Memorandum
City of Lawrence
City Manager’s Office
TO: David L. Corliss, City Manager
CC: Cynthia Boecker, Assistant City Manager
Diane Stoddard, Assistant City Manager
FROM: Roger Zalneraitis, Economic Development Coordinator/Planner
DATE: August 25, 2008
RE: Cost-Benefit Analysis for 87 Acre Site Adjoining East Business Hills
Douglas County Development, Inc. (“DCDI”) recently approached the City of Lawrence and Douglas County with an offer to sell an 87 Acre parcel on the east side of East Business Hills to the City and County at a nominal charge. The offer is contingent upon the City and County completing fill work to make the site ready for industrial development. The City is seeking to finance their portion of the infrastructure activity through a $1,000,000 General Obligation bond.
The following memo evaluates the likely costs and benefits associated with this offer. A cost benefit model was conducted under several build-out scenarios for the property. Assuming that the City and County complete all additional water, sewer, and roadwork for the site and offer an 80% tax abatement, benefits will only accrue after 10 years, and benefits will be higher from higher-value firms than from lower-value firms. Benefits could come sooner to both jurisdictions if fewer public incentives were offered.
Background:
East Hills Business Park was purchased by Douglas County (“the County”) in 1986 and is currently operated by DCDI. DCDI was incorporated to 1) foster the industrial and commercial growth and development of Douglas County, Kansas; and 2) purchase, develop, manage, and lease, sell or otherwise dispose of real estate, buildings and other forms of industrial and commercial improvements of any kind, and other associated property of whatever kind or description. In accordance with its mission, DCDI purchased an additional 87 acres of land east of Noria Road in 1999. This land was rezoned and annexed into the City of Lawrence (“the City”) in 2000.
On May 28th 2008, the City and County received a letter from DCDI offering to sell the 87 Acre site to the City of Lawrence and Douglas County for $10. The sale is contingent on the completion of the elevation of the site to make it “pad-ready” for development, and an agreement that the site be used for an industrial or commercial use that increases local employment (See attached letter).
Providing fill-dirt for a specific site is not without precedent. In 1998, the City and County applied for, and received, a $290,000 Kansas Partnership Fund loan to excavate dirt from one site in East Business Hills and fill a second site with the excavated dirt. This was undertaken to make two sites “pad ready” for two firms. The loan has since been paid off (See attached application and repayment schedule).
Characteristics of the 87 Acre site:
The 87 Acre Site sits east of Noria Road and north of County Road 442. The property is within the 500 year floodplain, but is outside of the 100 year floodplain. It would only take 2 feet of fill-dirt to raise the property above the 500 year floodplain; however, 7 feet of fill-dirt is needed due to the level topography and drainage requirements. This project would accommodate a pad site for at least a 400,000 square foot building.
The 87 Acre site is currently zoned Industrial-General and is platted into two parcels. The first parcel is approximately 38 acres, the second is approximately 49 acres. The two parcels are separated by a 15-foot wide utility easement that runs north-south across the entire property.
Costs for Making Site Ready for Private Investment:
DCDI has stipulated that any transfer of the property to the City and County occur after the site has been elevated. LandPlan Engineering estimated that the cost of completing this fill work would be approximately $2.1 million. Subsequent conversations with LandPlan suggest that some cost savings could be obtained by using fill dirt from within East Business Hills, such as the 30 acre, hilly, vacant site that sits on the west side of the Park. Accordingly, it is likely to cost about $1 million for the City and $1 million for the County to provide the fill necessary to make the site ready for development. The City seeks to pay their half through debt-financing with a General Obligation bond.
Upgrades to surrounding infrastructure are dependent on the type of business that ultimately locates at the 87 Acre site. Some road, water, and sewer upgrades are likely regardless of employment type, and higher intensity uses would generally require more upgrades. It should be noted that Resolution 5614 requires many of these costs to be borne by the developer. However, for the purpose of evaluating this site as a feasible employment center, we assumed a “high public incentive” scenario. Under this scenario, the City and County pay for all infrastructure development off-site. Further, this scenario assumes that this particular site is responsible for all the costs and receives all benefits from the infrastructure development[1]. This results, depending on use intensity, of additional infrastructure costs between $2.5 and $7.0 million.
We have also contacted the ECO2 Commission to evaluate whether fill work on the 87 Acre site would trigger an open space financing requirement. ECO2 was established in February of 2003 with the “dual purpose of advancing economic development and ecological stewardship opportunities in the form of preservation and management of, and access to, open space in Douglas County.” The ECO2 Commission believes that infrastructure work on the 87 Acre site would create an open-space requirement (See Attached Letter). At this time, the requirement is uncertain but may be between 5% and 25% of infrastructure costs. This could result in $100,000 to $500,000 of additional costs to protect open space. While ECO2 requirements have not yet been incorporated into the model, these open-space finances are considered in the conclusions, below.
Benefits and Costs of Developing the 87 Acre Site:
A benefit-cost analysis was prepared to evaluate what types of public benefits might accrue to the City and County should they accept DCDI’s offer for the 87 Acre site. This analysis was undertaken using a new, in-house cost-benefit model that has been developed by staff over the last three months.
One key consideration in the analysis is estimating what type of firm might locate at the site. In order to do so, we undertook a market survey to see what type of industrial firms currently exist in Lawrence, what types of firms have expressed an interest in the 87 Acre site, and what types of firms are currently moving into the Kansas City metro region.
Based on this survey, three scenarios were developed. The first scenario assumes a low wage firm with high infrastructure requirements and low capital investment in a building. The second scenario assumes a firm similar to industrial companies currently found in Lawrence and Douglas County, with average manufacturing wages, infrastructure requirements and capital investment. The third scenario assumes a “high value” market entrant that provides high wages and capital investment, and similar infrastructure demand to the second scenario. All three scenarios assume two phases of development about five years apart, resulting in 400,000-450,000 square feet of industrial space at build-out. We assume in this analysis that both phases seek and receive a 10 year, 80% tax abatement on real property taxes.
In addition to the cost of the building and wages provided, there are other key differences in the three scenarios. These include total numbers of employees, utility use intensity, and taxable spending by the firm within the community. The first scenario assumes 250 employees, the second scenario assumes 500 employees and the third scenario about 400 employees. Utility use intensity increases in the latter two scenarios as well, as these operations may require more water or electricity.
The discount rate is also a key feature for evaluating outcomes. The discount rate is equal to the 20 Year Treasury bill, plus a risk-adjusted rate of return for the project. In this model, the discount rate is 6.25%. In other words, we believe that an infrastructure-and-incentive package for this site requires a 6.25% rate of return in order to yield the same risk-adjusted outcome as investing in a 20 Year Treasury bill. Any rate of return less than this will result in cost-benefit ratio of less than one.
Finally, a key assumption is that the City and County sell the land at market rate and split the proceeds between them. Several recent transactions in the Kansas City metro area have involved the successful sale of a property. If the land is given away, we believe that this should be counted as an incentive offered to a potential firm.
Results:
The results of the three scenarios show that benefits rise as the quality of the firm increases. In the first, or “low value”, scenario, the City and the County both receive positive revenue over the life of the site. However, the future revenue stream for the City and County is comparatively low relative to up-front costs, resulting in a discounted cash flow that is negative. In other words, the up-front costs appear to outweigh the potential future benefits.
The second, or “middle value”, scenario yields a small, but positive, rate of return. In this scenario, the City and County can expect a revenue stream of about $5.8 million and $7.5 million, respectively, after tax abatements. Discounting this revenue yields a cost benefit ratio of 1.10 for the City and 1.22 for the County. The highest possible benefit-cost- assuming no abatements were offered- would be 1.22 and 1.47, respectively.
Finally, the third, or “high value”, scenario shows a benefit-cost ratio of 1.22 for the City and 1.36 for the County, after an 80% tax abatement, and 1.42 and 1.76 respectively before the abatement. The non-discounted revenue stream is about $10.1 million for the City and $11.3 million for the County.
Under all scenarios, a key driver of costs is new residents. Although the model suggests that higher wage residents are more likely to pay for themselves through property taxes, retail shopping and ancillary fees, under all three scenarios additional residents are close to break-even for the City. Residents from indirect jobs created tend to result in losses for the City, as these jobs pay less than the jobs at the firm.
The charts provided show that post-abatement benefits do not start accruing to either jurisdiction until after Year 10. The first ten years yield negative returns for two reasons. First, infrastructure investments are substantial and repaid in this period. Second, property tax abatements affect all property built by the firm. After year 10, property tax abatements begin to expire, and infrastructure investments are repaid. Thus in all scenarios, an investment in the 87 Acre site is only positive in the long-term.
Implications and Caveats:
There are several caveats and implications associated with this analysis. Perhaps most importantly, the model indicates that, over the life of the 87 Acre site, there is a good chance that, given the right firm, the City and County will benefit from the infrastructure investment required to make the property investment-ready.
The model has certain caveats. No model will account for every cost and benefit associated with a project. For example, if fill is used from the 30 acre site on the west side of East Business Hills, that brings that 30 acre site much closer to being marketable to another company. This is a benefit unaccounted for in the model. In addition, tax rates and market conditions can change over time, affecting employment in the private sector and revenue collection for the City and County. Also, the model does not try to measure either positive or negative externalities, such as a better job market or increased traffic. School district and state revenue impacts are still being incorporated into the model. Based on other models, we believe the School District and the State will have a higher benefit than either the City or the County. Should School District revenues be less-than-desired, a payment-in-lieu-of-taxes (PILOT) could be established.
Another important caveat is accounting for costs. As mentioned earlier, this analysis assumes that all costs and benefits for infrastructure investment accrue to the 87 Acre site. Using an “average” cost approach- that is, allocating costs across all beneficiaries instead of just this particular site- would raise the cost-benefit for a “mid-value” firm, after abatements, from 1.10 to 1.29 for the City, and the revenue stream from $5.8 million to $8.8 million.
The results from this analysis have some implications that need to be carefully considered. First, the results suggest that tax abatements and additional infrastructure work should be evaluated to ensure that the City and the County achieve their long-term goals of diversifying the tax base as well as offering more job opportunities to residents. Second, there may be additional sources of revenues and costs that the jurisdictions can consider. For example, the City and County could consider recouping some of their infrastructure investment through a special assessment. Third, the size of the project revenue stream is important to consider because of ECO2. Open-space acquisition requires evaluating not only the cost-benefit ratio, but the overall revenue stream to ensure that both financial obligations as well as jurisdictional tax goals are met. Finally, because long-term revenues are important, business retention is a crucial aspect for achieving a positive rate of return.
[1] Generally, for projects such as road improvements, other firms and users both contribute to the required need for the upgrade and benefit from the upgrade. For this reason, we would normally only allocate a portion of the costs to one particular project- which is referred to as the “average” cost of capital improvements. In this model, we are assuming a “marginal” cost for improvements: only the firm or site that triggers the infrastructure upgrades, bears the costs.