441 Page Mill ID 5284 - | Palo Alto OnlineTo: Russ Reich, Cara Silver May 7, 2014 Subject: 441 Page Mill Road: State Density Bonus Analysis Page 5 441 Page Mill Memo 5.7.14; ClientID

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ADVISORS IN:

REAL ESTATE

REDEVELOPMENT

AFFORDABLE HOUSING

ECONOMIC DEVELOPMENT

SAN FRANCISCO

A. JERRY KEYSER

TIMOTHY C. KELLY

KATE EARLE FUNK

DEBBIE M. KERN

REED T. KAWAHARA

DAVID DOEZEMA

LOS ANGELES

KATHLEEN H. HEAD

JAMES A. RABE

GREGORY D. SOO-HOO

KEVIN E. ENGSTROM

JULIE L. ROMEY

SAN DIEGO

PAUL C. MARRA

MEMORANDUM

To: Russ Reich, Cara Silver

City of Palo Alto

From: Reed Kawahara

Date: May 7, 2014

Subject: 441 Page Mill Road: State Density Bonus Analysis

I. Introduction & Summary Conclusion

In accordance with your request, Keyser Marston Associates, Inc. (KMA) has

undertaken an analysis of the proposed development at 441 Page Mill Road in the City

of Palo Alto, specifically as it relates to the request by the project’s owner and applicant

(“Applicant”)1, to obtain three development incentives/concessions in exchange for

inclusion of below market rate (BMR) housing units in the project. The project is eligible

for incentives/concessions pursuant to the State Density Bonus Law. The purpose of

KMA’s analysis is to review and analyze the development economics of the project in

order to render an opinion as to whether the three requested incentives/concessions are

required to offset the costs of the BMR units.

In summary and as further described in this memorandum, KMA concludes that the

costs of including the BMR units in the proposed project exceed the value gained from

the three incentives/concessions. Therefore, it is our conclusion that the project satisfies

the requirement of the State Density Bonus Law that the requested

incentives/concessions are required “in order to provide for affordable housing costs”

and also satisfies the city’s requirement that they result in “identifiable, financially

sufficient, and actual cost reductions” that “allows the applicant to provide affordable

rents or affordable sale prices”.

1 For this assignment, the Applicant has been represented by Norman Schwab.

To: Russ Reich, Cara Silver May 7, 2014

Subject: 441 Page Mill Road: State Density Bonus Analysis Page 2


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II. Background: State Density Bonus Law & City’s Ordinance

The City of Palo Alto recently adopted a new chapter to the city’s Municipal Code

(Chapter 18.15) to implement the State Density Bonus Law (Government Code Section

65915). In summary, the State Density Bonus Law allows a development to increase its

residential density by up to 35% if the project includes a certain amount of below market

rate (BMR) housing. In addition, the project is entitled to up to three incentives or

concessions from local planning/building standards if needed to deliver the BMR housing

units. According to the State Density Bonus Law, the project is entitled to the requested

incentives/concessions unless a written finding can be made, based upon substantial

evidence, that the incentive/concession2:

1) is not required in order to provide for affordable housing costs;

2) would have a “specific adverse impact … upon public health and safety or the

physical environment” that cannot be feasibly mitigated without rendering the

development unaffordable to low- and moderate-income households; or

3) would be contrary to state or federal law.

The city’s ordinance elaborates on the first requirement by stating that the requested

concessions and incentives must “result in identifiable, financially sufficient, and actual

cost reductions” that “allows the applicant to provide affordable rents or affordable sale

prices”.

III. KMA Work Tasks

For this assignment, KMA has undertaken the following tasks:

Reviewed background materials regarding the proposed project;

Participated in a work session with the Applicant, the Applicant’s architect and

other team members, and city staff regarding the proposed project, potential

lower density alternatives, and the economics of the project alternatives;

Reviewed documentation supplied by the Applicant regarding construction cost

estimates and other aspects of the project and its development economics;

Conducted independent market research and independent cost analysis in order

to assess the reasonableness of the Applicant’s estimates, and to modify the

estimates where KMA felt appropriate;

2 According to the State Density Bonus Law, the burden of proof is on the city or other challenger

to deny an Applicant’s request for incentives or concessions.




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Prepared an independent financial analysis of the costs of including the BMR

housing units in the project and whether the three incentives/concessions are

required to address those costs.

IV. Project Background & Requested Incentives/Concessions

The proposed project is located on a 0.62-acre site on Page Mill Road mid-block

between El Camino Real and Ash Street. The site is improved with single family homes

that will be cleared to allow for development of the proposed project. The site was

purchased in July of 2012 for an amount equal to $147 per sq. ft. of land area, or

$3,959,000 for the 0.62-acre (26,926 sq. ft.) site3.

The site is zoned Service Commercial (CS zoning) which permits a maximum 0.6 FAR

for residential and a 0.4 FAR for commercial, for an overall 1.0 FAR. CS zoning allows a

maximum of 30 dwelling units per acre irrespective of the percentage of the site

dedicated to commercial uses. The maximum density of 30 units per acre would yield a

maximum of 18.6 total residential units for the subject site (averaging 870 gross square

feet per unit4). Since most residential developments are larger than 870 gross square

feet per unit, for all practical purposes the 0.6 residential FAR is a more limiting factor

than the residential density.

The proposed project is a mixed use residential/office/retail project at an overall FAR of

1.33. The project is proposed to be a three story building above grade and a one-level

subterranean garage. The retail will be located on the ground floor, the office on the

second floor, and the 10 rental apartment units on the third floor. The Applicant is

requesting three incentives/concessions: (1) additional lot coverage, (2) additional

commercial FAR, and (3) additional total FAR. In order to qualify for the three

concessions, three of the 10 residential units will be restricted to Low-income

households, with rents priced at 30% of 60% of Area Median Income (AMI). Based on

KMA’s assessment, each of the three requested concessions provides an economic

benefit to the project and helps address the cost of the BMR units.

Under the city’s density bonus ordinance, the Applicant is able to increase the project’s

lot coverage and FAR by the total square footage of the BMR housing units, or 3,544 sq. 3 The original site purchase included an adjoining site on Pepper Avenue which included a single

family home. Subsequent to purchase, the Applicant made some improvements to the home and

re-sold the property. The $3,959,000 land value represents the initial site purchase allocated to

the remaining 0.62-acre site. 4 Applying a residential efficiency factor of 15%, 870 gross square feet per unit (which would

include hallways, lobbies, and other common areas) would result in a net livable area of about

740 square feet.




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ft. for the three proposed units. However, the Applicant is seeking to further increase the

lot coverage and FAR as shown in the following table.

CS Zoning Maximum

With On-Menu Concessions

With Proposed Off-Menu Concessions

Concession 1: Lot Coverage Coverage SF Coverage SF Coverage SF

50.0% 13,462 63.2% 17,006 68.8% 18,520

Concessions 2 & 3: FAR FAR SF FAR SF FAR SF

a) Residential 0.60 16,156 0.73 19,700 0.53 14,170

b) Commercial 0.40 10,770 0.40 10,770 0.80 21,541

Total FAR 1.00 26,926 1.13 30,470 1.33 35,711

It is noted that the actual State Density Bonus is not needed for the proposed project, as

the 10 proposed units equates to just 16 units per acre (compared to 30 units per acre

permitted by CS zoning).

V. Financial Analysis

As called for in the State Density Bonus Law and the city’s implementing ordinance, in

order to be eligible for the incentives/concessions, the requested incentives/concessions

must be needed to in order to address the costs of the BMR housing units. In order to

analyze this issue, it is necessary to undertake the following:

Quantify the cost of including the three BMR housing units in the proposed

project; and

Quantify the value benefit to the project of the requested incentives/concessions.

If the costs of including the BMR housing units exceed the value benefit of the

incentives/concessions, it is concluded that the incentives/concessions are needed to

offset the BMR housing costs. If the value of the incentives/concessions exceed the cost

of the BMR housing units, one or more of the incentives/concessions may not be

required.

a) Cost of BMR Housing Units

The net costs of developing the three below market rate (BMR) units in the proposed

project is estimated by comparing the construction costs to build the three BMR units

with the private investment supported by the rental income produced by those three

units. The restricted rents for the Low-income units are calculated pursuant to the

California Health & Safety Code Section 50052.5, which specifies that Low-income rents

are to be based on 30% of 60% of the local Area Median Income (AMI), adjusted for




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household size, and net of an allowance for tenant-paid utilities. On this basis, the

monthly Low-income rents are estimated at $1,227, $1,377, and $1,525 for the 1-, 2-,

and 3-bedroom units respectively (there is one of each in the proposed development).

After taking into account a vacancy factor, operating expenses and taxes, the project’s

net operating income (NOI) is estimated at approximately $27,000 (see the following

table).

From the project’s NOI, the amount of supported private investment can be calculated.

Based on a 7.0% unleveraged project return5, the total supported private investment is

estimated at $385,000. The construction costs for the three BMR units are estimated at

$2,232,000 based on a pro rata share of the total project costs (land acquisition costs

have been excluded because the land costs would apply whether or not there are BMR

units).

Based on these calculations, the net cost of providing the three BMR units in the

proposed project is $1,847,000.

Net Cost of Low Income Units

1-Bedroom (Low Income) $1,227 /month $14,724



Gross Rental Income $49,548

(Less) Vacancy 5.0% ($2,477)

(Less) Operating Expenses & Taxes ($20,100)

NOI $26,971

Supported Investment 7.0% return $385,000

(Less) Construction Costs $630 /sq.ft. ($2,232,000)

Net Cost of Low Income Units ($1,847,000)

b) Development Program Comparison

As noted previously, the proposed project is a mixed use building comprised of

residential, office, and ground floor retail uses with an overall FAR of 1.33 (see the

following table).

In order to test whether the requested incentives and concessions are needed to offset

the costs of the BMR units, it is necessary to estimate the value increment that can be

realized from the incentives/concessions over an alternative case without those

incentives/concessions. Since as was described previously the State Density Bonus is

5 A 7.0% return for the BMR units is higher than would be the case for unrestricted market rate

units because the future escalation of BMR rents is capped by increases in median incomes.




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not needed to build the 10 BMR units, the proposed project is instead compared against

a project that could be built with straight CS zoning.

For the CS zoning alternative, KMA’s analysis indicates that the project that maximizes

value is actually less than the maximum building permitted. Our analysis indicates that

the maximum value project is a 0.4 office FAR combined with approximately seven

residential units, for an overall FAR of roughly 0.78. The reason why this lower density

program is financially superior to the maximum 1.0 FAR is that the 0.78 FAR building

can be built with all the parking in an at-grade garage, thus relieving the project of

significant excavation and underground parking costs as well as environmental

remediation costs. The resulting cost savings more than offsets the fact that the fixed

land acquisition costs are higher on a per building square foot basis.

Alternative under CS Zoning

With Proposed Off-Menu Concessions Increase

Site Size 26,926 sf 26,926 sf 0 sf 0.62 acres 0.62 acres 0 acres

Net Rentable SF (NSF) Residential 8,874 sf 12,417 sf 3,543 sf Office 9,693 sf 16,337 sf 6,644 sf Retail 0 sf 2,895 sf 2,895 sf Total 18,567 sf 31,649 sf 13,082 sf

Gross Sq. Ft. FAR FAR Residential 10,200 sf 0.38 14,170 sf 0.53 3,970 sf Office 10,770 sf 0.40 18,646 sf 0.69 7,876 sf Retail 0 sf 0.00 2,895 sf 0.11 2,895 sf Total 20,970 sf 0.78 35,711 sf 1.33 14,741 sf

Parking At grade garage Subterranean & at grade garage

47 spaces 91 spaces

Residential Units Market Rate 7 units 7 units 0 units BMR (Low Income) 0 units 3 units 3 units Total 7 units 10 units 3 units

c) Value of Incentives/Concessions

The value of the requested incentives and concessions is quantified by comparing the

development economics of the base case (CS zoning) project with the proposed project

with the incentives/concessions. The economics of the two projects in their entirety are

analyzed because the three requested incentives/concessions (lot coverage, commercial

FAR, and total FAR) are of benefit to the entire project and not to the residential alone.

As shown in the following summary table, the base case project yields an overall

development return of 6.15% as compared to a 6.50% return for the proposed project




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with the incentives/concessions. Therefore, the proposed project, inclusive of the three

BMR units, is an improvement over the base case alternative. This result indicates that

the requested incentives/concessions, each of which contributes to the project’s value,

are a financial benefit to the project (i.e. they help reduce the costs of the BMR units)

and it also demonstrates why the Applicant is motivated to build the proposed project

rather than the base case under CS zoning.

It is noted that the returns for the two alternatives are relatively similar despite the fact

that the proposed project is significantly larger. The reason for this result is attributable

to the fact that the proposed project requires an expensive subterranean garage and

associated environmental remediation costs, which is not assumed in the CS zoning

alternative. This cost premium is a partial offset against the ability of the larger project to

spread the fixed land costs over a larger building.


With Proposed Off-Menu Concessions Increase

$/NSF Total $/NSF Total

Net Operating Income (NOI)

Residential $39 $346,171 $29 $363,795 $17,624

Office $63 $607,774 $63 $1,024,330 $416,556

Retail $0 $0 $57 $165,015 $165,015

Total NOI $51 $953,944 $49 $1,553,140 $599,195

Development Costs Acquisition, Carry, Environmental $239 $4,442,000 $161 $5,106,000 $664,000

Direct Construction $452 $8,384,000 $462 $14,622,000 $6,238,000

Indirects $110 $2,043,000 $99 $3,149,000 $1,106,000

Financing $35 $650,000 $32 $1,010,000 $360,000

Total Costs $836 $15,519,000 $755 $23,887,000 $8,368,000

Return on Cost (ROC) 6.15% 6.50% 0.36%

Note: See Appendix I for a discussion of the assumptions behind the income and cost estimates.

The value increment of the proposed project over the base case alternative can be

quantified in dollar terms by capitalizing the annual income stream generated by the two

alternatives and then deducting the development costs. On this basis, it is estimated that

the three incentives/concessions add $1,284,000 in value to the proposed project.


With Proposed Off-Menu Concessions

Value Increment

Capitalized Project Value

Gross Project Value 5.59% $17,053,000 5.82% $26,705,000 $9,652,000

(Less) Development Costs ($15,519,000) ($23,887,000) ($8,368,000)

Net Project Value $1,534,000 $2,818,000 $1,284,000

*Based on a 5.0%, 6.0%, and 7.0% cap rate for residential, office, and retail respectively.




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d) Conclusion

The net cost of delivering the three BMR units in the proposed project is estimated at

$1,847,000. The net value increment of the three concessions is estimated at

$1,284,000. Since the cost of the BMR housing exceeds the value increment, and since

each of the three concessions independently contributes to the value increment, it is

concluded that all three of the requested concessions are needed to address the BMR

housing costs in the proposed project.

Comparison of BMR Housing Cost to Value Increment

Net Cost of 3 BMR Housing Units $1,847,000

Net Value Increment from 3 Incentives/Concessions $1,284,000

1

APPENDIX I

Summary of Pro forma Assumptions 441 Page Mill Road: State Density Bonus Analysis

Development Costs

Acquisition, Carry, Environmental. Land acquisition costs were based on the July 2012 purchase price for the site, adjusted for the Pepper Avenue parcel subsequently sold. Land carry costs include taxes and interest carry from the July 2012 purchase to today. Environmental mitigation costs related to the HP plume estimated at $664,000 based on a third party general contractor estimate plus a 5% contingency (provided at request of Applicant).

Direct Construction Costs. Direct construction costs were estimated by KMA based on areview of three general contractor estimates provided for the Applicant, on third party data sources such as RS Means, and on pro formas for other recent mixed-use projects in the Bay Area. Costs include tenant improvements estimated by KMA at $60 per sq. ft. for office and $40 per sq. ft. for retail.

Indirect & Financing Costs. Indirect costs include all architecture and engineering costs, governmental fees and permits, taxes, insurance, legal, leasing/marketing, and overhead/administration costs. Fees and permits costs were estimated by the Applicant based on the city’s fee worksheets and were reviewed relative to other projects in Palo Alto. Other indirect costs were estimated by KMA based on industry standards and other mixed use developments in the Bay Area. Financing costs based on an assumed 65% loan to cost and a 24-month construction/lease-up period.

Operating Income

Residential Income. Market rate residential rents estimated at $4.10/sq. ft./month, or about $5,200/unit/month, based on a review of asking rents for apartments in Palo Alto, Menlo Park, and a survey of newer apartment developments in Mountain View and Sunnyvale (see Appendix II). BMR rents were based on 2014 Area Median Income (AMI) for Santa Clara County, adjusted for household size and net of estimated tenant-paid utility allowances. Operating expenses for apartments were based on current pro formas for other Bay Area apartments at similar densities. Taxes were based on the land purchase price plus apartment unit values from recently built projects in Santa Clara County.

2

Office Income. Office rents estimated at $5.50/sq. ft./month on a triple net (NNN) basis based on rent comps for Class A office space in Palo Alto as well as third party market data from commercial brokers such as Cassidy Turley and Colliers. For reference, current and recent rent listings in downtown Palo Alto are in the range of $6.00 to $7.00 per sq. ft. on a triple net basis. A 5% vacancy rate is assumed.

Retail Income. Retail rents estimated at $5.00/sq. ft./month on a triple net basis based on recent retail listings in strong retail locations in Palo Alto (downtown and along high traffic corridors). These listings are in the rough range of $4.00 to $6.00/sq. ft./month on a triple net basis, with the higher end of the range located downtown. For reference, the 2013 average asking retail rent in the Palo Alto/Mountain View/Los Altos submarket was $37.33/sq. ft./year ($3.11/month) according to Terranomics. A 5% vacancy rate is assumed.

APPENDIX II

Apartment Asking Rents - Palo Alto & Menlo Park Projects441 Page Mill Road: State Density Bonus AnalysisCity of Palo Alto

Address BR BA Sq. Ft. Rent $/SFI. Palo Alto Comps

3875 Park Blvd. 1 1 $2,0503081 Alma St. 1 1 500 $2,095 $4.19535 Arastradero Rd. 1 1 700 $2,195 $3.142106 Willimans St. 1 1 $2,450573 Lytton Ave. #B 1 1 $2,600746 Sutter Ave. 2 1 $2,9592850 Middlefield Rd. (Southwood) 1 1 750 $3,035 $4.05337 Hawthorne Ave. #337 1 1 850 $3,295 $3.88765 San Antonio Rd. 2 2 1,033 $3,300 $3.193085 Middlefield Rd. 2 2 970 $3,495 $3.60700 Clark Way (Stanford West) 2 2 995 $3,520 $3.543075 Alma St. #3075 3 2 1,100 $3,695 $3.36565 Arastradero Rd. 2 2 1,419 $3,890 $2.74665 Waverly St. 2 2 1,629 $4,200 $2.58734 Webster 2 1 $4,250700 Clark Way (Stanford West) 3 2 1,333 $4,340 $3.26University South 2 2 1,240 $4,450 $3.59427 Alma St. 2 2 $4,850565 Arastradero Rd. 3 2 1,830 $4,850 $2.65

II. Menlo Park Comps1309 Mills St. 1 1 $1,92521 Coleman Ave. 1 1 $1,925806 Coleman Ave. 1 1 800 $2,095 $2.62782 Coleman Ave. 1 1 650 $2,150 $3.31840 Coleman Ave. 2 1 $2,150786 Coleman Ave. 1 1 700 $2,295 $3.28720 Coleman Ave. 2 1 $2,450435 Encinal Ave. 2 1 $2,495744 Coleman Ave. 2 1 950 $2,795 $2.94424 Oak Grove Ave. 2 2 $2,9951028 Middle Ave. 2 1 900 $3,025 $3.36Downtown Menlo Park 2 1 900 $3,695 $4.11424 Oak Grove Ave. 3 2 $4,295

Source: Zumper.com; ApartmentGuide.com; project websites (May 2014)

_________________________________________________________Prepared by: Keyser Marston AssociatesFilename: Apartment Rents 4.10.14; Palo Alto

APPENDIX II

Apartment Asking Rents - Newer Built Projects

441 Page Mill Road: State Density Bonus Analysis

City of Palo Alto

BR BA Sq. Ft. Notes

Low High Low High

Carmel The Village

555 San Antonio Rd, Mountain View

Studio 1 537 $2,276 $2,612 $4.24 $4.86 Built in 2013

1 1 566 330 Units

1 1 585 Developer: Carmel Partners

1 1 651 $2,868 $2,910 $4.41 $4.47

1 1 678

1 1 690

1 1 693

1 1 754 $2,807 $2,950 $3.72 $3.91

1 1 890

1 1 1,004

1 1 1,079

2 2 1,054

2 2 1,141

2 2 1,070

2 2 1,098

2-Bedroom Avg 1,091

Lawrence Station Apartments

1271 Lawrence Station Rd, Sunnyvale

1 1 604 $2,205 $3,130 $3.65 $5.18 Built in 2012

1 1 703 $2,325 $3,220 $3.31 $4.58 336 Units

1 1 751 $2,340 $3,290 $3.12 $4.38 Developer: BRE Properties

1 1 1,621 $3,045 $3,940 $1.88 $2.43

2 2 1,035 $2,730 $3,970 $2.64 $3.84

2-Bedroom Avg 1,035 $2,730 $3,970 $2.64 $3.84

Solstice

299 W. Washington Avenue, Sunnyvale

Studio 1 482 Built in 2013

1 1 690 $2,835 $2,945 $4.11 $4.27 280 Units

1 1 735 $2,818 $3,098 $3.83 $4.21 Developer: BRE Properties

1 1 786 $3,047 $3,112 $3.88 $3.96

1 1 904 $3,065 $3,130 $3.39 $3.46

1 1.5 1,002

2 1 937 $3,335 $3,410 $3.56 $3.64

2 2 1,085 $3,805 $3,955 $3.51 $3.65

2 2 1,187 $4,091 $4,101 $3.45 $3.45

2 2 1,137

2 2 1,272 $4,033 $4,203 $3.17 $3.30

2 2.5 1,401

2 2.5 1,439

2-Bedroom Avg 1,208 $3,914 $3,917 $3.27 $3.51

Via

621 Tasman Drive, Sunnyvale

1 1 694 $2,350 $2,861 $3.39 $4.12 Built in 2011

1 1 916 $2,551 $3,078 $2.78 $3.36 284 Units

1 1 922 $2,570 $3,191 $2.79 $3.46 Developer: Essex Property Trust

2 2 1,043 $3,054 $4,168 $2.93 $4.00

2 2 1,225 $3,279 $4,592 $2.68 $3.75

2-Bedroom Avg 1,134 $3,167 $4,380 $2.80 $3.87

Source: Property websites, Apartmentguide.com (April 2014)

$4.65

$4.49

$5.18$2,495

$4,095

$4,080

$3,961

$3,285

$2.85

$2.91

$3.48

$3.28

$3.54

$3.46

$3.86

$4.46

$4.06

$4,322 $3.96

$4.46

$4.31

$3.50

Rent $/SF

$2,721

$2,544

$4,893

$4,607

$3,999

$3,787

$3,662

$3,554

$3,079

$2,678

$3,079

$2,755

$3.59

$3.39

_________________________________________________________

Prepared by: Keyser Marston Associates

Filename: Apartment Rents 4.10.14.xlsx; Sheet1

441 Page Mill ID 5284 - | Palo Alto OnlineTo: Russ Reich, Cara Silver May 7, 2014 Subject: 441 Page Mill Road: State Density Bonus Analysis Page 5 441 Page Mill Memo 5.7.14; ClientID

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