SUBJECT: EVALUATION OF REQUEST FOR PROPOSAL AND QUALIFICATION STATEMENT (RFP/RFQ) SUBMITTALS TO DEVELOP RETAIL/OFFICE BUILDING IN CONNECTION WITH DOWNTOWN PARKING STRUCTURE

Recommendation:

That the City Council:

1. Select the development team of Peha & Associates & Triwell Properties for the property ground lease.
2. Direct staff to negotiate terms for ground lease with selected development team.
3. Require a ground lease term of 50 years.
4. Require a ground lease value commensurate with the fair market appraisal for the property.
5. Require that the public sidewalk adjacent the project site be improved with special paving and landscaping consistent with the Lower Pier Avenue streetscape.
6. Require reimbursement of $2,500 for a lateral sewer line serving the subject property, currently being installed in connection with parking structure construction.
7. Require exterior of the east wall of the project be contiguous with the exterior of the parking structure and finished and painted to match the parking structure interior.

Background:

On March 23, 1999, the City Council directed staff to proceed with issuance of an RFP/RFQ for the retail building at the North Pier Parking Structure. On May 3, 1999 senior staff conducted interviews and evaluated proposals from prospective developers. On May 11, 1999 the City Council set a special meeting for Thursday, June 7, 1999 to review the project proposals and conduct interviews to select a development team..

Analysis:

Staff issued the RFP/RFQ to 34 development companies and two marketing services, Hawkins/Martel and Construction Market Data, for distribution over the internet. The City received three proposals (submitted to City Council on Monday, May 24, 1999). Most of the firms contacted were interested in developing larger sites and in owning the property rather than a ground lease. The City commissioned a fair market ground lease appraisal from Lea Associates. (Please See Attachment No. 2)

Site Characteristics

The site is approximately 2,280 square feet with a 24 foot depth and 95 foot length. Three stories of building area over the entire site provides up to 6,840 square feet of gross floor area. All parking is provided in the City's parking structure and no additional parking is required if the project only contains retail and office uses pursuant to the City's Coastal and local development permits and project EIR. The project is proposed to be a turn-key development with the selected developer designing, constructing, leasing and operating the building for the term of the lease. The City Council has indicated a preference for retail and office tenants and also recognized snack shops as possible tenants in the proposed project. Each of the submittals contain office or service related tenants and a snack shop use and none contain restaurant tenants.

Evaluation of Project Proposals

The City needs to select a qualified developer to develop, manage and operate the project. Although the City's risks are minimized by the fact that the City owns the property, if the developer defaults during construction, (because of poor design or inaccurate cost estimates) it will be incumbent on the City to complete the project by leasing the property to another developer. This will delay project completion. If the developer defaults on the loan because the project cannot command the rents shown in the project proforma, the lender will take the first position and there may be a protracted period where the building is either partially or completely vacant. Neither outcome is desirable for the downtown revitalization. Thus it is important that the project presented in the proforma is a project that can be constructed, leased and operated.

Once the City selects a developer, it will be necessary to draft the ground lease. The value of the ground lease is related to the value of the property. 8% to 10% is typically considered a good return on investment for rental property. The ground lease terms can range from fixed rent with CPI adjustments to percentage rents . Fixed ground leases are most common and provide a consistent annual rent. Percentage ground leases are keyed to gross receipts of the building tenants and fluctuate with the profitability of tenants. Percentage ground leases require accurate tenant sales information which is often difficult to obtain and creates additional accounting tasks for the City. The submittals include both fixed rent and percentage ground leases .

The City's appraisal prepared by Lea Associates concludes that the fair market rent for the property is $28,000. Fair market rental value is described in the appraisal as:

" A rental income that the property would most probably command in the open market."

The analysis reflects consideration of the benefits of parking rights in the City's parking structure and triple net leases (tenant reimbursement of expenses for maintenance, property taxes and insurance) and assumes a building "hard" cost of $550,000, building shell costs of $90.00 a square foot, average tenant lease rates at $2.12 per square foot and a return on investment of 10% for the project. The City's appraisal recommends a higher annual ground lease value than any of the proposals.

The following provides a description of the submittals. Staff has also prepared a table summarizing the project proposals for reference. (Please see attached table.)

Project 1 - Peha Associates/Triwell Properties

Peha Associates is a local architectural firm which has designed and built commercial and residential projects in the City. Triwell Properties is a property management and development company based in El Segundo and has participated in the renovation and management of the Bilowit (Club Sushi) Building on Hermosa Avenue. (Please see developer's proposal for company details.)

The project design is intended to reflect the adjacent Bijou Theater building with similar building fenestration, color, materials and detailing. The building is three stories and contains ground floor retail consisting of a Coffee Bean and Tea, Robek's Juice and a third retail tenant which is proposed to be a newsstand. Both Coffee Bean and Robek's Juice have submitted letters of interest in leasing the property, however there is no commitment from a newstand tenant. Retail spaces open onto the pedestrian plaza and Hermosa Avenue street frontage. The upper floors are proposed to be professional offices. The developer indicates that there is interest in leasing the 2nd and 3rd floor spaces although no other letter of interest have been submitted. The Coffee Bean (northerly ground floor tenant) utilize the adjacent public sidewalk area for outdoor seating with placement of tables and chairs.

The building is proposed to be steel frame construction permitting an open, flexible plan and to minimize the number of building columns. The proposed project schedule is compatible with the City's timeframe for occupancy of the parking structure by January 2000. The design provides a cantilever over the first floor level increasing leasable floor area and building articulation. The project architect indicates the added 2'-0" in depth will facilitate layout of the office spaces which are only 24 feet deep and help make the building more interesting architecturally. The developer is proposing construction costs of $586,000 (hard costs) which is consistent with the appraisal construction values estimated by Lea Associates. Proposed tenant lease rates are triple net (including maintenance, taxes and insurance expenses) and vary from 2.75 per square foot for retail space to $2.00 per square foot for office space. The developer is proposing an annual fixed ground lease of $18,000 with five year CPI adjustments.

Project Issues:

The proposed building cantilevers over the public right of way by approximately 2'-0" which would require an encroachment permit. The City may not want to permit this building extension. Elimination of this feature would reduce floor area and effect the project proforma. The developer has submitted a plan which includes use of the right of way for seating but does not indicate whether the space would be leased from the City. The developer is proposing a 50 year ground lease because of lender reluctance to commit to a project with a 30 year lease term. According to the developer after the first 20 years the building will be fully depreciated and if the City chooses to not to renew the ground lease at completion of the term, there is little value left for the bank for the duration of the ground lease term. For this reason, a lender will be unlikely to lend on a ground leased property for more than 20 years. Thus, the developer's debt service costs will be higher (amortized over 20 years rather than 30 years), there will be less net cash flow for the project and it will not make economic sense for the bank to lend on the property. The developer has also indicated that most ground leases are typically established for a 50 year term, however a longer term generally applies to larger projects with substantial capital investment according to the City's appraisal. (Please see Lea Associates, Appraisal Report, Land Lease Practices table). The lease values are higher for office and retail tenants than the lease estimates used in the City's appraisal. The proposed average tenant lease values and ground lease is higher than the Bacon proposal and lower than the Gangi proposal (a percentage ground lease ). It is also lower than the City's own appraised fair market rent value for the property. (Please refer to summary table.)

Project 2 - Roger Bacon

Roger Bacon developed and operates the Ralph's Shopping Center where his office is based and participated in development of MacDonald'Restaurant on Pacific Coast Highway in Hermosa Beach. (Please refer to developer's proposal for company details.)

The project design is intended to reflect the City parking structure relative to color, materials and detailing according the project architect. The project is a modern building shell constructed of precast panels and containing relief of dolphins on the building frontage. The building is proposed to be steel frame construction permitting an open, flexible plan and to minimize the number of building columns. The proposed project schedule is compatible with the City's timeframe for occupancy of the parking structure by January 2000. The three story building contains ground floor retail consisting of a Starbuck's Coffee and Hawthorn Savings. Both Starbuck's Coffee and Hawthorn Savings have submitted letters of interest in leasing the property. Retail spaces open onto the pedestrian plaza and Hermosa Avenue street frontage. The upper floors are proposed to be professional offices and Allstate Insurance has committed to a portion of the office space. The developer has also requested a 50 year ground lease but would accept a 30 year ground lease. Unlike other proposals, the developer has indicated that he can fund project development without a loan, although the project spreadsheet also includes loan debt service as an option. The developer is proposing to have a radio station occupy a portion of the office space area and cantilever the radio booth over the right of way, however the details for the station were not submitted for staff review. The developer is also proposing to have outdoor seating with placement of tables and chairs along sidewalk areas in connection with Starbuck's coffee. The developer is proposing construction costs of $1,000,000 (hard costs) which is inconsistent with the appraisal construction values estimated by Lea Associates. Proposed average tenant lease rates are $2.00 per square foot and triple net.

Project Issues:

The developer has submitted a plan and project model which includes use of the right of way for seating but does not indicated whether the space would be leased from the City. The proposed building cantilevers over the public right of way which would require an encroachment permit and the City may not want to permit this building extension. The City's RFP/RFQ required submittal of a 20 year proforma in order to evaluate annual project cash flow, expenditures and rent increases and the developer has only provided an average cost for one year. The proposed average tenant lease values and ground lease are below the two other submittals and the City's own appraised fair market rent value for the property.

The developer has indicated that the building hard costs are $1,000,000 with a shell cost of $166.00 per square foot. This is a very high construction cost and may reflect high tenant improvement costs particularly for office tenants. These T.I. costs are charges passed on to tenants, but charged as an expenditure in the proforma. Such improvement costs would be consistent with "Class A" office space but inconsistent with professional office costs expected in this market. The average lease values are higher for office and retail tenants than the lease estimates used in the City's appraisal. The average tenant lease values are lower than the Peha/Triwell and Gangi proposals and the ground lease value is lower than the City's own appraised fair market rent value for the property. (Please refer to summary table.)

Project 3 - Gangi Development

Gangi Development is a development company involved in residential and commercial projects and is based in Glendale. The company includes design and construction management as part of its services. (Please refer to developer's proposal for details on company projects.)

The project design is a modern building shell incorporating concrete or concrete block construction and plaster finish and standing seam metal roof. The building is proposed to have a central elevator corridor and stairway. The proposed project schedule is compatible with the City's timeframe for occupancy of the parking structure by January 2000, although an exclusive negotiation period and development agreement are also included in the project schedule, which could suggest an extended period of negotiation with the City. A two story building is proposed containing ground floor retail. Coffee Bean and Tea is a suggested tenant although the proposal did not contain a letter of interest. A flower vender and beach related retailer were also suggested. Other potential tenants have submitted letters of interest and the construction financing is proposed through East West Bank. (Please see attached.) Retail spaces open onto a pedestrian plaza and Hermosa Avenue street frontage. The upper floors are proposed to be professional offices. The developer has also requested a 50 year ground lease. The developer is also proposing to have outdoor seating with placement of tables and chairs or sidewalk vending carts along sidewalk areas in connection with retail tenants. The developer is proposing construction costs of $800,000 (hard costs) with a shell cost of $90.00 per square foot. Proposed average tenant lease rates are triple net at $3.25 per square foot for retail and $2.00 per square foot for office. The proposed ground lease is $18,000 year one and $29,316 year two. Thereafter it increases with CPI adjustments of 2%. The ground lease is based upon a percentage lease of 20% gross sales and the minimum annual base ground lease $24,000.

Project Issues:

The developer has submitted a plan which includes use of the right of way for seating and outdoor selling but does not indicated whether the space would be leased from the City. The proposed building will require additional exiting stairs to meet eggress requirements under the Building Code and this decrease in leaseable area effects the project proforma. The City may not wish to include outdoor sales as part of the project. The proposed average tenant leases and ground lease values are higher than the Peha/Triwell and Bacon proposals and the ground lease value is equivalent to the City's own appraised fair market rent value for the property. (Please refer to summary table.) The project construction costs and ground lease terms are consistent with the City's appraisal, however, there was not much attention to the building design presented in the proposal. The tenant lease costs may be high which means that the proforma revenues may be overstated . This is a potential problem relative to the proposed percentage ground lease for the City. In addition use of a percentage ground lease may severely under value the property over the coming years if the City's downtown revitalization continues and land values continue to escalate. (Property values can exceed CPI adjustment and gross tenant sales percentages if the area is a major pedestrian attraction which is the case in areas such as the Santa Monica Promenade). Thus the City may want to require a fixed ground lease or if a percentage ground lease is to be used it should include rent resetting provisions.

Conclusions:

Evaluating the annual gross rental for the projects and the annual net income after expenses provides one method to analyze the three submittals financially. The Bacon proposal is lowest on both gross income and net income estimates. For each $1.00 of rent received, the City receives $0.06 of gross revenue or $0.07 per net $1.00 of rent received (excluding debt service.) The Gangi proposal provides $0.17 for each $1.00 of rent received and $0.18 for the net. The Peha proposal provides $0.13 for every $1.00 of gross income. But $0.19 for the net (due to higher expected operating costs.) The City's appraisal shows $0.21 per $1.00 of gross rental income. The ground lease value is higher for Gangi, however, it is based on a percentage ground lease which fluctuates and requires disclosure of tenant sales and auditing by the City. For this reason a fixed ground lease or a variation of a fixed lease is recommended. The Peha/Triwell proposal has the next highest fixed lease value and provides a reasonable and consistent return to the City. The Bacon proposal has the lowest fixed lease value .

Staff evaluated the project proposals and interviewed prospective development teams. The strengths and weaknesses of the team proposals were evaluated on: team experience, lease value, project design, and conformance with RFP/RFQ objectives. Based upon the project proposals and interviews staff rated the teams as follows:

• Peha Associates/Triwell Properties No. 1
• Gangi Development No. 2
• Roger Bacon No. 3

Staff believes that the details of the lease terms should be negotiated with the development team and presented at a subsequent meeting for City Council approval.

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