BIGGEST SELL OUT IN THE MAKING – The Case of Downtown Land

September 26, 2016 § 6 Comments

by

Jasbinder Singh

 

The downtown development proposals are still under review, but we already know what we asked for, what we are getting and what the framework of the costs is likely to be regardless of the results of future negotiations. Further, the developers’ proposals have not changed materially since they were initially submitted in March, yet the Town has chosen not to inform our citizens of Herndon about the sacrifices they are about to make.

The public has a right to know this information before, not after, the election in November. It has a right to understand that a $10 million potential give-away along with another $8 million or so to complete the Art Center and more than $42 million on the Metro Development will not only increase taxes substantially, but also crowd out other important projects for the foreseeable future. It is worth noting that the Town’s operating budget is only $35 million.

As shown below, the gap between what the Town would receive and what it would give up is about $10 million. According to the Town, the gap is only $1-$2 million. The math is very simple. You be the judge.

What Will The Town Receive?

  • Either 280 parking spaces in a private garage, or, a 475-space public garage, and
  • A-yet-unspecified “Cold Dark Shell” for an Art Center. It will take about $8 million more to complete the yet-to-be designed Art Center.

The development will generate future uncertain real estate and other tax revenues from the development; however, the tax revenues should not be counted as a special benefit, because all privately financed developments generate tax benefits for towns and cities. The tax revenues are often used to defray some of the costs developments impose on the our citizens. Therefore, they cannot be counted as benefits.

What Will The Town Give?

  • Free Land: Both developers, directly or indirectly, want all, or, a substantial portion, of the land given to them at no charge, or, at a very low price. The land, if sold at the same rate as that used to buy the Ashwell property, should fetch at least $13 million.
  • Cash Contribution: Both developers have asked the Town to contribute sufficient funds for constructing the garage or garage spaces. This essentially means the developers would use the Town’s money to provide the garage spaces. Therefore,

    THE TOWN WOULD RECEIVE NOTHING MORE THAN A YET-UNDEFINED AND OVERPRICED $2 to $4 MILLION “COLD DARK SHELL” (for the Art Center) IN EXCHANGE FOR THE DOWNTOWN LAND WORTH ABOUT $13 million.

  • Parking Subsidies: As if the above bargain is not enough, both developers want the Town to subsidize already overpriced commercial parking spaces. This subsidy would cost the Town $1 to $2 million more.

The Net Result

The selling of $13 million downtown land for a $1 or $2 million shell would be a cruel joke on the people of Herndon. Most of the financial benefit would go to the selected developer in the form of extra-ordinarily high excess profits of between $7 and $10 million.

This $7 to $10 million gap cannot be bridged. The Town should walk away from the negotiating table, but it continues to want to negotiate regardless of the consequences, probably because it wants to build an Art Center, somehow. 

The Town’s Bull-Headed Attempt to Move Forward

The Town even hired a real estate consultant to “provide a further context for financial assumptions used within the proposals”. Unfortunately, his estimates of the land values contradicted not only the common rules-of-thumb builders are currently using to buy land (such as $40,000 / apartment) but also the appraisals the Town conducted in 2013 and 2014. The consultant’s estimates should have been higher than the previous values, but they were lower, by a substantial amount. At the low end, his estimate was $15,000 / apartment; it should have been close to $40,000 / apartment. At the high end, his estimate was $30,000 / apartment; it should have been close to $45,000 / apartment. Councilmember Singh came to believe that the consultant’s analysis was a “joke” and said so in the council’s close-door meeting on September 12th.  It was apparent that the consultant had used a very biased sample of comparables to do his analysis and obtain the desired result.

 

The Town received two downtown development proposals in February this year. After an initial evaluation, both developers were asked to submit detailed proposals. The Town plans to select one of the developers, for further negotiations, after evaluating the technical proposals only[1]. That could be problematic in this case, because many challenging issues, related to density and the nature of the development, remain unresolved[2]. Nevertheless, this article discusses the cost issues only.

A.  ABSENCE OF SPECIFICATIONS FOR THE “COLD HARD SHELL”

In November 2015, the Town invited developers to submit their proposals for downtown development and asked them to provide (1) 220 spaces for its shared parking program, (2) 60 spaces for an art center and (3) a 18,000 sf art center[3]. It also mandated that “the art center shall be delivered as a cold dark shell”. Yes, a successful bidder was supposed to deliver only a shell, not an Art Center. However, this mandate suffered from the following inadequacies:

  • Art Center Not Designed Yet: The Town still has not designed an art center. No one knows how the art center would fit within the proposed structures, where the foundations would be located, or where what kind of electrical systems would be needed. Yet, the Town asked the builders to provide an estimate of the cost of the center’s “cold dark shell”. The builders have most likely to bid as high as possible in order to reduce their risks.
  • “Cold Dark Shell” Not Specified: The cold dark shell generally means a shell without any HVAC and lights systems.  However, the definition can mean different things to different people, even when a facility has been designed fully.  For example,

1.  Are HVAC and electrical systems not installed or merely not connected?

2.  Are foundations and/or foundation slab included or not?

3.  Are structural columns included or not?

In the RFP, the Town did not provide any specifications for the shell. In the absence of any guidance from the Town, each developer most likely made his own (unique) assumptions to estimate the cost of “cold dark shell”. That means the estimated costs proposed by the two developers are not comparable and cannot be understood easily by the town staff either.

  • Allocation Of Costs Between The Shell And The Rest Of The Structure:  The proposals submitted by two developers suggest that the Art Center (including its shell) will share HVAC systems, Electrical Systems, Foundations, Foundation Slab, Structural Columns and other structural elements with the buildings in which it is located. Yet, the detailed proposals, submitted by the developers, do not address the “equitable” shares of the costs. It appears that 100% of the costs of the common components have been shifted to the town.

The lack of allocation of the costs between the developer and the Town has probably added several millions to the town’s equitable share of the cost of a “cold dark shell. It would not be surprising to find that the town’s “equitable” share is less than 1/3rd of the costs proposed by the developers.

B.  DEVELOPERS SHOULD NOT RECEIVE ANY PARKING SUBSIDIES

In 2015, the Council gave the Town Manager the authority to allow a developer to (among other things) put some of the spaces required to meet the parking needs of residential and commercial customers into the PSP program. Accordingly, regardless of the actual cost of parking, the developer would have to pay only $8,820 per space[4]. Suppose that a developer proposes the parking cost of $20,000 per space. He would get a subsidy of $11,180 (=$20,000-$8,820), if he puts a space into the PSP program and if the Town accepts the $20,000/space figure. If he puts 100 spaces into the program, he would receive a subsidy of $1.118 million. In other words, the taxpayers would foot the $1.118 million bill for parking. Both developers have availed themselves of this opportunity to lower their costs by at least one million dollars.

There are three reasons why the Town should not provide any subsidy for constructing a garage or for providing parking spaces in a garage.

  • Appraisals (of land) Already Include Parking Cost: The appraisals of both the Ashwell property and the Town-owned land were based on data for properties (comparables) that had provided structured parking for their residential, retail and office clients.
  • Lots Assembled by the Town No Longer Constitute a Small Lot: The Public Shared Parking program was enacted to help develop small lots in the downtown. However, the site created by consolidating several large lots has an area of more than 200,000 sq. ft. It is no longer a small site: therefore, there is no legal or reasonable basis for providing the subsidy under the PSP program.
  • Hot Residential Market: Extra-ordinarily low interest rates have revved-up the demand for residential properties. Developers are expected to earn, in economic jargon, excess profits in this market. There is no need for the government to provide any subsidies.

If the town accepts the proposed subsidies, each developer would receive a windfall of between $1 million and $2 million.

C.  THE TOWN SHOULD NOT GIVE AWAY THE LAND


The Town has spent an extra-ordinary effort and resources to assemble the downtown land over the last 15 years. It even paid millions more than it should have to buy two of the parcels[5]. In the case of the Ashwell property, the Town paid $3.5 million for the contaminated property.

Based on the data given in Town-ordered appraisals and discussions with a few developers, its value is between $13 and $15 million. The values have been rising near the Metro Areas in anticipation of the completion of the Phase II of the Metro Rail. They depend on the number of residential units, the amount of retail space, and/or the amount of office space a developer proposes to build (see the article on a “Free Art Center”). The current general rule of thumb is that the value of the land is $50,000/apartment in Reston near the Metro stations, a little more than $40,000 in Herndon downtown and about $30,000/apartment near the Loudoun hospital. In an appraisal prepared in late 2013 for the Town, JMSP, an appraisal company, estimated an average land value of $39,000/apartment in the downtown.

In comparison, a consultant, retained during the last four months by the town, estimated the land values to be between $15,000/unit and $30,000/unit. When asked to explain the difference between his values and those of others, he indicated that their comparables were selected carefully and that he could defend this estimates. The consultant, when asked again, could not explain the wide range between $15,000/apartment and $30,000/apartment.

Upon a close examination, the consultant’s comparables appear to be very different than those selected by JMSP and those selected by Parli, another appraiser selected by the Town in 2014 to appraise the Ashwell property. Parli estimated that the value of the subject property was between $45,000 and $50,000 per apartment. Parli’s values were considered too high to be usable because they were based on comparables located in Falls Church. Still, they provide reasonable benchmarks for assessing other values. Therefore, it is apparent that the consultant used a very biased sample of comparables to do his analysis and to obtain a desired result. 

During the close-door meeting, Councilmember Singh opined, “What happened here was a joke”.  He should have said that it was a cruel joke on the people of the Town. The close-door session, otherwise, was notable for the absence of questions from other councilmembers including the Mayor.

The Town should never agree to charge less than the market value of the land. If a developer were to create a development on his own, he would have to buy the land first with his money. Perhaps, the town should keep a part of the land for a public garage and an art center and sell the rest to a developer (s) after an open and competitive bidding process.

D.  THE TOWN SHOULD TEST THE VALIDITY OF THE COSTS OF THE PROPOSED PUBLIC FACILITIES

Two developers who responded to the town’s RFP have provided estimates of the cost of (1) garage parking and (2) the “cold dark shell” of the Art Center; however, they have not explained the basis of their estimates. The proposed rates vary significantly from one developer to another and from those found in the building industry. For example, costs proposed by the two developers are 20% to 50% higher than those of two garages constructed for the Department of Defense in 2015 in Reston, VA.

Any overstatement of the costs represents “pure” profit for the developer. For instance, if the actual cost of creating a space is $19,000 (According to Carl Walker’s report, in 2015, the average cost in Washington DC area was $18,593 per space) and a developer claims that his cost is $23,000 space, then he would earn a pure profit of $4,000/space, that is, if his figure is accepted and he is selected to do the job. Similarly, any overstatement in the costs of the “cold dark shell”, footings, concrete slabs, walls and columns would also represent pure profits for the developer. In this case, though, the overstatement in the cost of the “cold dark shell” cannot be determined accurately until (a) the specifications for the shell are developed, and (2) the Art center is designed first as discussed in a previous section.

In summary, the Town needs to do a great deal of work before evaluating both proposals. It should select a developer only after the valid costs estimates have been developed.

 

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FOOT NOTES

[1] This as communicated to me by the Town Manager, but it now it appears that the Town might revise its approach to consider Technical and Cost proposals simultaneously.  In government contracting, this is not the normal practice.  The final selection is usually made only after conducting extensive technical and cost negotiations.
[2] Many people believe the 2012-2014 council made monumental changes to the 2011 Downtown Master Plan (DMP) to allow 54’ to 68’ tall buildings, residential use  (including rental apartments) on 4 floors, stacked townhouses, and English basements.  Such features form the heart of one of the proposals.  They believe the proposal is inconsistent with the DMP (Read the 4-part series on “Herndon’s Fight for a Small Town Feel” in herndonopinion.com) The second proposal is more in line with the DMP, but still does not conform fully to the DMP.
[3] The 18,000 gross sf figure was selected arbitrarily by the Town Manager to ensure that the total cost of an art center would be palatable to the community.  He was aware that the Art groups would accept almost anything. The Town Manager allocated 2,500 sf for a lobby area and restrooms, 4,000 sf for gallery and classroom space, 8,000 sf for a 200-seat performing arts theater, 500 sf for a TV studio and 3,000 sf will be used as multi-purpose room.  In the 2003 design by WBL architects, such numbers were in net square feet and gross square ft, but the TM ignored this fact.  Thus, the needs of various art groups in Herndon and those of the residents at large have never been given adequate consideration.
[4] In 2009, the town set the cost of parking at $14,700.  The stated business share, 60% of $14,700, amounted to $8,820.  This value has not been updated.
[5]  Read: (1) HERNDON ART CENTER – Examination Of The (Costly) Purchase Of The Property For It, and (2) The bad and ugly art of buying a contaminated property, (Part I and Part II)

 

REDUCING OUR RESIDENTS’ BURDEN

October 28, 2016 § Leave a comment

REFUNDING UNFAIR WATER AND SEWER CHARGES

By
Jasbinder Singh

In 2011, the Town raised the sewer rates by 36% to pay its share of the wastewater capital expenditures in about 5 years. In comparison, Fairfax County (and other jurisdictions) spread such payments over a 30-year period in order to make sure that the burden of capital expenditures does not fall on the current residents. If the Town had spread the payments over 30 years, the town residents and businesses would have paid about $6.5 million less than they have paid. This article suggests that the Town should return the excess payments to our residents as a part of implementing state-of-the-art policies throughout the government.

1. ALLOCATION OF CAPITAL EXPENDITURES (Between the County and the Town)

Herndon does not have its own wastewater treatment plant. Under an agreement with Fairfax County, the Town’s sewage is treated at the Blue Plains Treatment Plant (Blue Plains) in Washington DC. Long ago, the County purchased 31mgd treatment capacity from Blue Plains. Herndon’s share of this capacity was 3 mgd. As a matter of customary practice, Blue Plains bills the County every quarter and the County, in turn, bills the Town for its share of the capital expenditures.

Capital expenditures are divided among the users of the Blue Plains plant in direct proportion to the capacities purchased by them. Herndon’s share amounts to about 9.7% (= 100*3mgd/31mgd) of the capacity purchased by the County. Accordingly, the town must pay 9.7% of the share of the capital expenditures allocated to the County by Blue Plains.

In 2010, Blue Plains informed the County that it expected to spend about $1 billion to comply with the Combined Sewer Overflow (CSO) and Nitrogen Removal mandates over the next few years. As shown in Table 1, the County’s share of the corresponding capital expenditures ended up being $97 million. Consequently, Herndon’s share of the expenditures turned out to be about $9.4 million (or, 9.7% of $97 million).

2. ALLOCATION AMONG CURRENT & FUTURE RESIDENTS

    a. Fairfax County’s Practice

The County, in accordance with its normal business practice, issued a 30-year revenue bond to raise its share of about $87.6 million. By spreading the debt payments over thirty years, the county made sure the sewer rate increases would be much smaller than they would have been otherwise. If the capital expenditures had been paid over, say, 5 years, the sewer rates increases would have been three or four times as much. The rate increases were also more equitable. Both the current and future residents would pay equally for the use of the capacity.

     b. Herndon’s Practice

In contrast, Herndon, in accordance with its established practice, pays its share of the capital expenditures on a “pay as you go” basis. Generally, it raises the sewer rates sufficiently to generate enough cash for paying its bills over a short period-of-time. In 2011, it increased the sewage rates by 36% from $3.72 per 1000 gallons to $5.05 per 1000 gallons. This action generated enough cash to pay Herndon’s share of $9.4 million over a period of about 5 years. Therefore, the burden of the capital expenditures incurred by Blue Plain fell almost entirely on the current (2012-2016) residents and businesses.

c. Costs of the Town’s Practice on the Current Residents

In 2011, when the 36% rate increase was proposed, Councilmember Singh, in order to reduce the burden on the current residents (and spread the cost of the program over future residents as well), argued that the Town should issue Revenue Bonds; however, he did not find enough support on the council for his idea. Had the idea been approved, the current residents and businesses would have paid about $2.90 million dollars (rather than the $9.4 million or so they have paid). In other words, they have paid about $6.5 million more than they should have.

Given that there are 5209 residential water connections in the town and the residents and businesses use equal amounts of water, an average household has paid about $620 more than they would have paid, if revenue bond(s) had been issued.

3. MAKING PAYMENTS FAIRER

a. Refunding the Excess Payments and Reducing the Rate

In order to correct these inequitable payments, we can take the following two actions:

RETURN $3.2 MILLION (OR, $620 PER HOUSEHOLD)  TO OUR RESIDENTS, AND

REDUCE THE SEWER RATE FROM from $5.05 to $4.13 PER 1000 GALLONS.

The 36% rate increase in 2011 has helped to maintain stable cash balances in the Water and Sewer Fund in spite of the fact that the vast majority of the town’s share has been paid to the County. In 2011, the cash balance was $13.51 million. It had hardly changed by 2015.

    b. Effect of the Refund on Financial Health of the Water and Sewer Fund

The return of $3.2 million to our residents and a reduction in the rate to $4.13 per 1000 gallons will not materially affect the financial health of the Water and Sewer fund or its future needs. Even if both actions are taken, the cash balance will reduce to $10.3 million – a healthy amount for meeting operating and other immediate cash needs.

Back in 2011, the staff contended that the rate increase was necessary not only to comply with the capital expenditure obligations but also to generate funds for purchasing additional water and sewer capacity for the Metro development. The town expects that it would cost about $33 million to purchase the additional water and sewer capacity. The return of the $3.2 million to the residents would not materially affect the town’s ability to raise the needed capital. For these reasons, the $3.2 million unjustified and unfair increase should be returned to our residents.

fc-and-herndon-share-of-capital-expenditures

TABLE 1.  FAIRFAX AND HERNDON’S PAYMENTS TO THE BLUE PLAINS TREATMENT PLANT

(click on image to zoom)

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