,000
Return on Investment (ROI)
Time
Risk
CapitalReq.
Risk/Reward/Timing of Investment in the Development Cycle
Return on Investment (ROI) continued
$50k/ unitinvestment
$5k/ unitinvestment
$200k/ unitinvestment
0%
5%
10%
15%
20%
25%
30%
35%
General PlanEntitlement
TentativeMap
BuildingPermit
ROI
Risk/Reward/Timing of Investment in the Development Cycle
Mezzanine15%
Debt75%
Equity10%
Return on Investment (ROI) continued
General Plan Tentative BuildingEntitlement Map Permit
Equity60%
Debt40%
Mezzanine10%
Equity40%
Debt50%
Sources and Mix of Capital Vary as Development Process Progresses
Return on Investment (ROI) continued
Estimated ROI Requirements in Stable Market
Expectation for Return and Risk Tolerance Varies for Each Source of Capital
Item Priority Risk
Debt 8-10% 8-10% 8-10% 1 Guaranteed PmtMezzanine N/A 10-12% 10-12% 2 Guaranteed PmtEquity 25-40% 20-30% 15-20% 3 At Risk
PaymentGeneralPlan Ent.
TentativeMap
BuildingPermit
• Acquisition & Development Loan• Sophisticated Developer & Lender• Secured & Guaranteed
Return on Investment (ROI) continuedSources and mix of capital vary as development process progresses
General Plan Tentative BuildingEntitlement Map Permit
Equity60%
Debt40%
Mezzanine15%
Debt75%
Equity10%
Mezzanine10%
Equity40%
Debt50%
Peeling the Development Investment Onion
• Cash• Option• Joint Venture• Speculative Expense
• Option Exercised• Add Equity Investors• Additional Draws
• Securing Site• Planning• Environmental
• Closing on Site• Engineering• Infrastructure Finance
• Site Improvements• Development Fees• Marketing /Sales/Service
• Hard Money –Tough Terms• guaranteed minimum• preferred / priority• share of profit
• Land Developer Sells to Merchant Builder or Commercial RE Co
• Construction Loan
Short term• “Take Out” Loan
Long term financing
Item Priority Risk
Debt 8-10% 8-10% 8-10% 1 Guaranteed PmtMezzanine N/A 10-12% 10-12% 2 Guaranteed PmtEquity 25-40% 20-30% 15-20% 3 At Risk
PaymentGeneralPlan Ent.
TentativeMap
BuildingPermit
Return on Investment (ROI) continuedExpectation for return and risk tolerance varies for each source of capital
Estimated ROI Requirements in Stable Market
Banks, Insurance Companies
SECURED DEBT 1st POSITION
Banks, Insurance Companies
SECURED DEBT 1st POSITION
Debt 8-10% 10% 10%Debt 8-10% 10% 10%Mezz. N/A 10-12% 10-12%Mezz. N/A 10-12% 10-12%Pension Funds, InstitutionalAnd Specialized Investors
MINIMUM and PREFERRED RATE OF RETURN + PROFIT SHARE
Pension Funds, InstitutionalAnd Specialized Investors
MINIMUM and PREFERRED RATE OF RETURN + PROFIT SHARE
RATES SUBJECT TO
CAPITAL MARKETPLAC
E Other
Opportunitiesfor ComparableRisk and Return
Item Priority Risk
Debt 8-10% 8-10% 8-10% 1 Guaranteed PmtMezzanine 25-40% 20-30% 15-20% 2 Guaranteed PmtEquity N/A 10-12% 10-12% 3 At Risk
PaymentGeneralPlan Ent.
TentativeMap
BuildingPermit
Return on Investment (ROI) continuedExpectation for return and risk tolerance varies for each source of capital
Estimated ROI Requirements in Stable Market
Equity 25-40% 20-30% 15-20%Equity 25-40% 20-30% 15-20%
At Risk
Internal Rate of Return (IRR)
• Project internal rate of return (IRR) = the discount rate at which the net present value of all cash flow invested in and thrown off by the project equals zero. Also known as the "unleveraged" IRR.
• Equity IRR = IRR of the share of that cash flow that goes to the owner, after receiving the loan proceeds, paying expenses, debt service, and repaying the loan
Source: Stuart Meck, FAICP, APA Research Department, May 2005
• Developer rate of return is NOT a percentage of sales price
e.g. $400,000.00 unit and developer return of 20% IRR $400,000.00 x .20 = $80,000.00/unit x 100 units = $8 M Equity = 10% of Project Cost = $3.9 M x .20 = $780,000.00
Development Economics
Lessons for Planners• Developers make buckets of money DELAY AND SQUEEZE TO GET ALL YOU
CAN• Plan it, and they will come • Market? We don’t need no stinkin’ market• Don’t worry about the costs, set high
standards for the market to meet public goals• Time taken to process the environmental
review and application has no consequences we need to be concerned about
Development Economics
Lessons for Planners• Development capital is a resource
• As important as air, water, transportation, design, public services, etc.
• Scarcity – competitive investment opportunities
• Plans for development with no market or not financially feasible will never be built
• Plans that don’t provide for market demand will more likely be amended
• Time and risk in development processing impact achievement of planning goals
Development Economics
Lessons for Planners• Adding Market Savvy to Planner’s
Toolkit• Transformational Planning
• what planning techniques can most effectively influence markets to meet planning goals?
• can markets provide effective planning tools? (i.e. carbon credit trading; transfer of development rights)
Contact Information
Joel Ellinwood, [email protected]
Tim [email protected] copy of this presentation and a list of
additional reference materials are available on the web at
http://www.lawyer-planner.com and http://www.epssac.com