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HC Packet 07-25-2019CITY OF CUPERTINO HOUSING COMMISSION AGENDA 10300 Torre Avenue, City Hall Conference Room A Thursday, July 25, 2019 9:00 AM Special Meeting NOTICE IS HEREBY GIVEN that a special meeting of the Housing Commission is hereby called for Thursday, July 25, 2019, commencing at 9:00 a.m., City Hall, Conference Room C, 10300 Torre Avenue, Cupertino, California. Said special meeting shall be for the purpose of conducting business on the subject matters listed below under the heading “Special Meeting”. SPECIAL MEETING: ROLL CALL APPROVAL OF MINUTES 1.Subject: Draft Minutes of July 11, 2018 Recommended Action: approve or modify the Draft Minutes of July 11, 2018 Draft Minutes of July 11, 2019 ORAL COMMUNICATIONS This portion of the meeting is reserved for persons wishing to address the commission on any matter not on the agenda. Speakers are limited to three (3) minutes. In most cases, State law will prohibit the commission from making any decisions with respect to a matter not listed on the agenda WRITTEN COMMUNICATIONS STUDY SESSION 2.Subject: Below Market Rate (BMR) Linkage Fees Update for the Cupertino BMR Housing Program. Application No(s).: CP-2019-01; Applicant(s): City of Cupertino; Location: citywide Recommended Action: Receive update and provide any input to staff Page 1 Housing Commission Agenda July 25, 2019 Staff Report A – July 2019 Economic Feasibility Analysis prepared by Strategic Economics B – LeSar Development Consultants Peer Review C – Track Changes Draft Economic Feasibility Analysis prepared by Strategic Economics D –Strategic Economics Memorandum Regarding Peer Review OLD BUSINESS NEW BUSINESS STAFF AND COMMISSION REPORTS ADJOURNMENT In compliance with the Americans with Disabilities Act (ADA), anyone who is planning to attend the next meeting who is visually or hearing impaired or has any disability that needs special assistance should call the City Clerk's Office at 408-777-3223, 48 hours in advance of the meeting to arrange for assistance. Upon request, in advance, by a person with a disability, meeting agendas and writings distributed for the meeting that are public records will be made available in the appropriate alternative format. Also upon request, in advance, an assistive listening device can be made available for use during the meeting. Any writings or documents provided to a majority of the members after publication of the agenda will be made available for public inspection. Please contact the City Clerk’s Office in City Hall located at 10300 Torre Avenue during normal business hours. IMPORTANT NOTICE: Please be advised that pursuant to Cupertino Municipal Code 2.08.100 written communications sent to the Cupertino City Council, Commissioners or City staff concerning a matter on the agenda are included as supplemental material to the agendized item. These written communications are accessible to the public through the City’s website and kept in packet archives. You are hereby admonished not to include any personal or private information in written communications to the City that you do not wish to make public; doing so shall constitute a waiver of any privacy rights you may have on the information provided to the City . Members of the public are entitled to address the members concerning any item that is described in the notice or agenda for this meeting, before or during consideration of that item. If you wish to address the members on any other item not on the agenda, you may do so during the public comment . Page 2 City of Cupertino 10300 Torre Avenue Cupertino, CA 95014 (408) 777-3308 DRAFT MINUTES OF THE REGULAR MEETING OF THE HOUSING COMMISSION HELD ON JULY 11, 2019 CALL TO ORDER Chair Zhao opened the meeting at 9:01am. Commission Bose joined the meeting at 9:05am. ROLL CALL Commission Members present: John Zhao, Chair Nina Daruwalla, Vice Chair Sue Bose, Commissioner Connie Cunningham, Commissioner Commission Members absent: None Staff present: Kerri Heusler, Housing Manager APPROVAL OF MINUTES 1. Minutes of the June 13, 2019 Housing Commission meeting were approved as written. Commissioner Daruwalla made a motion and Commissioner Cunningham seconded the motion. APPROVE: Zhao, Daruwalla, Cunningham ABSENT: Bose ABSTAIN: VOTE: 3-1-0 ORAL COMMUNICATIONS None WRITTEN COMMUNICATIONS None NEW BUSINESS 2. Presentation by Catholic Charities of Santa Clara County The Commission accepted a presentation from Wanda Hale of Catholic Charities. Ms. Hale answered questions from the Commissioners. STAFF AND COMMISSION REPORTS: Staff member Heusler provided information about the following items: 1. FY 2019-20 Housing Commission Work Program a. Adopted by City Council with one new item- Monitor, Participate and Report on regional housing meetings including ABAG, RHNA, and HCD 2 2. Housing Commission recruitment a. July 16 City Council- muni code second reading 3. September 12 BMR Workshop 4. July 25 special Housing Commission meeting 5. Email is moving to Office 365- look out for email from IT with instructions ADJOURNMENT: The meeting was adjourned at 10:20am to the next regularly scheduled Housing Commission meeting. Respectfully submitted: /s/Kerri Heusler Kerri Heusler Housing Manager 1 HOUSING COMMISSION STAFF REPORT July 25, 2019 Subject Below Market Rate (BMR) Linkage Fees Updatefor the Cupertino BMR Housing Program Recommended Action Receive update and provide any input to staff Discussion The City’s 2014-2022 Housing Element is a comprehensive eight-year plan to address the housing needs in Cupertino. During the planning process to prepare the Housing Element, City officials, staff, and the public discussed strategies to increase the supply of affordable housing in Cupertino. As adopted by the City Council in 2014, the Housing Element includes a “Residential Housing Mitigation Program” that requires certain residential development projects to include a percentage of their total units as below- market rate units that are affordable to moderate-income and lower-income households (commonly called an "inclusionary housing requirement"). The Housing Element's inclusionary housing requirements are implemented through the Below Market Rate (BMR) Housing Program required by Chapter 19.172 of the Cupertino Municipal Code (BMR Ordinance) and the BMR Housing Mitigation Program Procedural Manual (Housing Mitigation Manual). The BMR Housing Program also includes Housing Mitigation Fees for residential projects of less than seven units and commercial linkage fees for certain non-residential development. As part of its current work plan, the City Council is considering modifying the City's BMR Housing Program. Accordingly, the City worked with Strategic Economics to prepare an Economic Feasibility Analysis to inform the BMR Linkage Fees Update to study options for increasing the affordable housing supply within the City. The remainder of this staff report discusses the City's current BMR Housing Program, the legal framework for modifying the BMR Housing Program, the results of the Economic Feasibility Analysis, and policy topics for further consideration. 2 Current BMR Housing Program Requirements The City's current BMR Housing Program imposes an inclusionary housing requirement of 15% on for-sale and rental residential developments with seven or more units. For rental developments, the BMR units must be affordable to very-low (up to 50% Area Median Income “AMI”) or low-income (up to 80% AMI) households. For-sale developments must provide BMR units affordable to median- (up to 100% AMI) and moderate-income (up to 120% AMI) households. Small residential projects of less than seven units can pay the City’s Housing Mitigation Fees or provide one BMR unit. The Housing Mitigation Fees are based on the City’s 2015 Residential Below Market Rate Housing Nexus Analysis and Non-Residential Jobs- Housing Nexus Analysis (2015 Nexus Study). Housing Mitigation Fees are currently set at $17.82 per square feet for detached single family, $19.60 per square feet for small lot single family/townhomes, $23.76 for attached multifamily residences (ownership and rental), and $11.88 per square foot for commercial/retail uses. The City first adopted linkage fees for office and Research and Development (R&D) projects in 1992, and expanded the program to apply to retail and hotel developments in 2004. The City updated the commercial linkage fees in 2015 (based on the 2015 Nexus Study) to the current levels of $23.76 per square foot for office/R&D uses, and $11.88 per square foot for hotel and retail uses. The City’s Housing Mitigation Manual (most recently amended by Resolution 15-037 on May 5, 2015) includes rules and regulations for implementing the policy direction in the Housing Element and the Municipal Code. The Housing Mitigation Manual restates the Housing Element’s general requirements for on-site affordable housing production, but it includes more specific requirements for affordability levels by income. Table 1 provides a summary of the affordability requirements pursuant to the Housing Mitigation Manual. Table 1: Affordability of BMR Units (15% of development total) Ownership BMR Units Rental BMR Units % of Median-Income Units % of Moderate- Income Units % of Very-Low Income Units % of Low-Income Units 8% of ownership units (7% of ownership units 9% of rental units 6% of rental units For purposes of the BMR Housing Program, the City uses household income limits established by the California Department of Housing and Community Development (HCD) that are based on adjustments to the median income in Santa Clara County. Table 2 summarizes the incomes associated with the various affordability requirements. 3 Table 2: 2019 Household Income Limits Income Category Approximate Percent of Area Median Income* Income Limit for 4-Person Household Very Low Up to 50%$73,150 Low Up to 80%$103,900 Median Up to 100%$131,400 Moderate Up to 120%$157,700 *HCD makes various adjustments to very-low and low-income limits, which do not precisely equal 50% and 80% of the median. In addition to on-site BMR requirements, the Housing Mitigation Manual gives developers the option of requesting the Council to approve an alternative means of compliance, provided that the alternative gives the City affordable housing that is equivalent to the applicable BMR requirement. Applicants may request to: provide on- site rental BMR housing where for-sale is required; purchase off-site units to be dedicated and/or rehabilitated as BMR units; develop off-site BMR units; or donate land for the development of BMR units. As noted above, residential developments with six or fewer units may pay the Housing Mitigation fee instead of producing on-site BMR units. The Housing Mitigation fee is also applied to commercial development and fractional units required for residential developments with seven units or more. Such fees are placed in the City’s BMR Affordable Housing Fund (AHF), which may be used to finance affordable housing within the City, often in connection with other public financing sources to achieve larger numbers of affordable housing units or deeper affordability than can feasibly be required in connection with market rate development. Legal Framework Affordable housing policies in California can take different forms, with varying legal requirements for each. For residential projects, cities' and counties' police power provides authority to require a percentage of new residential projects be reserved as affordable housing. For non-residential projects, cities and counties can collect impact fees to mitigate new development's impact on the demand for affordable housing.Both approaches are subject to certain limitations, discussed below. Residential Projects In its 2015 decision California Building Industry Ass'n v. City of San José (CBIA), the California Supreme Court determined that inclusionary requirements for residential projects are land use provisions, similar to rent and price controls. Because land use and price control authority comes from a city's general police power, residential inclusionary requirements that are designed to further the public health, safety, and welfare can be adopted without being justified by a nexus study so long as the requirements do not 4 prevent a property owner from having the opportunity to earn a fair return on its property. To date, efforts to overturn the CBIA case at the United States Supreme Court have failed. Therefore, a nexus study is not currently required for residential inclusionary requirements; however, an economic feasibility study can be used to demonstrate that such requirements are not confiscatory. The Palmer/Sixth Street Properties L.P. v. City of Los Angeles (Palmer) case was decided in 2009, and for a time, Palmer precluded California cities from requiring long term rent restrictions or inclusionary requirements on rental units. On September 29, 2017, Governor Brown signed AB 1505 to restore cities' and counties' ability to require on-site affordable units within rental projects, and the law became effective on January 1, 2018. Under AB 1505, cities can impose inclusionary requirements on rental residential developments provided that: (1) the requirements are imposed in the zoning ordinance; (2) if more than 15 percent of rental units are required to be affordable to low-income households, HCD may require that the requirement be justified by an economic feasibility study under certain circumstances; and (3) alternatives to on-site compliance are allowed. Non-Residential Projects For non-residential projects, cities and counties are permitted to collect fees from new development to mitigate that development's impact on affordable housing, provided that the impact fees are reasonable and there is a sufficient nexus between the amount of the impact fee and the impact that the proposed development will have on the need for affordable housing. A nexus study is used to determine the upper limit for impact fees that may legally be imposed on new non-residential development and is required to justify affordable housing requirements for non-residential projects. Nexus study results are often combined with economic feasibility studies to ensure that impact fees do not preclude development. Legal Requirements for Modifications If the City desires to modify its BMR Housing Program, it has several options. Changes to the Housing Mitigation Manual may be adopted by Resolution, and the City Council can modify its BMR Ordinance. Unless it also amends the Housing Element, which would require HCD approval, changes to the BMR Ordinance or the Housing Mitigation Manual would need to be consistent with the policies included in the Housing Element. For example, the Housing Element does not specify an income range requirement applied to for-sale residential development. Therefore, the City could amend the Housing Mitigation Manual to adjust the percentages of median- and moderate- income housing required and still be consistent with the Housing Element. Similarly, the City likely could require rental residential housing be reserved for extremely-low income households, provided that the requirement is not confiscatory, as such housing would also be affordable to very-low and low-income households as required by the Housing Element. In addition, if the City were to amend its BMR Housing Program to require more than 15% of rental units be reserved for low-income households, HCD could require the City 5 to prepare an economic feasibility study demonstrating that the requirements do not make market rate residential development infeasible if the City fails to meet at least 75% of its share of the regional housing need for the above-moderate income category for five years or more or if it does not submit its annual housing element report for at least two consecutive years. Even if HCD does not require an economic feasibility study, such a study can be useful to inform the City’s policy-making efforts and to ensure that its requirements are not overly burdensome. To meet the applicable legal standard for inclusionary policies, the City’s requirements must not be so high as to be confiscatory. To update the BMR Housing Program's requirements related to commercial projects, the 2015 Nexus Study establishes a theoretical legal maximum for impact fees, but as with residential projects, any increases should be considered in the context of economic feasibility. Economic Feasibility Analysis Results The City retained Strategic Economics to evaluate potential changes to the BMR Housing Program in an Economic Feasibility Analysis. Specifically, the Economic Feasibility Analysis examined the following issues: (1) increasing on-site affordability requirements in residential projects; (2) requiring units for extremely-low income households or individuals with disabilities; (3) requiring units for median- and moderate-income households in rental residential projects; and (4) increasing commercial linkage fees on non-residential development projects. The Economic Feasibility Analysis also summarizes inclusionary housing programs and commercial linkage fees in other cities in Santa Clara County. As discussed above, the 2015 Nexus Study establishes the legal maximum for impact fees that may be imposed on commercial projects. It also analyzed the "affordability gap" that creates increased demand for affordable housing when market rate housing is developed. The Economic Feasibility Analysis provides a more current analysis of what increased affordability requirements and impact fees may be feasible in connection with future development in Cupertino by analyzing the economic effects of various affordability requirements on future projects. By analyzing the costs of development (such as land acquisition, soft costs, construction costs, and City requirements) in comparison to projected revenues, the Economic Feasibility Analysis evaluates whether the expected returns would be enough to support development in the City if affordability requirements were increased. Although the Economic Feasibility Analysis is a helpful tool to aid the City in its policymaking decisions, all studies of this kind have limitations. For example, the Economic Feasibility Analysis provides an overview-level assessment of development economics in Cupertino generally, because it is based on project prototypes rather than specific projects. Any individual future project will have unique characteristics that affect market returns and developer profit requirements. Based on individual project economics individual projects may look more or less feasible to developers than the Economic 6 Feasibility Analysis shows. In addition, the Economic Feasibility Analysis focuses on market conditions in 2019, making its conclusions most applicable to projects that have site control and are in the pre-development stage. As construction costs, rents, and sales prices continue to change, project feasibility will change as well. Similarly, the Economic Feasibility Analysis results are very sensitive to land price assumptions, which are a major cost of development and impact a project's ability to support other costs. It is generally assumed that developers will only purchase land at a price that will allow for financially feasible projects and that development costs, including affordability requirements, are reflected in land sale prices. However, it is possible that if the City increases affordability requirements, the increase would depress land values to accommodate what developers can afford to pay while meeting the City's requirements. Accordingly, over time, the market may adjust to this cost pressure in the form of reduced land costs, potentially making certain projects more feasible than they appear today. The final Economic Feasibility Analysis, which includes a full discussion of its methodology and conclusions, is attached to this Staff Report as Attachment A. The Analysis's key findings are summarized below. Increasing On-Site Affordability Requirements in Residential Projects The Economic Feasibility Analysis studied five different prototypes of residential development that are most likely to be developed in future projects within the City: detached single family; small lot single family/townhome units; condominiums; lower- density rental apartments; and higher-density rental apartments. For each prototype of ownership housing, the Economic Feasibility Analysis studied project feasibility under five different scenarios of affordability requirements: basic feasibility (no affordability requirements); 15% inclusionary (existing City policy of 8% to median income households and 7% to moderate income households); 20% inclusionary (10% to median income households and 10% to moderate income households); 25% inclusionary (13% to median income households and 12% to moderate income households); and in-lieu fees only. Similarly, for each prototype of rental housing, the Economic Feasibility Analysis studied project feasibility under five different scenarios of affordability requirements: basic feasibility (no affordability requirements); 15% inclusionary (existing City policy of 9% to very low income households and 6% to low income households); 20% inclusionary (10% to very low income households and 10% to low income households); 25% inclusionary (5% to very-low income households, 10% to very-low income households, and 10% to low income households); and in-lieu fees only. The Economic Feasibility Analysis concludes that increasing the on-site affordability requirement from 15% to 20% of units is feasible for ownership housing prototypes 7 (single-family detached, small lot single-family/townhouse, and condominium developments). However, neither lower-density nor higher-density rental apartments would be economically feasible if the requirement was increased above 15%, and using the assumptions regarding current market rents, construction costs, and land costs, any production requirement could be challenging for the studied prototypes. Moreover, none of the residential prototypes would be feasible if the on-site affordability requirement increased to 25% of units. The Economic Feasibility Study concludes that in-lieu fees can be increased for all but the lower density rental apartments without impacting project feasibility. (The City currently charges Housing Mitigation Fees ranging from $17.82 to $23.76 per square foot.) Table 3 summarizes key findings with respect to increasing affordability requirements in residential projects. Table 3: Increased Inclusionary/In Lieu Fee Feasibility Summary Residential Prototype Feasibility of Program Change 20% Inclusionary 25% Inclusionary In-Lieu Fees Detached Single Family Feasible Currently Infeasible Increase to $30/sf Feasible Small Lot SF and Townhomes Feasible Currently Infeasible Increase to $35/sf Feasible Condos Feasible Currently Infeasible Increase to $35/sf Feasible Lower-Density Rental Apartments Currently Infeasible Currently Infeasible Increase Currently Infeasible Higher-Density Rental Apartments Currently Infeasible Currently Infeasible Increase to $30/sf Feasible Increasing Impact Fee Requirements in Non-Residential Projects The Economic Feasibility Analysis also studied the feasibility of increasing its commercial linkage fees on three non-residential development prototypes: office/R&D, hotel, and 8 retail. The building characteristics of each development prototype, including size, density (floor-area-ratio), and parking assumptions are based on a review of projects that were recently built, and in planning stages in Cupertino, as well as recently built and pipeline projects in surrounding areas. For each non-residential prototype studied, the Economic Feasibility Analysis tested various fee levels to determine if increases would be feasible. Office and R&D uses are currently subject to a linkage fee of $23.76/sf, which can feasibly be increased to $25/sf, with an increase to $30/sf remaining marginally feasible. Hotel uses are currently subject to a linkage fee of $11.88/sf that is feasible, with an increase to $15/sf remaining marginally feasible; however, increases to $20/sf are projected to be currently infeasible. Based on the prototype assumptions, stand-alone retail uses are barely feasible without any linkage fee, so no increase is projected to be supported. However, the Economic Feasibility Analysis concludes that retail uses may be feasible when developed in conjunction with office or residential uses in a mixed-use environment, but it does not identify linkage fee levels for this development style. Peer Review As discussed above, the Economic Feasibility Study's conclusions are sensitive to assumptions regarding land cost, construction costs, market potential, and developer profits. Therefore, to further test the methodology and the conclusions presented in the Economic Feasibility Study, the City commissioned LeSar Development Consultants to perform a peer review of the Economic Feasibility Study while it was in draft form. The peer review identified a number of questions and requested additional information related to the Economic Feasibility Study's methodology and data sources that may have influenced the Economic Feasibility Study's conclusions. The peer review is included as Attachment B. In response, the Economic Feasibility Study was revised to include additional discussion of its approach to analysis and to provide additional analysis in support of the assumptions related to housing demand, which drives potential developer revenues and feasibility. The revised Economic Feasibility Study also expanded upon the information presented in the pro forma analysis for each prototypes. A track changes version of the Economic Feasibility Study showing changes in response to the peer review in included as Attachment C, and a supplemental memo from Strategic Economics directly answering questions from the peer review is included as Attachment D. The revisions result in a more clear and comprehensive document, but it is important to note that none of the revisions changed the Economic Feasibility Study's conclusions regarding feasibility of BMR program changes. Conclusions and Next Steps Based on its assumptions and analysis, the Economic Feasibility Study shows the potential to increase inclusionary requirements for for-sale residential development to 20% from 15% and to increase in-lieu fees. 9 With respect to rental residential development, higher-density rental apartments appear to be able to support an increased in-lieu fee. Most developments that include affordable units for extremely-low income households or for people with disabilities require public subsidies to operate; therefore, the City could choose to prioritize fee collection over on- site inclusionary requirements, which could increase the amount of public funds the City would have available to contribute to projects. As discussed above, rental residential projects are not good candidates for increasing on-site production requirements or deepening affordability levels to include extremely-low income households or from increasing requirements above 15% to require units affordable to median- or moderate- income households in addition to existing requirements. In addition, it may be possible to increase linkage fees for office/R&D uses and hotels to increase the resources available in the City's BMR AHF. Even with additional funding at its disposal, the City would have a challenge meeting the need for these housing types, because site acquisition and construction costs can require subsidies of several hundred thousands of dollars per unit, even while leveraging other available funding sources. Therefore, the Housing Commission should provide direction about whether the City should continue to prioritize on-site production of housing affordable to very-low, low-, median-, and moderate income households to be built in conjunction with market rate projects over time, or whether the City should prioritize fee collection in an effort to subsidize projects with smaller numbers of more deeply affordable housing units. Sustainability Impact No sustainability impact. Fiscal Impact No fiscal impact. _____________________________________ Prepared by: Kerri Heusler, Housing Manager Reviewed by: Richard Taylor, Assistant City Attorney Approved for Submission by: Benjamin Fu, Director of Community Development Attachments: A – July 2019 Economic Feasibility Analysis prepared by Strategic Economics B – LeSar Development Consultants Peer Review C – Track Changes Draft Economic Feasibility Analysis prepared by Strategic Economics D –Strategic Economics Memorandum Regarding Peer Review ECONOMIC FEASIBILITY ANALYSIS CUPERTINO BELOW MARKET RATE (BMR) HOUSING PROGRAM Prepared for: City of Cupertino 7/16/19 TABLE OF CONTENTS Introduction ............................................................................................................................. 1 BMR Requirements for Residential Development ............................................................... 3 Approach................................................................................................................................................... 3 Financial Feasibility Methodology ........................................................................................................ 10 Key Results ............................................................................................................................................ 19 Peer Cities ............................................................................................................................................. 32 Non-Residential Linkage Fee ........................................................................................... 34 Approach................................................................................................................................................ 34 Peer Cities ............................................................................................................................................. 45 Key Takeaways .................................................................................................................. 47 Appendix ....................................................................................................................................... 49 1 TABLE OF FIGURES Figure 1: Description of Prototypes ............................................................................................................ 6 Figure 2: City of Cupertino BMR Income Limits and Income Target for Pricing BMR Units .................... 7 Figure 3: Inclusionary Housing Scenarios Tested for Ownership Prototypes (Detached Single-Family Prototype 1, Small Lot/Townhouse Prototype 2, and Condominium Prototype 3) .................................. 8 Figure 4: Inclusionary Housing Scenarios Tested for Rental Prototypes (Lower Density Rental Prototype 4 and Higher Density Rental Prototype 5) .................................................................................................. 9 Figure 5: Minimum Return Thresholds by Prototype .............................................................................. 11 Figure 6: Market Rate Residential Sale Prices and Monthly Rents, By Prototype ................................ 13 Figure 7. Market Rate Residential Value Calculation, by Prototype ...................................................... 14 Figure 8. Below Market Rate Residential Values, by Prototype and AMI Level .................................... 15 Figure 9. Retail Revenue Assumptions and Capitalized Value .............................................................. 16 Figure 10: Development Cost Assumptions ............................................................................................ 18 Figure 11: Return On Cost for Ownership Prototypes by Inclusionary Housing Scenario .................... 21 Figure 12: Yield on Cost under Different Inclusionary Housing Scenarios for Multi-Family Rental Prototypes 4 and 5.................................................................................................................................... 21 Figure 13: Yield on Cost Under Different Revenue Assumptions for Lower Density Multi-Family Rental (Prototype 4) with 15% BMR Requirement ............................................................................................. 22 Figure 14: Feasibility of Lower Density Multi-Family Rental Prototype (Prototype 4) with 15% Inclusionary BMR Requirement and Increased Revenues ..................................................................... 22 Figure 15: Yield on Cost Under Different Cost Assumptions for Lower Density Multi-Family Rental (Prototype 4) with 15% BMR Requirement ............................................................................................. 23 Figure 16: Feasibility Results of Lower Density Multi-Family Rental Prototype (Prototype 4) with 15% Inclusionary BMR Requirement and Lower Costs ................................................................................... 23 Figure 17: Yield on Cost Under Different Revenue Assumptions for Higher Density Multi-Family Rental (Prototype 5) with 15% BMR Requirement ............................................................................................. 24 Figure 18: Feasibility Results of Higher Density Multi-Family Rental Prototype (Prototype 5) with 15% Inclusionary BMR Requirement and Higher Revenues .......................................................................... 24 Figure 19: Yield on Cost Under Different Cost Assumptions for Higher Density Multi-Family Rental (Prototype 5) with 15% BMR Requirement ............................................................................................. 25 Figure 20: Feasibility Results of Higher Density Multi-Family Rental Prototype (Prototype 5) with 15% Inclusionary BMR Requirement and Lower Costs ................................................................................... 25 Figure 21. Detailed calculation of the City of Cupertino’s permits and fees for each prototype (Per Unit) ................................................................................................................................................................... 26 2 Figure 22: Financial Feasibility Results for Single-Family Detached Prototype 1 ................................. 27 Figure 23: Financial Feasibility Results for Small Lot Single-Family/Townhouse Prototype 2 ............ 28 Figure 24: Financial Feasibility Results for Condominium Prototype 3 ................................................. 29 Figure 25: Financial Feasibility Results for Lower Density Rental Apartments Prototype 4 ................ 30 Figure 26: Financial Feasibility Results for Higher Density Rental Apartments Prototype 5 ............... 31 Figure 27: Inclusionary Housing Requirements and Housing Mitigation Fees in Peer Cities ............. 33 Figure 28. Description of Development Prototypes ................................................................................ 35 Figure 29. Hard Costs Assumptions by Prototype ................................................................................... 36 Figure 30. Land Comparables for Office and Hotel ................................................................................ 37 Figure 31. Soft Cost Assumptions by Prototype ...................................................................................... 37 Figure 32. Revenue Assumptions by Prototype ...................................................................................... 39 Figure 33. Office Comparables ................................................................................................................ 39 Figure 34: Retail Comparables in Cupertino ........................................................................................... 39 Figure 35: Yield on Cost Thresholds by Prototype .................................................................................. 40 Figure 36. Summary of Financial Feasibility of Office/R&D Prototype .................................................. 40 Figure 37. Summary of Financial Feasibility of Hotel Prototype ............................................................ 41 Figure 38. Summary of Financial Feasibility of Retail Prototype ........................................................... 41 Figure 39. Office/R&D Pro Forma Results .............................................................................................. 42 Figure 40. Hotel Pro Forma Results ......................................................................................................... 43 Figure 41. Retail Pro Forma Results ........................................................................................................ 44 Figure 42. Non-Residential Linkage Fees (per Gross S. Ft. of Net New Space) in Nearby Cities ........ 46 Figure 43: Current and Maximum Housing Mitigation Fees Based On Nexus for Ownership Prototypes ................................................................................................................................................................... 47 1 INTRODUCTION Strategic Economics was retained by the City of Cupertino (the “City) to evaluate potential changes to the Below Market Rate (BMR) Housing Program. The BMR program requirements are currently as follows: • The City currently has a BMR Housing Program that imposes an inclusionary requirement of 15% on for-sale and rental residential developments with seven or more units. For rental developments, the BMR units must be affordable to very-low (up to 50% Area Median Income “AMI”) or low-income (up to 80% AMI) households 1. For-sale developments must provide BMR units affordable to median- (up to 100% AMI) and moderate-income (up to 120% AMI) households.2 • Small residential projects of less than seven units can pay the City’s Housing Mitigation In-Lieu Fees 3 (the “Housing Mitigation Fees”) or provide one BMR unit. The Housing Mitigation Fees are based on the City’s 2015 Residential Below Market Rate Housing Nexus Analysis and Non- Residential Jobs-Housing Nexus Analysis (the “2015 Nexus Study”). Housing Mitigation Fees are currently set at $17.82 per square feet for detached single family, $19.60 per square feet for small lot single family/townhomes, $23.76 for attached multifamily residences (ownership and rental), and $11.88 per square foot for commercial/retail uses. • The City first adopted linkage fees for office and Research and Development (“R&D”) projects in 1992 and expanded the program to apply to retail and hotel developments in 2004. The City updated the non-residential linkage fees in 2015 (based on the 2015 Nexus Study) to the current levels of $23.76 per square foot for office/R&D uses, and $11.88 per square foot for hotel and retail uses.4 The City Council is considering modifying the BMR Housing Program, providing direction to examine the following issues: • Study the potential to increase the inclusionary requirements to 20% or 25% • Explore inclusionary housing policy to include units for extremely-low income/disabled persons • Include median- and moderate-income units in rental projects • Study inclusionary housing programs in other cities as a comparison • Study the economic feasibility of increasing non-residential linkage fees on new office/R&D, hotel, and retail developments This report provides technical findings on the economic feasibility of increasing the City’s BMR requirements for residential developments and non-residential developments. It also provides findings regarding the potential for including extremely-low income housing units and/or median-and moderate-income units in rental projects. The report also summarizes inclusionary housing programs and non-residential linkage fees in other cities in Santa Clara County. The report is divided into three sections. 1 Rental BMR policy states that 40% of affordable units must be set aside for low income, and 60% for very low income units. 2 For-Sale BMR policy states that half of affordable units must be set aside for median income households, and half for moderate income households. 3 Housing Mitigation In-Lieu Fees: A fee assessed in accordance with the City's General Plan Housing Element, Municipal Code (CMC 19.172) and the City's BMR Housing Mitigation Program Procedural Manual. 4 Keyser Marston Associates, “City of Cupertino: Non-residential Jobs-Housing Nexus Analysis,” City of Cupertino, April 2015. 2 • Section II: The first section focuses on the BMR requirements on housing development. • Section III: The second section is focused on the non-residential linkage fees on new office/R&D, hotel, and retail developments. • Section IV: The third section provides key takeaways and conclusions. The appendix to the report provides additional background data on housing trends. 3 BMR REQUIREMENTS FOR RESIDENTIAL DEVELOPMENT Approach The following summarizes the methodology of the financial feasibility analysis. Step 1. Develop Prototypes The first step in the financial feasibility analysis is to review the types of residential and mixed-use (residential and retail) projects that would be subject to the BMR policy. In close coordination with City staff, Strategic Economics updated the residential and nonresidential prototypes used in the 2015 Nexus Study, ensuring that they represent the ownership and rental residential development types that are likely to occur in city in the short term. The prototypes varied based on assumptions regarding building type, density, unit size, etc. Step 2. Develop Assumptions about BMR Units Strategic Economics worked closely with City staff to develop assumptions about the percentage of inclusionary units that should be tested, the income targets, and the affordable sales prices and rents. Maximum sales prices and rents were calculated using the method and parameters established by City policy, in coordination with Hello Housing, the BMR Program administrator. Step 3. Collect Key Inputs and Build Pro Forma The financial feasibility of each prototype is measured using a static pro forma model that solves for the profit to the developer. A pro forma model is a tool that is commonly used to estimate whether a project is likely to be profitable. The key inputs into the financial feasibility analysis are the revenues (rents/ sales prices), development costs, and land costs. Strategic Economics collected and summarized data on land prices, residential values, and construction costs using the following data sources: • Costar, a commercial real estate database that tracks rental multifamily properties and property transactions • Interviews with local developers and brokers • Redfin, a real estate brokerage firm that collects data on residential sales prices • Review of pro formas from other projects and clients Step 4. Calculate Financial Feasibility The pro forma model tallies all development costs, including land costs, hard costs (construction costs), soft costs, and financing costs. The pro forma also tallies the project’s total value. The project’s total value is the sum of (1) the estimated value of the condominiums or townhomes (i.e. the average per unit sale price multiplied by the number of units), and (2) if applicable, the capitalized value of retail. The project’s ROC is then calculated by dividing the project’s net revenue (i.e. total value minus total development costs), by total development costs. To understand the potential impact of inclusionary requirements on financial feasibility, the ROC results for each prototype and inclusionary housing scenario are compared to developers’ typical expectation of return, or the threshold for feasibility. If the ROC for a project is above the threshold for feasibility, it is considered financially feasible. If the ROC is below the threshold, it is not financially feasible. 4 More details on each step of the analysis is provided in the section below. DEVELOPMENT PROTOTYPES The analysis estimates the feasibility of different inclusionary requirements for five residential prototypes, as described in Figure 1. The building characteristics of each development prototype, including size, density (floor-area-ratio), and parking assumptions are based on prototypes analyzed as part of the City’s 2015 Nexus Study 5. These development prototypes represent the range of typical residential development expected to come online in Cupertino in the short term. These prototypes are mostly based on recently completed projects or development proposals in the pipeline in Cupertino. It is also assumed that future development will likely be located along Stevens Creek Boulevard, and in existing residential neighborhoods, given that these locations have been identified in the City’s General Plan and Heart of the City Specific Plan as key areas for new residential and mixed-use development. The prototypes vary based on the following characteristics: • Ownership and Rental. Three of the prototypes include only for-sale units (Prototypes 1, 2, and 3) and two are rental developments (Prototypes 4 and 5). • Mixed-Use and Residential Only. Two of the prototypes (Prototypes 1 and 2) are 100% residential while the attached multifamily prototypes have a ground-floor retail component (Prototypes 3, 4, and 5). • Project Density and Size o The single-family detached prototype 1 represents detached single-family custom-built homes with an average density of 4.5 dwelling units per acre. Because this prototype has fewer than eight units, it would be allowed to pay the in-lieu fee or provide one BMR unit under the current BMR policy. The small number of units in this prototype reflects the fact that there are few potential single-family detached sites in Cupertino that can accommodate more than 7 units. o Prototype 2 represents two-story small lot single-family and townhome developments with a density of 15 dwelling units per acre. o Prototype 3 is a three-story multi-family condominium building with a density of 35 units per acre. Parking is accommodated in an above-ground podium. o Prototype 4 is a three-story multifamily rental building with a density of 40 units per acre. Parking is accommodated in an above-ground podium. o Prototype 5 is a higher-density six-story project with a density of 76 units per acre. This prototype is based on a Housing Element site that allows six to eight story heights. Parking is accommodated in an above-ground podium. • Parking Ratios. The City requires 2 parking spaces per unit. However, for the multi-family prototypes there are opportunities to achieve parking reductions under certain conditions. The assumptions in the pro forma are as follows. o For Prototype 1 and Prototype 2, the assumption is that the development would provide all of the required parking. 5 Keyser Marston Associates (2015). Residential Below Market Rate Housing Nexus Analysis. 5 o For the condominium prototype 3, developers can lower parking by 10%, assuming that the reduction is justified by a parking study. o For multi-family rental housing prototypes 4 and 5, developers can receive parking reductions on residential units in the scenarios where 5% of the housing units are for very low-income households, in accordance with Gov’t Code Sec. 65915(p). 6 FIGURE 1: DESCRIPTION OF PROTOTYPES Prototype 1 Prototype 2 Prototype 3 Prototype 4 Prototype 5 Detached Single Family Small Lot Single Family/Townhome Condominium Lower Density Rental Apartments Higher Density Rental Apartments Tenure For-Sale For-Sale For-Sale Rental Rental Unit Mix 5 bedrooms 3 bedrooms 2 and 3 bedrooms Studios, 1, 2, and 3 bedrooms Studios, 1, 2, and 3 bedrooms Format Low-rise, large sites Low-rise, small sites Mid-rise, small sites Mid-rise, small sites Higher density, small sites Number of Units 7 50 100 100 100 Parcel Size (Acres) 1.6 3.3 2.9 2.9 1.3 Residential Program Studios - - - 10 10 1-BD - - - 45 45 2-BD - - 50 40 40 3-BD - 50 50 5 5 4-BD 0 - - - - 5-BD 7 - - - - Total 7 50 100 100 100 Dwelling Units Per Acre 4.5 15 35 35 76 Ground Floor Retail (Sq. Ft.) 0 0 10,000 10,000 15,000 Parking 2-Car Garage + Driveway 2-Car Garage + Driveway Podium Podium Podium Parking Requirement (Per Unit) 4 2.8 2 2 2 Parking Requirement (Commercial) n/a n/a 4 per 1,000 sq. ft. 4 per 1,000 sq. ft. 4 per 1,000 sq. ft. Required Parking Spaces 28 140 240 240 260 Reduced Parking Spaces (a) 28 140 216 185 205 (a) For the condominium prototype 3, developers can lower parking by 10%, assuming that the reduction is justified by a parking study. For multi-family rental housing prototypes 4 and 5, developers can receive parking reductions on residential units in the scenarios where 5% of the housing units are for very low-income households (50% AMI), in accordance with Gov’t Code Sec. 65915(p). Source: Strategic Economics, City of Cupertino. 7 BMR HOUSING PROGRAM ASSUMPTIONS Strategic Economics built a pro forma model that tested the feasibility of various inclusionary housing scenarios under the existing BMR housing program and alternative scenarios. Below is a summary of the existing BMR program: • The City currently has a BMR Housing Program that imposes an inclusionary requirement of 15% on for-sale and rental residential developments with seven or more units. For rental developments, the BMR units must be affordable to very low or low-income households6. For-sale developments must provide BMR units affordable to median- and moderate-income households.7 • Small residential projects of less than seven units can pay the housing mitigation fee or provide one BMR unit. The housing mitigation fees are based on the 2015 Nexus Study, and are currently set at $17.82 per square feet for detached single family, $19.60 per square feet for small lot single family/townhomes, $23.76 for attached multifamily residences (ownership and rental), and $11.88 per square foot for commercial/retail uses. • The BMR program uses income limits published annually by the California Department of Housing and Community Development (HCD) for Santa Clara County, per household size. For some income categories, the income targets for pricing BMR units are slightly different from household income limits that determine eligibility. Maximum BMR sales and rent prices are determined by the City and its BMR program administrator, Hello Housing, based on the maximum affordable housing cost provisions of Section 50052.5 of the California Health and Safety Code, Section 6920 of the California Code of Regulations, and most recent published HCD income limits. The household income limits for BMR eligibility as well as the income targets for pricing BMR units are shown in Figure 2. FIGURE 2: CITY OF CUPERTINO BMR INCOME LIMITS AND INCOME TARGET FOR PRICING BMR UNITS Household Income Limits Income Target for Pricing BMR Units Ownership Median 100% AMI 90% AMI Moderate 120% AMI 110% Ami Rental Extremely Low 30% AMI 30% AMI Very Low 50% AMI 50% AMI Low 80% AMI 60% AMI Sources City of Cupertino Housing Element; City of Cupertino Housing Mitigation Program Procedural Manual. The inclusionary housing scenarios tested in this analysis reflect the range of policy options under consideration by the City for ownership and rental development. They are summarized below and shown in Figure 3 and Figure 4. 6 Rental BMR policy states that 40% of affordable units must be set aside for low income, and 60% for very low-income units. 7 For-Sale BMR policy states that half of affordable units must be set aside for median income households, and half for moderate income households. 8 OWNERSHIP DEVELOPMENT Strategic Economics tested the economic feasibility of the development of ownership housing (single- family, townhouse, and condominium prototypes) under five different inclusionary scenarios: • Scenario 0 (No Requirements): This scenario assumes that the project is 100% market- rate, with no affordable units and no in-lieu fees required. • Scenario 1 (Existing Policy): This scenario mirrors the City’s existing inclusionary housing requirement. The development projects must provide 15% of the units at prices affordable to median- (100% AMI) and moderate-income households (120% AMI). • Scenario 2 (20% Inclusionary): This scenario requires new ownership projects to include at least 20% BMR units, targeting median and moderate-income households. • Scenario 3 (25% Inclusionary): This scenario requires new ownership projects to include at least 25% BMR units, targeting median and moderate-income households. • Scenario 4 (In-Lieu Fees): This scenario assumes that the development is required to pay in-lieu fees instead of providing affordable units on-site. These scenarios are summarized in Figure 3 below. FIGURE 3: INCLUSIONARY HOUSING SCENARIOS TESTED FOR OWNERSHIP PROTOTYPES (DETACHED SINGLE-FAMILY PROTOTYPE 1, SMALL LOT/TOWNHOUSE PROTOTYPE 2, AND CONDOMINIUM PROTOTYPE 3) Inclusionary Housing Scenarios % of Units at BMR Prices Income Targets for BMR Units* In-Lieu Fee Payment Scenario 0 (No Requirements) 0% N/A No Scenario 1 (Existing Policy) 15% 8% of units at 90% AMI 7% of units for 110% AMI No Scenario 2 (20% Inclusionary) 20% 10% of units at 90% AMI 10% of units at 110% AMI No Scenario 3 (25% Inclusionary) 25% 13% of units at 90% AMI 12% of units at 110% AMI No Scenario 4 (In-Lieu Fees) 0 N/A Yes *Per the City of Cupertino Housing Mitigation Program Procedural Manual, the maximum sales price for median income BMR units is set at 90% AMI. The maximum sales price for moderate income BMR units is set at 110% AMI. Sources: City of Cupertino Housing Mitigation Program Procedural Manual, 2018; Strategic Economics, 2018. RENTAL DEVELOPMENT Strategic Economics tested the economic feasibility of the development of ownership housing (single- family, townhouse, and condominium prototypes) under five different inclusionary scenarios: • Scenario 0 (No Requirements): This scenario assumes that the project is 100% market- rate, with no affordable units and no in-lieu fees required. • Scenario 1 (Existing Policy): This scenario mirrors the City’s existing inclusionary housing requirement. The development projects must provide 15% of the units at prices affordable to low-income (80% AMI) and very low-income households (50% AMI). • Scenario 2 (20% Inclusionary): This scenario requires new ownership projects to include at least 20% BMR units, targeting median and moderate-income households. 9 • Scenario 3 (25% Inclusionary): This scenario has a higher inclusionary requirement of 25% and targets lower income groups. The income targets include low-income (80% AMI), very low-income (50% AMI), and extremely low-income households (30% AMI). • Scenario 4 (In-Lieu Fees): This scenario assumes that the development is required to pay in-lieu fees instead of providing affordable units on-site. These scenarios are summarized in Figure 4 below. FIGURE 4: INCLUSIONARY HOUSING SCENARIOS TESTED FOR RENTAL PROTOTYPES (LOWER DENSITY RENTAL PROTOTYPE 4 AND HIGHER DENSITY RENTAL PROTOTYPE 5) Inclusionary Housing Scenarios % of Units at BMR Rents Income Targets for BMR Units* In-Lieu Fee Payment Scenario 0 (No Requirements) 0% N/A No Scenario 1 (Existing Policy) 15% 9% of units at 50% AMI 6% of units at 60% AMI No Scenario 2 (20% Inclusionary) 20% 10% of units at 50% AMI 10% of units at 60% AMI No Scenario 3 (25% Inclusionary) 25% 10% of units at 50% AMI 10% of units at 60% AMI 5% of units at 30% AMI No Scenario 4 (In-Lieu Fees) 0 N/A Yes *Per City policy, pricing for low-income BMR units is set at 60% AMI. Sources: City of Cupertino Housing Mitigation Program Procedural Manual, 2018; Strategic Economics, 2018. 10 Financial Feasibility Methodology This section describes the method used to measure financial feasibility and the major cost and revenue assumptions underlying the analysis. Additional information is provided in the Appendix. MEASURING FINANCIAL FEASIBILITY The financial feasibility of each prototype is measured using a static pro forma model that solves for the profit to the developer. A pro forma model is a tool that is commonly used to estimate whether a project is likely to be profitable. For a policy analysis like this one, we use development prototypes to represent typical projects. However, it is important to note that individual development projects may be less or more profitable than these prototypes, depending on the specifics of the development program, development costs (construction and land), sources of financing, and other factors. Furthermore, because it is a static model reflecting today’s market conditions, the pro forma analysis does not factor in changes in prices/rents, construction costs, or financing. For the purposes of measuring financial feasibility in this analysis, developer profit was measured by using one of two metrics: • Return on cost (ROC) for ownership housing. ROC is a common measure of project profitability for residential ownership development. The pro forma model tallies all development costs, including land costs, hard costs (construction costs), soft costs, and financing costs. The pro forma also tallies the project’s total value. The project’s total value is the sum of (1) the estimated value of the condominiums or townhomes (i.e. the average per unit sale price multiplied by the number of units), and (2) if applicable, the capitalized value of retail. The project’s ROC is then calculated by dividing the project’s net revenue (i.e. total value minus total development costs), by total development costs. • Yield on cost (YOC) for rental housing. YOC is a common measure of profitability for income- generating projects, such as residential rental development. The pro forma model tallies all development costs (land costs, hard costs, soft costs, and financing costs). The pro forma also estimates total revenues: the project’s net annual operating income is the stabilized income from the property (i.e. rental income generated from both the residential and retail uses), minus operating expenses and an allowance for vacancy. The YOC is estimated by dividing the total annual net operating income by total development costs. RETURN THRESHOLDS To understand the potential impact of inclusionary requirements on financial feasibility, the ROC and YOC results for each prototype and inclusionary housing scenario are compared to developers’ typical expectation of return. These return thresholds are summarized in Figure 5 and discussed below: • For the Single-Family Detached Prototype 1, the minimum ROC threshold ranges between 10 to 15%, based on developer interviews for new single-family development in Cupertino. • For the Small Lot Single-Family/Townhouse Prototype 2 and the Condominium Prototype 3, the minimum ROC threshold ranges between 18 to 20%, based on a review of pro forma models for new multifamily ownership projects in Santa Clara County. • For the Lower Density Apartment Prototype 4 and the Higher Density Apartment Prototype 5, the minimum YOC threshold ranges between 4.75% and 5.25%. According to the developers interviewed for this study, and a review of recent development project pro formas in the Silicon 11 Valley, the minimum YOC for a new multi-family development project should usually be 1.0 to 1.5 points higher than the published capitalization rate (cap rate). The current cap rate for multifamily properties in the San José Metropolitan Area is between 3.75 to 4.25%.8 The cap rate, measured by dividing the net operating income generated by a property by the total project value, is a commonly used metric to estimate the value of an asset. Cap rates rise and fall along with interest rates. In a climate of rising interest rates, it is important to set the expectations of YOC at a conservative level, to allow for a margin between the cap rate and the rate of return. It is also important to consider that investors consider a wide range of factors to determine if a development project makes financial sense, and some investors may have different levels of risk tolerance than others. FIGURE 5: MINIMUM RETURN THRESHOLDS BY PROTOTYPE Return on Cost Thresholds Prototype 1: Detached Single Family 10-15% Prototype 2: Small Lot/Townhomes 18-20% Prototype 3: Condominiums 18-20% Yield on Cost Thresholds Prototype 4: Lower-Density Rental Apartments 4.75-5.25% Prototype 5: Higher-Density Rental Apartments 4.75-5.25% Source: Developer interviews and a review of recent project pro formas, 2018; Strategic Economics, 2018. REVENUE ASSUMPTIONS MARKET RATE RESIDENTIAL There is significant pent-up housing demand in Santa Clara County and the broader Bay Area region, as housing development has not kept up with employment growth. Between 2009 and 2015, Santa Clara County added over 170,000 new jobs between 2010 and 2015, but only 29,000 new housing units.9 Apartment rents accelerated beginning in 2011, as the economy emerged from the Great Recession, and continued growing at an average annual rate of nearly eight percent until 2015. Since then rents have continued to grow at a slower pace of about four percent. Sales prices in Cupertino and Santa Clara County have been escalating at a rapid rate over the last five years. In Cupertino, the median sales price for a single-family home increased from $1.68 million in 2014 to $2.37 million in 2018. 10 Similarly, the median sales price for a condominium climbed from $895,500 in 2014 to $1.4 million in 2018.11 The market-rate sale prices and rents assumed for each prototype are summarized in Figure 6. The values are calculated as a weighted average to reflect that different types of units have different unit 8 CBRE Investor’s Cap Rate Survey (H1, 2018). 9 SPUR, “Room for More: Housing Agenda for San José,” August 2017. 10 Santa Clara County Association of Realtors, 2014 and 2018. https://www.sccaor.com/pdf/stats/2014.pdf https://www.sccaor.com/pdf/stats/2018.pdf. 11 Ibid 12 values. For new single-family detached development (Prototype 1), sale prices were based on sales of newly built single-family homes in Cupertino as reported by Redfin. Sales prices for small lot single- family/townhomes (Prototype 2) and condominium projects (Prototype 3) were based on recent re- sales in Cupertino as reported by Redfin. The Appendix to this report (Figures A-1 through A-3) includes detailed information on the project comparables used to inform these estimates. Because of the lack of recently built apartment projects in Cupertino, the rental rate estimates for rental units (Prototypes 4 and 5) were based on developer interviews and a review of recently built, comparable apartment projects in Cupertino and neighboring cities (Mountain View, Sunnyvale, Campbell, and Santa Clara), as reported by Costar. Since Cupertino’s apartment buildings command higher rents than in the other cities, a 5% premium was applied over the market area’s weighted average. Figure A-4 in the Appendix includes detailed information on the project comparables used to inform these estimates. 13 FIGURE 6: MARKET RATE RESIDENTIAL SALE PRICES AND MONTHLY RENTS, BY PROTOTYPE Unit Mix Unit Size (Sq. Ft.) Sale Price Per Sq. Ft. Sale Price Per Unit Prototype 1: Single Family 5-BD 100% 3,700 $946 $3,500,200 Prototype 2: Small Lots/Townhomes 3-BD 100% 1,850 $970 $1,794,500 Prototype 3: Condominiums 2-BD 50% 1,350 $1,100 $1,485,000 3-BD 50% 1,600 $1,000 $1,600,000 Weighted Average Unit Size/Sale Price 1,475 $1,050 $1,542,500 Prototype 4: Lower-Density Rental Studios 10% 680 $4.94 $3,360 1-BD 45% 800 $4.73 $3,780 2-BD 40% 1,100 $4.30 $4,725 3-BD 5% 1,400 $4.13 $5,775 Weighted Average Unit Size/Monthly Rent 938 $4.54 $4,216 Prototype 5: Higher-Density Rental Studios 10% 680 $4.94 $3,360 1-BD 45% 800 $4.73 $3,780 2-BD 40% 1,100 $4.30 $4,725 3-BD 5% 1,400 $4.13 $5,775 Weighted Average Unit Size/Monthly Rent $4.54 $4,216 Source: Strategic Economics, 2018. The total value of market-rate units is summarized in Figure 7. For the ownership prototypes (Prototypes 1, 2, and 3), the total project value is obtained by multiplying the per unit sale price by the total number of units. For the rental prototypes (Prototypes 4 and 5), an income capitalization approach is used. This approach first estimates the annual net operating income (NOI) of the prototype, which is the difference between project income (annual rents) and project expenses 14 (operating costs and vacancies). The NOI is then divided by the current cap rate to derive total project value.12 FIGURE 7. MARKET RATE RESIDENTIAL VALUE CALCULATION, BY PROTOTYPE Prototype 1 Prototype 2 Prototype 3 Prototype 4 Prototype 5 Detached Single Family Small Lot Single Family/ Townhome Condo Lower Density Rental Apartments Higher Density Rental Apartments Weighted Average Monthly Rent (a) per unit n/a n/a n/a $4,216 $4,216 Annual Rent per unit n/a n/a n/a $50,589 $50,589 Vacancy Allowance n/a n/a n/a 5.00% 5.00% Operating Expenses % gross revenue n/a n/a n/a 30.00% 30.00% Annual Net Operating Income per unit n/a n/a n/a $32,883 $32,883 Capitalization Rate (b) n/a n/a n/a 4.25% 4.25% Sales Value/Capitalized Value per unit $3,500,200 $1,794,500 $1,542,500 $773,714 $773,714 Total Units 7 50 100 100 100 Total Residential Value (c) total project $24,501,400 $89,725,000 $154,250,000 $77,371,412 $77,371,412 (a) See Figure 5 for details on how the per unit sale price was derived. (b) CBRE, H1 2018 Cap Rate Survey. Cap rates for the San José Metropolitan Area were between 3.75% and 4.25% for infill multifamily Class A. (c) Assuming all units are market rate. Total residential value is calculated by multiplying the per unit sales value/capitalized value (which is a weighted average) by the total number of units. Sources: CBRE, 2018; CoStar, 2018; Strategic Economics, 2018. BELOW MARKET RATE HOUSING BMR residential values at different AMI levels are summarized in Figure 8. Maximum sales prices and rents were provided by Hello Housing, the City’s BMR program administrator. Sales prices and rents for BMR units were calculated using the method and parameters established in the City’s Policy and Procedures Manual for Administering Deed Restricted Affordable Housing Units (“BMR Manual”).13 An income capitalization approach is also applied to BMR units to derive total residential value. 12 As mentioned above, the CBRE Investor’s Cap Rate Survey (H1, 2018) estimates the cap rate for infill multifamily Class A in San José Metro Area to range from 3.75 to 4.25%. 13 Maximum sales price calculations incorporate a 10% down payment, as well as an interest rate based on a 10-year rolling average for 30- year fixed-rate mortgages, according to data from Freddie Mac. Resale prices for existing BMR units are determined by the City. Annual housing costs associated with BMR rental units, including rent, utility costs, parking fees, and other costs, may not in sum exceed 30% of the annual income associated with the income target for which the unit is designated. 15 FIGURE 8. BELOW MARKET RATE RESIDENTIAL VALUES, BY PROTOTYPE AND AMI LEVEL Prototype 1 Prototype 2 Prototype 3 Prototype 4 Prototype 5 Income Target for Pricing BMR Units Detached Single Family Small Lot Single Family/ Townhomes Condominium Lower Density Rental Apartments Higher Density Rental Apartments 30% AMI (Extremely Low) n/a n/a n/a $116,806 $116,806 50% AMI (Very Low) n/a n/a n/a $211,968 $211,968 60% AMI (Low)* n/a n/a n/a $260,224 $260,224 90% AMI (Median)* $483,270 $344,879 $322,981 n/a n/a 110% AMI (Moderate)* $612,662 $462,872 $435,374 n/a n/a *Per policy, the maximum price for BMR units for low income is set at 60% AMI, median income at 90% AMI, and moderate income at 110% AMI. Note: All values are weighted averages, according to each prototype’s unit mix. Affordable sale prices and rents were provided by the City of Cupertino and Hello Housing, based on 2018 Santa Clara County income and rent limits, published by the California Tax Credit Allocation Committee, and the 2018 Santa Clara County maximum utility allowance, published by HUD. RETAIL COMMERCIAL Retail lease assumptions were developed from Costar listings for comparable ground floor retail spaces in Cupertino, with capitalization rates reported by CBRE for the San José Metro Area. The annual net operating income and capitalized value were calculated based on the assumptions shown in Figure 9. 16 FIGURE 9. RETAIL REVENUE ASSUMPTIONS AND CAPITALIZED VALUE Unit New Retail (NNN) Assumptions Monthly Rent, Triple Net (a) Per SF $4.25 Vacancy Percent 10% Operating Expenses Percent Pass through Capitalization Rate Percent 7.00% Capitalized Value Gross Annual Retail Income Per SF $51.00 Less Retail Vacancy Per SF -$5.10 Less Operating Expenses Per SF $0.00 Annual Net Operating Income Per SF $45.90 Capitalized Value Per SF $655.71 (a) Based on recent lease transactions in Cupertino for recently constructed ground-floor retail. Under a triple net lease (NNN) the tenant pays operating expenses, including real estate taxes, building insurance, and maintenance (the three "nets") on the property in addition to the rents. (b) Based on the CBRE H1 2018 Cap Rate Survey. Cap rates for the San José Metropolitan Area were between 4.5% to 5.5% for (Class A) and 6.25% to 7.25% (Class B) for Neighborhood Retail. Source: CBRE, 2018; Costar, 2018; Strategic Economics, 2018. 17 DEVELOPMENT COSTS The development costs incorporated into the pro forma analysis include land costs, hard costs (construction materials and labor), soft costs, and financing costs. Cost assumptions are summarized in Figure 10 and described below. LAND COSTS A critical factor for development feasibility is the cost of land. To determine the market value of sites zoned for residential use in Cupertino, Strategic Economics interviewed developers and reviewed recent pro formas for similar development projects in Cupertino and nearby communities. Recognizing that one of the key factors that drives the value of the site is the permitted density, this analysis assumes that sites zoned for single family detached homes are valued at $9 million per acre ($207 per square foot), while sites zoned for higher-density housing are valued at $10 million per acre ($230 per square foot). Note that these values are approximations for the purposes of the feasibility analysis; in reality, the value of any particular site is likely to vary based on its location, amenities, and property owner expectations. HARD COSTS Hard costs are based on Strategic Economics’ review of pro formas for similar development projects, as well as interviews with developers active in Cupertino and surrounding cities. The assumptions for hard costs, shown in Figure 10, include estimates for basic site improvements and construction costs for residential areas, retail areas, and parking structures. It should be noted that construction costs have been escalating rapidly in the Bay Area in the last several years14; project feasibility is highly sensitive to changes in construction cost assumptions. SOFT COSTS AND FINANCING COSTS Soft costs include items such as architectural fees, engineering fees, insurance, taxes, legal fees, accounting fees, marketing costs, developer overhead, and city fees, as shown in Figure 10. City fees and other development impact fees were calculated for the individual prototypes based on data provided by City staff. Detailed fee calculations are shown in Figure 21. Other soft costs were estimated based on standard industry ratios, calculated as a percentage of hard costs. 14 Terner Center for Housing Innovation, UC Berkeley. Understanding the Drivers of Rising Construction Costs in California (Ongoing Research), https://ternercenter.berkeley.edu/construction-costs. 18 FIGURE 10: DEVELOPMENT COST ASSUMPTIONS Metric Estimate Land Costs Land zoned for single-family per site acre $9 million Land zoned for townhomes/multi-family/mixed-use per site acre $10 million Hard Costs Site Costs (demo, infrastructure, etc.) per site sq. ft. $30 Residential Area Single Family (includes 2-car garage) per gross sq. ft. $95 Townhomes (includes 2-car garage) per gross sq. ft. $150 Stacked condominiums (Type V) per gross sq. ft. $275 Stacked apartments (Type V) per gross sq. ft. $235 Higher density apartments (Type 3 modified) per gross sq. ft. $300 Retail Area (Including T.I) per gross retail sq. ft. $130 Surface parking per space $10,000 Podium parking per space $35,000 Soft Costs Architectural, Engineering, Consulting % of hard costs 6% Taxes, Insurance, Legal, Accounting % of hard costs 3% Other % of hard costs 3% Contingency % of hard costs 5% Developer Overhead and Fees % of hard costs 4% City Permits and Fees (a) Prototype 1 per unit $153,022 Prototype 2 per unit $83,463 Prototype 3 per unit $67,755 Prototype 4 per unit $65,949 Prototype 5 per unit $67,241 Financing Costs Financing % of hard and soft costs 6% (a) Includes City fees and permits, school district fees, and sanitation district fees paid on the residential and retail component of each prototype for market rate units. Includes housing mitigation fee for the retail component. Sources: Developer interviews, 2018; City of Cupertino, 2018; Cupertino School District and Fremont High School District, 2018; Strategic Economics, 2018. 19 Key Results This section summarizes the findings of the financial feasibility analysis under different inclusionary housing scenarios for each prototype. Figure 11 and Figure 12 demonstrate the return obtained by each prototype, compared to the minimum threshold for feasibility. Figure 21 shows development costs by type and detailed City fees. Figure 22 through Figure 26 provide the pro forma results for each prototype. Ownership residential development can feasibly support higher inclusionary requirements than rental development. While growth in apartment rents has reportedly started to plateau in Santa Clara County in the last year, ownership prices (including condominium prices) continue to increase, making it generally more feasible to build ownership projects.15 Detached single-family development (Prototype 1) can support an inclusionary requirement of 15%, 20%, or the payment of Housing Mitigation Fees. As shown in Figure 11, the single-family detached Prototype 1 shows positive project revenues for Scenarios 1, 2, and 4, achieving a return on cost (ROC) well above the minimum threshold of 10%. Recent sales prices of newly constructed single-family homes in Cupertino are sufficient to offset development costs as well as support inclusionary requirements or the payment of Housing Mitigation Fees. However, the single-family detached prototype cannot support an inclusionary requirement of 25% (Scenario 3), which generates a return of less than 1%. Figure 22 provides more detailed pro forma results for this prototype. Small lot/townhome development (Prototype 2) can also support all inclusionary requirement of 15%, 20%, or the payment of Housing Mitigation Fees. As shown in Figure 11, Prototype 2 shows positive project revenues for Scenarios 1, 2, and 4, achieving a return exceeding the minimum threshold of 15% required for feasibility. Although there has been limited townhome construction in recent years in Cupertino, recent townhome re-sales suggest that prices for new construction would generate sufficient revenues to offset development costs as well as support any inclusionary requirement or the payment of Housing Mitigation Fees. Figure 23 provides more detailed pro forma results for this prototype. A mixed-use condominium prototype (Prototype 3) can support inclusionary requirements of 15%, 20%, or the payment of Housing Mitigation Fees. As shown in Figure 11, Prototype 3 shows positive project revenues for Scenarios 1, 2, and 4, achieving a return well above the minimum threshold of 15%. Despite the lack of recent condominium construction in Cupertino, condominium re-sales suggest that prices for new construction would support any of the scenarios that impose an inclusionary requirement or the payment of in-lieu fees. Figure 24 provides more detailed pro forma results for this prototype. The lower density mixed-use apartment prototype (Prototype 4) is nearly feasible as a 100% market- rate project. Without any BMR requirements, the lower density rental prototype achieves a yield on cost of 4.5%, below the minimum requirement of 4.75%, as shown in Figure 12. The lower density rental prototype does not generate sufficient revenues to support inclusionary requirements or in-lieu fees under current rents and costs. Figure 25 provides the pro forma for this prototype. 15 Mercury News, Louis Hansen, May 16, 2018. Bay Area condo market heats up as alternative to pricey homes. https://www.mercurynews.com/2018/05/16/bay-area-condo-market-heats-up-as-alternative-to-pricier-homes/ 20 The higher density rental multifamily prototype (Prototype 5) can support Housing Mitigation Fee payments (Scenario 4) but cannot feasibly provide inclusionary BMR units under current market rents, construction costs, and land costs. Prototype 5 achieves a higher YOC than Prototype 4, largely due to the greater efficiencies of a higher density project, and is financially feasible in Scenario 1 and Scenario 4 (see Figure 12). Figure 26 provides more detailed pro forma results. The lower density mixed-use apartment prototype (Prototype 4) can feasibly provide up to 15% inclusionary BMR units if it could command 15% higher revenues or if construction and land costs were reduced by 15%. If a lower density rental project were able to achieve higher revenues (15% higher) on the apartment units and on the ground-floor retail space, as shown in Figure 13 and Figure 14, the project could feasibly accommodate an inclusionary requirement of 15% BMR units. Alternatively, if a development project were able to secure a construction bid and purchase a site that reduced these costs by 15%, the lower density mixed-use apartment prototype could feasibly provide 15% inclusionary BMR units (see Figure 15 and Figure 16). The higher density mixed-use apartment prototype (Prototype 5) can feasibly provide inclusionary BMR units if it can command 10% higher revenues or if construction and land costs were reduced by 5%. If a higher density rental project can achieve 10% higher rents on the apartments and retail space, the project can feasibly accommodate an inclusionary requirement of 15% BMR units (see Figure 17 and Figure 18). In another scenario, if a higher density mixed-use apartment could secure a construction bid and site that is 5% less expensive, this prototype could also feasibly provide 15% inclusionary BMR units (see Figure 19 and Figure 20). 21 FIGURE 11: RETURN ON COST FOR OWNERSHIP PROTOTYPES BY INCLUSIONARY HOUSING SCENARIO Inclusionary Housing Scenarios Prototype 1: Prototype 2: Prototype 3: Single Family Detached Small Lot SF/Townhouse Condominiums Minimum Required Return 10-15% 18-20% 18-20% Scenario 0 (No Requirements) 31% 41% 38% Scenario 1 (Existing Policy) 15% 26% 23% Scenario 2 (20% Inclusionary) 14% 21% 19% Scenario 3 (25% Inclusionary) 1% 16% 14% Scenario 4 (In-Lieu Fees) 28% 37% 33% Source: Strategic Economics, 2019. FIGURE 12: YIELD ON COST UNDER DIFFERENT INCLUSIONARY HOUSING SCENARIOS FOR MULTI-FAMILY RENTAL PROTOTYPES 4 AND 5 Inclusionary Housing Scenarios Prototype 4: Prototype 5: Lower Density Rental Higher Density Rental Minimum Required Yield on Cost 4.75%-5.25% 4.75%-5.25% Scenario 0 (No Requirements) 4.52% 4.93% Scenario 1 (15% Inclusionary) 4.22% 4.63% Scenario 2 (20% Inclusionary) 4.10% 4.50% Scenario 3 (25% Inclusionary) 3.94% 4.34% Scenario 4 (In Lieu Fees) 4.40% 4.76% Source: Strategic Economics, 2019. 22 FIGURE 13: YIELD ON COST UNDER DIFFERENT REVENUE ASSUMPTIONS FOR LOWER DENSITY MULTI-FAMILY RENTAL (PROTOTYPE 4) WITH 15% BMR REQUIREMENT Revenue Assumptions Monthly Market Rate Apt. Rent per Unit Monthly Retail Rent per SF Yield on Cost Feasibility Results Current Apartment and Retail Rents $4,216 $4.25 4.22% Not Feasible Increased Rents (15% Higher Revenues) $4,848 $4.89 4.82% Feasible Source: Strategic Economics, 2019. FIGURE 14: FEASIBILITY OF LOWER DENSITY MULTI-FAMILY RENTAL PROTOTYPE (PROTOTYPE 4) WITH 15% INCLUSIONARY BMR REQUIREMENT AND INCREASED REVENUES Source: Strategic Economics, 2019. 0.00% 0.50% 1.00% 1.50% 2.00% 2.50% 3.00% 3.50% 4.00% 4.50% 5.00% 5.50% Current Apartment and Retail Rents Increased Rents (15% Higher Apartment and Retail Revenues)Profit (Yield on Cost) Minimum Threshold for Feasibility of 4.75% 23 FIGURE 15: YIELD ON COST UNDER DIFFERENT COST ASSUMPTIONS FOR LOWER DENSITY MULTI-FAMILY RENTAL (PROTOTYPE 4) WITH 15% BMR REQUIREMENT Cost Assumptions Construction Cost per Unit Land Cost per Unit Yield on Cost Feasibility Results Current Costs $385,958 $250,000 4.22% Not Feasible Reduced Costs (15% Lower Costs) $328,064 $212,500 4.90% Feasible Source: Strategic Economics, 2019. FIGURE 16: FEASIBILITY RESULTS OF LOWER DENSITY MULTI-FAMILY RENTAL PROTOTYPE (PROTOTYPE 4) WITH 15% INCLUSIONARY BMR REQUIREMENT AND LOWER COSTS Source: Strategic Economics, 2019. 0.00% 0.50% 1.00% 1.50% 2.00% 2.50% 3.00% 3.50% 4.00% 4.50% 5.00% 5.50% Current Costs Reduced Costs (15% Lower Costs)Yield on CostMinimum Threshold for Feasibility of 4.75% 24 FIGURE 17: YIELD ON COST UNDER DIFFERENT REVENUE ASSUMPTIONS FOR HIGHER DENSITY MULTI-FAMILY RENTAL (PROTOTYPE 5) WITH 15% BMR REQUIREMENT Revenue Assumptions Monthly Market Rate Apt. Rent per Unit Monthly Retail Rent per SF Yield on Cost Feasibility Results Current Rents $4,216 $4.25 4.63% Not Feasible Increased Rents (10% Higher Revenues) $4,637 $4.68 4.91% Feasible Source: Strategic Economics, 2019. FIGURE 18: FEASIBILITY RESULTS OF HIGHER DENSITY MULTI-FAMILY RENTAL PROTOTYPE (PROTOTYPE 5) WITH 15% INCLUSIONARY BMR REQUIREMENT AND HIGHER REVENUES Source: Strategic Economics, 2019. 0.00% 0.50% 1.00% 1.50% 2.00% 2.50% 3.00% 3.50% 4.00% 4.50% 5.00% 5.50% Current Rents Increased Rents (10% Higher Apartment and Retail Revenues)Yield on Cost Minimum Threshold for Feasibility of 4.75% 25 FIGURE 19: YIELD ON COST UNDER DIFFERENT COST ASSUMPTIONS FOR HIGHER DENSITY MULTI-FAMILY RENTAL (PROTOTYPE 5) WITH 15% BMR REQUIREMENT Cost Assumptions Construction Cost per Unit Land Cost per Unit Yield on Cost Feasibility Results Current Costs $460,195 $131,579 4.63% Not Feasible Reduced Costs (5% Lower Costs) $437,185 $125,000 4.85% Feasible Source: Strategic Economics, 2019. FIGURE 20: FEASIBILITY RESULTS OF HIGHER DENSITY MULTI-FAMILY RENTAL PROTOTYPE (PROTOTYPE 5) WITH 15% INCLUSIONARY BMR REQUIREMENT AND LOWER COSTS Source: Strategic Economics, 2019. 0.00% 0.50% 1.00% 1.50% 2.00% 2.50% 3.00% 3.50% 4.00% 4.50% 5.00% 5.50% Current Costs Reduced Costs (5% Lower)Yield on Cost Minimum Threshold for Feasibility of 4.75% 26 FIGURE 21. DETAILED CALCULATION OF THE CITY OF CUPERTINO’S PERMITS AND FEES FOR EACH PROTOTYPE (PER UNIT) Prototype 1 Prototype 2 Prototype 3 Prototype 4 Prototype 5 Detached Single Family Small Lot Single Family/Townhome Condominium Lower Density Rental Apartments Higher Density Rental Apartments Planning Fees Planning Applications $9,210 $1,289 $645 $400 $400 CEQA $3,571 $2,447 $1,223 $1,223 $1,223 Consultant Review $2,111 $296 $148 $148 $148 Housing Mitigation Fee (Non-residential only) $0 $0 $1,188 $1,188 $1,782 Public Works Fees Transportation Impact Fee $6,177 $3,380 $4,374 $4,374 $4,871 Grading $420 $59 $29 $29 $29 Tract Map $1,350 $189 $94 $94 $94 Plan Check and Inspection $543 $76 $38 $38 $38 Storm Drain Fees $4,902 $501 $367 $354 $312 Parkland Dedication (a) $105,000 $60,000 $54,000 $54,000 $54,000 Building Division Fees Building Fees $11,428 $10,592 $1,664 $1,133 $1,199 Construction Tax $752 $752 $1,075 $1,075 $1,237 Other Fees School District Fees (b) $7,012 $3,506 $2,826 $1,808 $1,823 Sanitary Sewer District Connection Permit Fee $350 $350 $70 $70 $70 Stormwater Management Fee $197 $28 $14 $14 $14 Estimated City Fees, Total Per Unit $153,022 $83,463 $67,755 $65,949 $67,241 (a) Parkland dedication fees waived for affordable units. (b) Based on the average of Cupertino School District and Fremont Union High School District school fees. Sources: City of Cupertino, 2018; Fremont Union School District; Cupertino School District; Cupertino Sanitary Sewer District, 2018. 27 FIGURE 22: FINANCIAL FEASIBILITY RESULTS FOR SINGLE-FAMILY DETACHED PROTOTYPE 1 Scenario 0 (No BMR Req.) Scenario 1 (15% On-Site) Scenario 2 (20% On-Site) Scenario 3 (25% On-Site) Scenario 4 (In-Lieu Fees) Total Units 7 7 7 7 7 Market Rate Units 7 6 6 5 7 Affordable Units 0 1 1 2 0 Fractional Units 0 0.05 0.4 0 0 Revenues Residential Capitalized Value $24,501,400 $21,484,470 $21,484,470 $18,596,932 $24,501,400 Per Unit $3,500,200 $3,069,210 $3,069,210 $2,656,705 $3,500,200 Development Costs Land Costs Land Costs $14,000,000 $14,000,000 $14,000,000 $14,000,000 $14,000,000 Per Unit $2,000,000 $2,000,000 $2,000,000 $2,000,000 $2,000,000 Direct Costs Gross Residential Area (a) $2,775,564 $2,775,564 $2,775,564 $2,775,564 $2,775,564 Subtotal Direct Costs $2,775,564 $2,775,564 $2,775,564 $2,775,564 $2,775,564 Per Unit $396,509 $396,509 $396,509 $396,509 $396,509 Per Gross Sq. Ft. $95 $95 $95 $95 $95 Indirect Costs City Fees (b) $1,071,155 $991,537 $1,169,211 $861,155 $1,532,693 Other Soft Costs (c) $582,868 $582,868 $582,868 $582,868 $582,868 Per Unit $83,266.92 $83,266.92 $83,266.92 $83,266.92 $83,266.92 Subtotal Indirect Costs $1,654,023 $1,574,405 $1,752,079 $1,444,023 $2,115,561 Per Unit $236,289 $224,915 $250,297 $206,289 $302,223 Financing $265,775 $260,998 $271,659 $253,175 $293,468 Per Unit $37,968 $37,285 $38,808 $36,168 $41,924 Total Development Costs $18,695,363 $18,610,968 $18,799,302 $18,472,763 $19,184,593 Per Unit $2,670,766 $2,658,710 $2,685,615 $2,638,966 $2,740,656 Per Gross Sq. Ft. $640 $637 $643 $632 $657 Feasibility Net Revenue (d) $5,806,037 $2,873,502 $2,685,168 $124,169 $5,316,807 Return on Cost (e) 31% 15% 14% 1% 28% (a) Includes costs for site prep and 2-car parking garage (b) Figure 14 shows detailed City fees. Includes fractional in-lieu housing mitigation fee for scenario 1 and 2. Parkland dedication fees waived for affordable units. (c) Includes architectural fees, engineering fees, insurance, taxes, legal fees, accounting fees, marketing costs, and developer overhead (d) Net revenue is the project total revenue minus total development costs. (d) Return on cost is the net revenue, divided by total development costs. (e) Return on cost is the net revenue, divided by total development costs. Source: Strategic Economics, 2018. 28 FIGURE 23: FINANCIAL FEASIBILITY RESULTS FOR SMALL LOT SINGLE-FAMILY/TOWNHOUSE PROTOTYPE 2 Scenario 0 (No BMR Req.) Scenario 1 (15% On-Site) Scenario 2 (20% On-Site) Scenario 3 (25% On-Site) Scenario 4 (In-Lieu Fees) Total Units 50 50 50 50 50 Market Rate Units 50 42 40 37 50 Affordable Units 0 8 10 13 0 Revenues Residential Capitalized Value $89,725,000 $79,265,818 $75,818,755 $72,312,696 $89,725,000 Retail Capitalized Value $0 $0 $0 $0 $0 Total Capitalized Value $89,725,000 $79,265,818 $75,818,755 $72,312,696 $89,725,000 Per Unit $1,794,500 $1,585,316 $1,516,375 $1,446,254 $1,794,500 Development Costs Land Costs Land Costs $33,333,333 $33,333,333 $33,333,333 $33,333,333 $33,333,333 Per Unit $666,667 $666,667 $666,667 $666,667 $666,667 Direct Costs Site Prep/Demo $4,356,000 $4,356,000 $4,356,000 $4,356,000 $4,356,000 Gross Residential Area (a) $15,651,677 $15,651,677 $15,651,677 $15,651,677 $15,651,677 Subtotal Direct Costs $20,007,677 $20,007,677 $20,007,677 $20,007,677 $20,007,677 Per Unit $400,154 $400,154 $400,154 $400,154 $400,154 Per Gross Sq. Ft. $192 $192 $192 $192 $192 Indirect Costs City Fees (b) $4,173,154 $3,693,154 $3,573,154 $3,393,154 $5,986,154 Other Soft Costs (c) $4,201,612 $4,201,612 $4,201,612 $4,201,612 $4,201,612 Per Unit $84,032 $84,032 $84,032 $84,032 $84,032 Subtotal Indirect Costs $8,374,767 $7,894,767 $7,774,767 $7,594,767 $10,187,767 Per Unit $167,495 $157,895 $155,495 $151,895 $203,755 Financing $1,702,947 $1,674,147 $1,666,947 $1,656,147 $1,811,727 Per Unit $34,059 $33,483 $33,339 $33,123 $36,235 Total Development Costs $63,418,723 $62,909,923 $62,782,723 $62,591,923 $65,340,503 Per Unit $1,268,374 $1,258,198 $1,255,654 $1,251,838 $1,306,810 Per Gross Sq. Ft. $608 $603 $602 $600 $626 Feasibility Net Revenue (d) $26,306,277 $16,355,895 $13,036,032 $9,720,772 $24,384,497 Return on Cost (e) 41% 26% 21% 16% 37% (a) Includes 2-car parking garage (b) Figure 14 shows applicable city fees. Only Scenario 4 pays in-lieu housing mitigation fees. Parkland dedication fees waived for affordable units. (c) Includes architectural fees, engineering fees, insurance, taxes, legal fees, accounting fees, marketing costs, and developer overhead (d) Net revenue is the project total revenue minus total development costs. (d) Return on cost is the net revenue, divided by total development costs. (e) Return on cost is the net revenue, divided by total development costs. Source: Strategic Economics, 2018. 29 FIGURE 24: FINANCIAL FEASIBILITY RESULTS FOR CONDOMINIUM PROTOTYPE 3 Scenario 0 (No BMR Req.) Scenario 1 (15% On-Site) Scenario 2 (20% On-Site) Scenario 3 (25% On-Site) Scenario 4 (In-Lieu Fees) Total Units 100 100 100 100 100 Market Rate Units 100 85 80 75 100 Affordable Units 0 15 20 25 0 Revenues Residential Capitalized Value $154,250,000 $136,743,959 $130,983,540 $125,110,729 $154,250,000 Retail Capitalized Value $6,557,143 $6,557,143 $6,557,143 $6,557,143 $6,557,143 Total Capitalized Value $160,807,143 $143,301,101 $137,540,683 $131,667,871 $160,807,143 Per Unit $1,608,071 $1,433,011 $1,375,407 $1,316,679 $1,608,071 Development Costs Land Costs Land Costs $28,571,429 $28,571,429 $28,571,429 $28,571,429 $28,571,429 Per Unit $285,714 $285,714 $285,714 $285,714 $285,714 Direct Costs Site Prep/Demo $3,733,714 $3,733,714 $3,733,714 $3,733,714 $3,733,714 Gross Residential Area $50,703,125 $50,703,125 $50,703,125 $50,703,125 $50,703,125 Gross Retail Area $1,300,000 $1,300,000 $1,300,000 $1,300,000 $1,300,000 Parking $7,560,000 $7,560,000 $7,560,000 $7,560,000 $7,560,000 Subtotal Direct Costs $63,296,839 $63,296,839 $63,296,839 $63,296,839 $63,296,839 Per Unit $632,968 $632,968 $632,968 $632,968 $632,968 Per Gross Sq. Ft. $343 $343 $343 $343 $343 Indirect Costs City Fees (a) $6,775,479 $5,965,479 $5,695,479 $5,425,479 $10,398,879 Other Soft Costs (b) $13,292,336 $13,292,336 $13,292,336 $13,292,336 $13,292,336 Per Unit $132,923 $132,923 $132,923 $132,923 $132,923 Subtotal Indirect Costs $20,067,815 $19,257,815 $18,987,815 $18,717,815 $23,572,415 Per Unit $200,678 $192,578 $189,878 $187,178 $235,724 Financing $5,001,879 $4,953,279 $4,937,079 $4,920,879 $5,212,155 Per Unit $50,019 $49,533 $49,371 $49,209 $52,122 Total Development Costs $116,937,963 $116,079,363 $115,793,163 $115,506,963 $120,652,839 Per Unit $1,169,380 $1,160,794 $1,157,932 $1,155,070 $1,206,528 Per Gross Sq. Ft. $634 $630 $628 $626 $654 Feasibility Net Revenue (c) $43,869,180 $27,221,739 $21,747,520 $16,160,909 $40,154,304 Return on Cost (d) 38% 23% 19% 14% 33% (a) Figure 14 shows detailed city fees. In-lieu housing mitigation fees apply to non-residential sq. ft. and Scenario 4. Parkland dedication fees waived for affordable units. (b) Includes architectural fees, engineering fees, insurance, taxes, legal fees, accounting fees, marketing costs, and developer overhead. (c) Net revenue is the project total revenue minus total development costs. (d) Return on cost is the net revenue, divided by total development costs. Source: Strategic Economics, 2018. 30 FIGURE 25: FINANCIAL FEASIBILITY RESULTS FOR LOWER DENSITY RENTAL APARTMENTS PROTOTYPE 4 Scenario 0 (No BMR Req.) Scenario 1 (15% On-Site) Scenario 2 (20% On-Site) Scenario 3 (25% On-Site) Scenario 4 (In-Lieu Fees) Total Units 100 100 100 100 100 Market Rate Units 100 85 80 75 100 Affordable Units 0 15 20 25 0 Revenues Residential Net Operating Income $3,288,285 $2,942,477 $2,831,310 $2,691,717 $3,288,285 Retail Net Operating Income $459,000 $459,000 $459,000 $459,000 $459,000 Total Net Operating Income $3,747,285 $3,401,477 $3,290,310 $3,150,717 $3,747,285 Total Capitalized Value $83,928,555 $75,791,903 $73,176,197 $69,891,657 $83,928,555 Per Unit $839,286 $757,919 $731,762 $698,917 $839,286 Development Costs Land Costs Land Costs $25,000,000 $25,000,000 $25,000,000 $25,000,000 $25,000,000 Per Unit $250,000 $250,000 $250,000 $250,000 $250,000 Direct Costs Site Prep/Demo $3,267,000 $3,267,000 $3,267,000 $3,267,000 $3,267,000 Gross Residential Area $27,553,750 $27,553,750 $27,553,750 $27,553,750 $27,553,750 Gross Retail Area $1,300,000 $1,300,000 $1,300,000 $1,300,000 $1,300,000 Parking $7,560,000 $6,475,000 $6,475,000 $6,475,000 $7,560,000 Subtotal Direct Costs $39,680,750 $38,595,750 $38,595,750 $38,595,750 $39,680,750 Per Unit $396,808 $385,958 $385,958 $385,958 $396,808 Per Gross Sq. Ft. $338 $329 $329 $329 $338 Indirect Costs City Fees (a) $6,594,875 $5,784,875 $5,514,875 $5,244,875 $8,942,363 Other Soft Costs (b) $8,332,958 $8,105,108 $8,105,108 $8,105,108 $8,332,958 Per Unit $83,329.58 $81,051.08 $81,051.08 $81,051.08 $83,329.58 Subtotal Indirect Costs $14,927,832 $13,889,982 $13,619,982 $13,349,982 $17,156,520 Per Unit $149,278 $138,900 $136,200 $133,500 $171,565 Financing $3,276,515 $3,149,144 $3,132,944 $3,116,744 $3,410,236 Per Unit $32,765 $31,491 $31,329 $31,167 $34,102 Total Development Costs $82,885,097 $80,634,876 $80,348,676 $80,062,476 $85,247,506 Per Unit $828,851 $806,349 $803,487 $800,625 $852,475 Per Gross Sq. Ft. $707 $688 $685 $683 $727 Feasibility Net Revenue (c) $1,043,457 ($4,842,973) ($7,172,479) ($10,170,819) ($1,318,952) Yield on Cost (d) 4.5% 4.2% 4.1% 3.9% 4.4% (a) Appendix shows detailed city fees. Excludes affordable housing mitigation in-lieu fee, except in Scenario 4. Parkland dedication fees waived for affordable units. (b) Includes architectural fees, engineering fees, insurance, taxes, legal fees, accounting fees, marketing costs, and developer overhead. (c) Net revenue is the project total revenue minus total development costs. (d) Yield on cost is the total project net operating income divided by total development costs. Source: Strategic Economics, 2018. 31 FIGURE 26: FINANCIAL FEASIBILITY RESULTS FOR HIGHER DENSITY RENTAL APARTMENTS PROTOTYPE 5 Scenario 0 (No BMR Req.) Scenario 1 (15% On-Site) Scenario 2 (20% On-Site) Scenario 3 (25% On-Site) Scenario 4 (In-Lieu Fees) Total Units 100 100 100 100 100 Market Rate Units 100 85 80 75 100 Affordable Units 0 15 20 25 0 Revenues Residential Net Operating Income $3,288,285 $2,942,477 $2,831,310 $2,691,717 $3,288,285 Retail Net Operating Income $688,500 $688,500 $688,500 $688,500 $688,500 Total Net Operating Income $3,976,785 $3,630,977 $3,519,810 $3,380,217 $3,976,785 Total Capitalized Value $87,207,126 $79,070,475 $76,454,769 $73,170,229 $87,207,126 Per Unit $872,071 $790,705 $764,548 $731,702 $872,071 Development Costs Land Costs Land Costs $13,157,895 $13,157,895 $13,157,895 $13,157,895 $13,157,895 Per Unit $131,579 $131,579 $131,579 $131,579 $131,579 Direct Costs Site Prep/Demo $1,719,474 $1,719,474 $1,719,474 $1,719,474 $1,719,474 Gross Residential Area $35,175,000 $35,175,000 $35,175,000 $35,175,000 $35,175,000 Gross Retail Area $1,950,000 $1,950,000 $1,950,000 $1,950,000 $1,950,000 Parking $8,190,000 $7,175,000 $7,175,000 $7,175,000 $8,190,000 Subtotal Direct Costs $47,034,474 $46,019,474 $46,019,474 $46,019,474 $47,034,474 Per Unit $470,345 $460,195 $460,195 $460,195 $470,345 Per Gross Sq. Ft. $401 $392 $392 $392 $401 Indirect Costs City Fees (a) $6,724,069 $5,914,069 $5,644,069 $5,374,069 $9,688,129 Other Soft Costs (b) $9,877,239 $9,664,089 $9,664,089 $9,664,089 $9,877,239 Per Unit $98,772 $96,641 $96,641 $96,641 $98,772 Subtotal Indirect Costs $16,601,308 $15,578,158 $15,308,158 $15,038,158 $19,387,168 Per Unit $166,013 $155,782 $153,082 $150,382 $193,872 Financing $3,818,147 $3,695,858 $3,679,658 $3,663,458 $3,985,299 Per Unit $38,181 $36,959 $36,797 $36,635 $39,853 Total Development Costs $80,611,823 $78,451,384 $78,165,184 $77,878,984 $83,564,835 Per Unit $806,118 $784,514 $781,652 $778,790 $835,648 Per Gross Sq. Ft. $688 $669 $667 $664 $713 Feasibility Net Revenue (c) $6,595,303 $619,090 ($1,710,416) ($4,708,755) $3,642,291 Yield on Cost (d) 4.9% 4.6% 4.5% 4.3% 4.8% (a) Appendix shows detailed city fees. Excludes affordable housing mitigation in-lieu fee, except in Scenario 4. Parkland dedication fees waived for affordable units. (b) Includes architectural fees, engineering fees, insurance, taxes, legal fees, accounting fees, marketing costs, and developer overhead. (c) Net revenue is the project total revenue minus total development costs. (d) Yield on cost is the total project net operating income divided by total development costs. Source: Strategic Economics, 2018. 32 Peer Cities Strategic Economics researched BMR housing programs in peer cities, including: San Jose, Santa Clara, Campbell, Mountain View, Sunnyvale, and Palo Alto. The key findings from the research are explained below and summarized in Figure 27. INCLUSIONARY REQUIREMENTS As shown in Figure 27, all of the cities have inclusionary requirements for ownership housing. They are typically set at 15%, with the exception of Mountain View and Sunnyvale, which have requirements of 10% and 12.5%, respectively. For rental housing, Palo Alto and Sunnyvale have a housing mitigation fee, but no inclusionary requirements. However, both cities are considering revising their policies on rental housing. TARGET INCOME For inclusionary requirements on ownership housing, all of the peer cities have targeted moderate- income households, roughly defined as between 80 and 120% of AMI. For rental housing, the income target is typically low-income (up to 80% AMI), although San Jose also targets very low-income households (up to 50% AMI). Santa Clara has targeted moderate-income households for both ownership and rental housing requirements. Cities that charge housing mitigation fees on rental or ownership housing have set their fees based on nexus studies that measure the affordable housing needs of very-low, low-, and moderate-income households. None of the peer cities have targeted extremely-low income households for their inclusionary requirements. However, city staff from Sunnyvale and San Jose have indicated that they are providing funding to develop housing for extremely-low income households through the revenues they have collected from housing mitigation fees, in-lieu fees, and other housing funds. Local revenues are often combined with Santa Clara County Measure A funds – which are specifically targeted to extremely-low income households – as well as 9% and 4% Low Income Housing Tax Credits (LIHTC) and Section 8 vouchers from the Santa Clara County Housing Authority. ALTERNATIVE MEANS OF COMPLIANCE All of the cities prefer that units are built onsite, but they allow alternative means of complying with inclusionary requirements. Developers can typically satisfy the requirement by providing units off-site, paying in-lieu fees, or dedicating land for affordable housing. However, in some cases, the developer must first demonstrate that the inclusionary requirement is not feasible. For example, the City of Palo Alto requires that the applicant present “substantial evidence to support a finding of infeasibility” and of “feasibility of any proposed alternative.” In other cities, like Mountain View, Sunnyvale, and Santa Clara, developers must receive approval from the City Council for the alternative. In Sunnyvale and San Jose, developers that pursue an alternative to the onsite inclusionary requirement must provide a higher number of affordable units. 33 FIGURE 27: INCLUSIONARY HOUSING REQUIREMENTS AND HOUSING MITIGATION FEES IN PEER CITIES City Inclusionary Requirement Target Income for BMR Policy Housing Mitigation Fee/In Lieu Fees Alternatives to compliance Ownership Rental Ownership Rental Ownership Rental Cupertino 15% 15% 1/2 of BMR units at Median (100% AMI) and 1/2 of BMR units at Moderate (120% AMI)* 60% of BMR units at Very Low (50% AMI) and 40% of BMR units at Low (60% AMI) -Single family: $17.82/sf -Small lot single family/Townhome: $19.60/sf -Multifamily attached: $23.76/sf -Multifamily Attached (up to 35 du/ac): $23.76/sf -Multifamily attached (over 35 du/ac): $29.70/sf Onsite units are preferred, but alternatives may be possible with City Council approval. These include: on-site BMR rental units where ownership units or a fee is required; purchase of off-site units to be dedicated/rehabbed as for-sale or rental BMR units; development of off-site units to be dedicated as for-sale or rental BMR units; land for development of affordable housing. An Affordable Housing Plan is required. Mountain View 10% 15% Moderate (80 - 120% AMI) Low (50-80% AMI) In-lieu fee of 3% of sales price $34/sf (applies to fractional units only) Onsite units are preferred, but City Council can approve other alternatives. Sunnyvale 12.5% None Moderate (Below 120% AMI) Low (Below 80% AMI) In-lieu fee of 7% of sales price $17/sf For ownership units, onsite units are preferred. With Council approval, developers may provide alternatives if they result in a higher number of BMR units. San Jose 15% 15% Moderate (Below 120% AMI) 9% Mod (80% AMI) 6% VLI (30- 50% AMI) In-lieu fee of $153,000 per unit. $17.41/sf for projects of 3 to 19 units in size Developers have the option of providing units off-site or paying in-lieu fees, but the affordable housing requirement is 20%, and the target income is lower. Santa Clara 15% 15% Moderate (Below 100% AMI) Moderate (Below 100% AMI) $20-$30/sf, depending on housing type Alternatives include dedication of land for affordable housing, development of affordable units at an off-site location, or some combination thereof, with approval from City Council through a Development Agreement. Campbell 15% 15% Moderate (Below 110% AMI) Low (Below 70% AMI) $34.50/sf for projects of 6 units or less None Developers can dedicate land or pay in lieu fees. Palo Alto 15% None 2/3 BMR units at 80- 100% AMI and 1/3 BMR units at 100- 120% AMI Mod (80- 120% AMI) Low (50-80% AMI) VLI (30-50% AMI) $50-$75/sf depending on housing type $20/sf Developers can dedicate land, pay in lieu fees, provide rental units within the ownership project, convert or rehabilitate affordable housing units. They must first demonstrate that the inclusionary requirement is not feasible. *Sales prices set at 110% for BMR moderate income unit and 90% for a BMR median income unit. Source: Interviews with City staff, BMR housing ordinances, Strategic Economics, 34 NON-RESIDENTIAL LINKAGE FEE The City is considering updating non-residential fees, otherwise known as commercial linkage fees, on new workplace buildings (office, R&D, hotel, and retail development projects). Linkage fees are used to mitigate the impacts of an increase in affordable housing demand associated with a net increase in worker households. as employees at new non-residential developments seek housing nearby. The funds raised by the linkage fees are deposited into a housing fund specifically reserved for use by a local jurisdiction to increase the supply of affordable housing for the workforce. Linkage fees are one of several funding sources that jurisdictions can use to help meet affordable housing needs of new workers. The City first adopted linkage fees for office and R&D projects in 1992, and expanded the program to apply to retail and hotel developments in 2004. Following a 2015 nexus study update completed by Keyser Marston Associates, the City amended the fees for all three uses to their current levels--$23.76 for office/R&D uses, and $11.88 for hotel and retail uses.16 This memo report provides updated policy analysis, including a financial feasibility analysis, and a review of current non-residential linkage fees in neighboring cities to establish a recommendation on updated linkage fees in Cupertino. Approach METHODOLOGY The financial feasibility of establishing updated non-residential linkage fees in Cupertino was tested using a pro forma model that measures profit for the developer or investor. Yield on cost (YOC) is a commonly used metric indicating the profitability of a non-residential project. The pro forma model tallies all development costs, including land, direct construction costs, indirect costs (including financing), and developer fees. Revenues from lease rates or hotel room rates are the basis for calculating annual income from the new non-residential development. The total operating costs are subtracted from the total revenues to calculate the annual net operating income. The YOC is then estimated by dividing the annual net operating income by the total development costs. The fee levels were then added as an additional development cost to measure the resulting change in the YOC. DEVELOPMENT PROTOTYPES The analysis estimates the feasibility of potential linkage fees for three non-residential prototypes: office/R&D, hotel, and retail. The building characteristics of each development prototype, including size, density (floor-area-ratio), and parking assumptions are based on a review of projects that were recently built, and in planning stages in Cupertino, as well as recently built and pipeline projects in surrounding areas. Based on the development activity in Cupertino, the following is assumed regarding each prototype: • Office/R&D: Based on a review of market activity in the City, recent and proposed developments in neighboring cities, it is assumed that the office/R&D development project would be a speculative building serving the tech industry. 16 Keyser Marston Associates, “City of Cupertino: Non-residential Jobs-Housing Nexus Analysis,” City of Cupertino, April 2015. 35 • Hotel: Newer hotel development projects in Cupertino and surrounding areas are typically upscale, select-service chains that serve business travelers. • Retail: The retail development prototype is assumed to be a small low-density retail center. The details regarding the size, density (floor-area ratio), parking, and other key assumptions for each prototype are summarized in Figure 28 below. FIGURE 28. DESCRIPTION OF DEVELOPMENT PROTOTYPES Prototype Description Office/R&D Hotel Retail Project Type Class A Office Speculative Building Select-Service Upscale Business Hotel Neighborhood Retail Shopping Center Parcel Size (Sq. Ft.) 174,240 87,120 21,780 Parcel Size (Acres) 4 2 0.5 Total Stories 4 5 1 Floor-Area Ratio (without parking) (a) 1.50 1.20 0.35 Gross Building Area (GSF) 261,360 104,544 7,623 Efficiency Ratio (b) 90% n/a 90% Net area (NSF) 235,224 n/a 6,861 Number of rooms n/a 140 n/a Total Parking Spaces 825 155 30 Surface 93 70 30 Structured Garage 732 0 0 Underground 0 85 0 Parking Ratio (per room) n/a 1.1 n/a Parking Ratio (per 1,000 SF) 3.2 1.5 4.0 Notes: (a) The Floor-Area Ratio (FAR) is often used as a measure of density. In this analysis, it is calculated as the gross building area, not including parking, divided by the parcel size. (b) The Efficiency Ratio refers to the ratio of gross building area to ne leasable area. An efficiency ratio of 90% means that 90% of the gross building area is leasable space. In hotels, revenue is informed by room count, rather than square footage, and therefore the net area is omitted. DEVELOPMENT COSTS The development costs incorporated into the pro forma analysis include hard costs, (construction materials and labor) land costs, soft costs (indirect costs), and financing costs. HARD COSTS Hard costs are based on Strategic Economics’ review of pro formas for similar development projects, industry publications, and interviews with developers with projects in Cupertino and nearby jurisdictions. The assumptions for hard costs by prototype are described in Figure 29. They include estimates for basic site improvements, construction costs for the building, and costs for parking by type. In addition, the cost of construction includes a tenant improvement allowance for office/R&D and retail uses, as well as a Furniture, Fixtures, and Equipment (FF&E) allotment for hotel uses, which are both typical for this market. 36 FIGURE 29. HARD COSTS ASSUMPTIONS BY PROTOTYPE Cost Category Metric Office/R&D Hotel Retail Site Prep Per Site Sq. Ft. $3 $3 $3 Construction Costs Per Gross Building Sq. Ft. $300 $250 $165 Per Room $342,472 Parking Costs Cost per Space Surface $7,000 Structured Garage $30,000 Underground $60,000 Land Costs Entitled Land Per Site St. Ft. $137.74 $137.74 $75.00 Per Acre $6,000,000 $6,000,000 $3,267,000 Tenant Improvement Allowance Per Building Net Sq. Ft. $75 n/a $35 Furniture, Fixtures, Equipment Per Room n/a $35,000 n/a Source: Costar, 2019; HVS Consulting, 2017; review of pro formas for comparable development projects in Santa Clara County; interviews with developers in Cupertino and Santa Clara County, 2019; Strategic Economics, 2019. LAND COSTS One of the critical cost factors for a non-residential development project is land cost. To determine the land value of sites zoned for commercial uses, Strategic Economics analyzed recent sales transactions and estimates for properties in Santa Clara County and interviewed developers. Land values are similar for both hotel and office development in the Cupertino area, based on a review of recent transactions. Comparable values for office and hotel sites are showed in Figure 22 below. As shown, the land values typically range from $120 to $185 per square foot. One exception in the Cinnabar Street land sale for over $200 per square foot, which is in the Diridon Station Area, and planned for higher intensity development projects than the prototypes for this study. For the purposes of this analysis, it is assumed that sites zoned for office/R&D or hotel would have a land value of $138 per square foot ($6 million per acre). There are fewer land sales transactions for sites that are entitled for low-density retail development. However, a review of smaller retail property transactions shows that typically the land values are usually under $100 per square foot. For the purposes of this analysis, it is assumed that a low-density retail site in Cupertino would have a land value of $75 per square foot (about $3.2 million per acre). 37 FIGURE 30. LAND COMPARABLES FOR OFFICE AND HOTEL Property Jurisdiction Year Sold Acres Estimated Value Per Sq. Ft. Land Proposed Land Use 4995 Patrick Henry Dr. Santa Clara 2016 48.6 $118 Office 357-387 Cinnabar St. (a) San Jose 2017 5.6 $210 Office 767 Mathilda Ave. Sunnyvale 2017 3.28 $146 Hotel 10801 N. Wolfe Rd. (b) Cupertino 2018 1.72 $185 Hotel Notes: (a) 357-387 Cinnabar St. is in the Diridon Station area, and part of Google's transit village, which will have a significantly higher FAR than the office prototype. (b) Estimated value for 10801 N. Wolfe Rd. is based on valuation from CBRE in 2018 rather than a sales transaction. Sources: Costar, 2019; CBRE, 2018; SOFT COSTS Soft costs (often referred to as indirect costs) include items such as architectural fees, engineering fees, insurance, taxes, legal fees, accounting fees, city fees, and marketing costs. Cupertino’s Traffic Impact Fee was calculated based on the City’s fee schedule. Other permits and fees were calculated for each prototypes based on estimates generated for new development projects as part of the feasibility analysis for the Vallco Specific Plan. Soft costs were estimated based on standard industry ratios, calculated as a percentage of hard costs. These assumptions are shown in Figure 31. FIGURE 31. SOFT COST ASSUMPTIONS BY PROTOTYPE Soft Cost Metric Office/R&D Hotel Retail City Permits and Fees Traffic Impact Fee Office Per Gross Building Sq. Ft. $17.40 $4.70 $9.94 Hotel Per Room $3,387 Other Permits and Fees Per Gross Building Sq. Ft. $48.01 $38.34 $57.16 Subtotal City Permits and Fees Per Gross Building Sq. Ft. $65.41 $43.04 $67.10 Other Soft Costs Arch, Eng., & Consulting % of Hard Costs 5% 5% 5% Taxes, Insurance, Legal, Acct % of Hard Costs 3% 3% 3% Developer Overhead % of Hard Costs 4% 4% 4% Subtotal Other Soft Costs (Excluding Fees) % of Hard Costs 12% 12% 12% Construction Financing % of Hard + Soft Costs 6% 6% 6% Source: Review of pro formas for comparable development projects in Cupertino, 2019; Individual developer interviews, 2019; Vallco Specific Plan Feasibility Analysis, 2018; Strategic Economics, 2019. 38 REVENUES Revenue assumptions for each prototype are informed by a range of resources, including commercial broker reports, hospitality industry reports, and Costar, as well as from interviews with developers and brokers active in Cupertino and Santa Clara County. They are summarized in Figure 32. Office: For office rents, Strategic Economics reviewed Cupertino’s office market and the greater Santa Clara County office market. The largest office development in Cupertino has been the Apple Park project, which is a build-to-suit development specifically intended for Apple. There has been minimal recent speculative office development in Cupertino targeting other users. (Main Street was the only such project completed in the last five years, and most of the space has also been leased to Apple.) Buildings that are leased by Apple typically achieve rents of $4 per square foot per month (NNN), compared to lease rates of $4.50-$5.00 per square foot for tech office buildings in neighboring West San Jose and Sunnyvale (see Figure 33). This is due to the fact that landlords are willing to accept a lower rent for a long-term lease with Apple, due to the low risk associated with a major corporation. According to brokers and developers, there is potential to achieve higher rents for buildings that attract other smaller tech office tenants. For the purposes of this analysis, the rental rate assumption is $4.50 per square foot per month (NNN). While this rental rate is higher than the current average office rent in Cupertino, it is a reasonable estimate for a new, multi-tenant tech office building in the Silicon Valley. Hotel: The assumptions of hotel revenues are based on a combination of data sources, including interviews with hotel developers in Cupertino, and data from STR, a hotel research firm that tracks hotel room rates, vacancy rates, and revenues per available room for properties in Cupertino (see Figure 32). Retail: Strategic Economics reviewed leases from 2018 and 2019 for retail spaces in Cupertino, as summarized in Figure 34. Average lease rates (asking NNN) were between 4.25 to 5.42. All of these recent leases were for restaurant spaces on Stevens Creek Boulevard. For the purposes of this analysis, it is assumed that the retail space would lease for about $4 per square foot per month (NNN). 39 FIGURE 32. REVENUE ASSUMPTIONS BY PROTOTYPE Prototypes Metric Assumption Retail Annual Rent (NNN) Per Net Sq. Ft. $48.00 Vacancy Rate 5% Operating Expenses % of Gross Revenue 10% Annual Net Operating Income Per Net Sq. Ft. $40.80 Office/R&D Annual Rent (NNN) Per Net Sq. Ft. $54.00 Vacancy Rate 5% Operating Expenses % of Gross Revenue 7% Annual Net Operating Income Per Net Sq. Ft. $47.52 Hotel Gross annual Room Income RevPAR (a) $79,154 Gross Annual Other Revenue (b) Per Room $27,704 Gross Revenue Per Room $106,858 Vacancy Rate (c) n/a Operating Expenses 70% of Gross Revenue ($74,800) Annual Net Operating Income $32,057 Source: Costar, 2019; STR Trends Report, 2019; Individual developer interviews, 2019; Strategic Economics, 2019. Notes: (a) RevPAR is a measure of revenue per room, calculated as occupancy percentage times average daily rate. (b) Other Revenue for hotels based on data from STR Consulting, and from hotel developer interviews. (c) Vacancy is already reflected in RevPAR estimate. FIGURE 33. OFFICE COMPARABLES Project Name Address City Year Built Mo. Rent/ Sq. Ft. Lease Type Source Lot 11 @ Santana Row 500 Santana Row San Jose 2017 $4.45 NNN Costar Santana Row 700 Santana Row San Jose 2019 $4.45 NNN Costar Bldg. 5 Pathline Park (a) 700 Mary Ave Sunnyvale 2019 $4.95 NNN Costar Main Street 19319 Stevens Ck. Cupertino 2016 $3.75-$4.00 NNN Interviews FIGURE 34: RETAIL COMPARABLES IN CUPERTINO Project Name Address Year Built Mo. Rent/ Sq. Ft. Lease Type Source The Biltmore 20030-80 Stevens Creek Blvd 2015 $4.50 NNN (asking) Costar Main Street 19369 Stevens Creek Blvd 2016 $5.42 full service Costar Saich Way Station 20803 Stevens Creek Blvd 2015 $4.25 NNN (asking) Costar 40 YIELD ON COST THRESHOLDS In order to understand how the introduction of non-residential linkage fees impacts financial feasibility, the yield on cost (YOC) results can be compared to an investor’s expectations of return for each type of development. The YOC thresholds for this analysis were established relative to capitalization rates (cap rates) for each product type in the Bay Area. The cap rate, which is measured by dividing net income generated by a property by the total project value, is a commonly used metric to estimate potential returns. To ensure that the financial analysis is conservative and does not reflect peak market conditions, the thresholds selected for determining project feasibility are slightly higher than the published cap rates. Office/R&D projects with a YOC of above 6.0% and hotel projects with a YOC above 7.5% were considered feasible in this analysis. Retail projects were considered feasible with a YOC higher than 7.0%. These thresholds are summarized in the Figure 35 below. FIGURE 35: YIELD ON COST THRESHOLDS BY PROTOTYPE Prototype Yield on Cost Threshold Published Cap Rate Office/R&D (Class AA) 6.0% 4.50%-5.25% Hotel (Select Service) 7.5% 7.0%-8.0% Retail 7.0% 6.25-7.25% Source: CBRE Cap Rate Survey, H2 2018; HVS, 2019; Developer interviews. RESULTS Using the YOC thresholds defined above, the following summarizes the results of the financial feasibility of different linkage fee scenarios for each prototype. The pro formas for each prototype is shown in Figure 39, Figure 40, and Figure 41. OFFICE/ R&D As shown in Figure 36 and Figure 39, the prototypical office/R&D project can support the existing linkage fee of $23.76 per square foot, which generates a YOC of 6.04%. A linkage fee of $25 (Scenario 2) would also be feasible. However, the prototype cannot feasibly support a fee higher than $30 per square foot. At this fee level, the prototype is only marginally feasible, with a yield on cost of 5.99%. FIGURE 36. SUMMARY OF FINANCIAL FEASIBILITY OF OFFICE/R&D PROTOTYPE Fee Scenario Fee Level Per Sq. Ft. Yield on Cost Office Feasibility Current Linkage Fee $23.76 6.04% Feasible Scenario 1 (No Fee) $0 6.25% Feasible Scenario 2 $25 6.03% Feasible Scenario 3 $30 5.99% Marginally Feasible Note: Office/R&D projects must have a minimum yield on cost of 6.0% to be considered feasible Source: Strategic Economics, 2019. HOTEL As summarized in Figure 37 for hotel projects, the existing linkage fee of $11.88 is financially feasible, with a yield of cost of 7.65%. A fee of $15 per square foot (Scenario 2) is marginally feasible, resulting 41 in a YOC of 7.46%. A higher linkage fee of $20 per square foot (Scenario 3) is not feasible (see Figure 40). FIGURE 37. SUMMARY OF FINANCIAL FEASIBILITY OF HOTEL PROTOTYPE Fee Scenario Fee Level Per Sq. Ft. Yield on Cost Hotel Feasibility Current Linkage Fee $11.88 7.50% Feasible Scenario 1 (No Fee) $0 7.65% Feasible Scenario 2 $15 7.46% Marginally Feasible Scenario 3 $20 7.39% Not Feasible Note: Hotel projects must have a minimum yield on cost of 7.5% to be considered feasible Source: Strategic Economics, 2019. RETAIL The financial feasibility analysis shows that retail developments are not financially feasible under current market conditions. Even without a linkage fee (Scenario 1), the retail project achieves a yield on cost that is lower than the threshold of 7.0 % (see Figure 38 and Figure 41). There may be cases in which a retail project could support the current Housing Mitigation Fee if it were combined with other land uses (residential or office) in a mixed-use project. FIGURE 38. SUMMARY OF FINANCIAL FEASIBILITY OF RETAIL PROTOTYPE Fee Scenario Fee Level Per Sq. Ft. Yield on Cost Retail Feasibility Current Linkage Fee $11.88 6.35% Not Feasible Scenario 1 (No Fee) $0 6.48% Not Feasible Scenario 2 $15 6.32% Not Feasible Scenario 3 $20 6.26% Not Feasible Note: Retail projects must have a minimum yield on cost of 7.0% to be considered feasible. Source: Strategic Economics, 2019. 42 FIGURE 39. OFFICE/R&D PRO FORMA RESULTS Office/R&D Site and Building Characteristics Parcel Size (Sq. Ft.) 174,240 Parcel Size (acres) 4.00 Total Stories 4 - 5 stories Building Type Steel FAR (without parking) 1.50 Revenues Income $12,702,096 Net Operating Income $11,177,844 Project Costs Land Costs $24,000,000 Direct Costs Site Prep $522,720 Gross Building Area $78,408,000 Tenant Improvement Allowance $17,641,800 Parking $22,611,000 Subtotal Direct Costs $119,183,520 per net Sq. Ft. $507 per gross Sq. Ft. $456 Indirect Costs Soft Costs $14,302,022 City Permits and Fees (excl. non-residential linkage) $12,548,925 Subtotal Indirect Costs $26,850,948 Financing Costs $8,762,068 Total Development Cost Including Land (TDC) $178,796,536 per net Sq. Ft. $760 Fee as % of Total Development Cost Scenario 1: No Linkage Fee 0% Scenario 2: Linkage Fee of $25/Sq. Ft. 2.84% Scenario 3: Linkage Fee of $30/Sq. Ft. 3.53% Current Linkage Fee ($23.76/Sq. Ft.) 3.36% Yield on Cost (NOI/TDC) Scenario 1: No Linkage Fee 6.25% Scenario 2: Linkage Fee of $25/Sq. Ft. 6.03% Scenario 3: Linkage Fee of $30/Sq. Ft. 5.99% Current Linkage Fee ($23.76/Sq. Ft.) 6.04% Source: Strategic Economics, 2019. 43 FIGURE 40. HOTEL PRO FORMA RESULTS Hotel Site and Building Characteristics Parcel Size (Sq. Ft.) 87,120 Parcel Size (acres) 2.00 Total Stories 5 stories Building Type Concrete FAR (without parking) 1.20 Revenues Income $15,494,376 Net Operating Income $4,648,313 Project Costs Land Costs $12,000,000 Direct Costs Site Prep $261,360 Gross Building Area $26,136,000 FF&E $5,075,000 Parking $5,590,000 Subtotal Direct Costs $37,062,360 per gross Sq. Ft. $355 Indirect Costs Soft Costs $4,447,483 City Permits and Fees (excl. non-residential linkage) $4,499,679 Subtotal Indirect Costs $8,947,162 Financing Costs $2,760,571 Total Development Cost Including Land (TDC) $60,770,093 per room $419,104 Fee as % of Total Development Cost Scenario 1: No Linkage Fee 0% Scenario 2: Linkage Fee of $15/Sq. Ft. 1.69% Scenario 3: Linkage Fee of $20/Sq. Ft. 2.52% Current Linkage Fee ($11.88/Sq. Ft.) 2.00% Yield on Cost (NOI/TDC) Scenario 1: No Linkage Fee 7.65% Scenario 2: Linkage Fee of $15/Sq. Ft. 7.46% Scenario 3: Linkage Fee of $20/Sq. Ft. 7.39% Current Linkage Fee ($11.88/Sq. Ft.) 7.50% Source: Strategic Economics, 2019. 44 FIGURE 41. RETAIL PRO FORMA RESULTS Retail Site and Building Characteristics Parcel Size (Sq. Ft.) 21,780 Parcel Size (acres) 0.50 Total Stories 1 story Building Type Concrete FAR (without parking) 0.35 Revenues Income $329,314 Net Operating Income $279,917 Project Costs Land Costs $1,633,500 Direct Costs Site Prep $65,340 Gross Building Area $1,257,795 Tenant Improvement Allowance $266,805 Parking $213,444 Subtotal Direct Costs $1,803,384 per net Sq. Ft. $263 per gross Sq. Ft. $237 Indirect Costs Soft Costs $216,406 City Permits and Fees (excl. non-residential linkage) $511,470 Subtotal Indirect Costs $727,876 Financing Costs $151,876 Total Development Cost Including Land (TDC) $4,316,636 per net Sq. Ft. $629 Fee as % of Total Development Cost Scenario 1: No Linkage Fee 0% Scenario 2: Linkage Fee of $15/Sq. Ft. 1.74% Scenario 3: Linkage Fee of $20/Sq. Ft. 2.58% Current Linkage Fee ($11.88/Sq. Ft.) 2.05% Yield on Cost (NOI/TDC) Scenario 1: No Linkage Fee 6.48% Scenario 2: Linkage Fee of $15/Sq. Ft. 6.32% Scenario 3: Linkage Fee of $20/Sq. Ft. 6.26% Current Linkage Fee ($11.88/Sq. Ft.) 6.35% Source: Strategic Economics, 2019. 45 Peer Cities A large share of municipalities in San Mateo and Santa Clara counties, particularly cities that are desirable locations for tech and biotech companies, have adopted non-residential linkage fees. Figure 42 summarizes non-residential linkage fees in these jurisdictions. For office/R&D uses, most cities have set linkage fees between $15 and $25 per square foot. The majority of cities have lower fee levels for retail uses, typically in the range of $5 to $10 per square foot. The non-residential linkage fees for hotel uses are usually between $5 and $15 per square foot. The cities of Palo Alto and San Francisco have higher linkage fees than the rest of the local jurisdictions. These cities also have higher average retail and office rents, and hotel room rates than other Bay Area locations. Many municipalities provide exemptions or fee reductions for the following types of projects: • Smaller non-residential projects. For example, non-residential linkage fees do not apply to projects adding less than 5,000 gross square feet in Redwood City, San Carlos, San Mateo City, Colma, or Burlingame. Projects adding less than 3,500 gross square feet in unincorporated land in San Mateo County, and less than 10,000 gross square feet in Menlo Park or East Palo Alto are also exempt. Some cities also tie their fee to building size on a sliding scale. Mountain View offers a 50% fee reduction for office projects under 10,000 square feet, and hotel or retail projects under 25,000 square feet. Sunnyvale also offers a 50% fee discount for the first 25,000 square feet of any project. • Prevailing wage. Multiple jurisdictions, including Redwood City, San Carlos, San Mateo City, and San Mateo County, provide 25% fee reductions for projects that pay prevailing wage. • Community-serving facilities. Most cities exempt projects such as hospitals/clinics, child care, public, educational, religious, and/or non-profit uses. Additionally, projects that are replacing property damaged from natural disasters are also often exempted. It is common for jurisdictions to allow alternative means of complying with non-residential linkage fee requirements. Developers can typically satisfy the requirement by providing affordable housing either on or off-site, or by dedicating land for affordable housing. East Palo Alto and Palo Alto allow for the requirement to be met by either converting market-rate units to affordable units, or by rehabilitating existing affordable units. In most cases, the applicant must first prove that an alternative is necessary. For example, Palo Alto requires that the applicant present “substantial evidence to support a finding of infeasibility” of paying the fee, and of “feasibility of any proposed alternative.” Many cities have either enacted or updated their fees in the last four years, and fees are typically adjusted annually, based on either ENR’s Construction Cost Index for the San Francisco Bay area, or on the national Consumer Price Index. 46 FIGURE 42. NON-RESIDENTIAL LINKAGE FEES (PER GROSS S. FT. OF NET NEW SPACE) IN NEARBY CITIES Jurisdiction Office/ R&D/ Medical Office Hotel Retail/ Restaurant/ Services Date Fee Was Adopted Burlingame (a) $18 - $25 $12 $7 2017 Colma $5 $5 $5 2006 Cupertino $23.76 $11.88 $11.88 2015 East Palo Alto $10.72 none none 2016 Foster City $27.50 $12.50 $6.25 2016 Los Altos $25 $15 $15 2018 Menlo Park $17.79 $9.66 $9.66 2018 Mountain View (a) $13.14 - $26.27 $1.41 - $2.81 $1.41 - $2.81 2014 Palo Alto $36.22 $21.08 $21.08 2017 Redwood City $20 $5 $5 2015 San Bruno $12.50 $12.50 $6.25 2015 San Carlos $20 $10 $5 2017 San Francisco (b) $19.04 - $28.57 $21.39 $26.66 1996 San Mateo City $25 $10 $7.50 2016 San Mateo County $25 $10 $5 2016 Santa Clara City (a) $10 - $20 $5 $5 2017 South San Francisco $15 $5 $2.50 2018 Sunnyvale (a) $8.25 - $16.50 $8.25 $8.25 2015 Source: City Ordinances and Fee Schedules; 21 Elements, 2019; Silicon Valley at Home, 2019; Strategic Economics, 2019 Notes: (a) Fees vary based on project size in four cities: Burlingame, Mountain View, Santa Clara, and Sunnyvale. Hotel and retail projects under 25,000 sq. ft, and office projects under 10,000 sq. ft. in Mountain View are charged the lower fee; In Burlingame, Santa Clara and Sunnyvale, office projects under 50,000 sq. ft., 20,000 sq. ft. and 25,000 sq. ft. respectively pay the lower fee. (b) San Francisco's fees for R&D are $19.04 per sq. ft., while its fees for office are $28.57 per sq ft. Small Enterprise Workspace and Production/Distribution/Repair fees are $22.46 per sq. ft. 47 KEY TAKEAWAYS Based on the economic feasibility analysis, Strategic Economics offers the following conclusions regarding the City Council’s direction on the BMR Housing Program. Is it financially feasible to increase the inclusionary requirements to 20% or 25%? • For ownership housing prototypes, it would be financially feasible to raise the inclusionary requirement from 15% to 20%. The analysis indicates that the existing requirement of 15% and a higher requirement of 20% are economically feasible for single-family detached, small lot single-family/townhouse, and condominium developments. • Ownership housing prototypes can support a higher Housing Mitigation Fee per square foot. The analysis shows that single-family detached, small lot single-family/townhouse, and condominium developments could support paying the maximum housing mitigation fee (in-lieu fee). The maximum nexus-based fees are $30.10-$30.60 per square foot for single-family detached; $35.60 per square foot for small lot single-family/townhouse development; and $35.10 per square foot for condominiums. The City’s Housing Mitigation Fees cannot exceed the maximum housing impact fees justified by the 2015 Nexus Study (see Figure 43 below). Exceeding the amounts shown below would require conducting a new nexus study. FIGURE 43: CURRENT AND MAXIMUM HOUSING MITIGATION FEES BASED ON NEXUS FOR OWNERSHIP PROTOTYPES Prototype Current Housing Mitigation Fee Maximum Nexus- Based Fee Return on Cost At Maximum Fee Is Maximum Fee Feasible? Single-Family Detached $17.82 $30.10-$30.60 25.5% Yes Small Lot SF/ Townhouse $19.60 $35.60 34.2% Yes Condominium $23.76 $35.10 31.4% Yes Source: Keyser Marston Associates (2015). Residential Below Market Rate Housing Nexus Analysis • The rental apartment prototypes cannot feasibly support an inclusionary requirement under current rents and construction/land costs. The higher density rental housing prototype can support payment of Housing Mitigation Fees of nearly $30 per square foot, but cannot feasibly provide inclusionary BMR units under today’s rents, construction costs and land costs. However, with increases in rental revenues or decreases in construction costs and land costs, rental housing development could potentially support the current inclusionary requirement of 15%. Can the inclusionary housing policy be amended to include units for extremely low income/ disabled persons? The results from the feasibility analysis show that rental development in Cupertino cannot feasibly provide BMR units on-site under current market conditions. An increase in revenues or a decrease in construction and land costs could make it possible for lower density and higher density rental prototypes to provide 15% inclusionary BMR units for very low income and low income households. Under current market conditions, it is not financially feasible for the inclusionary housing policy to include units for extremely low-income households. 48 However, there are strategies that could allow the City to generate funding for the development of extremely low-income units, and for disabled persons. City staff from Sunnyvale and San Jose have indicated that they are providing funding to develop housing for extremely low-income households through the revenues they have collected from housing mitigation fees, in-lieu fees, and other housing funds. These local revenues are often combined with Santa Clara County Measure A funds – which are specifically targeted to extremely-low income households – as well as 9% and 4% Low Income Housing Tax Credits (LIHTC) and Section 8 vouchers from the Santa Clara County Housing Authority. Can the inclusionary housing policy be amended to include median-income and moderate-income units in rental projects? The results from the feasibility analysis show that rental housing development in Cupertino is not feasible with an inclusionary requirement of 15% under current conditions (see Figure 25 and Figure 26). However, a 15% increase in project revenues or a decrease in construction and land costs of 15% could make the low density rental prototype feasible with a 15% BMR requirement. The higher-density rental prototype can feasibly provide Housing Mitigation Fees at the current level. An increase in revenues of 10% or a decrease in construction and land costs of 5% can make the higher density rental prototype feasible with a 15% BMR requirement. Adding a requirement for median-income and moderate-income units in addition to the existing inclusionary requirement of 15% would not be economically feasible for the rental prototypes. For this reason, it is not financially feasible for the inclusionary housing policy to be amended to also require units for median-income and moderate-income households. Can the BMR requirements for non-residential development (linkage fees) be increased for office/R&D, hotel, and retail developments? • For office and R&D development, it would be possible to raise the Housing Mitigation Fees to a level between $25 to $30 per square foot. As shown in Figure 39, the office/R&D prototype is feasible with a non-residential linkage fee of $25 per square foot. At $30 per square foot, the prototype achieves a yield on cost that is slightly under the threshold required for feasibility. • For hotel development, it may be possible to increase the Housing Mitigation Fees to between $12 and $15 per square foot. At the current fee level of $11.88, a hotel project is feasible (Figure 37). With a fee of $15 per square foot, the project achieves a yield on cost that is slightly lower than the threshold for feasibility. • The financial feasibility analysis shows that retail developments are not financially feasible under current market conditions. Even without a Housing Mitigation Fees, the retail project achieves a yield on cost that is lower than the threshold of 7.0% (see Figure 38). There may be cases in which a retail project could support the current Housing Mitigation Fee if it were combined with other land uses (residential or office) in a mixed-use project. 49 APPENDIX The appendix includes additional information on: • Recent single-family sales for new construction in Cupertino (Figure A-1) • Recent townhome re-sales in Cupertino (Figure A-2) • Recent condominium re-sales in Cupertino (Figure A-3) • Recent rental project comparables in Cupertino and surrounding cities (Figure A-4) 50 FIGURE A-1: RECENTLY BUILT SINGLE FAMILY COMPARABLES Address City Lot Size Beds Baths Price Square Feet Price/Sq. Ft. Year Built 21825 Lomita Ave Cupertino 9,671 5 4.5 $3,380,000 3,891 $869 2016 21800 Almaden Ave Cupertino 11,098 5 3.5 $3,220,000 3,555 $906 2017 10240 Lebanon Dr Cupertino 9,048 5 4.5 $4,100,000 3,623 $1,132 2018 10257 Glencoe Dr Cupertino 9,375 5 4.5 $3,593,800 3,727 $964 2016 7425 Heatherwood Dr Cupertino 9,396 5 4 $3,650,000 3,763 $970 2017 805 Rose Blossom Dr Cupertino 8,660 5 4.5 $2,980,000 3,339 $892 2017 10308 N Stelling Rd Cupertino 9,612 5 4.5 $3,350,000 3,769 $889 2017 10381 Bret Ave Cupertino 9,374 5 4.5 $3,270,000 3,727 $877 2016 20861 Dunbar Dr Cupertino 9,750 5 3.5 $3,998,000 3,949 $1,012 2016 Weighted Average $3,512,995 3,705 $946 Sources: Redfin, 2018; Strategic Economics, 2018. Sources: Redfin, 2018; Strategic Economics, 2018. 51 FIGURE A-2: RECENTLY BUILT TOWNHOME COMPARABLES Address City Lot Size Beds Baths Price Square Feet Price/Sq. Ft. Year Built 10280 Park Green Ln #836 Cupertino 2,176 3 2.5 $1,760,000 1,670 $1,054 2006 10281 Torre Ave #817 Cupertino 2,176 3 2.5 $1,800,000 1,670 $1,078 2006 10700 Stevens Canyon Rd Cupertino 1,570 3 2.5 $1,852,000 2,239 $827 2007 20652 Gardenside Cir Cupertino 1,480 3 2.5 $1,680,000 1,704 $986 1990 20679 Gardenside Cir Cupertino 1,440 3 2 $1,665,000 1,640 $1,015 1990 23020 Stonebridge St Cupertino 3,348 3 2 $1,830,000 2,202 $831 1980 23030 Stonebridge Cupertino 3,348 3 2 $1,698,000 2,202 $771 1980 22981 Stonebridge Cupertino 3,348 3 2 $1,710,000 2,202 $777 1980 10910 Lucky Oak St Cupertino 1,312 3 3.5 $1,780,000 2,082 $855 1980 10826 Northridge Sq Cupertino 1,487 3 2 $1,455,000 1,389 $1,048 1978 10107 Lamplighter Sq Cupertino 1,753 3 2.5 $1,740,000 1,727 $1,008 1975 10174 Potters Hatch Cmn Cupertino 1,575 3 2.5 $1,816,000 1,785 $1,017 1974 10020 Mossy Oak Ct Cupertino 1,662 3 2.5 $1,680,000 1,645 $1,021 1972 10142 Amador Oak Ct Cupertino 1,854 3 2.5 $1,600,000 1,614 $991 1970 Weighted Averages: All years $1,728,250 1,841 $934 Since 2000 $1,808,896 1,860 $970 Sources: Redfin, 2018; Strategic Economics, 2018. 52 FIGURE A-2: RECENT RE-SALES OF TOWNHOME COMPARABLES Address City Beds Baths Price Square Feet Price/Sq. Ft. Year Built 20488 Stevens Creek Blvd #2207 Cupertino 2 2 $1,338,000 1,171 $1,143 2003 20488 Stevens Creek Blvd #2309 Cupertino 2 2 $1,430,000 1,171 $1,221 2003 19999 Stevens Creek Blvd #209 Cupertino 2 2 $1,266,000 1,039 $1,218 2003 19999 Stevens Creek Blvd #101 Cupertino 2 2 $1,265,000 1,192 $1,061 2003 19503 Stevens Creek Blvd #317 Cupertino 2 2 $1,400,000 1,158 $1,209 2006 19503 Stevens Creek Blvd #251 Cupertino 2 2 $1,200,000 1,087 $1,104 2006 19503 Stevens Creek Blvd #139 Cupertino 2 2 $1,468,000 1,130 $1,299 2006 19503 Stevens Creek Blvd #261 Cupertino 2 2 $1,530,000 1,359 $1,126 2006 19503 Stevens Creek Blvd #331 Cupertino 3 2 $1,728,000 1,502 $1,150 2006 20488 Stevens Creek Blvd #1813 Cupertino 3 3 $1,930,000 1,766 $1,093 2003 20488 Stevens Creek Blvd #1401 Cupertino 3 2 $1,480,000 1,578 $938 2003 Weighted Averages: 2-Bd $1,367,604 1163 $1,171 3-Bd $1,720,858 1615 $1,060 Sources: Redfin, 2018; Strategic Economics, 2018. 53 FIGURE A-3: RECENT RE-SALES OF CONDOMINIUM COMPARABLES Address City Beds Baths Price Square Feet Price/Sq. Ft. Year Built 20488 Stevens Creek Blvd #2207 Cupertino 2 2 $1,338,000 1,171 $1,143 2003 20488 Stevens Creek Blvd #2309 Cupertino 2 2 $1,430,000 1,171 $1,221 2003 19999 Stevens Creek Blvd #209 Cupertino 2 2 $1,266,000 1,039 $1,218 2003 19999 Stevens Creek Blvd #101 Cupertino 2 2 $1,265,000 1,192 $1,061 2003 19503 Stevens Creek Blvd #317 Cupertino 2 2 $1,400,000 1,158 $1,209 2006 19503 Stevens Creek Blvd #251 Cupertino 2 2 $1,200,000 1,087 $1,104 2006 19503 Stevens Creek Blvd #139 Cupertino 2 2 $1,468,000 1,130 $1,299 2006 19503 Stevens Creek Blvd #261 Cupertino 2 2 $1,530,000 1,359 $1,126 2006 19503 Stevens Creek Blvd #331 Cupertino 3 2 $1,728,000 1,502 $1,150 2006 20488 Stevens Creek Blvd #1813 Cupertino 3 3 $1,930,000 1,766 $1,093 2003 20488 Stevens Creek Blvd #1401 Cupertino 3 2 $1,480,000 1,578 $938 2003 Weighted Averages: 2-Bd $1,367,604 1163 $1,171 3-Bd $1,720,858 1615 $1,060 Sources: Polaris Pacific, 2018; Redfin, 2018; Strategic Economics, 2018. 54 FIGURE A-4: RECENTLY BUILT RENTAL COMPARABLES Rent Per Unit Unit Size Rent Per Sq. Ft. Project Name City Year Built Stories Studios 1-BD 2-BD 3-BD Studios 1-BD 2-BD 3-BD Studios 1-BD 2-BD 3-BD Nineteen 800 Cupertino 2014 6 $4,026 $5,477 0 1,339 1,562 $3.01 $3.51 Main Street Lofts Cupertino 2018 4 $3,508 $3,995 916 1,044 $3.83 $3.83 Verve Mountain View 2017 3 $3,860 $5,071 $6,195 737 1,112 1,286 $5.24 $4.56 $4.82 Domus on the Boulevard Mountain View 2015 4 $3,868 $4,876 788 1,061 $4.91 $4.60 Elan Mountain View Mountain View 2018 4 $3,860 $5,071 $6,195 737 1,112 1,286 $5.24 $4.56 $4.82 Montrose Mountain View 2016 4 $3,816 $5,443 739 1,154 $5.16 $4.72 Madera Apartments Mountain View 2013 4 $4,113 $5,510 849 1,181 $4.84 $4.67 Carmel the Village Mountain View 2013 5 $3,282 $3,623 $5,866 573 797 1,258 $5.73 $4.55 $4.66 6tenEAST Sunnyvale 2017 4 $3,309 $3,515 $4,414 $5,185 701 808 1,136 1,406 $4.72 $4.35 $3.89 $3.69 Naya Sunnyvale 2016 4 $3,250 $4,336 693 1,038 - $4.69 $4.18 481 On Mathilda Sunnyvale 2016 4 $3,098 $3,251 $4,160 701 781 1,174 $4.42 $4.16 $3.54 Encasa Apartments Sunnyvale 2016 3 $2,854 $3,356 $4,235 $5,854 572 856 1,163 1,688 $4.99 $3.92 $3.64 $3.47 Anton 1101 Sunnyvale 2015 4 $3,145 $3,280 $4,490 569 704 1,069 $5.53 $4.66 $4.20 2295-2305 Winchester Blvd Sunnyvale 2014 3 $3,371 $4,248 662 1,005 $5.09 $4.23 Ironworks Sunnyvale 2017 7 $3,520 $4,036 $5,109 . 784 1,174 1,365 $4.49 $3.44 $3.74 Solstice Sunnyvale 2013 6 $2,955 $3,329 $4,099 462 778 1,122 $6.40 $4.28 $3.65 Orchard City Lofts Campbell 2018 3 $2,946 $3,707 $4,817 607 924 1,237 $4.85 $4.01 $3.89 Revere Campbell Campbell 2015 5 $3,662 $3,912 $5,219 1,015 1,198 1,233 $3.61 $3.27 $4.23 Monticello Village Santa Clara 2016 6 $3,356 $3,244 $4,074 920 842 1,251 $3.65 $3.85 $3.26 Weighted Average $3,225 $3,568 $4,541 $5,516 677 790 1,137 1,383 $4.71 $4.49 $3.98 $3.98 Sources: Costar, 2018; Strategic Economics, 2018. 1 To: Kerri Heusler, Housing Manager, City of Cupertino From: Diana Elrod, Principal Date: June 26, 2019 Re: Peer Review of Draft Economic Feasibility Study for the City of Cupertino’s BMR Program Thank you for the opportunity to provide comments on the economic feasibility study drafted by Strategic Economics (SE) for the update of the City’s BMR Program requirements. It is my understanding that SE conducted this study to discern whether, and to what extent, inclusionary requirements for residential development and commercial impact fees may be modified from the baselines established in 2015. That year, Keyser Marston Associates (KMA) completed an extensive nexus study on both commercial and market‐rate residential development to assess the impacts of new development on the need for affordable housing. As the nexus was established in 2015, a further nexus study was not required here. Rather, SE’s current study is intended to analyze the feasibility of applying different inclusionary percentages (from the current requirement of 15%), as well as analyze whether the current mitigation fees for new market rate residential and commercial development can be increased. I have reviewed SE’s draft in conjunction with a review of KMA’s analyses from 2015 to help evaluate the report’s conclusions. I have identified a set of questions to assist in further understanding SE’s work, and more information about SE's methodology is needed before I finalize my assessment of the report's recommendations. Residential Analysis 1. It is hard to understand the step‐by‐step process that SE used for its methodology. The report lacks a clear narrative how it got from point A to point B to point C. It would be helpful to explain in simple language how the process works and why the particular data points are used. 2. Most inclusionary feasibility studies we typically see are based on a residual land cost analysis, rather than on a return on cost (ROC) or yield on cost (YOC). Can SE provide more background as to why ROC and YOC analysis were used rather than a residual land cost analysis and if that difference would meaningfully change any of the reported results? 3. The ROC analysis’s sources on page 10 reference “recent project proformas” and developer interviews. Can further documentation be provided on what recent proformas were analyzed, and what developers were interviewed? 404 Euclid Avenue, Suite 212 San Diego, CA 92114 (619) 236‐0612 www.LeSarDevelopment.com 2 4. I am curious about the use of Redfin for data in the analysis. There are a number of professional data aggregators that one typically sees, such as DataQuick, Costar, etc. which SE does use for some of the analysis. What was the thought behind using Redfin (which I personally experienced containing incorrect data in reporting sales)? 5. The report uses comps for townhomes and other housing types in Cupertino that are quite old. Typically, if the review of comps finds that no development is currently taking place, then adding an additional requirement would further constrain the development of housing. Is that the case here, or are there other market factors influencing the types of projects proposed and approved in Cupertino? 6. Figure A‐3 in the appendix is titled “Recent Re‐Sales of Condominium Comparables” when in fact the table shows rents. Figure A‐4 repeats this information but calls the table “Recently Built Rental Comparables.” Can SE update the table to include the dates when these comps were built? 7. On page 11, the sales prices per unit are in some cases significantly different than what was shown in the KMA report just four years ago. For example, condominiums in the 2015 report were on the order of $800,000. What accounts for the more than 100% increase in four years? Is this the result of construction cost escalation, and can SE say more about the market's ability to sustain the higher current sale prices while absorbing additional affordability requirements? 8. In addition, rents shown on that page are also substantially higher than in KMA’s study. Can SE provide some additional explanation about the market forces that are driving these increases? 9. On page 13, should the income limits be updated to the 2019 counts? Would showing increased rents using the 2019 data result in higher affordability requirements being feasible? Non‐Residential Analysis 1. KMA provided information on mitigation fees as a percentage of total development cost as one way to measure a fee’s reasonableness. How does SE’s methodology compare? 2. The pool of comparables used in the analysis is quite small. Would that impact the resulting outcomes? Summary Based on the questions and comments outlined above, additional information is necessary to assess whether there may be additional potential to feasibly modify the City's affordability requirements. I am happy to provide additional input and further evaluation once these questions are fully fleshed out. ECONOMIC FEASIBILITY ANALYSIS CUPERTINO BELOW MARKET RATE (BMR) HOUSING PROGRAM Prepared for: City of Cupertino 7/16/197/16/19 TABLE OF CONTENTS Introduction ............................................................................................................................. 1 BMR Requirements for Residential Development ............................................................... 3 Approach................................................................................................................................................... 3 Financial Feasibility Methodology ........................................................................................................ 10 Key Results ............................................................................................................................................ 19 Peer Cities ............................................................................................................................................. 32 Non-Residential Linkage Fee ........................................................................................... 34 Approach................................................................................................................................................ 34 Peer Cities ............................................................................................................................................. 46 Key Takeaways .................................................................................................................. 48 Appendix ....................................................................................................................................... 50 1 TABLE OF FIGURES Figure 1: Description of Prototypes ............................................................................................................ 6 Figure 2: City of Cupertino BMR Income Limits and Income Target for Pricing BMR Units .................... 7 Figure 3: Inclusionary Housing Scenarios Tested for Ownership Prototypes (Detached Single-Family Prototype 1, Small Lot/Townhouse Prototype 2, and Condominium Prototype 3) .................................. 8 Figure 4: Inclusionary Housing Scenarios Tested for Rental Prototypes (Lower Density Rental Prototype 4 and Higher Density Rental Prototype 5) .................................................................................................. 9 Figure 5: Minimum Return Thresholds by Prototype .............................................................................. 11 Figure 6: Market Rate Residential Sale Prices and Monthly Rents, By Prototype ................................ 13 Figure 7. Market Rate Residential Value Calculation, by Prototype ...................................................... 14 Figure 8. Below Market Rate Residential Values, by Prototype and AMI Level .................................... 15 Figure 9. Retail Revenue Assumptions and Capitalized Value .............................................................. 16 Figure 10: Development Cost Assumptions ............................................................................................ 18 Figure 11: Return On Cost for Ownership Prototypes by Inclusionary Housing Scenario .................... 21 Figure 12: Yield on Cost under Different Inclusionary Housing Scenarios for Multi-Family Rental Prototypes 4 and 5.................................................................................................................................... 21 Figure 13: Yield on Cost Under Different Revenue Assumptions for Lower Density Multi-Family Rental (Prototype 4) with 15% BMR Requirement ............................................................................................. 22 Figure 14: Feasibility of Lower Density Multi-Family Rental Prototype (Prototype 4) with 15% Inclusionary BMR Requirement and Increased Revenues ..................................................................... 22 Figure 15: Yield on Cost Under Different Cost Assumptions for Lower Density Multi-Family Rental (Prototype 4) with 15% BMR Requirement ............................................................................................. 23 Figure 16: Feasibility Results of Lower Density Multi-Family Rental Prototype (Prototype 4) with 15% Inclusionary BMR Requirement and Lower Costs ................................................................................... 23 Figure 17: Yield on Cost Under Different Revenue Assumptions for Higher Density Multi-Family Rental (Prototype 5) with 15% BMR Requirement ............................................................................................. 24 Figure 18: Feasibility Results of Higher Density Multi-Family Rental Prototype (Prototype 5) with 15% Inclusionary BMR Requirement and Higher Revenues .......................................................................... 24 Figure 19: Yield on Cost Under Different Cost Assumptions for Higher Density Multi-Family Rental (Prototype 5) with 15% BMR Requirement ............................................................................................. 25 Figure 20: Feasibility Results of Higher Density Multi-Family Rental Prototype (Prototype 5) with 15% Inclusionary BMR Requirement and Lower Costs ................................................................................... 25 Figure 21. Detailed calculation of the City of Cupertino’s permits and fees for each prototype (Per Unit) ................................................................................................................................................................... 26 2 Figure 22: Financial Feasibility Results for Single-Family Detached Prototype 1 ................................. 27 Figure 23: Financial Feasibility Results for Small Lot Single-Family/Townhouse Prototype 2 ............ 28 Figure 24: Financial Feasibility Results for Condominium Prototype 3 ................................................. 29 Figure 25: Financial Feasibility Results for Lower Density Rental Apartments Prototype 4 ................ 30 Figure 26: Financial Feasibility Results for Higher Density Rental Apartments Prototype 5 ............... 31 Figure 27: Inclusionary Housing Requirements and Housing Mitigation Fees in Peer Cities ............. 33 Figure 28. Description of Development Prototypes ................................................................................ 35 Figure 29. Hard Costs Assumptions by Prototype ................................................................................... 36 Figure 30. Land Comparables for Office and Hotel ................................................................................ 37 Figure 31. Soft Cost Assumptions by Prototype ...................................................................................... 37 Figure 32. Revenue Assumptions by Prototype ...................................................................................... 39 Figure 33. Office Comparables ................................................................................................................ 39 Figure 34: Retail Comparables in Cupertino ........................................................................................... 39 Figure 35: Yield on Cost Thresholds by Prototype .................................................................................. 40 Figure 36. Summary of Financial Feasibility of Office/R&D Prototype .................................................. 40 Figure 37. Summary of Financial Feasibility of Hotel Prototype ............................................................ 41 Figure 38. Summary of Financial Feasibility of Retail Prototype ........................................................... 41 Figure 39. Office/R&D Pro Forma Results .............................................................................................. 42 Figure 40. Hotel Pro Forma Results ......................................................................................................... 43 Figure 41. Retail Pro Forma Results ........................................................................................................ 45 Figure 42. Non-Residential Linkage Fees (per Gross S. Ft. of Net New Space) in Nearby Cities ........ 47 Figure 43: Current and Maximum Housing Mitigation Fees Based On Nexus for Ownership Prototypes ................................................................................................................................................................... 48 1 INTRODUCTION Strategic Economics was retained by the City of Cupertino (the “City) to evaluate potential changes to the Below Market Rate (BMR) Housing Program. The BMR program requirements are currently as follows: • The City currently has a BMR Housing Program that imposes an inclusionary requirement of 15% on for-sale and rental residential developments with seven or more units. For rental developments, the BMR units must be affordable to very-low (up to 50% Area Median Income “AMI”) or low-income (up to 80% AMI) households1. For-sale developments must provide BMR units affordable to median- (up to 100% AMI) and moderate-income (up to 120% AMI) households.2 • Small residential projects of less than seven units can pay the City’s Housing Mitigation In-Lieu Fees3 (the “Housing Mitigation Fees”) or provide one BMR unit. The Housing Mitigation Fees are based on the City’s 2015 Residential Below Market Rate Housing Nexus Analysis and Non- Residential Jobs-Housing Nexus Analysis (the “2015 Nexus Study”). Housing Mitigation Fees are currently set at $17.82 per square feet for detached single family, $19.60 per square feet for small lot single family/townhomes, $23.76 for attached multifamily residences (ownership and rental), and $11.88 per square foot for commercial/retail uses. • The City first adopted linkage fees for office and Research and Development (“R&D”) projects in 1992 and expanded the program to apply to retail and hotel developments in 2004. The City updated the non-residential linkage fees in 2015 (based on the 2015 Nexus Study) to the current levels of $23.76 per square foot for office/R&D uses, and $11.88 per square foot for hotel and retail uses.4 The City Council is considering modifying the BMR Housing Program, providing direction to examine the following issues: • Study the potential to increase the inclusionary requirements to 20% or 25% • Explore inclusionary housing policy to include units for extremely-low income/disabled persons • Include median- and moderate-income units in rental projects • Study inclusionary housing programs in other cities as a comparison • Study the economic feasibility of increasing non-residential linkage fees on new office/R&D, hotel, and retail developments This report provides technical findings on the economic feasibility of increasing the City’s BMR requirements for residential developments and non-residential developments. It also provides findings regarding the potential for including extremely-low income housing units and/or median-and moderate-income units in rental projects. The report also summarizes inclusionary housing programs and non-residential linkage fees in other cities in Santa Clara County. The report is divided into three sections. 1 Rental BMR policy states that 40% of affordable units must be set aside for low income, and 60% for very low income units. 2 For-Sale BMR policy states that half of affordable units must be set aside for median income households, and half for moderate income households. 3 Housing Mitigation In-Lieu Fees: A fee assessed in accordance with the City's General Plan Housing Element, Municipal Code (CMC 19.172) and the City's BMR Housing Mitigation Program Procedural Manual. 4 Keyser Marston Associates, “City of Cupertino: Non-residential Jobs-Housing Nexus Analysis,” City of Cupertino, April 2015. 2 • Section II: The first section focuses on the BMR requirements on housing development. • Section III: The second section is focused on the non-residential linkage fees on new office/R&D, hotel, and retail developments. • Section IV: The third section provides key takeaways and conclusions. The appendix to the report provides additional background data on housing trends. 3 BMR REQUIREMENTS FOR RESIDENTIAL DEVELOPMENT Approach The following describessummarizes the methodology of steps taken in the financial feasibility analysis. Step 1. Develop Prototypes for Pro Forma Analysis The first step in the financial feasibility analysis is to review the types of residential and mixed-use (residential and retail) projects that would be subject to the BMR policy. In close coordination with City staff, Strategic Economics updated the residential and nonresidential prototypes used in the 2015 Nexus Study, ensuring that they represent the ownership and rental residential development types that are likely to occur in city in the short term. The prototypes varied based on assumptions regarding building type, density, unit size, etc. Step 2. Develop Assumptions about BMR Units Strategic Economics worked closely with City staff to develop assumptions about the percentage of inclusionary units that should be tested, the income targets, and the affordable sales prices and rents. Maximum sales prices and rents were calculated using the method and parameters established by City policy, in coordination with Hello Housing, the BMR Program administrator. Step 3. Collect Key Inputs and Build for Pro Forma The financial feasibility of each prototype is measured using a static pro forma model that solves for the profit to the developer. A pro forma model is a tool that is commonly used to estimate whether a project is likely to be profitable. The key inputs into the financial feasibility analysis are the revenues (rents/ sales prices), development costs, and land costs. Strategic Economics collected and summarized data on land prices, residential values, and construction costs using the following data sources: • Costar, a commercial real estate database that tracks rental multifamily properties and property transactions • Interviews with local developers and brokers • Redfin, a real estate brokerage firm that collects data on residential sales prices • Review of pro formas from other projects and clients Step 43. Calculate Financial Feasibility The pro forma model tallies all development costs, including land costs, hard costs (construction costs), soft costs, and financing costs. The pro forma also tallies the project’s total value. The project’s total value is the sum of (1) the estimated value of the condominiums or townhomes (i.e. the average per unit sale price multiplied by the number of units), and (2) if applicable, the capitalized value of retail. The project’s ROC is then calculated by dividing the project’s net revenue (i.e. total value minus total development costs), by total development costs. To understand the potential impact of inclusionary requirements on financial feasibility, the ROC results for each prototype and inclusionary housing scenario are compared to developers’ typical expectation of return, or the threshold for feasibility. If the ROC for a project is above the threshold for feasibility, it is considered financially feasible. If the ROC is below the threshold, it is not financially feasible.Approach Formatted: Font: Not Bold Formatted: Font: Not Bold Formatted: Font: Bold Formatted: Font: Bold 4 Approach To examine the potential impact of new BMR requirements on the financial feasibility of new development, Strategic Economics worked with City staff to make assumptions about development prototypes, which represent the types of new residential development projects likely to be built in Cupertino. The five development prototypes include ownership and rental development types. Then, Strategic Economics built a pro forma model to test the financial feasibility of different inclusionary requirements or the payment of in lieu fees on each prototype. The pro forma model’s inputs are based on present-day estimates of revenues and costs. This section outlines the development prototypes and inclusionary housing scenarios tested in this analysis. More details on each step of the analysis is provided in the section below. DEVELOPMENT PROTOTYPES The analysis estimates the feasibility of different inclusionary requirements for five residential prototypes, as described in Figure 1. The building characteristics of each development prototype, including size, density (floor-area-ratio), and parking assumptions are based on prototypes analyzed as part of the City’s 2015 Nexus Study 5. These development prototypes represent the range of typical residential development expected to come online in Cupertino in the short term. These prototypes are mostly based on recently completed projects or development proposals in the pipeline in Cupertino. It is also assumed that future development will likely be located along Stevens Creek Boulevard, and in existing residential neighborhoods, given that these locations have been identified in the City’s General Plan and Heart of the City Specific Plan as key areas for new residential and mixed-use development. The prototypes vary based on the following characteristics: • Ownership and Rental. Three of the prototypes include only for-sale units (Prototypes 1, 2, and 3) and two are rental developments (Prototypes 4 and 5). • Mixed-Use and Residential Only. Two of the prototypes (Prototypes 1 and 2) are 100% residential while the attached multifamily prototypes have a ground-floor retail component (Prototypes 3, 4, and 5). • Project Density and Size o The single-family detached prototype 1 represents detached single-family custom-built homes with an average density of 4.5 dwelling units per acre. Because this prototype has fewer than eight units, it would be allowed to pay the in-lieu fee or provide one BMR unit under the current BMR policy. The small number of units in this prototype reflects the fact that there are few potential single-family detached sites in Cupertino that can accommodate more than 7 units. o Prototype 2 represents two-story small lot single-family and townhome developments with a density of 15 dwelling units per acre. o Prototype 3 is a three-story multi-family condominium building with a density of 35 units per acre. Parking is accommodated in an above-ground podium. 5 Keyser Marston Associates (2015). Residential Below Market Rate Housing Nexus Analysis. Formatted: Normal 5 o Prototype 4 is a three-story multifamily rental building with a density of 40 units per acre. Parking is accommodated in an above-ground podium. o Prototype 5 is a higher-density six-story project with a density of 76 units per acre. This prototype is based on a Housing Element site that allows six to eight story heights. Parking is accommodated in an above-ground podium. • Parking Ratios. The City requires 2 parking spaces per unit. However, for the multi-family prototypes there are opportunities to achieve parking reductions under certain conditions. The assumptions in the pro forma are as follows. o For Prototype 1 and Prototype 2, the assumption is that the development would provide all of the required parking. o For the condominium prototype 3, developers can lower parking by 10%, assuming that the reduction is justified by a parking study. o For multi-family rental housing prototypes 4 and 5, developers can receive parking reductions on residential units in the scenarios where 5% of the housing units are for very low-income households, in accordance with Gov’t Code Sec. 65915(p). 6 FIGURE 1: DESCRIPTION OF PROTOTYPES Prototype 1 Prototype 2 Prototype 3 Prototype 4 Prototype 5 Detached Single Family Small Lot Single Family/Townhome Condominium Lower Density Rental Apartments Higher Density Rental Apartments Tenure For-Sale For-Sale For-Sale Rental Rental Unit Mix 5 bedrooms 3 bedrooms 2 and 3 bedrooms Studios, 1, 2, and 3 bedrooms Studios, 1, 2, and 3 bedrooms Format Low-rise, large sites Low-rise, small sites Mid-rise, small sites Mid-rise, small sites Higher density, small sites Number of Units 7 50 100 100 100 Parcel Size (Acres) 1.6 3.3 2.9 2.9 1.3 Residential Program Studios - - - 10 10 1-BD - - - 45 45 2-BD - - 50 40 40 3-BD - 50 50 5 5 4-BD 0 - - - - 5-BD 7 - - - - Total 7 50 100 100 100 Dwelling Units Per Acre 4.5 15 35 35 76 Ground Floor Retail (Sq. Ft.) 0 0 10,000 10,000 15,000 Parking 2-Car Garage + Driveway 2-Car Garage + Driveway Podium Podium Podium Parking Requirement (Per Unit) 4 2.8 2 2 2 Parking Requirement (Commercial) n/a n/a 4 per 1,000 sq. ft. 4 per 1,000 sq. ft. 4 per 1,000 sq. ft. Required Parking Spaces 28 140 240 240 260 Reduced Parking Spaces (a) 28 140 216 185 205 (a) For the condominium prototype 3, developers can lower parking by 10%, assuming that the reduction is justified by a parking study. For multi-family rental housing prototypes 4 and 5, developers can receive parking reductions on residential units in the scenarios where 5% of the housing units are for very low-income households (50% AMI), in accordance with Gov’t Code Sec. 65915(p). Source: Strategic Economics, City of Cupertino. 7 BMR HOUSING PROGRAM ASSUMPTIONS Strategic Economics built a pro forma model that tested the feasibility of various inclusionary housing scenarios under the existing BMR housing program and alternative scenarios. Below is a summary of the existing BMR program: • The City currently has a BMR Housing Program that imposes an inclusionary requirement of 15% on for-sale and rental residential developments with seven or more units. For rental developments, the BMR units must be affordable to very low or low-income households6. For-sale developments must provide BMR units affordable to median- and moderate-income households.7 • Small residential projects of less than seven units can pay the housing mitigation fee or provide one BMR unit. The housing mitigation fees are based on the 2015 Nexus Study, and are currently set at $17.82 per square feet for detached single family, $19.60 per square feet for small lot single family/townhomes, $23.76 for attached multifamily residences (ownership and rental), and $11.88 per square foot for commercial/retail uses. • The BMR program uses income limits published annually by the California Department of Housing and Community Development (HCD) for Santa Clara County, per household size. For some income categories, the income targets for pricing BMR units are slightly different from household income limits that determine eligibility. Maximum BMR sales and rent prices are determined by the City and its BMR program administrator, Hello Housing, based on the maximum affordable housing cost provisions of Section 50052.5 of the California Health and Safety Code, Section 6920 of the California Code of Regulations, and most recent published HCD income limits. The household income limits for BMR eligibility as well as the income targets for pricing BMR units are shown in Figure 2. FIGURE 2: CITY OF CUPERTINO BMR INCOME LIMITS AND INCOME TARGET FOR PRICING BMR UNITS Household Income Limits Income Target for Pricing BMR Units Ownership Median 100% AMI 90% AMI Moderate 120% AMI 110% Ami Rental Extremely Low 30% AMI 30% AMI Very Low 50% AMI 50% AMI Low 80% AMI 60% AMI Sources City of Cupertino Housing Element; City of Cupertino Housing Mitigation Program Procedural Manual. The inclusionary housing scenarios tested in this analysis reflect the range of policy options under consideration by the City for ownership and rental development. They are summarized below and shown in Figure 3 and Figure 4. 6 Rental BMR policy states that 40% of affordable units must be set aside for low income, and 60% for very low-income units. 7 For-Sale BMR policy states that half of affordable units must be set aside for median income households, and half for moderate income households. 8 OWNERSHIP DEVELOPMENT Strategic Economics tested the economic feasibility of the development of ownership housing (single- family, townhouse, and condominium prototypes) under five different inclusionary scenarios: • Scenario 0 (No Requirements): This scenario assumes that the project is 100% market- rate, with no affordable units and no in-lieu fees required. • Scenario 1 (Existing Policy): This scenario mirrors the City’s existing inclusionary housing requirement. The development projects must provide 15% of the units at prices affordable to median- (100% AMI) and moderate-income households (120% AMI). • Scenario 2 (20% Inclusionary): This scenario requires new ownership projects to include at least 20% BMR units, targeting median and moderate-income households. • Scenario 3 (25% Inclusionary): This scenario requires new ownership projects to include at least 25% BMR units, targeting median and moderate-income households. • Scenario 4 (In-Lieu Fees): This scenario assumes that the development is required to pay in-lieu fees instead of providing affordable units on-site. These scenarios are summarized in Figure 3 below. FIGURE 3: INCLUSIONARY HOUSING SCENARIOS TESTED FOR OWNERSHIP PROTOTYPES (DETACHED SINGLE-FAMILY PROTOTYPE 1, SMALL LOT/TOWNHOUSE PROTOTYPE 2, AND CONDOMINIUM PROTOTYPE 3) Inclusionary Housing Scenarios % of Units at BMR Prices Income Targets for BMR Units* In-Lieu Fee Payment Scenario 0 (No Requirements) 0% N/A No Scenario 1 (Existing Policy) 15% 8% of units at 90% AMI 7% of units for 110% AMI No Scenario 2 (20% Inclusionary) 20% 10% of units at 90% AMI 10% of units at 110% AMI No Scenario 3 (25% Inclusionary) 25% 13% of units at 90% AMI 12% of units at 110% AMI No Scenario 4 (In-Lieu Fees) 0 N/A Yes *Per the City of Cupertino Housing Mitigation Program Procedural Manual, the maximum sales price for median income BMR units is set at 90% AMI. The maximum sales price for moderate income BMR units is set at 110% AMI. Sources: City of Cupertino Housing Mitigation Program Procedural Manual, 2018; Strategic Economics, 2018. RENTAL DEVELOPMENT Strategic Economics tested the economic feasibility of the development of ownership housing (single- family, townhouse, and condominium prototypes) under five different inclusionary scenarios: • Scenario 0 (No Requirements): This scenario assumes that the project is 100% market- rate, with no affordable units and no in-lieu fees required. • Scenario 1 (Existing Policy): This scenario mirrors the City’s existing inclusionary housing requirement. The development projects must provide 15% of the units at prices affordable to low-income (80% AMI) and very low-income households (50% AMI). • Scenario 2 (20% Inclusionary): This scenario requires new ownership projects to include at least 20% BMR units, targeting median and moderate-income households. 9 • Scenario 3 (25% Inclusionary): This scenario has a higher inclusionary requirement of 25% and targets lower income groups. The income targets include low-income (80% AMI), very low-income (50% AMI), and extremely low-income households (30% AMI). • Scenario 4 (In-Lieu Fees): This scenario assumes that the development is required to pay in-lieu fees instead of providing affordable units on-site. These scenarios are summarized in Figure 4 below. FIGURE 4: INCLUSIONARY HOUSING SCENARIOS TESTED FOR RENTAL PROTOTYPES (LOWER DENSITY RENTAL PROTOTYPE 4 AND HIGHER DENSITY RENTAL PROTOTYPE 5) Inclusionary Housing Scenarios % of Units at BMR Rents Income Targets for BMR Units* In-Lieu Fee Payment Scenario 0 (No Requirements) 0% N/A No Scenario 1 (Existing Policy) 15% 9% of units at 50% AMI 6% of units at 60% AMI No Scenario 2 (20% Inclusionary) 20% 10% of units at 50% AMI 10% of units at 60% AMI No Scenario 3 (25% Inclusionary) 25% 10% of units at 50% AMI 10% of units at 60% AMI 5% of units at 30% AMI No Scenario 4 (In-Lieu Fees) 0 N/A Yes *Per City policy, pricing for low-income BMR units is set at 60% AMI. Sources: City of Cupertino Housing Mitigation Program Procedural Manual, 2018; Strategic Economics, 2018. 10 Financial Feasibility Methodology This section describes the method used to measure financial feasibility and the major cost and revenue assumptions underlying the analysis. Additional information is provided in the Appendix. MEASURING FINANCIAL FEASIBILITY The financial feasibility of each prototype is measured using a static pro forma model that solves for the profit to the developer. A pro forma model is a tool that is commonly used to estimate whether a project is likely to be profitable. For a policy analysis like this one, we use development prototypes to represent typical projects. However, it is important to note that individual development projects may be less or more profitable than these prototypes, depending on the specifics of the development program, development costs (construction and land), sources of financing, and other factors. Furthermore, because it is a static model reflecting today’s market conditions, the pro forma analysis does not factor in changes in prices/rents, construction costs, or financing. For the purposes of measuring financial feasibility in this analysis, developer profit was measured by using one of two metrics: • Return on cost (ROC) for ownership housing. ROC is a common measure of project profitability for residential ownership development. The pro forma model tallies all development costs, including land costs, hard costs (construction costs), soft costs, and financing costs. The pro forma also tallies the project’s total value. The project’s total value is the sum of (1) the estimated value of the condominiums or townhomes (i.e. the average per unit sale price multiplied by the number of units), and (2) if applicable, the capitalized value of retail. The project’s ROC is then calculated by dividing the project’s net revenue (i.e. total value minus total development costs), by total development costs. • Yield on cost (YOC) for rental housing. YOC is a common measure of profitability for income- generating projects, such as residential rental development. The pro forma model tallies all development costs (land costs, hard costs, soft costs, and financing costs). The pro forma also estimates total revenues: the project’s net annual operating income is the stabilized income from the property (i.e. rental income generated from both the residential and retail uses), minus operating expenses and an allowance for vacancy. The YOC is estimated by dividing the total annual net operating income by total development costs. RETURN THRESHOLDS To understand the potential impact of inclusionary requirements on financial feasibility, the ROC and YOC results for each prototype and inclusionary housing scenario are compared to developers’ typical expectation of return. These return thresholds are summarized in Figure 5 and discussed below: • For the Single-Family Detached Prototype 1, the minimum ROC threshold ranges between 10 to 15%, based on developer interviews for new single-family development in Cupertino. • For the Small Lot Single-Family/Townhouse Prototype 2 and the Condominium Prototype 3, the minimum ROC threshold ranges between 18 to 20%, based on a review of pro forma models for new multifamily ownership projects in Santa Clara County. • For the Lower Density Apartment Prototype 4 and the Higher Density Apartment Prototype 5, the minimum YOC threshold ranges between 4.75% and 5.25%. According to the developers interviewed for this study, and a review of recent development project pro formas in the Silicon 11 Valley, the minimum YOC for a new multi-family development project should usually be 1.0 to 1.5 points higher than the published capitalization rate (cap rate). The current cap rate for multifamily properties in the San José Metropolitan Area is between 3.75 to 4.25%.8 The cap rate, measured by dividing the net operating income generated by a property by the total project value, is a commonly used metric to estimate the value of an asset. Cap rates rise and fall along with interest rates. In a climate of rising interest rates, it is important to set the expectations of YOC at a conservative level, to allow for a margin between the cap rate and the rate of return. It is also important to consider that investors consider a wide range of factors to determine if a development project makes financial sense, and some investors may have different levels of risk tolerance than others. FIGURE 5: MINIMUM RETURN THRESHOLDS BY PROTOTYPE Return on Cost Thresholds Prototype 1: Detached Single Family 10-15% Prototype 2: Small Lot/Townhomes 18-20% Prototype 3: Condominiums 18-20% Yield on Cost Thresholds Prototype 4: Lower-Density Rental Apartments 4.75-5.25% Prototype 5: Higher-Density Rental Apartments 4.75-5.25% Source: Developer interviews and a review of recent project pro formas, 2018; Strategic Economics, 2018. REVENUE ASSUMPTIONS MARKET RATE RESIDENTIAL There is significant pent-up housing demand in Santa Clara County and the broader Bay Area region, as housing development has not kept up with employment growth. Between 2009 and 2015, Santa Clara County added over 170,000 new jobs between 2010 and 2015, but only 29,000 new housing units.9 Apartment rents accelerated beginning in 2011, as the economy emerged from the Great Recession, and continued growing at an average annual rate of nearly eight percent until 2015. Since then rents have continued to grow at a slower pace of about four percent. Sales prices in Cupertino and Santa Clara County have been escalating at a rapid rate over the last five years. In Cupertino, the median sales price for a single-family home increased from $1.68 million in 2014 to $2.37 million in 2018. 10 Similarly, the median sales price for a condominium climbed from $895,500 in 2014 to $1.4 million in 2018.11 The market-rate sale prices and rents assumed for each prototype are summarized in Figure 6. The values are calculated as a weighted average to reflect that different types of units have different unit 8 CBRE Investor’s Cap Rate Survey (H1, 2018). 9 SPUR, “Room for More: Housing Agenda for San José,” August 2017. 10 Santa Clara County Association of Realtors, 2014 and 2018. https://www.sccaor.com/pdf/stats/2014.pdf https://www.sccaor.com/pdf/stats/2018.pdf. 11 Ibid 12 values. For new single-family detached development (Prototype 1), sale prices were based on sales of newly built single-family homes in Cupertino as reported by Redfin. Sales prices for small lot single- family/townhomes (Prototype 2) and condominium projects (Prototype 3) were based on recent re- sales in Cupertino as reported by Redfin. The Appendix to this report (Figures A-1 through A-3) includes detailed information on the project comparables used to inform these estimates. Because of the lack of recently built apartment projects in Cupertino, the rental rate estimates for rental units (Prototypes 4 and 5) were based on developer interviews and a review of recently built, comparable apartment projects in Cupertino and neighboring cities (Mountain View, Sunnyvale, Campbell, and Santa Clara), as reported by Costar. Since Cupertino’s apartment buildings command higher rents than in the other cities, a 5% premium was applied over the market area’s weighted average. Figure A-4 in the Appendix includes detailed information on the project comparables used to inform these estimates. 13 FIGURE 6: MARKET RATE RESIDENTIAL SALE PRICES AND MONTHLY RENTS, BY PROTOTYPE Unit Mix Unit Size (Sq. Ft.) Sale Price Per Sq. Ft. Sale Price Per Unit Prototype 1: Single Family 5-BD 100% 3,700 $946 $3,500,200 Prototype 2: Small Lots/Townhomes 3-BD 100% 1,850 $970 $1,794,500 Prototype 3: Condominiums 2-BD 50% 1,350 $1,100 $1,485,000 3-BD 50% 1,600 $1,000 $1,600,000 Weighted Average Unit Size/Sale Price 1,475 $1,050 $1,542,500 Prototype 4: Lower-Density Rental Studios 10% 680 $4.94 $3,360 1-BD 45% 800 $4.73 $3,780 2-BD 40% 1,100 $4.30 $4,725 3-BD 5% 1,400 $4.13 $5,775 Weighted Average Unit Size/Monthly Rent 938 $4.54 $4,216 Prototype 5: Higher-Density Rental Studios 10% 680 $4.94 $3,360 1-BD 45% 800 $4.73 $3,780 2-BD 40% 1,100 $4.30 $4,725 3-BD 5% 1,400 $4.13 $5,775 Weighted Average Unit Size/Monthly Rent $4.54 $4,216 Source: Strategic Economics, 2018. The total value of market-rate units is summarized in Figure 7. For the ownership prototypes (Prototypes 1, 2, and 3), the total project value is obtained by multiplying the per unit sale price by the total number of units. For the rental prototypes (Prototypes 4 and 5), an income capitalization approach is used. This approach first estimates the annual net operating income (NOI) of the prototype, which is the difference between project income (annual rents) and project expenses 14 (operating costs and vacancies). The NOI is then divided by the current cap rate to derive total project value.12 FIGURE 7. MARKET RATE RESIDENTIAL VALUE CALCULATION, BY PROTOTYPE Prototype 1 Prototype 2 Prototype 3 Prototype 4 Prototype 5 Detached Single Family Small Lot Single Family/ Townhome Condo Lower Density Rental Apartments Higher Density Rental Apartments Weighted Average Monthly Rent (a) per unit n/a n/a n/a $4,216 $4,216 Annual Rent per unit n/a n/a n/a $50,589 $50,589 Vacancy Allowance n/a n/a n/a 5.00% 5.00% Operating Expenses % gross revenue n/a n/a n/a 30.00% 30.00% Annual Net Operating Income per unit n/a n/a n/a $32,883 $32,883 Capitalization Rate (b) n/a n/a n/a 4.25% 4.25% Sales Value/Capitalized Value per unit $3,500,200 $1,794,500 $1,542,500 $773,714 $773,714 Total Units 7 50 100 100 100 Total Residential Value (c) total project $24,501,400 $89,725,000 $154,250,000 $77,371,412 $77,371,412 (a) See Figure 5 for details on how the per unit sale price was derived. (b) CBRE, H1 2018 Cap Rate Survey. Cap rates for the San José Metropolitan Area were between 3.75% and 4.25% for infill multifamily Class A. (c) Assuming all units are market rate. Total residential value is calculated by multiplying the per unit sales value/capitalized value (which is a weighted average) by the total number of units. Sources: CBRE, 2018; CoStar, 2018; Strategic Economics, 2018. BELOW MARKET RATE HOUSING BMR residential values at different AMI levels are summarized in Figure 8. Maximum sales prices and rents were provided by Hello Housing, the City’s BMR program administrator. Sales prices and rents for BMR units were calculated using the method and parameters established in the City’s Policy and Procedures Manual for Administering Deed Restricted Affordable Housing Units (“BMR Manual”).13 An income capitalization approach is also applied to BMR units to derive total residential value. 12 As mentioned above, the CBRE Investor’s Cap Rate Survey (H1, 2018) estimates the cap rate for infill multifamily Class A in San José Metro Area to range from 3.75 to 4.25%. 13 Maximum sales price calculations incorporate a 10% down payment, as well as an interest rate based on a 10-year rolling average for 30- year fixed-rate mortgages, according to data from Freddie Mac. Resale prices for existing BMR units are determined by the City. Annual housing costs associated with BMR rental units, including rent, utility costs, parking fees, and other costs, may not in sum exceed 30% of the annual income associated with the income target for which the unit is designated. 15 FIGURE 8. BELOW MARKET RATE RESIDENTIAL VALUES, BY PROTOTYPE AND AMI LEVEL Prototype 1 Prototype 2 Prototype 3 Prototype 4 Prototype 5 Income Target for Pricing BMR Units Detached Single Family Small Lot Single Family/ Townhomes Condominium Lower Density Rental Apartments Higher Density Rental Apartments 30% AMI (Extremely Low) n/a n/a n/a $116,806 $116,806 50% AMI (Very Low) n/a n/a n/a $211,968 $211,968 60% AMI (Low)* n/a n/a n/a $260,224 $260,224 90% AMI (Median)* $483,270 $344,879 $322,981 n/a n/a 110% AMI (Moderate)* $612,662 $462,872 $435,374 n/a n/a *Per policy, the maximum price for BMR units for low income is set at 60% AMI, median income at 90% AMI, and moderate income at 110% AMI. Note: All values are weighted averages, according to each prototype’s unit mix. Affordable sale prices and rents were provided by the City of Cupertino and Hello Housing, based on 2018 Santa Clara County income and rent limits, published by the California Tax Credit Allocation Committee, and the 2018 Santa Clara County maximum utility allowance, published by HUD. RETAIL COMMERCIAL Retail lease assumptions were developed from Costar listings for comparable ground floor retail spaces in Cupertino, with capitalization rates reported by CBRE for the San José Metro Area. The annual net operating income and capitalized value were calculated based on the assumptions shown in Figure 9. 16 FIGURE 9. RETAIL REVENUE ASSUMPTIONS AND CAPITALIZED VALUE Unit New Retail (NNN) Assumptions Monthly Rent, Triple Net (a) Per SF $4.25 Vacancy Percent 10% Operating Expenses Percent Pass through Capitalization Rate Percent 7.00% Capitalized Value Gross Annual Retail Income Per SF $51.00 Less Retail Vacancy Per SF -$5.10 Less Operating Expenses Per SF $0.00 Annual Net Operating Income Per SF $45.90 Capitalized Value Per SF $655.71 (a) Based on recent lease transactions in Cupertino for recently constructed ground-floor retail. Under a triple net lease (NNN) the tenant pays operating expenses, including real estate taxes, building insurance, and maintenance (the three "nets") on the property in addition to the rents. (b) Based on the CBRE H1 2018 Cap Rate Survey. Cap rates for the San José Metropolitan Area were between 4.5% to 5.5% for (Class A) and 6.25% to 7.25% (Class B) for Neighborhood Retail. Source: CBRE, 2018; Costar, 2018; Strategic Economics, 2018. 17 DEVELOPMENT COSTS The development costs incorporated into the pro forma analysis include land costs, hard costs (construction materials and labor), soft costs, and financing costs. Cost assumptions are summarized in Figure 10 and described below. LAND COSTS A critical factor for development feasibility is the cost of land. To determine the market value of sites zoned for residential use in Cupertino, Strategic Economics interviewed developers and reviewed recent pro formas for similar development projects in Cupertino and nearby communities. Recognizing that one of the key factors that drives the value of the site is the permitted density, this analysis assumes that sites zoned for single family detached homes are valued at $9 million per acre ($207 per square foot), while sites zoned for higher-density housing are valued at $10 million per acre ($230 per square foot). Note that these values are approximations for the purposes of the feasibility analysis; in reality, the value of any particular site is likely to vary based on its location, amenities, and property owner expectations. HARD COSTS Hard costs are based on Strategic Economics’ review of pro formas for similar development projects, as well as interviews with developers active in Cupertino and surrounding cities. The assumptions for hard costs, shown in Figure 10, include estimates for basic site improvements and construction costs for residential areas, retail areas, and parking structures. It should be noted that construction costs have been escalating rapidly in the Bay Area in the last several years14; project feasibility is highly sensitive to changes in construction cost assumptions. SOFT COSTS AND FINANCING COSTS Soft costs include items such as architectural fees, engineering fees, insurance, taxes, legal fees, accounting fees, marketing costs, developer overhead, and city fees, as shown in Figure 10. City fees and other development impact fees were calculated for the individual prototypes based on data provided by City staff. Detailed fee calculations are shown in Figure 21. Other soft costs were estimated based on standard industry ratios, calculated as a percentage of hard costs. 14 Terner Center for Housing Innovation, UC Berkeley. Understanding the Drivers of Rising Construction Costs in California (Ongoing Research), https://ternercenter.berkeley.edu/construction-costs. 18 FIGURE 10: DEVELOPMENT COST ASSUMPTIONS Metric Estimate Land Costs Land zoned for single-family per site acre $9 million Land zoned for townhomes/multi-family/mixed-use per site acre $10 million Hard Costs Site Costs (demo, infrastructure, etc.) per site sq. ft. $30 Residential Area Single Family (includes 2-car garage) per gross sq. ft. $95 Townhomes (includes 2-car garage) per gross sq. ft. $150 Stacked condominiums (Type V) per gross sq. ft. $275 Stacked apartments (Type V) per gross sq. ft. $235 Higher density apartments (Type 3 modified) per gross sq. ft. $300 Retail Area (Including T.I) per gross retail sq. ft. $130 Surface parking per space $10,000 Podium parking per space $35,000 Soft Costs Architectural, Engineering, Consulting % of hard costs 6% Taxes, Insurance, Legal, Accounting % of hard costs 3% Other % of hard costs 3% Contingency % of hard costs 5% Developer Overhead and Fees % of hard costs 4% City Permits and Fees (a) Prototype 1 per unit $153,022 Prototype 2 per unit $83,463 Prototype 3 per unit $67,755 Prototype 4 per unit $65,949 Prototype 5 per unit $67,241 Financing Costs Financing % of hard and soft costs 6% (a) Includes City fees and permits, school district fees, and sanitation district fees paid on the residential and retail component of each prototype for market rate units. Includes housing mitigation fee for the retail component. Sources: Developer interviews, 2018; City of Cupertino, 2018; Cupertino School District and Fremont High School District, 2018; Strategic Economics, 2018. 19 Key Results This section summarizes the findings of the financial feasibility analysis under different inclusionary housing scenarios for each prototype. Figure 11 and Figure 12 demonstrate the return obtained by each prototype, compared to the minimum threshold for feasibility. Figure 21 shows development costs by type and detailed City fees. Figure 22 through Figure 26 provide the pro forma results for each prototype. Ownership residential development can feasibly support higher inclusionary requirements than rental development. While growth in apartment rents has reportedly started to plateau in Santa Clara County in the last year, ownership prices (including condominium prices) continue to increase, making it generally more feasible to build ownership projects.15 Detached single-family development (Prototype 1) can support an inclusionary requirement of 15%, 20%, or the payment of Housing Mitigation Fees. As shown in Figure 11, the single-family detached Prototype 1 shows positive project revenues for Scenarios 1, 2, and 4, achieving a return on cost (ROC) well above the minimum threshold of 10%. Recent sales prices of newly constructed single-family homes in Cupertino are sufficient to offset development costs as well as support inclusionary requirements or the payment of Housing Mitigation Fees. However, the single-family detached prototype cannot support an inclusionary requirement of 25% (Scenario 3), which generates a return of less than 1%. Figure 22 provides more detailed pro forma results for this prototype. Small lot/townhome development (Prototype 2) can also support all inclusionary requirement of 15%, 20%, or the payment of Housing Mitigation Fees. As shown in Figure 11, Prototype 2 shows positive project revenues for Scenarios 1, 2, and 4, achieving a return exceeding the minimum threshold of 15% required for feasibility. Although there has been limited townhome construction in recent years in Cupertino, recent townhome re-sales suggest that prices for new construction would generate sufficient revenues to offset development costs as well as support any inclusionary requirement or the payment of Housing Mitigation Fees. Figure 23 provides more detailed pro forma results for this prototype. A mixed-use condominium prototype (Prototype 3) can support inclusionary requirements of 15%, 20%, or the payment of Housing Mitigation Fees. As shown in Figure 11, Prototype 3 shows positive project revenues for Scenarios 1, 2, and 4, achieving a return well above the minimum threshold of 15%. Despite the lack of recent condominium construction in Cupertino, condominium re-sales suggest that prices for new construction would support any of the scenarios that impose an inclusionary requirement or the payment of in-lieu fees. Figure 24 provides more detailed pro forma results for this prototype. The lower density mixed-use apartment prototype (Prototype 4) is nearly feasible as a 100% market- rate project. Without any BMR requirements, the lower density rental prototype achieves a yield on cost of 4.5%, below the minimum requirement of 4.75%, as shown in Figure 12. The lower density rental prototype does not generate sufficient revenues to support inclusionary requirements or in-lieu fees under current rents and costs. Figure 25 provides the pro forma for this prototype. 15 Mercury News, Louis Hansen, May 16, 2018. Bay Area condo market heats up as alternative to pricey homes. https://www.mercurynews.com/2018/05/16/bay-area-condo-market-heats-up-as-alternative-to-pricier-homes/ 20 The higher density rental multifamily prototype (Prototype 5) can support Housing Mitigation Fee payments (Scenario 4) but cannot feasibly provide inclusionary BMR units under current market rents, construction costs, and land costs. Prototype 5 achieves a higher YOC than Prototype 4, largely due to the greater efficiencies of a higher density project, and is financially feasible in Scenario 1 and Scenario 4 (see Figure 12). Figure 26 provides more detailed pro forma results. The lower density mixed-use apartment prototype (Prototype 4) can feasibly provide up to 15% inclusionary BMR units if it could command 15% higher revenues or if construction and land costs were reduced by 15%. If a lower density rental project were able to achieve higher revenues (15% higher) on the apartment units and on the ground-floor retail space, as shown in Figure 13 and Figure 14, the project could feasibly accommodate an inclusionary requirement of 15% BMR units. Alternatively, if a development project were able to secure a construction bid and purchase a site that reduced these costs by 15%, the lower density mixed-use apartment prototype could feasibly provide 15% inclusionary BMR units (see Figure 15 and Figure 16). The higher density mixed-use apartment prototype (Prototype 5) can feasibly provide inclusionary BMR units if it can command 10% higher revenues or if construction and land costs were reduced by 5%. If a higher density rental project can achieve 10% higher rents on the apartments and retail space, the project can feasibly accommodate an inclusionary requirement of 15% BMR units (see Figure 17 and Figure 18). In another scenario, if a higher density mixed-use apartment could secure a construction bid and site that is 5% less expensive, this prototype could also feasibly provide 15% inclusionary BMR units (see Figure 19 and Figure 20). Formatted: Not Highlight Formatted: Not Highlight Formatted: Not Highlight Formatted: Not Highlight Formatted: Not Highlight Formatted: Not Highlight 21 FIGURE 11: RETURN ON COST FOR OWNERSHIP PROTOTYPES BY INCLUSIONARY HOUSING SCENARIO Inclusionary Housing Scenarios Prototype 1: Prototype 2: Prototype 3: Single Family Detached Small Lot SF/Townhouse Condominiums Minimum Required Return 10-15% 18-20% 18-20% Scenario 0 (No Requirements) 31% 41% 38% Scenario 1 (Existing Policy) 15% 26% 23% Scenario 2 (20% Inclusionary) 14% 21% 19% Scenario 3 (25% Inclusionary) 1% 16% 14% Scenario 4 (In-Lieu Fees) 28% 37% 33% Source: Strategic Economics, 2019. FIGURE 12: YIELD ON COST UNDER DIFFERENT INCLUSIONARY HOUSING SCENARIOS FOR MULTI-FAMILY RENTAL PROTOTYPES 4 AND 5 Inclusionary Housing Scenarios Prototype 4: Prototype 5: Lower Density Rental Higher Density Rental Minimum Required Yield on Cost 4.75%-5.25% 4.75%-5.25% Scenario 0 (No Requirements) 4.52% 4.93% Scenario 1 (15% Inclusionary) 4.22% 4.63% Scenario 2 (20% Inclusionary) 4.10% 4.50% Scenario 3 (25% Inclusionary) 3.94% 4.34% Scenario 4 (In Lieu Fees) 4.40% 4.76% Source: Strategic Economics, 2019. 22 FIGURE 13: YIELD ON COST UNDER DIFFERENT REVENUE ASSUMPTIONS FOR LOWER DENSITY MULTI-FAMILY RENTAL (PROTOTYPE 4) WITH 15% BMR REQUIREMENT Revenue Assumptions Monthly Market Rate Apt. Rent per Unit Monthly Retail Rent per SF Yield on Cost Feasibility Results Current Apartment and Retail Rents $4,216 $4.25 4.22% Not Feasible Increased Rents (15% Higher Revenues) $4,848 $4.89 4.82% Feasible Source: Strategic Economics, 2019. FIGURE 14: FEASIBILITY OF LOWER DENSITY MULTI-FAMILY RENTAL PROTOTYPE (PROTOTYPE 4) WITH 15% INCLUSIONARY BMR REQUIREMENT AND INCREASED REVENUES Source: Strategic Economics, 2019. 0.00% 0.50% 1.00% 1.50% 2.00% 2.50% 3.00% 3.50% 4.00% 4.50% 5.00% 5.50% Current Apartment and Retail Rents Increased Rents (15% Higher Apartment and Retail Revenues)Profit (Yield on Cost) Minimum Threshold for Feasibility of 4.75% Formatted: Not Highlight Formatted: Not Highlight Formatted: Not Highlight Formatted: Not Highlight Formatted: Not Highlight Formatted: Not Highlight 23 FIGURE 15: YIELD ON COST UNDER DIFFERENT COST ASSUMPTIONS FOR LOWER DENSITY MULTI-FAMILY RENTAL (PROTOTYPE 4) WITH 15% BMR REQUIREMENT Cost Assumptions Construction Cost per Unit Land Cost per Unit Yield on Cost Feasibility Results Current Costs $385,958 $250,000 4.22% Not Feasible Reduced Costs (15% Lower Costs) $328,064 $212,500 4.90% Feasible Source: Strategic Economics, 2019. FIGURE 16: FEASIBILITY RESULTS OF LOWER DENSITY MULTI-FAMILY RENTAL PROTOTYPE (PROTOTYPE 4) WITH 15% INCLUSIONARY BMR REQUIREMENT AND LOWER COSTS Source: Strategic Economics, 2019. 0.00% 0.50% 1.00% 1.50% 2.00% 2.50% 3.00% 3.50% 4.00% 4.50% 5.00% 5.50% Current Costs Reduced Costs (15% Lower Costs)Yield on CostMinimum Threshold for Feasibility of 4.75% Formatted: Not Highlight Formatted: Not Highlight Formatted: Not Highlight 24 FIGURE 17: YIELD ON COST UNDER DIFFERENT REVENUE ASSUMPTIONS FOR HIGHER DENSITY MULTI-FAMILY RENTAL (PROTOTYPE 5) WITH 15% BMR REQUIREMENT Revenue Assumptions Monthly Market Rate Apt. Rent per Unit Monthly Retail Rent per SF Yield on Cost Feasibility Results Current Rents $4,216 $4.25 4.63% Not Feasible Increased Rents (10% Higher Revenues) $4,637 $4.68 4.91% Feasible Source: Strategic Economics, 2019. FIGURE 18: FEASIBILITY RESULTS OF HIGHER DENSITY MULTI-FAMILY RENTAL PROTOTYPE (PROTOTYPE 5) WITH 15% INCLUSIONARY BMR REQUIREMENT AND HIGHER REVENUES Source: Strategic Economics, 2019. 0.00% 0.50% 1.00% 1.50% 2.00% 2.50% 3.00% 3.50% 4.00% 4.50% 5.00% 5.50% Current Rents Increased Rents (10% Higher Apartment and Retail Revenues)Yield on Cost Minimum Threshold for Feasibility of 4.75% 25 FIGURE 19: YIELD ON COST UNDER DIFFERENT COST ASSUMPTIONS FOR HIGHER DENSITY MULTI-FAMILY RENTAL (PROTOTYPE 5) WITH 15% BMR REQUIREMENT Cost Assumptions Construction Cost per Unit Land Cost per Unit Yield on Cost Feasibility Results Current Costs $460,195 $131,579 4.63% Not Feasible Reduced Costs (5% Lower Costs) $437,185 $125,000 4.85% Feasible Source: Strategic Economics, 2019. FIGURE 20: FEASIBILITY RESULTS OF HIGHER DENSITY MULTI-FAMILY RENTAL PROTOTYPE (PROTOTYPE 5) WITH 15% INCLUSIONARY BMR REQUIREMENT AND LOWER COSTS Source: Strategic Economics, 2019. 0.00% 0.50% 1.00% 1.50% 2.00% 2.50% 3.00% 3.50% 4.00% 4.50% 5.00% 5.50% Current Costs Reduced Costs (5% Lower)Yield on Cost Minimum Threshold for Feasibility of 4.75% 26 FIGURE 21. DETAILED CALCULATION OF THE CITY OF CUPERTINO’S PERMITS AND FEES FOR EACH PROTOTYPE (PER UNIT) Prototype 1 Prototype 2 Prototype 3 Prototype 4 Prototype 5 Detached Single Family Small Lot Single Family/Townhome Condominium Lower Density Rental Apartments Higher Density Rental Apartments Planning Fees Planning Applications $9,210 $1,289 $645 $400 $400 CEQA $3,571 $2,447 $1,223 $1,223 $1,223 Consultant Review $2,111 $296 $148 $148 $148 Housing Mitigation Fee (Non-residential only) $0 $0 $1,188 $1,188 $1,782 Public Works Fees Transportation Impact Fee $6,177 $3,380 $4,374 $4,374 $4,871 Grading $420 $59 $29 $29 $29 Tract Map $1,350 $189 $94 $94 $94 Plan Check and Inspection $543 $76 $38 $38 $38 Storm Drain Fees $4,902 $501 $367 $354 $312 Parkland Dedication (a) $105,000 $60,000 $54,000 $54,000 $54,000 Building Division Fees Building Fees $11,428 $10,592 $1,664 $1,133 $1,199 Construction Tax $752 $752 $1,075 $1,075 $1,237 Other Fees School District Fees (b) $7,012 $3,506 $2,826 $1,808 $1,823 Sanitary Sewer District Connection Permit Fee $350 $350 $70 $70 $70 Stormwater Management Fee $197 $28 $14 $14 $14 Estimated City Fees, Total Per Unit $153,022 $83,463 $67,755 $65,949 $67,241 (a) Parkland dedication fees waived for affordable units. (b) Based on the average of Cupertino School District and Fremont Union High School District school fees. Sources: City of Cupertino, 2018; Fremont Union School District; Cupertino School District; Cupertino Sanitary Sewer District, 2018. 27 FIGURE 22: FINANCIAL FEASIBILITY RESULTS FOR SINGLE-FAMILY DETACHED PROTOTYPE 1 Scenario 0 (No BMR Req.) Scenario 1 (15% On-Site) Scenario 2 (20% On-Site) Scenario 3 (25% On-Site) Scenario 4 (In-Lieu Fees) Total Units 7 7 7 7 7 Market Rate Units 7 6 6 5 7 Affordable Units 0 1 1 2 0 Fractional Units 0 0.05 0.4 0 0 Revenues Residential Capitalized Value $24,501,400 $21,484,470 $21,484,470 $18,596,932 $24,501,400 Per Unit $3,500,200 $3,069,210 $3,069,210 $2,656,705 $3,500,200 Development Costs Land Costs Land Costs $14,000,000 $14,000,000 $14,000,000 $14,000,000 $14,000,000 Per Unit $2,000,000 $2,000,000 $2,000,000 $2,000,000 $2,000,000 Direct Costs Gross Residential Area (a) $2,775,564 $2,775,564 $2,775,564 $2,775,564 $2,775,564 Subtotal Direct Costs $2,775,564 $2,775,564 $2,775,564 $2,775,564 $2,775,564 Per Unit $396,509 $396,509 $396,509 $396,509 $396,509 Per Gross Sq. Ft. $95 $95 $95 $95 $95 Indirect Costs City Fees (b) $1,071,155 $991,537 $1,169,211 $861,155 $1,532,693 Other Soft Costs (c) $582,868 $582,868 $582,868 $582,868 $582,868 Per Unit $83,266.92 $83,266.92 $83,266.92 $83,266.92 $83,266.92 Subtotal Indirect Costs $1,654,023 $1,574,405 $1,752,079 $1,444,023 $2,115,561 Per Unit $236,289 $224,915 $250,297 $206,289 $302,223 Financing $265,775 $260,998 $271,659 $253,175 $293,468 Per Unit $37,968 $37,285 $38,808 $36,168 $41,924 Total Development Costs $18,695,363 $18,610,968 $18,799,302 $18,472,763 $19,184,593 Per Unit $2,670,766 $2,658,710 $2,685,615 $2,638,966 $2,740,656 Per Gross Sq. Ft. $640 $637 $643 $632 $657 Feasibility Net Revenue (d) $5,806,037 $2,873,502 $2,685,168 $124,169 $5,316,807 Return on Cost (e) 31% 15% 14% 1% 28% (a) Includes costs for site prep and 2-car parking garage (b) Figure 14 shows detailed City fees. Includes fractional in-lieu housing mitigation fee for scenario 1 and 2. Parkland dedication fees waived for affordable units. (c) Includes architectural fees, engineering fees, insurance, taxes, legal fees, accounting fees, marketing costs, and developer overhead (d) Net revenue is the project total revenue minus total development costs. (d) Return on cost is the net revenue, divided by total development costs. (e) Return on cost is the net revenue, divided by total development costs. Source: Strategic Economics, 2018. 28 FIGURE 23: FINANCIAL FEASIBILITY RESULTS FOR SMALL LOT SINGLE-FAMILY/TOWNHOUSE PROTOTYPE 2 Scenario 0 (No BMR Req.) Scenario 1 (15% On-Site) Scenario 2 (20% On-Site) Scenario 3 (25% On-Site) Scenario 4 (In-Lieu Fees) Total Units 50 50 50 50 50 Market Rate Units 50 42 40 37 50 Affordable Units 0 8 10 13 0 Revenues Residential Capitalized Value $89,725,000 $79,265,818 $75,818,755 $72,312,696 $89,725,000 Retail Capitalized Value $0 $0 $0 $0 $0 Total Capitalized Value $89,725,000 $79,265,818 $75,818,755 $72,312,696 $89,725,000 Per Unit $1,794,500 $1,585,316 $1,516,375 $1,446,254 $1,794,500 Development Costs Land Costs Land Costs $33,333,333 $33,333,333 $33,333,333 $33,333,333 $33,333,333 Per Unit $666,667 $666,667 $666,667 $666,667 $666,667 Direct Costs Site Prep/Demo $4,356,000 $4,356,000 $4,356,000 $4,356,000 $4,356,000 Gross Residential Area (a) $15,651,677 $15,651,677 $15,651,677 $15,651,677 $15,651,677 Subtotal Direct Costs $20,007,677 $20,007,677 $20,007,677 $20,007,677 $20,007,677 Per Unit $400,154 $400,154 $400,154 $400,154 $400,154 Per Gross Sq. Ft. $192 $192 $192 $192 $192 Indirect Costs City Fees (b) $4,173,154 $3,693,154 $3,573,154 $3,393,154 $5,986,154 Other Soft Costs (c) $4,201,612 $4,201,612 $4,201,612 $4,201,612 $4,201,612 Per Unit $84,032 $84,032 $84,032 $84,032 $84,032 Subtotal Indirect Costs $8,374,767 $7,894,767 $7,774,767 $7,594,767 $10,187,767 Per Unit $167,495 $157,895 $155,495 $151,895 $203,755 Financing $1,702,947 $1,674,147 $1,666,947 $1,656,147 $1,811,727 Per Unit $34,059 $33,483 $33,339 $33,123 $36,235 Total Development Costs $63,418,723 $62,909,923 $62,782,723 $62,591,923 $65,340,503 Per Unit $1,268,374 $1,258,198 $1,255,654 $1,251,838 $1,306,810 Per Gross Sq. Ft. $608 $603 $602 $600 $626 Feasibility Net Revenue (d) $26,306,277 $16,355,895 $13,036,032 $9,720,772 $24,384,497 Return on Cost (e) 41% 26% 21% 16% 37% (a) Includes 2-car parking garage (b) Figure 14 shows applicable city fees. Only Scenario 4 pays in-lieu housing mitigation fees. Parkland dedication fees waived for affordable units. (c) Includes architectural fees, engineering fees, insurance, taxes, legal fees, accounting fees, marketing costs, and developer overhead (d) Net revenue is the project total revenue minus total development costs. (d) Return on cost is the net revenue, divided by total development costs. (e) Return on cost is the net revenue, divided by total development costs. Source: Strategic Economics, 2018. 29 FIGURE 24: FINANCIAL FEASIBILITY RESULTS FOR CONDOMINIUM PROTOTYPE 3 Scenario 0 (No BMR Req.) Scenario 1 (15% On-Site) Scenario 2 (20% On-Site) Scenario 3 (25% On-Site) Scenario 4 (In-Lieu Fees) Total Units 100 100 100 100 100 Market Rate Units 100 85 80 75 100 Affordable Units 0 15 20 25 0 Revenues Residential Capitalized Value $154,250,000 $136,743,959 $130,983,540 $125,110,729 $154,250,000 Retail Capitalized Value $6,557,143 $6,557,143 $6,557,143 $6,557,143 $6,557,143 Total Capitalized Value $160,807,143 $143,301,101 $137,540,683 $131,667,871 $160,807,143 Per Unit $1,608,071 $1,433,011 $1,375,407 $1,316,679 $1,608,071 Development Costs Land Costs Land Costs $28,571,429 $28,571,429 $28,571,429 $28,571,429 $28,571,429 Per Unit $285,714 $285,714 $285,714 $285,714 $285,714 Direct Costs Site Prep/Demo $3,733,714 $3,733,714 $3,733,714 $3,733,714 $3,733,714 Gross Residential Area $50,703,125 $50,703,125 $50,703,125 $50,703,125 $50,703,125 Gross Retail Area $1,300,000 $1,300,000 $1,300,000 $1,300,000 $1,300,000 Parking $7,560,000 $7,560,000 $7,560,000 $7,560,000 $7,560,000 Subtotal Direct Costs $63,296,839 $63,296,839 $63,296,839 $63,296,839 $63,296,839 Per Unit $632,968 $632,968 $632,968 $632,968 $632,968 Per Gross Sq. Ft. $343 $343 $343 $343 $343 Indirect Costs City Fees (a) $6,775,479 $5,965,479 $5,695,479 $5,425,479 $10,398,879 Other Soft Costs (b) $13,292,336 $13,292,336 $13,292,336 $13,292,336 $13,292,336 Per Unit $132,923 $132,923 $132,923 $132,923 $132,923 Subtotal Indirect Costs $20,067,815 $19,257,815 $18,987,815 $18,717,815 $23,572,415 Per Unit $200,678 $192,578 $189,878 $187,178 $235,724 Financing $5,001,879 $4,953,279 $4,937,079 $4,920,879 $5,212,155 Per Unit $50,019 $49,533 $49,371 $49,209 $52,122 Total Development Costs $116,937,963 $116,079,363 $115,793,163 $115,506,963 $120,652,839 Per Unit $1,169,380 $1,160,794 $1,157,932 $1,155,070 $1,206,528 Per Gross Sq. Ft. $634 $630 $628 $626 $654 Feasibility Net Revenue (c) $43,869,180 $27,221,739 $21,747,520 $16,160,909 $40,154,304 Return on Cost (d) 38% 23% 19% 14% 33% (a) Figure 14 shows detailed city fees. In-lieu housing mitigation fees apply to non-residential sq. ft. and Scenario 4. Parkland dedication fees waived for affordable units. (b) Includes architectural fees, engineering fees, insurance, taxes, legal fees, accounting fees, marketing costs, and developer overhead. (c) Net revenue is the project total revenue minus total development costs. (d) Return on cost is the net revenue, divided by total development costs. Source: Strategic Economics, 2018. 30 FIGURE 25: FINANCIAL FEASIBILITY RESULTS FOR LOWER DENSITY RENTAL APARTMENTS PROTOTYPE 4 Scenario 0 (No BMR Req.) Scenario 1 (15% On-Site) Scenario 2 (20% On-Site) Scenario 3 (25% On-Site) Scenario 4 (In-Lieu Fees) Total Units 100 100 100 100 100 Market Rate Units 100 85 80 75 100 Affordable Units 0 15 20 25 0 Revenues Residential Net Operating Income $3,288,285 $2,942,477 $2,831,310 $2,691,717 $3,288,285 Retail Net Operating Income $459,000 $459,000 $459,000 $459,000 $459,000 Total Net Operating Income $3,747,285 $3,401,477 $3,290,310 $3,150,717 $3,747,285 Total Capitalized Value $83,928,555 $75,791,903 $73,176,197 $69,891,657 $83,928,555 Per Unit $839,286 $757,919 $731,762 $698,917 $839,286 Development Costs Land Costs Land Costs $25,000,000 $25,000,000 $25,000,000 $25,000,000 $25,000,000 Per Unit $250,000 $250,000 $250,000 $250,000 $250,000 Direct Costs Site Prep/Demo $3,267,000 $3,267,000 $3,267,000 $3,267,000 $3,267,000 Gross Residential Area $27,553,750 $27,553,750 $27,553,750 $27,553,750 $27,553,750 Gross Retail Area $1,300,000 $1,300,000 $1,300,000 $1,300,000 $1,300,000 Parking $7,560,000 $6,475,000 $6,475,000 $6,475,000 $7,560,000 Subtotal Direct Costs $39,680,750 $38,595,750 $38,595,750 $38,595,750 $39,680,750 Per Unit $396,808 $385,958 $385,958 $385,958 $396,808 Per Gross Sq. Ft. $338 $329 $329 $329 $338 Indirect Costs City Fees (a) $6,594,875 $5,784,875 $5,514,875 $5,244,875 $8,942,363 Other Soft Costs (b) $8,332,958 $8,105,108 $8,105,108 $8,105,108 $8,332,958 Per Unit $83,329.58 $81,051.08 $81,051.08 $81,051.08 $83,329.58 Subtotal Indirect Costs $14,927,832 $13,889,982 $13,619,982 $13,349,982 $17,156,520 Per Unit $149,278 $138,900 $136,200 $133,500 $171,565 Financing $3,276,515 $3,149,144 $3,132,944 $3,116,744 $3,410,236 Per Unit $32,765 $31,491 $31,329 $31,167 $34,102 Total Development Costs $82,885,097 $80,634,876 $80,348,676 $80,062,476 $85,247,506 Per Unit $828,851 $806,349 $803,487 $800,625 $852,475 Per Gross Sq. Ft. $707 $688 $685 $683 $727 Feasibility Net Revenue (c) $1,043,457 ($4,842,973) ($7,172,479) ($10,170,819) ($1,318,952) Yield on Cost (d) 4.5% 4.2% 4.1% 3.9% 4.4% (a) Appendix shows detailed city fees. Excludes affordable housing mitigation in-lieu fee, except in Scenario 4. Parkland dedication fees waived for affordable units. (b) Includes architectural fees, engineering fees, insurance, taxes, legal fees, accounting fees, marketing costs, and developer overhead. (c) Net revenue is the project total revenue minus total development costs. (d) Yield on cost is the total project net operating income divided by total development costs. Source: Strategic Economics, 2018. 31 FIGURE 26: FINANCIAL FEASIBILITY RESULTS FOR HIGHER DENSITY RENTAL APARTMENTS PROTOTYPE 5 Scenario 0 (No BMR Req.) Scenario 1 (15% On-Site) Scenario 2 (20% On-Site) Scenario 3 (25% On-Site) Scenario 4 (In-Lieu Fees) Total Units 100 100 100 100 100 Market Rate Units 100 85 80 75 100 Affordable Units 0 15 20 25 0 Revenues Residential Net Operating Income $3,288,285 $2,942,477 $2,831,310 $2,691,717 $3,288,285 Retail Net Operating Income $688,500 $688,500 $688,500 $688,500 $688,500 Total Net Operating Income $3,976,785 $3,630,977 $3,519,810 $3,380,217 $3,976,785 Total Capitalized Value $87,207,126 $79,070,475 $76,454,769 $73,170,229 $87,207,126 Per Unit $872,071 $790,705 $764,548 $731,702 $872,071 Development Costs Land Costs Land Costs $13,157,895 $13,157,895 $13,157,895 $13,157,895 $13,157,895 Per Unit $131,579 $131,579 $131,579 $131,579 $131,579 Direct Costs Site Prep/Demo $1,719,474 $1,719,474 $1,719,474 $1,719,474 $1,719,474 Gross Residential Area $35,175,000 $35,175,000 $35,175,000 $35,175,000 $35,175,000 Gross Retail Area $1,950,000 $1,950,000 $1,950,000 $1,950,000 $1,950,000 Parking $8,190,000 $7,175,000 $7,175,000 $7,175,000 $8,190,000 Subtotal Direct Costs $47,034,474 $46,019,474 $46,019,474 $46,019,474 $47,034,474 Per Unit $470,345 $460,195 $460,195 $460,195 $470,345 Per Gross Sq. Ft. $401 $392 $392 $392 $401 Indirect Costs City Fees (a) $6,724,069 $5,914,069 $5,644,069 $5,374,069 $9,688,129 Other Soft Costs (b) $9,877,239 $9,664,089 $9,664,089 $9,664,089 $9,877,239 Per Unit $98,772 $96,641 $96,641 $96,641 $98,772 Subtotal Indirect Costs $16,601,308 $15,578,158 $15,308,158 $15,038,158 $19,387,168 Per Unit $166,013 $155,782 $153,082 $150,382 $193,872 Financing $3,818,147 $3,695,858 $3,679,658 $3,663,458 $3,985,299 Per Unit $38,181 $36,959 $36,797 $36,635 $39,853 Total Development Costs $80,611,823 $78,451,384 $78,165,184 $77,878,984 $83,564,835 Per Unit $806,118 $784,514 $781,652 $778,790 $835,648 Per Gross Sq. Ft. $688 $669 $667 $664 $713 Feasibility Net Revenue (c) $6,595,303 $619,090 ($1,710,416) ($4,708,755) $3,642,291 Yield on Cost (d) 4.9% 4.6% 4.5% 4.3% 4.8% (a) Appendix shows detailed city fees. Excludes affordable housing mitigation in-lieu fee, except in Scenario 4. Parkland dedication fees waived for affordable units. (b) Includes architectural fees, engineering fees, insurance, taxes, legal fees, accounting fees, marketing costs, and developer overhead. (c) Net revenue is the project total revenue minus total development costs. (d) Yield on cost is the total project net operating income divided by total development costs. Source: Strategic Economics, 2018. 32 Peer Cities Strategic Economics researched BMR housing programs in peer cities, including: San Jose, Santa Clara, Campbell, Mountain View, Sunnyvale, and Palo Alto. The key findings from the research are explained below and summarized in Figure 27. INCLUSIONARY REQUIREMENTS As shown in Figure 27, all of the cities have inclusionary requirements for ownership housing. They are typically set at 15%, with the exception of Mountain View and Sunnyvale, which have requirements of 10% and 12.5%, respectively. For rental housing, Palo Alto and Sunnyvale have a housing mitigation fee, but no inclusionary requirements. However, both cities are considering revising their policies on rental housing. TARGET INCOME For inclusionary requirements on ownership housing, all of the peer cities have targeted moderate- income households, roughly defined as between 80 and 120% of AMI. For rental housing, the income target is typically low-income (up to 80% AMI), although San Jose also targets very low-income households (up to 50% AMI). Santa Clara has targeted moderate-income households for both ownership and rental housing requirements. Cities that charge housing mitigation fees on rental or ownership housing have set their fees based on nexus studies that measure the affordable housing needs of very-low, low-, and moderate-income households. None of the peer cities have targeted extremely-low income households for their inclusionary requirements. However, city staff from Sunnyvale and San Jose have indicated that they are providing funding to develop housing for extremely-low income households through the revenues they have collected from housing mitigation fees, in-lieu fees, and other housing funds. Local revenues are often combined with Santa Clara County Measure A funds – which are specifically targeted to extremely-low income households – as well as 9% and 4% Low Income Housing Tax Credits (LIHTC) and Section 8 vouchers from the Santa Clara County Housing Authority. ALTERNATIVE MEANS OF COMPLIANCE All of the cities prefer that units are built onsite, but they allow alternative means of complying with inclusionary requirements. Developers can typically satisfy the requirement by providing units off-site, paying in-lieu fees, or dedicating land for affordable housing. However, in some cases, the developer must first demonstrate that the inclusionary requirement is not feasible. For example, the City of Palo Alto requires that the applicant present “substantial evidence to support a finding of infeasibility” and of “feasibility of any proposed alternative.” In other cities, like Mountain View, Sunnyvale, and Santa Clara, developers must receive approval from the City Council for the alternative. In Sunnyvale and San Jose, developers that pursue an alternative to the onsite inclusionary requirement must provide a higher number of affordable units. 33 FIGURE 27: INCLUSIONARY HOUSING REQUIREMENTS AND HOUSING MITIGATION FEES IN PEER CITIES City Inclusionary Requirement Target Income for BMR Policy Housing Mitigation Fee/In Lieu Fees Alternatives to compliance Ownership Rental Ownership Rental Ownership Rental Cupertino 15% 15% 1/2 of BMR units at Median (100% AMI) and 1/2 of BMR units at Moderate (120% AMI)* 60% of BMR units at Very Low (50% AMI) and 40% of BMR units at Low (60% AMI) -Single family: $17.82/sf -Small lot single family/Townhome: $19.60/sf -Multifamily attached: $23.76/sf -Multifamily Attached (up to 35 du/ac): $23.76/sf -Multifamily attached (over 35 du/ac): $29.70/sf Onsite units are preferred, but alternatives may be possible with City Council approval. These include: on-site BMR rental units where ownership units or a fee is required; purchase of off-site units to be dedicated/rehabbed as for-sale or rental BMR units; development of off-site units to be dedicated as for-sale or rental BMR units; land for development of affordable housing. An Affordable Housing Plan is required. Mountain View 10% 15% Moderate (80 - 120% AMI) Low (50-80% AMI) In-lieu fee of 3% of sales price $34/sf (applies to fractional units only) Onsite units are preferred, but City Council can approve other alternatives. Sunnyvale 12.5% None Moderate (Below 120% AMI) Low (Below 80% AMI) In-lieu fee of 7% of sales price $17/sf For ownership units, onsite units are preferred. With Council approval, developers may provide alternatives if they result in a higher number of BMR units. San Jose 15% 15% Moderate (Below 120% AMI) 9% Mod (80% AMI) 6% VLI (30- 50% AMI) In-lieu fee of $153,000 per unit. $17.41/sf for projects of 3 to 19 units in size Developers have the option of providing units off-site or paying in-lieu fees, but the affordable housing requirement is 20%, and the target income is lower. Santa Clara 15% 15% Moderate (Below 100% AMI) Moderate (Below 100% AMI) $20-$30/sf, depending on housing type Alternatives include dedication of land for affordable housing, development of affordable units at an off-site location, or some combination thereof, with approval from City Council through a Development Agreement. Campbell 15% 15% Moderate (Below 110% AMI) Low (Below 70% AMI) $34.50/sf for projects of 6 units or less None Developers can dedicate land or pay in lieu fees. Palo Alto 15% None 2/3 BMR units at 80- 100% AMI and 1/3 BMR units at 100- 120% AMI Mod (80- 120% AMI) Low (50-80% AMI) VLI (30-50% AMI) $50-$75/sf depending on housing type $20/sf Developers can dedicate land, pay in lieu fees, provide rental units within the ownership project, convert or rehabilitate affordable housing units. They must first demonstrate that the inclusionary requirement is not feasible. *Sales prices set at 110% for BMR moderate income unit and 90% for a BMR median income unit. Source: Interviews with City staff, BMR housing ordinances, Strategic Economics, 34 NON-RESIDENTIAL LINKAGE FEE The City is considering updating non-residential fees, otherwise known as commercial linkage fees, on new workplace buildings (office, R&D, hotel, and retail development projects). Linkage fees are used to mitigate the impacts of an increase in affordable housing demand associated with a net increase in worker households. as employees at new non-residential developments seek housing nearby. The funds raised by the linkage fees are deposited into a housing fund specifically reserved for use by a local jurisdiction to increase the supply of affordable housing for the workforce. Linkage fees are one of several funding sources that jurisdictions can use to help meet affordable housing needs of new workers. The City first adopted linkage fees for office and R&D projects in 1992, and expanded the program to apply to retail and hotel developments in 2004. Following a 2015 nexus study update completed by Keyser Marston Associates, the City amended the fees for all three uses to their current levels--$23.76 for office/R&D uses, and $11.88 for hotel and retail uses.16 This memo report provides updated policy analysis, including a financial feasibility analysis, and a review of current non-residential linkage fees in neighboring cities to establish a recommendation on updated linkage fees in Cupertino. Approach METHODOLOGY The financial feasibility of establishing updated non-residential linkage fees in Cupertino was tested using a pro forma model that measures profit for the developer or investor. Yield on cost (YOC) is a commonly used metric indicating the profitability of a non-residential project. The pro forma model tallies all development costs, including land, direct construction costs, indirect costs (including financing), and developer fees. Revenues from lease rates or hotel room rates are the basis for calculating annual income from the new non-residential development. The total operating costs are subtracted from the total revenues to calculate the annual net operating income. The YOC is then estimated by dividing the annual net operating income by the total development costs. The fee levels were then added as an additional development cost to measure the resulting change in the YOC. DEVELOPMENT PROTOTYPES The analysis estimates the feasibility of potential linkage fees for three non-residential prototypes: office/R&D, hotel, and retail. The building characteristics of each development prototype, including size, density (floor-area-ratio), and parking assumptions are based on a review of projects that were recently built, and in planning stages in Cupertino, as well as recently built and pipeline projects in surrounding areas. Based on the development activity in Cupertino, the following is assumed regarding each prototype: • Office/R&D: Based on a review of market activity in the City, recent and proposed developments in neighboring cities, it is assumed that the office/R&D development project would be a speculative building serving the tech industry. 16 Keyser Marston Associates, “City of Cupertino: Non-residential Jobs-Housing Nexus Analysis,” City of Cupertino, April 2015. 35 • Hotel: Newer hotel development projects in Cupertino and surrounding areas are typically upscale, select-service chains that serve business travelers. • Retail: The retail development prototype is assumed to be a small low-density retail center. The details regarding the size, density (floor-area ratio), parking, and other key assumptions for each prototype are summarized in Figure 28 below. FIGURE 28. DESCRIPTION OF DEVELOPMENT PROTOTYPES Prototype Description Office/R&D Hotel Retail Project Type Class A Office Speculative Building Select-Service Upscale Business Hotel Neighborhood Retail Shopping Center Parcel Size (Sq. Ft.) 174,240 87,120 21,780 Parcel Size (Acres) 4 2 0.5 Total Stories 4 5 1 Floor-Area Ratio (without parking) (a) 1.50 1.20 0.35 Gross Building Area (GSF) 261,360 104,544 7,623 Efficiency Ratio (b) 90% n/a 90% Net area (NSF) 235,224 n/a 6,861 Number of rooms n/a 140 n/a Total Parking Spaces 825 155 30 Surface 93 70 30 Structured Garage 732 0 0 Underground 0 85 0 Parking Ratio (per room) n/a 1.1 n/a Parking Ratio (per 1,000 SF) 3.2 1.5 4.0 Notes: (a) The Floor-Area Ratio (FAR) is often used as a measure of density. In this analysis, it is calculated as the gross building area, not including parking, divided by the parcel size. (b) The Efficiency Ratio refers to the ratio of gross building area to ne leasable area. An efficiency ratio of 90% means that 90% of the gross building area is leasable space. In hotels, revenue is informed by room count, rather than square footage, and therefore the net area is omitted. DEVELOPMENT COSTS The development costs incorporated into the pro forma analysis include hard costs, (construction materials and labor) land costs, soft costs (indirect costs), and financing costs. HARD COSTS Hard costs are based on Strategic Economics’ review of pro formas for similar development projects, industry publications, and interviews with developers with projects in Cupertino and nearby jurisdictions. The assumptions for hard costs by prototype are described in Figure 29. They include estimates for basic site improvements, construction costs for the building, and costs for parking by type. In addition, the cost of construction includes a tenant improvement allowance for office/R&D and retail uses, as well as a Furniture, Fixtures, and Equipment (FF&E) allotment for hotel uses, which are both typical for this market. 36 FIGURE 29. HARD COSTS ASSUMPTIONS BY PROTOTYPE Cost Category Metric Office/R&D Hotel Retail Site Prep Per Site Sq. Ft. $3 $3 $3 Construction Costs Per Gross Building Sq. Ft. $300 $250 $165 Per Room $342,472 Parking Costs Cost per Space Surface $7,000 Structured Garage $30,000 Underground $60,000 Land Costs Entitled Land Per Site St. Ft. $137.74 $137.74 $75.00 Per Acre $6,000,000 $6,000,000 $3,267,000 Tenant Improvement Allowance Per Building Net Sq. Ft. $75 n/a $35 Furniture, Fixtures, Equipment Per Room n/a $35,000 n/a Source: Costar, 2019; HVS Consulting, 2017; review of pro formas for comparable development projects in Santa Clara County; interviews with developers in Cupertino and Santa Clara County, 2019; Strategic Economics, 2019. LAND COSTS One of the critical cost factors for a non-residential development project is land cost. To determine the land value of sites zoned for commercial uses, Strategic Economics analyzed recent sales transactions and estimates for properties in Santa Clara County and interviewed developers. Land values are similar for both hotel and office development in the Cupertino area, based on a review of recent transactions. Comparable values for office and hotel sites are showed in Figure 22 below. As shown, the land values typically range from $120 to $185 per square foot. One exception in the Cinnabar Street land sale for over $200 per square foot, which is in the Diridon Station Area, and planned for higher intensity development projects than the prototypes for this study. For the purposes of this analysis, it is assumed that sites zoned for office/R&D or hotel would have a land value of $138 per square foot ($6 million per acre). There are fewer land sales transactions for sites that are entitled for low-density retail development. However, a review of smaller retail property transactions shows that typically the land values are usually under $100 per square foot. For the purposes of this analysis, it is assumed that a low-density retail site in Cupertino would have a land value of $75 per square foot (about $3.2 million per acre). 37 FIGURE 30. LAND COMPARABLES FOR OFFICE AND HOTEL Property Jurisdiction Year Sold Acres Estimated Value Per Sq. Ft. Land Proposed Land Use 4995 Patrick Henry Dr. Santa Clara 2016 48.6 $118 Office 357-387 Cinnabar St. (a) San Jose 2017 5.6 $210 Office 767 Mathilda Ave. Sunnyvale 2017 3.28 $146 Hotel 10801 N. Wolfe Rd. (b) Cupertino 2018 1.72 $185 Hotel Notes: (a) 357-387 Cinnabar St. is in the Diridon Station area, and part of Google's transit village, which will have a significantly higher FAR than the office prototype. (b) Estimated value for 10801 N. Wolfe Rd. is based on valuation from CBRE in 2018 rather than a sales transaction. Sources: Costar, 2019; CBRE, 2018; SOFT COSTS Soft costs (often referred to as indirect costs) include items such as architectural fees, engineering fees, insurance, taxes, legal fees, accounting fees, city fees, and marketing costs. Cupertino’s Traffic Impact Fee was calculated based on the City’s fee schedule. Other permits and fees were calculated for each prototypes based on estimates generated for new development projects as part of the feasibility analysis for the Vallco Specific Plan. Soft costs were estimated based on standard industry ratios, calculated as a percentage of hard costs. These assumptions are shown in Figure 31. FIGURE 31. SOFT COST ASSUMPTIONS BY PROTOTYPE Soft Cost Metric Office/R&D Hotel Retail City Permits and Fees Traffic Impact Fee Office Per Gross Building Sq. Ft. $17.40 $4.70 $9.94 Hotel Per Room $3,387 Other Permits and Fees Per Gross Building Sq. Ft. $48.01 $38.34 $57.16 Subtotal City Permits and Fees Per Gross Building Sq. Ft. $65.41 $43.04 $67.10 Other Soft Costs Arch, Eng., & Consulting % of Hard Costs 5% 5% 5% Taxes, Insurance, Legal, Acct % of Hard Costs 3% 3% 3% Developer Overhead % of Hard Costs 4% 4% 4% Subtotal Other Soft Costs (Excluding Fees) % of Hard Costs 12% 12% 12% Construction Financing % of Hard + Soft Costs 6% 6% 6% Source: Review of pro formas for comparable development projects in Cupertino, 2019; Individual developer interviews, 2019; Vallco Specific Plan Feasibility Analysis, 2018; Strategic Economics, 2019. 38 REVENUES Revenue assumptions for each prototype are informed by a range of resources, including commercial broker reports, hospitality industry reports, and Costar, as well as from interviews with developers and brokers active in Cupertino and Santa Clara County. They are summarized in Figure 32. Office: For office rents, Strategic Economics reviewed Cupertino’s office market and the greater Santa Clara County office market. The largest office development in Cupertino has been the Apple Park project, which is a build-to-suit development specifically intended for Apple. There has been minimal recent speculative office development in Cupertino targeting other users. (Main Street was the only such project completed in the last five years, and most of the space has also been leased to Apple.) Buildings that are leased by Apple typically achieve rents of $4 per square foot per month (NNN), compared to lease rates of $4.50-$5.00 per square foot for tech office buildings in neighboring West San Jose and Sunnyvale (see Figure 33). This is due to the fact that landlords are willing to accept a lower rent for a long-term lease with Apple, due to the low risk associated with a major corporation. According to brokers and developers, there is potential to achieve higher rents for buildings that attract other smaller tech office tenants. For the purposes of this analysis, the rental rate assumption is $4.50 per square foot per month (NNN). While this rental rate is higher than the current average office rent in Cupertino, it is a reasonable estimate for a new, multi-tenant tech office building in the Silicon Valley. Hotel: The assumptions of hotel revenues are based on a combination of data sources, including interviews with hotel developers in Cupertino, and data from STR, a hotel research firm that tracks hotel room rates, vacancy rates, and revenues per available room for properties in Cupertino (see Figure 32). Retail: Strategic Economics reviewed leases from 2018 and 2019 for retail spaces in Cupertino, as summarized in Figure 34. Average lease rates (asking NNN) were between 4.25 to 5.42. All of these recent leases were for restaurant spaces on Stevens Creek Boulevard. For the purposes of this analysis, it is assumed that the retail space would lease for about $4 per square foot per month (NNN). 39 FIGURE 32. REVENUE ASSUMPTIONS BY PROTOTYPE Prototypes Metric Assumption Retail Annual Rent (NNN) Per Net Sq. Ft. $48.00 Vacancy Rate 5% Operating Expenses % of Gross Revenue 10% Annual Net Operating Income Per Net Sq. Ft. $40.80 Office/R&D Annual Rent (NNN) Per Net Sq. Ft. $54.00 Vacancy Rate 5% Operating Expenses % of Gross Revenue 7% Annual Net Operating Income Per Net Sq. Ft. $47.52 Hotel Gross annual Room Income RevPAR (a) $79,154 Gross Annual Other Revenue (b) Per Room $27,704 Gross Revenue Per Room $106,858 Vacancy Rate (c) n/a Operating Expenses 70% of Gross Revenue ($74,800) Annual Net Operating Income $32,057 Source: Costar, 2019; STR Trends Report, 2019; Individual developer interviews, 2019; Strategic Economics, 2019. Notes: (a) RevPAR is a measure of revenue per room, calculated as occupancy percentage times average daily rate. (b) Other Revenue for hotels based on data from STR Consulting, and from hotel developer interviews. (c) Vacancy is already reflected in RevPAR estimate. FIGURE 33. OFFICE COMPARABLES Project Name Address City Year Built Mo. Rent/ Sq. Ft. Lease Type Source Lot 11 @ Santana Row 500 Santana Row San Jose 2017 $4.45 NNN Costar Santana Row 700 Santana Row San Jose 2019 $4.45 NNN Costar Bldg. 5 Pathline Park (a) 700 Mary Ave Sunnyvale 2019 $4.95 NNN Costar Main Street 19319 Stevens Ck. Cupertino 2016 $3.75-$4.00 NNN Interviews FIGURE 34: RETAIL COMPARABLES IN CUPERTINO Project Name Address Year Built Mo. Rent/ Sq. Ft. Lease Type Source The Biltmore 20030-80 Stevens Creek Blvd 2015 $4.50 NNN (asking) Costar Main Street 19369 Stevens Creek Blvd 2016 $5.42 full service Costar Saich Way Station 20803 Stevens Creek Blvd 2015 $4.25 NNN (asking) Costar 40 YIELD ON COST THRESHOLDS In order to understand how the introduction of non-residential linkage fees impacts financial feasibility, the yield on cost (YOC) results can be compared to an investor’s expectations of return for each type of development. The YOC thresholds for this analysis were established relative to capitalization rates (cap rates) for each product type in the Bay Area. The cap rate, which is measured by dividing net income generated by a property by the total project value, is a commonly used metric to estimate potential returns. To ensure that the financial analysis is conservative and does not reflect peak market conditions, the thresholds selected for determining project feasibility are slightly higher than the published cap rates. Office/R&D projects with a YOC of above 6.0% and hotel projects with a YOC above 7.5% were considered feasible in this analysis. Retail projects were considered feasible with a YOC higher than 7.0%. These thresholds are summarized in the Figure 35 below. FIGURE 35: YIELD ON COST THRESHOLDS BY PROTOTYPE Prototype Yield on Cost Threshold Published Cap Rate Office/R&D (Class AA) 6.0% 4.50%-5.25% Hotel (Select Service) 7.5% 7.0%-8.0% Retail 7.0% 6.25-7.25% Source: CBRE Cap Rate Survey, H2 2018; HVS, 2019; Developer interviews. RESULTS Using the YOC thresholds defined above, the following summarizes the results of the financial feasibility of different linkage fee scenarios for each prototype. The pro formas for each prototype is shown in Figure 39, Figure 40, and Figure 41. OFFICE/ R&D As shown in Figure 36 and Figure 39, the prototypical office/R&D project can support the existing linkage fee of $23.76 per square foot, which generates a YOC of 6.04%. A linkage fee of $25 (Scenario 2) would also be feasible. However, the prototype cannot feasibly support a fee higher than $30 per square foot. At this fee level, the prototype is only marginally feasible, with a yield on cost of 5.99%. FIGURE 36. SUMMARY OF FINANCIAL FEASIBILITY OF OFFICE/R&D PROTOTYPE Fee Scenario Fee Level Per Sq. Ft. Yield on Cost Office Feasibility Current Linkage Fee $23.76 6.04% Feasible Scenario 1 (No Fee) $0 6.25% Feasible Scenario 2 $25 6.03% Feasible Scenario 3 $30 5.99% Marginally Feasible Note: Office/R&D projects must have a minimum yield on cost of 6.0% to be considered feasible Source: Strategic Economics, 2019. HOTEL As summarized in Figure 37 for hotel projects, the existing linkage fee of $11.88 is financially feasible, with a yield of cost of 7.65%. A fee of $15 per square foot (Scenario 2) is marginally feasible, resulting 41 in a YOC of 7.46%. A higher linkage fee of $20 per square foot (Scenario 3) is not feasible (see Figure 40). FIGURE 37. SUMMARY OF FINANCIAL FEASIBILITY OF HOTEL PROTOTYPE Fee Scenario Fee Level Per Sq. Ft. Yield on Cost Hotel Feasibility Current Linkage Fee $11.88 7.50% Feasible Scenario 1 (No Fee) $0 7.65% Feasible Scenario 2 $15 7.46% Marginally Feasible Scenario 3 $20 7.39% Not Feasible Note: Hotel projects must have a minimum yield on cost of 7.5% to be considered feasible Source: Strategic Economics, 2019. RETAIL The financial feasibility analysis shows that retail developments are not financially feasible under current market conditions. Even without a linkage fee (Scenario 1), the retail project achieves a yield on cost that is lower than the threshold of 7.0 % (see Figure 38 and Figure 41). There may be cases in which a retail project could support the current Housing Mitigation Fee if it were combined with other land uses (residential or office) in a mixed-use project. FIGURE 38. SUMMARY OF FINANCIAL FEASIBILITY OF RETAIL PROTOTYPE Fee Scenario Fee Level Per Sq. Ft. Yield on Cost Retail Feasibility Current Linkage Fee $11.88 6.35% Not Feasible Scenario 1 (No Fee) $0 6.48% Not Feasible Scenario 2 $15 6.32% Not Feasible Scenario 3 $20 6.26% Not Feasible Note: Retail projects must have a minimum yield on cost of 7.0% to be considered feasible. Source: Strategic Economics, 2019. 42 FIGURE 39. OFFICE/R&D PRO FORMA RESULTS Office/R&D Site and Building Characteristics Parcel Size (Sq. Ft.) 174,240 Parcel Size (acres) 4.00 Total Stories 4 - 5 stories Building Type Steel FAR (without parking) 1.50 Revenues Income $12,702,096 Net Operating Income $11,177,844 Project Costs Land Costs $24,000,000 Direct Costs Site Prep $522,720 Gross Building Area $78,408,000 Tenant Improvement Allowance $17,641,800 Parking $22,611,000 Subtotal Direct Costs $119,183,520 per net Sq. Ft. $507 per gross Sq. Ft. $456 Indirect Costs Soft Costs $14,302,022 City Permits and Fees (excl. non-residential linkage) $12,548,925 Subtotal Indirect Costs $26,850,948 Financing Costs $8,762,068 Total Development Cost Including Land (TDC) $178,796,536 per net Sq. Ft. $760 Fee as % of Total Development Cost Scenario 1: No Linkage Fee 0% Scenario 2: Linkage Fee of $25/Sq. Ft. 2.84% Scenario 3: Linkage Fee of $30/Sq. Ft. 3.53% Current Linkage Fee ($23.76/Sq. Ft.) 3.36% Yield on Cost (NOI/TDC) Scenario 1: No Linkage Fee 6.25% Scenario 2: Linkage Fee of $25/Sq. Ft. 6.03% Scenario 3: Linkage Fee of $30/Sq. Ft. 5.99% Current Linkage Fee ($23.76/Sq. Ft.) 6.04% Source: Strategic Economics, 2019. Formatted Table Formatted: Left Formatted: Font: Not Bold Formatted: Right Formatted: Font: Not Bold Formatted: Right Formatted: Font: Not Bold Formatted: Right Formatted: Font: Not Bold Formatted: Right 43 FIGURE 40. HOTEL PRO FORMA RESULTS Hotel Site and Building Characteristics Parcel Size (Sq. Ft.) 87,120 Parcel Size (acres) 2.00 Total Stories 5 stories Building Type Concrete FAR (without parking) 1.20 Revenues Income $15,494,376 Net Operating Income $4,648,313 Project Costs Land Costs $12,000,000 Direct Costs Site Prep $261,360 Gross Building Area $26,136,000 FF&E $5,075,000 Parking $5,590,000 Subtotal Direct Costs $37,062,360 per gross Sq. Ft. $355 Indirect Costs Soft Costs $4,447,483 City Permits and Fees (excl. non-residential linkage) $4,499,679 Subtotal Indirect Costs $8,947,162 Financing Costs $2,760,571 Total Development Cost Including Land (TDC) $60,770,093 per room $419,104 Fee as % of Total Development Cost Scenario 1: No Linkage Fee 0% Scenario 2: Linkage Fee of $15/Sq. Ft. 1.69% Scenario 3: Linkage Fee of $20/Sq. Ft. 2.52% Current Linkage Fee ($11.88/Sq. Ft.) 2.00% Yield on Cost (NOI/TDC) Scenario 1: No Linkage Fee 7.65% Scenario 2: Linkage Fee of $15/Sq. Ft. 7.46% Scenario 3: Linkage Fee of $20/Sq. Ft. 7.39% Current Linkage Fee ($11.88/Sq. Ft.) 7.50% Source: Strategic Economics, 2019. Formatted Table Formatted: Left Formatted: Left Formatted: Right Formatted: Left Formatted: Right Formatted: Left Formatted: Right Formatted: Left Formatted: Right 44 45 FIGURE 41. RETAIL PRO FORMA RESULTS Retail Site and Building Characteristics Parcel Size (Sq. Ft.) 21,780 Parcel Size (acres) 0.50 Total Stories 1 story Building Type Concrete FAR (without parking) 0.35 Revenues Income $329,314 Net Operating Income $279,917 Project Costs Land Costs $1,633,500 Direct Costs Site Prep $65,340 Gross Building Area $1,257,795 Tenant Improvement Allowance $266,805 Parking $213,444 Subtotal Direct Costs $1,803,384 per net Sq. Ft. $263 per gross Sq. Ft. $237 Indirect Costs Soft Costs $216,406 City Permits and Fees (excl. non-residential linkage) $511,470 Subtotal Indirect Costs $727,876 Financing Costs $151,876 Total Development Cost Including Land (TDC) $4,316,636 per net Sq. Ft. $629 Fee as % of Total Development Cost Scenario 1: No Linkage Fee 0% Scenario 2: Linkage Fee of $15/Sq. Ft. 1.74% Scenario 3: Linkage Fee of $20/Sq. Ft. 2.58% Current Linkage Fee ($11.88/Sq. Ft.) 2.05% Yield on Cost (NOI/TDC) Scenario 1: No Linkage Fee 6.48% Scenario 2: Linkage Fee of $15/Sq. Ft. 6.32% Scenario 3: Linkage Fee of $20/Sq. Ft. 6.26% Current Linkage Fee ($11.88/Sq. Ft.) 6.35% Source: Strategic Economics, 2019. 46 Peer Cities A large share of municipalities in San Mateo and Santa Clara counties, particularly cities that are desirable locations for tech and biotech companies, have adopted non-residential linkage fees. Figure 42 summarizes non-residential linkage fees in these jurisdictions. For office/R&D uses, most cities have set linkage fees between $15 and $25 per square foot. The majority of cities have lower fee levels for retail uses, typically in the range of $5 to $10 per square foot. The non-residential linkage fees for hotel uses are usually between $5 and $15 per square foot. The cities of Palo Alto and San Francisco have higher linkage fees than the rest of the local jurisdictions. These cities also have higher average retail and office rents, and hotel room rates than other Bay Area locations. Many municipalities provide exemptions or fee reductions for the following types of projects: • Smaller non-residential projects. For example, non-residential linkage fees do not apply to projects adding less than 5,000 gross square feet in Redwood City, San Carlos, San Mateo City, Colma, or Burlingame. Projects adding less than 3,500 gross square feet in unincorporated land in San Mateo County, and less than 10,000 gross square feet in Menlo Park or East Palo Alto are also exempt. Some cities also tie their fee to building size on a sliding scale. Mountain View offers a 50% fee reduction for office projects under 10,000 square feet, and hotel or retail projects under 25,000 square feet. Sunnyvale also offers a 50% fee discount for the first 25,000 square feet of any project. • Prevailing wage. Multiple jurisdictions, including Redwood City, San Carlos, San Mateo City, and San Mateo County, provide 25% fee reductions for projects that pay prevailing wage. • Community-serving facilities. Most cities exempt projects such as hospitals/clinics, child care, public, educational, religious, and/or non-profit uses. Additionally, projects that are replacing property damaged from natural disasters are also often exempted. It is common for jurisdictions to allow alternative means of complying with non-residential linkage fee requirements. Developers can typically satisfy the requirement by providing affordable housing either on or off-site, or by dedicating land for affordable housing. East Palo Alto and Palo Alto allow for the requirement to be met by either converting market-rate units to affordable units, or by rehabilitating existing affordable units. In most cases, the applicant must first prove that an alternative is necessary. For example, Palo Alto requires that the applicant present “substantial evidence to support a finding of infeasibility” of paying the fee, and of “feasibility of any proposed alternative.” Many cities have either enacted or updated their fees in the last four years, and fees are typically adjusted annually, based on either ENR’s Construction Cost Index for the San Francisco Bay area, or on the national Consumer Price Index. 47 FIGURE 42. NON-RESIDENTIAL LINKAGE FEES (PER GROSS S. FT. OF NET NEW SPACE) IN NEARBY CITIES Jurisdiction Office/ R&D/ Medical Office Hotel Retail/ Restaurant/ Services Date Fee Was Adopted Burlingame (a) $18 - $25 $12 $7 2017 Colma $5 $5 $5 2006 Cupertino $23.76 $11.88 $11.88 2015 East Palo Alto $10.72 none none 2016 Foster City $27.50 $12.50 $6.25 2016 Los Altos $25 $15 $15 2018 Menlo Park $17.79 $9.66 $9.66 2018 Mountain View (a) $13.14 - $26.27 $1.41 - $2.81 $1.41 - $2.81 2014 Palo Alto $36.22 $21.08 $21.08 2017 Redwood City $20 $5 $5 2015 San Bruno $12.50 $12.50 $6.25 2015 San Carlos $20 $10 $5 2017 San Francisco (b) $19.04 - $28.57 $21.39 $26.66 1996 San Mateo City $25 $10 $7.50 2016 San Mateo County $25 $10 $5 2016 Santa Clara City (a) $10 - $20 $5 $5 2017 South San Francisco $15 $5 $2.50 2018 Sunnyvale (a) $8.25 - $16.50 $8.25 $8.25 2015 Source: City Ordinances and Fee Schedules; 21 Elements, 2019; Silicon Valley at Home, 2019; Strategic Economics, 2019 Notes: (a) Fees vary based on project size in four cities: Burlingame, Mountain View, Santa Clara, and Sunnyvale. Hotel and retail projects under 25,000 sq. ft, and office projects under 10,000 sq. ft. in Mountain View are charged the lower fee; In Burlingame, Santa Clara and Sunnyvale, office projects under 50,000 sq. ft., 20,000 sq. ft. and 25,000 sq. ft. respectively pay the lower fee. (b) San Francisco's fees for R&D are $19.04 per sq. ft., while its fees for office are $28.57 per sq ft. Small Enterprise Workspace and Production/Distribution/Repair fees are $22.46 per sq. ft. 48 KEY TAKEAWAYS Based on the economic feasibility analysis, Strategic Economics offers the following conclusions regarding the City Council’s direction on the BMR Housing Program. Is it financially feasible to increase the inclusionary requirements to 20% or 25%? • For ownership housing prototypes, it would be financially feasible to raise the inclusionary requirement from 15% to 20%. The analysis indicates that the existing requirement of 15% and a higher requirement of 20% are economically feasible for single-family detached, small lot single-family/townhouse, and condominium developments. • Ownership housing prototypes can support a higher Housing Mitigation Fee per square foot. The analysis shows that single-family detached, small lot single-family/townhouse, and condominium developments could support paying the maximum housing mitigation fee (in-lieu fee). The maximum nexus-based fees are $30.10-$30.60 per square foot for single-family detached; $35.60 per square foot for small lot single-family/townhouse development; and $35.10 per square foot for condominiums. The City’s Housing Mitigation Fees cannot exceed the maximum housing impact fees justified by the 2015 Nexus Study (see Figure 43 below). Exceeding the amounts shown below would require conducting a new nexus study. FIGURE 43: CURRENT AND MAXIMUM HOUSING MITIGATION FEES BASED ON NEXUS FOR OWNERSHIP PROTOTYPES Prototype Current Housing Mitigation Fee Maximum Nexus- Based Fee Return on Cost At Maximum Fee Is Maximum Fee Feasible? Single-Family Detached $17.82 $30.10-$30.60 25.5% Yes Small Lot SF/ Townhouse $19.60 $35.60 34.2% Yes Condominium $23.76 $35.10 31.4% Yes Source: Keyser Marston Associates (2015). Residential Below Market Rate Housing Nexus Analysis • The rental apartment prototypes cannot feasibly support an inclusionary requirement under current rents and construction/land costs. The higher density rental housing prototype can support payment of Housing Mitigation Fees of nearly $30 per square foot, but cannot feasibly provide inclusionary BMR units under today’s rents, construction costs and land costs. However, with increases in rental revenues or decreases in construction costs and land costs, rental housing development could potentially support the current inclusionary requirement of 15%. Can the inclusionary housing policy be amended to include units for extremely low income/ disabled persons? The results from the feasibility analysis show that rental development in Cupertino cannot feasibly provide BMR units on-site under current market conditions. An increase in revenues or a decrease in construction and land costs could make it possible for lower density and higher density rental prototypes to provide 15% inclusionary BMR units for very low income and low income households. Under current market conditions, it is not financially feasible for the inclusionary housing policy to include units for extremely low-income households. 49 However, there are strategies that could allow the City to generate funding for the development of extremely low-income units, and for disabled persons. City staff from Sunnyvale and San Jose have indicated that they are providing funding to develop housing for extremely low-income households through the revenues they have collected from housing mitigation fees, in-lieu fees, and other housing funds. These local revenues are often combined with Santa Clara County Measure A funds – which are specifically targeted to extremely-low income households – as well as 9% and 4% Low Income Housing Tax Credits (LIHTC) and Section 8 vouchers from the Santa Clara County Housing Authority. Can the inclusionary housing policy be amended to include median-income and moderate-income units in rental projects? The results from the feasibility analysis show that rental housing development in Cupertino is not feasible with an inclusionary requirement of 15% under current conditions (see Figure 25 and Figure 26). However, a 15% increase in project revenues or a decrease in construction and land costs of 15% could make the low density rental prototype feasible with a 15% BMR requirement. The higher-density rental prototype can feasibly provide Housing Mitigation Fees at the current level. An increase in revenues of 10% or a decrease in construction and land costs of 5% can make the higher density rental prototype feasible with a 15% BMR requirement. Adding a requirement for median-income and moderate-income units in addition to the existing inclusionary requirement of 15% would not be economically feasible for the rental prototypes. For this reason, it is not financially feasible for the inclusionary housing policy to be amended to also require units for median-income and moderate-income households. Can the BMR requirements for non-residential development (linkage fees) be increased for office/R&D, hotel, and retail developments? • For office and R&D development, it would be possible to raise the Housing Mitigation Fees to a level between $25 to $30 per square foot. As shown in Figure 39, the office/R&D prototype is feasible with a non-residential linkage fee of $25 per square foot. At $30 per square foot, the prototype achieves a yield on cost that is slightly under the threshold required for feasibility. • For hotel development, it may be possible to increase the Housing Mitigation Fees to between $12 and $15 per square foot. At the current fee level of $11.88, a hotel project is feasible (Figure 37). With a fee of $15 per square foot, the project achieves a yield on cost that is slightly lower than the threshold for feasibility. • The financial feasibility analysis shows that retail developments are not financially feasible under current market conditions. Even without a Housing Mitigation Fees, the retail project achieves a yield on cost that is lower than the threshold of 7.0% (see Figure 38). There may be cases in which a retail project could support the current Housing Mitigation Fee if it were combined with other land uses (residential or office) in a mixed-use project. 50 APPENDIX The appendix includes additional information on: • Recent single-family sales for new construction in Cupertino (Figure A-1) • Recent townhome re-sales in Cupertino (Figure A-2) • Recent condominium re-sales in Cupertino (Figure A-3) • Recent rental project comparables in Cupertino and surrounding cities (Figure A-4) 51 FIGURE A-1: RECENTLY BUILT SINGLE FAMILY COMPARABLES Address City Lot Size Beds Baths Price Square Feet Price/Sq. Ft. Year Built 21825 Lomita Ave Cupertino 9,671 5 4.5 $3,380,000 3,891 $869 2016 21800 Almaden Ave Cupertino 11,098 5 3.5 $3,220,000 3,555 $906 2017 10240 Lebanon Dr Cupertino 9,048 5 4.5 $4,100,000 3,623 $1,132 2018 10257 Glencoe Dr Cupertino 9,375 5 4.5 $3,593,800 3,727 $964 2016 7425 Heatherwood Dr Cupertino 9,396 5 4 $3,650,000 3,763 $970 2017 805 Rose Blossom Dr Cupertino 8,660 5 4.5 $2,980,000 3,339 $892 2017 10308 N Stelling Rd Cupertino 9,612 5 4.5 $3,350,000 3,769 $889 2017 10381 Bret Ave Cupertino 9,374 5 4.5 $3,270,000 3,727 $877 2016 20861 Dunbar Dr Cupertino 9,750 5 3.5 $3,998,000 3,949 $1,012 2016 Weighted Average $3,512,995 3,705 $946 Sources: Redfin, 2018; Strategic Economics, 2018. Sources: Redfin, 2018; Strategic Economics, 2018. 52 FIGURE A-2: RECENTLY BUILT TOWNHOME COMPARABLES Address City Lot Size Beds Baths Price Square Feet Price/Sq. Ft. Year Built 10280 Park Green Ln #836 Cupertino 2,176 3 2.5 $1,760,000 1,670 $1,054 2006 10281 Torre Ave #817 Cupertino 2,176 3 2.5 $1,800,000 1,670 $1,078 2006 10700 Stevens Canyon Rd Cupertino 1,570 3 2.5 $1,852,000 2,239 $827 2007 20652 Gardenside Cir Cupertino 1,480 3 2.5 $1,680,000 1,704 $986 1990 20679 Gardenside Cir Cupertino 1,440 3 2 $1,665,000 1,640 $1,015 1990 23020 Stonebridge St Cupertino 3,348 3 2 $1,830,000 2,202 $831 1980 23030 Stonebridge Cupertino 3,348 3 2 $1,698,000 2,202 $771 1980 22981 Stonebridge Cupertino 3,348 3 2 $1,710,000 2,202 $777 1980 10910 Lucky Oak St Cupertino 1,312 3 3.5 $1,780,000 2,082 $855 1980 10826 Northridge Sq Cupertino 1,487 3 2 $1,455,000 1,389 $1,048 1978 10107 Lamplighter Sq Cupertino 1,753 3 2.5 $1,740,000 1,727 $1,008 1975 10174 Potters Hatch Cmn Cupertino 1,575 3 2.5 $1,816,000 1,785 $1,017 1974 10020 Mossy Oak Ct Cupertino 1,662 3 2.5 $1,680,000 1,645 $1,021 1972 10142 Amador Oak Ct Cupertino 1,854 3 2.5 $1,600,000 1,614 $991 1970 Weighted Averages: All years $1,728,250 1,841 $934 Since 2000 $1,808,896 1,860 $970 Sources: Redfin, 2018; Strategic Economics, 2018. 53 FIGURE A-2: RECENT RE-SALES OF TOWNHOME COMPARABLES Address City Beds Baths Price Square Feet Price/Sq. Ft. Year Built 20488 Stevens Creek Blvd #2207 Cupertino 2 2 $1,338,000 1,171 $1,143 2003 20488 Stevens Creek Blvd #2309 Cupertino 2 2 $1,430,000 1,171 $1,221 2003 19999 Stevens Creek Blvd #209 Cupertino 2 2 $1,266,000 1,039 $1,218 2003 19999 Stevens Creek Blvd #101 Cupertino 2 2 $1,265,000 1,192 $1,061 2003 19503 Stevens Creek Blvd #317 Cupertino 2 2 $1,400,000 1,158 $1,209 2006 19503 Stevens Creek Blvd #251 Cupertino 2 2 $1,200,000 1,087 $1,104 2006 19503 Stevens Creek Blvd #139 Cupertino 2 2 $1,468,000 1,130 $1,299 2006 19503 Stevens Creek Blvd #261 Cupertino 2 2 $1,530,000 1,359 $1,126 2006 19503 Stevens Creek Blvd #331 Cupertino 3 2 $1,728,000 1,502 $1,150 2006 20488 Stevens Creek Blvd #1813 Cupertino 3 3 $1,930,000 1,766 $1,093 2003 20488 Stevens Creek Blvd #1401 Cupertino 3 2 $1,480,000 1,578 $938 2003 Weighted Averages: 2-Bd $1,367,604 1163 $1,171 3-Bd $1,720,858 1615 $1,060 Sources: Redfin, 2018; Strategic Economics, 2018. 54 FIGURE A-3: RECENT RE-SALES OF CONDOMINIUM COMPARABLES Address City Beds Baths Price Square Feet Price/Sq. Ft. Year Built 20488 Stevens Creek Blvd #2207 Cupertino 2 2 $1,338,000 1,171 $1,143 2003 20488 Stevens Creek Blvd #2309 Cupertino 2 2 $1,430,000 1,171 $1,221 2003 19999 Stevens Creek Blvd #209 Cupertino 2 2 $1,266,000 1,039 $1,218 2003 19999 Stevens Creek Blvd #101 Cupertino 2 2 $1,265,000 1,192 $1,061 2003 19503 Stevens Creek Blvd #317 Cupertino 2 2 $1,400,000 1,158 $1,209 2006 19503 Stevens Creek Blvd #251 Cupertino 2 2 $1,200,000 1,087 $1,104 2006 19503 Stevens Creek Blvd #139 Cupertino 2 2 $1,468,000 1,130 $1,299 2006 19503 Stevens Creek Blvd #261 Cupertino 2 2 $1,530,000 1,359 $1,126 2006 19503 Stevens Creek Blvd #331 Cupertino 3 2 $1,728,000 1,502 $1,150 2006 20488 Stevens Creek Blvd #1813 Cupertino 3 3 $1,930,000 1,766 $1,093 2003 20488 Stevens Creek Blvd #1401 Cupertino 3 2 $1,480,000 1,578 $938 2003 Weighted Averages: 2-Bd $1,367,604 1163 $1,171 3-Bd $1,720,858 1615 $1,060 Sources: Polaris Pacific, 2018; Redfin, 2018; Strategic Economics, 2018. 55 FIGURE A-4: RECENTLY BUILT RENTAL COMPARABLES Rent Per Unit Unit Size Rent Per Sq. Ft. Project Name City Year Built Stories Studios 1-BD 2-BD 3-BD Studios 1-BD 2-BD 3-BD Studios 1-BD 2-BD 3-BD Nineteen 800 Cupertino 2014 6 $4,026 $5,477 0 1,339 1,562 $3.01 $3.51 Main Street Lofts Cupertino 2018 4 $3,508 $3,995 916 1,044 $3.83 $3.83 Verve Mountain View 2017 3 $3,860 $5,071 $6,195 737 1,112 1,286 $5.24 $4.56 $4.82 Domus on the Boulevard Mountain View 2015 4 $3,868 $4,876 788 1,061 $4.91 $4.60 Elan Mountain View Mountain View 2018 4 $3,860 $5,071 $6,195 737 1,112 1,286 $5.24 $4.56 $4.82 Montrose Mountain View 2016 4 $3,816 $5,443 739 1,154 $5.16 $4.72 Madera Apartments Mountain View 2013 4 $4,113 $5,510 849 1,181 $4.84 $4.67 Carmel the Village Mountain View 2013 5 $3,282 $3,623 $5,866 573 797 1,258 $5.73 $4.55 $4.66 6tenEAST Sunnyvale 2017 4 $3,309 $3,515 $4,414 $5,185 701 808 1,136 1,406 $4.72 $4.35 $3.89 $3.69 Naya Sunnyvale 2016 4 $3,250 $4,336 693 1,038 - $4.69 $4.18 481 On Mathilda Sunnyvale 2016 4 $3,098 $3,251 $4,160 701 781 1,174 $4.42 $4.16 $3.54 Encasa Apartments Sunnyvale 2016 3 $2,854 $3,356 $4,235 $5,854 572 856 1,163 1,688 $4.99 $3.92 $3.64 $3.47 Anton 1101 Sunnyvale 2015 4 $3,145 $3,280 $4,490 569 704 1,069 $5.53 $4.66 $4.20 2295-2305 Winchester Blvd Sunnyvale 2014 3 $3,371 $4,248 662 1,005 $5.09 $4.23 Ironworks Sunnyvale 2017 7 $3,520 $4,036 $5,109 . 784 1,174 1,365 $4.49 $3.44 $3.74 Solstice Sunnyvale 2013 6 $2,955 $3,329 $4,099 462 778 1,122 $6.40 $4.28 $3.65 Orchard City Lofts Campbell 2018 3 $2,946 $3,707 $4,817 607 924 1,237 $4.85 $4.01 $3.89 Revere Campbell Campbell 2015 5 $3,662 $3,912 $5,219 1,015 1,198 1,233 $3.61 $3.27 $4.23 Monticello Village Santa Clara 2016 6 $3,356 $3,244 $4,074 920 842 1,251 $3.65 $3.85 $3.26 Weighted Average $3,225 $3,568 $4,541 $5,516 677 790 1,137 1,383 $4.71 $4.49 $3.98 $3.98 Sources: Costar, 2018; Strategic Economics, 2018. STRATEGIC ECONOMICS | 2991 SHATTUCK AVE. BERKELEY, CA. 94705 | 510.647.5291 MEMORANDUM To: Kerri Heusler, City of Cupertino From: Sujata Srivastava Date: July 16, 2019 Project: Economic Feasibility Report of BMR Program Subject: Response to Peer Review Questions INTRODUCTION Strategic Economics submitted a draft report summarizing the results of an economic feasibility analysis of the City of Cupertino’s Below Market Rate (BMR) Housing program. The City of Cupertino then retained Lesar Development Consultants to peer review the draft report. Lesar Development Consultants identified a number of key questions to assist with the peer review. This memo report provides responses to those questions. RESIDENTIAL ANALYSIS 1. It is hard to understand the step‐by‐step process that SE used for its methodology. The report lacks a clear narrative how it got from point A to point B to point C. It would be helpful to explain in simple language how the process works and why the particular data points are used. Strategic Economics has edited the draft report to include a summary of the financial feasibility methodology and the data sources. 2. Most inclusionary feasibility studies we typically see are based on a residual land cost analysis, rather than on a return on cost (ROC) or yield on cost (YOC). Can SE provide more background as to why ROC and YOC analysis were used rather than a residual land cost analysis and if that difference would meaningfully change any of the reported results? There is no single methodology used by economic consultants to measure the financial feasibility of inclusionary requirements. Last year, the Terner Center, Grounded Solutions Network, and the Lincoln Land Institute convened a group of stakeholders to identify “best” practices in feasibility analysis, bringing together economic consultants (including a participant from Strategic Economics), as well as academic researchers, nonprofits, and public agencies that commission these studies.1 According to 1 Grounded Solutions Network, UC Berkeley Terner Center, and Lincoln Land Institute, “Strengthening Inclusionary Housing Feasibility Studies Convening Report,” December 2018. https://inclusionaryhousing.org/wp-content/uploads/2018/11/ih-feasibility-studies- convening-report.pdf Response to Peer Review Questions 1 July 16, 2019 the summary report, return on cost and yield on cost were more commonly used to measure feasibility than residual land value; however, the “participants generally agreed that there was no one best measure in all cases and no reason to encourage every study to use the same metrics.”2 Strategic Economics chose to use the yield on cost metric because it is a commonly used approach that allows one to compare the return achieved from the development project to other real estate investments. This method is often more intuitive for stakeholders than the residual land value of a project. Nevertheless, because the key inputs (developer return and land prices) would be the same using either of these approaches, the outcome of the analysis would not change if we had solved for the residual land value instead. 3. The ROC analysis’s sources on page 10 reference “recent project proformas” and developer interviews. Can further documentation be provided on what recent proformas were analyzed, and what developers were interviewed? Some of the pro formas reviewed are not public documents. Strategic Economics interviewed the following developers and brokers for this analysis: • Alex Kang, single-family builder • Suejane Han, single-family builder • Christopher Huang, Marina Plaza (retail) • Brandon Bain, Cushman & Wakefield (office) • Edward Chan, Hyatt House (hotel) • Michael Strahs, Kimco (hotel) • Reed Moulds, Sand Hill (multi-family residential and office) • Tim Steele, Sobrato (multi-family residential and office) Strategic Economics also reached out to the following stakeholders, but did not receive a response: • Mike Ducote, Prometheus • Nandy Kumar, Main Street Apartments • Greg DeLong and Mike Benevento, CBRE • Phil Mahoney • Alexandra Reynolds, Federal Realty • Steve Horton, Cushman & Wakefield • Jill Arias, Newmark Knight Frank • Andy Poppink, Jones Lang Lasalle • Mark Calvano, Calvano • Curtis Leigh, Hunter Properties • Gene Payne, Broadreach Capital Partners 4. I am curious about the use of Redfin for data in the analysis. There are a number of professional data aggregators that one typically sees, such as DataQuick, Costar, etc. which SE does use for some 2 Ibid, page 6. Response to Peer Review Questions 2 July 16, 2019 of the analysis. What was the thought behind using Redfin (which I personally experienced containing incorrect data in reporting sales)? Costar only tracks rental apartments, and does not contain information on ownership residential data, so it cannot be used to determine the sales prices on ownership products. CoreLogic (formerly DataQuick) reports on transactions for ownership residential (single-family and condominiums/townhouses); However, CoreLogic data has a significant cost, and frequently the data shows many errors. It can also be very difficult to break out the multi-family ownership from the single- family ownership products using the CoreLogic dataset. For these reasons, Strategic Economics used Redfin for the analysis. 5. The report uses comps for townhomes and other housing types in Cupertino that are quite old. Typically, if the review of comps finds that no development is currently taking place, then adding an additional requirement would further constrain the development of housing. Is that the case here, or are there other market factors influencing the types of projects proposed and approved in Cupertino? It is preferable to use new development projects as comparables for a feasibility analysis. However, in the case of Cupertino, there were no recent examples of newly built townhomes. Based on our understanding of the strong demand for housing of all types in Cupertino, Strategic Economics believes that the market for townhouse development is strong. There may be many other factors that have inhibited recent development of townhomes, including a scarcity of sites, competition from other types of land uses that can pay more for land (including multi-family residential and nonresidential uses), and the complexity of the approvals/entitlements process. 6. Figure A‐3 in the appendix is titled “Recent Re‐Sales of Condominium Comparables” when in fact the table shows rents. Figure A‐4 repeats this information but calls the table “Recently Built Rental Comparables.” Can SE update the table to include the dates when these comps were built? This was an error. Strategic Economics has inserted the correct table under Figure A-3. Strategic Economics added a column in Figure A-4 showing the year that the project was built. 7. On page 11, the sales prices per unit are in some cases significantly different than what was shown in the KMA report just four years ago. For example, condominiums in the 2015 report were on the order of $800,000. What accounts for the more than 100% increase in four years? Is this the result of construction cost escalation, and can SE say more about the market's ability to sustain the higher current sale prices while absorbing additional affordability requirements? Strategic Economics cannot comment on KMA’s data sources and research from the 2015 nexus study. However, a review of data collected by the Santa Clara County Association of Realtors shows that the median price for existing condominiums increased from $895,500 in 2014 to $1.4 million in 2018.3 This feasibility analysis assumes average price of $1,485,000 for a new two-bedroom condominium unit, and an average price of $1.6 million for a new three-bedroom unit . This is slightly higher than the median in 2018, because the assumption is that a newly built condominium unit would 3 Santa Clara County Association of Realtors, 2014 and 2018. https://www.sccaor.com/pdf/stats/2014.pdf https://www.sccaor.com/pdf/stats/2018.pdf. Response to Peer Review Questions 3 July 16, 2019 be priced higher than the median for all existing condos, which include older units. Using a lower sales price assumption would make it less likely that a new development project could feasibly provide inclusionary units. The report has been amended to discuss general trends in sales prices and rents in the city and region. 8. In addition, rents shown on that page are also substantially higher than in KMA’s study. Can SE provide some additional explanation about the market forces that are driving these increases? Similar to the dynamics described above with condominium prices, rental rates in Santa Clara County have increased rapidly in the last five years. There is significant pent-up demand in Santa Clara County and the broader Bay Area region, as housing development has not kept up with employment growth. Between 2009 and 2015, Santa Clara County added over 170,000 new jobs between 2010 and 2015, but only 29,000 new housing units.4 Apartment rents accelerated beginning in 2011, as the economy emerged from the Great Recession, and continued growing at an average annual rate of nearly eight percent until 2015. Since then rents have continued to grow at a slower pace of about four percent. The report has been amended to discuss general trends in sales prices and rents in the city and region. 9. On page 13, should the income limits be updated to the 2019 counts? Would showing increased rents using the 2019 data result in higher affordability requirements being feasible? Strategic Economics completed the technical modeling and analysis before the new limits were published for 2019. In 2019, the area median income (AMI) for Santa Clara County is $131,400. This is a slight increase from the AMI of $125,200 in 2018. Because the income change from 2018 to 2019 is relatively minor, Strategic Economics does not believe that updating the affordable rents to 2019 figures would create significant differences in the feasibility findings. Non‐Residential Analysis 1. KMA provided information on mitigation fees as a percentage of total development cost as one way to measure a fee’s reasonableness. How does SE’s methodology compare? The pro forma model provides more information about the feasibility of a development by comparing the revenues and costs of a development, and determining whether it would be likely to attract development. Measuring the commercial linkage fees as a percentage of total development cost provides information about the extent to which proposed fees would increase overall development costs, but it does not allow one to draw conclusions about feasibility. In order to provide some consistency between the 2015 nexus study and this report, Strategic Economics has added rows to the pro forma showing the commercial linkage fee levels tested in the pro forma analysis as a percentage of total development costs. 2. The pool of comparables used in the analysis is quite small. Would that impact the resulting outcomes? Strategic Economics reviewed comparables – recently built nonresidential development projects and property transactions – to estimate land values, office rents, hotel room rates, and retail rents. The analysis of comparables was not the only source of data. It was supplemented with findings from 4 SPUR, “Room for More: Housing Agenda for San José,” August 2017. Response to Peer Review Questions 4 July 16, 2019 stakeholder interviews, as well as data vendors like Costar and Smith Travel Research. Because we have used a mix of sources to inform our inputs, we feel comfortable that we used selected comparables that represent the market conditions in Cupertino.