Development Economics For Planners and Other Land Use Professionals

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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, 2008

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Development Economics For Planners and Other Land Use Professionals

  1. 1. Development Economics for Planners How the Marketplace Affects Planning Outcomes APA-CA 2008 Conference September 23, 2008
  2. 2. Development Economics <ul><li>Why should Planners care? </li></ul><ul><ul><li>Old School – We just set the standards – making money is the developer’s problem </li></ul></ul><ul><ul><li>New School - Plans that don’t work are a waste of resources and public involvement </li></ul></ul><ul><ul><li>Public-Private Partnerships – Win/Win (not surrender) </li></ul></ul><ul><li>Financial Markets – capital is a global commodity essential to community well-being </li></ul><ul><li>Lost in Translation - planner speak vs. developer speak </li></ul>
  3. 3. Development Economics <ul><li>Public Facilities Financing Plans and Fiscal Impact Analyses </li></ul><ul><ul><li>Ensuring development pays its own way for public infrastructure and services </li></ul></ul><ul><ul><li>“ Community Benefit” </li></ul></ul><ul><li>Economic Development / Redevelopment Project Feasibility Analysis </li></ul><ul><ul><li>- Determining need and magnitude of subsidies or incentives </li></ul></ul><ul><li>No Free Lunch – Who Pays? </li></ul><ul><ul><li>Public objectives have real costs (clean air, water, affordable housing, schools) </li></ul></ul>
  4. 4. Basics of Development Economics <ul><li>Market Research </li></ul><ul><ul><li>Purpose </li></ul></ul><ul><ul><li>Objectives </li></ul></ul><ul><li>Linkage between Market Research and Financial Feasibility </li></ul><ul><li>Financial Feasibility </li></ul><ul><ul><li>Purpose </li></ul></ul><ul><ul><li>Case Studies </li></ul></ul><ul><li>Risk/Return/Time Value of Money </li></ul>
  5. 5. Market Study Objectives <ul><li>Creation of a Land Use Plan or Building Project consistent with current trends </li></ul><ul><li>Validation of a Development Project </li></ul><ul><ul><li>Justify debt or equity financing </li></ul></ul><ul><li>Market Creation Strategy </li></ul><ul><ul><li>Identify the basis for new projects or products that cannot be justified by current trends </li></ul></ul>
  6. 6. Types of Market Studies <ul><li>Long-range planning (5-20 yrs) </li></ul><ul><ul><li>Regional plans </li></ul></ul><ul><ul><li>City General Plans </li></ul></ul><ul><ul><li>Specific Plans </li></ul></ul><ul><ul><li>Community Plans </li></ul></ul><ul><li>Site Plans (2-10 yrs) </li></ul><ul><ul><li>Residential subdivision </li></ul></ul><ul><ul><li>Commercial center </li></ul></ul><ul><li>Buildings (6 months–2 yrs) </li></ul><ul><ul><li>Residential </li></ul></ul><ul><ul><li>Non-residential (Retail, Office, Industrial, Mixed Use) </li></ul></ul>
  7. 7. Linkage Between Market and Feasibility Analyses <ul><li>Market analysis provides technical assumptions for feasibility analysis </li></ul><ul><li>Feasibility analysis tests market assumptions to develop viable project </li></ul><ul><ul><li>Sales prices </li></ul></ul><ul><ul><li>Supportable square feet of development </li></ul></ul>
  8. 8. Financial Feasibility Analysis <ul><li>The “Pro Forma” </li></ul><ul><ul><li>Identify key variables through market research </li></ul></ul><ul><ul><ul><li>Sales prices </li></ul></ul></ul><ul><ul><ul><li>Construction costs </li></ul></ul></ul><ul><ul><ul><li>Fees </li></ul></ul></ul><ul><ul><ul><li>Land Values </li></ul></ul></ul><ul><li>Test sensitivity to changes in market conditions </li></ul><ul><li>Evaluate conditions necessary to achieve return requirements </li></ul>
  9. 9. Residual Land Value <ul><li>Final Sales Price </li></ul><ul><li>Market Derived </li></ul>minus Development Costs equals <ul><li>Residual Land Value </li></ul><ul><li>Market comparables </li></ul><ul><li>Estimated Dev. Costs </li></ul><ul><ul><li>Impact Fees </li></ul></ul><ul><ul><li>Backbone Infrastructure & Mitigation </li></ul></ul><ul><ul><li>Site Development Costs </li></ul></ul><ul><ul><li>Building Construction Costs </li></ul></ul><ul><ul><li>Contingencies </li></ul></ul><ul><li>Builder’s Profit </li></ul>
  10. 10. Hypothetical Project Alternatives Analyzing Density for New Transit-Oriented Development
  11. 11. Financial Feasibility: Current Market Conditions Target: $40-$50/ land sq. ft. Target: $90-$100/ land sq. ft.
  12. 12. Financial Feasibility: Break-Even Conditions No adjustment required Increased $42k to achieve feas.
  13. 13. Fee Breakdown
  14. 14. Return on Investment (ROI) Time Risk Capital Req. Risk/Reward/Timing of Investment in the Development Cycle
  15. 15. Return on Investment (ROI) continued Risk/Reward/Timing of Investment in the Development Cycle
  16. 16. Return on Investment (ROI) continued <ul><li>General Plan Tentative Building Entitlement Map Permit </li></ul>Sources and Mix of Capital Vary as Development Process Progresses
  17. 17. 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 Pmt Mezzanine N/A 10-12% 10-12% 2 Guaranteed Pmt Equity 25-40% 20-30% 15-20% 3 At Risk Payment General Plan Ent. Tentative Map Building Permit
  18. 18. Return on Investment (ROI) continued Sources and mix of capital vary as development process progresses <ul><li>General Plan Tentative Building Entitlement Map Permit </li></ul><ul><li>Acquisition & Development Loan </li></ul><ul><li>Sophisticated Developer & Lender </li></ul><ul><li>Secured & Guaranteed </li></ul>Peeling the Development Investment Onion <ul><li>Cash </li></ul><ul><li>Option </li></ul><ul><li>Joint Venture </li></ul><ul><li>Speculative Expense </li></ul><ul><li>Option Exercised </li></ul><ul><li>Add Equity Investors </li></ul><ul><li>Additional Draws </li></ul><ul><li>Securing Site </li></ul><ul><li>Planning </li></ul><ul><li>Environmental </li></ul><ul><li>Closing on Site </li></ul><ul><li>Engineering </li></ul><ul><li>Infrastructure Finance </li></ul><ul><li>Site Improvements </li></ul><ul><li>Development Fees </li></ul><ul><li>Marketing /Sales/Service </li></ul><ul><li>Hard Money –Tough Terms </li></ul><ul><li>guaranteed minimum </li></ul><ul><li>preferred / priority </li></ul><ul><li>share of profit </li></ul><ul><li>Land Developer Sells to Merchant Builder or Commercial RE Co </li></ul><ul><li>Construction Loan </li></ul><ul><ul><li>Short term </li></ul></ul><ul><li>“ Take Out” Loan </li></ul><ul><ul><li>Long term financing </li></ul></ul>
  19. 19. Return on Investment (ROI) continued Expectation for return and risk tolerance varies for each source of capital Estimated ROI Requirements in Stable Market Banks, Insurance Companies SECURED DEBT 1 st POSITION Debt 8-10% 10% 10% Mezz. N/A 10-12% 10-12% Pension Funds, Institutional And Specialized Investors MINIMUM and PREFERRED RATE OF RETURN + PROFIT SHARE RATES SUBJECT TO CAPITAL MARKETPLACE Other Opportunities for Comparable Risk and Return Item Priority Risk Debt 8-10% 8-10% 8-10% 1 Guaranteed Pmt Mezzanine N/A 10-12% 10-12% 2 Guaranteed Pmt Equity 25-40% 20-30% 15-20% 3 At Risk Payment General Plan Ent. Tentative Map Building Permit
  20. 20. Return on Investment (ROI) continued Expectation for return and risk tolerance varies for each source of capital Estimated ROI Requirements in Stable Market Equity 25-40% 20-30% 15-20% At Risk
  21. 21. Internal Rate of Return (IRR) <ul><li>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 &quot;unleveraged&quot; IRR. </li></ul><ul><li>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 </li></ul>Source: Stuart Meck, FAICP, APA Research Department, May 2005 <ul><li>Developer rate of return is NOT a percentage of sales price </li></ul><ul><ul><li>e.g. $400,000.00 unit and developer return of 20% IRR </li></ul></ul><ul><ul><li>$400,000.00 x .20 = $80,000.00/unit x 100 units = $8 M </li></ul></ul><ul><ul><li>Equity = 10% of Project Cost = $3.9 M x .20 = $780,000.00 </li></ul></ul>
  22. 22. Development Economics <ul><li>Lessons for Planners </li></ul><ul><ul><li>Developers make buckets of money </li></ul></ul><ul><ul><li>DELAY AND SQUEEZE TO GET ALL YOU CAN </li></ul></ul><ul><ul><li>Plan it, and they will come </li></ul></ul><ul><ul><li>Market? We don’t need no stinkin’ market </li></ul></ul><ul><ul><li>Don’t worry about the costs, set high standards for the market to meet public goals </li></ul></ul><ul><ul><li>Time taken to process the environmental review and application has no consequences we need to be concerned about </li></ul></ul>
  23. 23. Development Economics <ul><li>Lessons for Planners </li></ul><ul><ul><li>Development capital is a resource </li></ul></ul><ul><ul><ul><li>As important as air, water, transportation, design, public services, etc. </li></ul></ul></ul><ul><ul><ul><li>Scarcity – competitive investment opportunities </li></ul></ul></ul><ul><ul><li>Plans for development with no market or not financially feasible will never be built </li></ul></ul><ul><ul><li>Plans that don’t provide for market demand will more likely be amended </li></ul></ul><ul><ul><li>Time and risk in development processing impact achievement of planning goals </li></ul></ul>
  24. 24. Development Economics <ul><li>Lessons for Planners </li></ul><ul><ul><li>Adding Market Savvy to Planner’s Toolkit </li></ul></ul><ul><ul><li>Transformational Planning </li></ul></ul><ul><ul><ul><li>what planning techniques can most effectively influence markets to meet planning goals? </li></ul></ul></ul><ul><ul><ul><li>can markets provide effective planning tools? (i.e. carbon credit trading; transfer of development rights) </li></ul></ul></ul>
  25. 25. Contact Information Joel Ellinwood, AICP 916.789.9932 [email_address] Tim Youmans 916.649.8010 [email_address] www.epsys.com A 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

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