Development Economics For Planners and Other Land Use Professionals

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.


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.


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


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%


General Plan Tentative BuildingEntitlement Map Permit

Equity60%

Debt40%

Mezzanine10%

Equity40%

Debt50%

Sources and Mix of Capital Vary as Development Process Progresses


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


TentativeMap

BuildingPermit

Return on Investment (ROI) continuedExpectation for return and risk tolerance varies for each source of capital


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


TentativeMap

BuildingPermit

Return on Investment (ROI) continuedExpectation for return and risk tolerance varies for each source of capital


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


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


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

http://www.lawyer-planner.com/

Development Economics For Planners and Other Land Use Professionals

Technology

Transcript of Development Economics For Planners and Other Land Use Professionals