MEETING DATE:
OCTOBER 14, 2014
SUBJECT:
Title
CREEKSIDE MARKETPLACE AND DMV FINANCING OPTIONS FOR BUILDING PURCHASE, TENANT IMPROVEMENTS, AND RELATED CAPITAL COSTS
Body
Recommendation
Recommendation
1. CONSIDER AND DIRECT the use of excess unassigned general fund reserves for the acquisition of the former Lowe's building.
2. CONSIDER AND DIRECT financing options/use of excess unassigned general fund reserves for funding the necessary tenant improvements and other related capital costs associated with preparing the building for leasing to WinCo Foods, LLC and Hobby Lobby Stores Inc.
3. CONSIDER AND DIRECT financing options/use of one-time opportunity general fund reserves for related capital costs associated with the construction of the new DMV building.
Body
Board or Commission Action
Not Applicable
Relevant Council Strategic Theme
Economic Development
Planning for the Future
Relevant Department Goal
Continuing to Maintain Fiscal and Financial Health of the City
Introduction
At the September 10, 2013 and June 24, 2014 City Council meetings, the City rejected Lowe's official Notice of Transfer which allowed the City option of purchasing the former Lowe's building (Building A) at book value, substantially less than market value. Subsequently, the City finalized and executed lease agreements with WinCo Foods, LLC and Hobby Lobby Stores, Inc. To date, all parties through signed lease agreements have agreed to terms regarding the purchase and construction of Building A and the respective tenant improvements.
On October 31, 2014 the City will be expected to exercise its option and purchase the Building A (formerly Lowe's) at book value as determined on October 31, 2013 in the amount of $4,479,004. Additionally, modifications to existing Building A will need to begin to complete the Landlord's required modifications per the lease agreements with WinCo and Hobby Lobby. The building's front will be modified to accommodate two storefronts and its frontage along Grand Avenue expanded into the former garden area of Lowes. The overall footprint of the existing building with the garden center will be reduced because of the project. Capital funding costs for construction, tenant improvements, and soft costs are estimated to be $5.6 million.
Council is also aware that the City, acting for and on behalf of the Rancheros Commercial Park, has begun discussions and planning on the approximately 30,000 square foot net usable build-to-suit office building (the "Project") for the State of California Department of General Services to be used by the Department of Motor Vehicles (the "DMV") located at 600 Rancheros Drive. The site is currently owned by the partnership which also owns an office building located at 570 Rancheros, which is directly adjacent to the DMV site (the two sites together are located on a single level parcel). The cost to construct the building is estimated at approximately $10.4 million which will include a cash contribution from the partnership estimated at $2.3 million and a city cash contribution of approximately $1.37 million. The resulting construction costs will need to be financed. The Project is expected to begin construction immediately with occupancy by the DMV to occur in May 2015. Rent payments received from the DMV pursuant to a lease agreement are expected to commence with occupancy.
Discussion
The City developed Creekside Marketplace as part of the fulfillment of Section 203 of the San Marcos Charter, which emphasizes enterprise activities designed to produce non-tax revenue sources. Since its opening, Creekside Marketplace has provided the City with substantial lease revenues, totaling over $3 million per year, in addition to sales tax revenues associated with commercial activities.
Completing the improvements and moving the tenants in will facilitate substantial revenues for Creekside Marketplace. It is estimated that $1.64 million will be collected in annual base rent beginning in Fiscal Year 2015-16, along with common area reimbursements and sales tax revenues.
The City will be required to purchase Building A on October 31, 2014 in the amount of $4,479,004. Under the terms of the lease agreements with WinCo and Hobby Lobby, the City will immediately be required to modify the existing building. The City expects to complete the construction of phase 1 by early spring, allowing the tenants enough time to complete their improvements. These documents have been reviewed by Planning and Building. Total financing for the purchase of Building A along with subsequent modifications, tenant improvements, and soft costs are estimated to be $10,078,978.
The Rancheros Commercial Park is a California limited partnership originally formed pursuant to the Limited Partnership Agreement made March 6, 1989 (the "LP Agreement"), by and between LBP Partnership and the former Redevelopment Agency of the City of San Marcos (the "Partnership"). The Partnership was formed for the purpose of engaging in the business of leasing, developing, constructing, maintaining, and operating the parcel located at 570 Rancheros Drive in the City. At this time, the Partnership is exploring financing options that will best suit both the parties and be payable solely from the rent payments received from the DMV.
After thorough market analysis into construction financing in terms of both short and long term loan financing, staff is recommending financing options for Council's discussion and consideration. Market analysis into the financial options for these projects included gathering lender information from financial institutions and analyzing our current levels of general fund reserves to use as a potential funding source. Staff assumed a varied percentage of pledged lease revenues from WinCo, Hobby Lobby, and the DMV for security of the loan effecting both the term and interest rate.
Creekside Financing Options
· Option 1 - Fund Building and Tenant Improvements out of Excess Unassigned General Fund Reserves (least costly).
a. Excess unassigned general fund reserves would fund purchase of building on October 31, 2014 in the amount of $4,479,004.
b. Remaining project costs of approximately $5.6 million funded on a monthly disbursement schedule sufficient to cover anticipated monthly expenditures based on draw schedule from contractor.
c. General Fund Opportunity Cost for Use of Reserves
i. City investment portfolio average rate of interest < 1%
ii. Avoid loan fees and interest costs of 4.5-5% over 10+ years
iii. New reserve levels after disbursements could fall below 50%
iv. Replenish reserves from Project's future lease payments and operating revenues
· Option 2 - Use outside lender to finance all or portion of Project costs using a market rate of interest along with potential transaction fees - most costly.
DMV Financing Options
· Option 1 - Fund complete City cash contribution and loan to partner remaining construction costs out of one-time opportunity use of general fund reserves (least costly).
a. General Fund reserves would fund cash contribution of approximately $1.37 million as needed for DMV construction.
b. Remaining financing for construction costs of approximately $10 million loaned to partnership at a below market rate of interest (2.5%) funded on a monthly disbursement schedule sufficient to cover anticipated monthly expenditures based on draw schedule from contractor.
c. General Fund Opportunity Cost for Use of Reserves
i. City investment portfolio average rate of interest < 1%
ii. Avoid loan fees and interest costs of 4.5-5% over 20+ years
iii. New reserve levels after disbursements could fall below 50%
iv. Replenish reserves from DMV's future lease payments and operating revenues
· Option 2 - Use outside lender to finance all or portion of DMV costs using a market rate of interest along with potential transaction fees - most costly.
Staff is recommending Council give consideration to the use of approximately $12 million of excess unassigned general fund reserves for funding both the purchase of the former Lowe's building as well as the WinCo/Hobby Lobby tenant improvements. Lease payments from both WinCo and Hobby Lobby will be used to replenish the general fund reserve levels.
Staff is also recommending Council give consideration to using one-time opportunity use of general fund reserves to loan at a below market rate of interest at 2.5% to the partnership to complete the necessary construction costs associated with the DMV. Lease revenues, net of annual operating costs, from the DMV will be the primary source of revenue for the repayment of the loan. The partnership may, if it so chooses, use additional lease revenues from 570 Rancheros Drive to shorten up the term of the loan.
Attached are analyses showing the effect on the excess unassigned general fund reserve levels from funding the project costs and the subsequent replenishment of those reserves from lease payments from WinCo, Hobby Lobby, and the DMV until at which time all the funds are estimated to be repaid.
Fiscal Impact
The fiscal impact of Staff's recommendation to use excess unassigned general fund reserves and one-time opportunity use of reserves would be approximately a decrease of $21 million over a span of six - nine months for constructions costs. Immediately upon completion of construction and subsequent occupancy, lease payments from WinCo and Hobby Lobby, and lease payments along with interest costs associated with the DMV loan, would begin to replenish the reserves. Reserve levels would continue to be replenished from lease payments until all of the loaned funds are repaid.
From a risk, cash flow, and long term investment standpoint, Staff believes the City would be much better served by financing both of these projects as recommended. Original cash flow projections for the Lowe's building acquisition showed substantial financial returns. Our current analysis now shows a ten year cash flow of approximately $40 million which includes a projected terminal value of the building of approximately $23 million after ten years. Subtracting the approximate $10 million of acquisition/capital costs yields a long term cash flow of approximately $30 million. This is approximately $3 million more than originally estimated and is still non-inclusive of any economic boost generated from sales tax.
Similarly, the City and the Partnership are in a position to benefit from the DMV building and subsequent lease revenues. The Partnership is expected to see net lease revenues projected to be close to $12 million over ten years, with an option for the DMV to extend up to another 10 years. The City will see interest earnings of approximately $1.5 million from the loan to the Partnership along with any Partnership net income generated from the project. As a sixty percent partner, we are benefitting from the increase in land and building value as well.
Furthermore, after careful market analysis, the City and the Partnership would incur significant short term borrowing costs. Market interest rates are roughly averaging 5% and upwards of 1% in additional transaction fees on loan amounts. The City's investment portfolio is averaging less than 1%. Given that fact, the City's loss of investment on the use of reserves averaged over ten years is approximately $639K for the DMV and $392K for Creekside. This is far less inexpensive than incurring borrowing costs of 5% and transactional loans fees. See Exhibit I for the savings to the City and the Partnership for the use of General Fund excess reserves versus market financing.
Upon final determination of construction bids and subsequent costing relative to the projects, Staff will bring required budget amendments to a future City Council meeting for approval.
Attachment(s)
Exhibit A - Potential Advantages of Use of Excess Fund Balance Reserves
Exhibit B - Projected General Fund Balance Summary
Exhibit C - WinCo/Hobby Lobby Capital Funding Costs
Exhibit D - General Fund Excess Reserve Analysis - Funding of WinCo/Hobby Lobby Costs
Exhibit E - DMV Funding of Capital Costs Term Sheet
Exhibit F - DMV Capital Funding Costs
Exhibit G - General Fund Excess Reserve Analysis - Funding of DMV Costs
Exhibit H - General Fund Excess Reserve Analysis - Combined Funding of Creekside/DMV
Exhibit I - Return on Investment - Outside Financial Market vs. General Fund Use of Reserves
Prepared by: Laura Rocha, Finance Director
Approved by: Jack Griffin, City Manager