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.

 

———————————————————————————————–

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)

 

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§ 6 Responses to BIGGEST SELL OUT IN THE MAKING – The Case of Downtown Land

  • Thank you graciously Council Member Singh for taking the time and effort to explain clearly what all the development in Herndon REALLY means for the town and its people. I am with you 100% on transparency and accountability.

    Like

  • Tom Kellner says:

    In an article in the Washington Post a few weeks back, it talked about the poor neighborhoods of Baltimore City and the problems that they now have with the lack of open space. The complaint of older women there is that young men congregate on street corners and accost them. The young men reply that this where they live and where else are they going to go. Where else indeed?

    What we have now in our downtown is the most valuable thing that this municipality can have–open space where all town residents can participate in neighborhood gatherings such as fairs, festivals and free concerts with the added bonus that this open land is bought and paid for. After the shiny and new of the neighborhoods proposed wear off, and our fairs, festivals and concerts disappear, in the next ten years or so, our crammed together downtown stuck in the middle of nowhere will more than likely become a slum anchored by a bankrupt art center.

    Like

    • Ruchi says:

      Very vivid description. One of the reasons we chose to live close to downtown was it’s proximity to the “herndon green,” and the concerts and events that take place at walking distance. It would be sad indeed if the future turned so bleek.

      Like

  • E Payne says:

    The reality is, this is a new business venture and Herndon residents are being forcefully placed in the position of Venture capitalists providing the $30+ million in funding. This effort is significantly different than the town contracting to have someone build town office space.

    Upon completion, the business MUST be capable of generating something on the order of $3 – $5 million per year in revenue to remain viable so what is the business plan laying this out? Any sane venture capitalist would demand that a 3-5 year revenue plan be laid out demonstrating a positive cash flow in 3 years, where is that? What is the plan to prop-up this business venture for the first 3 years while it will most likely loose money?

    There is supposed to be retail space in this new business venture, what is the plan for that? Who is going to be the anchor store? What is the business mix necessary to provide for $3-$5 million in revenue?

    All businesses face risks, some risks you can mitigate, the rest you just have to live with and manage. Where is the risk management plan for this new business? What is the impact upon the increased traffic places on the already stressed infrastructure (roads) and what impact will those businesses in downtown Herndon see? Will the downtown become so congested that customers for Total Autoparts or the Harvest Bread company become so great that they go elsewhere and drive our small businesses out?

    My take on all of this is that there are 4 members on the Town Council that are affiliated with the Art Center and are using this opportunity as a way to further the Art Center’s efforts at the expense of Hendon residents. Of the 7 members of the town council 4 are school teachers, 1 is an IT expert, 1 is an accountant and Mr. Singh, the only one that even remotely has any commercial real estate development knowledge, is being ignored by the rest of the council.

    Collectively the town council does not have the requisite knowledge and experience to undertake this project and should simply sell the land and let people who know how to do this take it over.

    Like

  • Singh says:

    Just a clarification. The developers have proposed that the Town give up all or most of the land, provide considerable cash, and subsidize commercial parking in exchange for (1) a municipal garage or 280 spaces in a garage and (2) a yet undefined shell of an Art Center. Developers would assume all business risks. However, the exchange is hardly a bargain for the Town. It is in fact a cruel joke on the Town.

    Like

    • E Payne says:

      A developer is not necessarily the owner. The risk is being transferred to the town with free land and a $10 million gift, which is probably 30% of the development costs. Why are we so eager to jump off of this bridge when we do not know what is at the bottom?

      Whoever obtains/retains ownership assumes the business risks for that business and that business only. What are the risks to the rest of the town and what is our remedy for those risks? What happens if it fails in it’s efforts for an “upscale” property and resorts to rental by the hour to make enough money to pay the bills? I can guarantee you that the developer is not going to care one iota what happens to the small businesses or the traffic congestion in the downtown area.

      Why is the council taking such a myopic view of this effort?

      Like

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