DRAFT

City of Lawrence

Public Incentives Review Committee

November 16, 2009 minutes

MEMBERS PRESENT:	Scott Morgan, Cindy Yulich, Brad Burnside (for Mike McGrew at the request of the Lawrence Chamber of Commerce), Rob Chestnut, Brenda McFadden, Mike Gaughan, Dennis Highberger, and Mike Amyx
MEMBERS ABSENT:	None
STAFF PRESENT:	David L. Corliss, Diane Stoddard, Roger Zalneraitis
PUBLIC PRESENT:	LaVerne Epp, Carey Novak, Marilyn Bittenbender, Hank Booth, Beth Johnson, Kirk McClure, Jo Scannell, and Jim Mullins

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Mayor Chestnut called the meeting to order at 4:05 p.m.

Mayor Chestnut stated that PIRC was there to review, forwarded to them for  recommendation from the City Commission, a request from the Lawrence Douglas County Bioscience Authority for the City and the County to consider purchasing the West Lawrence Laboratories Building at 4950 Research Parkway.  Mayor Chestnut also indicated that he thought it would be appropriate for PIRC to hear public comment after its discussion.

Diane Stoddard briefly described the request and introduced LaVerne Epp, President and Chairman of the Board of the Lawrence Douglas County Bioscience Authority (LDCBA).

Epp stated he is very excited about the request that LDCBA submitted for land acquisition and lease for the West Lawrence Labs facility  for three reasons – 1) the community, along with the University of Kansas and business community have collaborated to create the development of the Economic Development system and leveraging research and activity going on at the University.  The West Lawrence Labs facility is a perfect compliment to the Incubator and the Multi-disciplinary building located on west campus.  The design is perfect for startup companies and other research companies.  It gives them essentially Phase I or the next step to companies that need space.  It expands the footprint and gives additional leverage to attract companies to Lawrence and create that system they are trying to build; 2) reason is CritiTech, a life sciences company that exists in Lawrence, one of our own, born and raised here, the company currently has under development significant cancer drugs and would be the anchor tenant in this facility.  We have worked with them to negotiate a lease agreement to ensure they would stay local at least within the next five years.  CritiTech currently occupies between 2100 - 2300 square feet.  At the time that we would take control of the space, they would go to 3200 square feet and are looking to expand beyond that in the next three to five years.  Having control of the space gives us the opportunity to work with them and help keep them in town; and 3) it is important for us from the standpoint of the LDCBA - having the additional space allows us to strengthen our relationship with the University of Kansas.  The University of Kansas is a staple in the bioscience field and having the space allows us to negotiate if KU needs additional space.

Epp then stated he wanted to turn things over to Carey Novak, who has been very important to this process and analyzing this project.  He is an adjunct member of the bioscience staff and analyzed the facility to see whether it has potential for KU.

McFadden asked Epp what the timetable is for the construction process.  Epp stated that construction would be completed late May or early June next year.   The project is currently on budget and on time. 

McFadden asked for Epp to describe the process on the incubator being built and the transition to this space.  How at that stage do they generate revenues?  Epp indicated it depends on the company.  In this case, the company is doing research and it takes a long time.  McFadden asked what the average length of stay is and when do they get to the point of whether the company is going to make it, and what is the average turnover.  Epp stated again that it depends on the company and what they are developing; however, the rule of thumb is roughly five years.  LDCBA will help them grow and develop in that time and allows the company to move on.  Having the West Labs building will allow that process to happen.

McFadden asked Epp to describe the process of starting out how the incubator was being built and transitioning to this space and how at that stage do they generate their revenues. Are they selling anything?  Epp stated it depends on the company and that they are doing research and it takes some time.  Sometimes there are capital investments and grant revenues to help with the money.

McFadden asked if CritiTech would leave what would it cost the city.  Mayor Chestnut indicated roughly 15 jobs.

Epp indicated when the market research was done to prepare for the business plan for the incubator, they identified spec companies that had left the area for lack of space – this would help fill that gap.  The goal is not to let the facility remain dark waiting for a company – we would be very aggressive and they already have had contact with a company wanting to move to Lawrence.  The challenge is pricing the space and it’s an advantage of having KU right next door.

Epp also stated it’s an intangible benefit to keep CritiTech.  We want to keep the company and not get a reputation that we can’t keep a company that we started here – other companies will see what happens and will have a pretty powerful recruitment tool.

Gaughan asked how long CritiTech has been going and at what point determined successful.  Epp stated CritiTech had been in Lawrence for 10 years and have been functioning at this level since 2004.  If you look at two drug technologies now at various stages of development both are very promising futures.  At what stage can you say successful?  Not sure, but they are definitely successful.

Gaughan asked where CritiTech fit into the timeline.  Epp stated that CritiTech wouldn’t go into the incubator as they are too far along and they would not be an ideal candidate for the incubator.

McFadden asked who owns the property.  Epp stated that LDCBA owns the building and the land is owned by the KU Endowment Association.  LDCBA has a long term lease. 

McFadden asked if bonds were issued for the purchase.  Epp stated no, that funds were raised and City and County made ten year commitment to LDCBA of $2 million.  KU matched that commitment in land and cash and LDCBA matched $2.5 million.  Funds for the most part are local, however a portion are state funds.

Carey Novak introduced himself and said he wanted to explain why they look at the building as part of the infrastructure and give PIRC some idea of what other university communities are doing in this area.

In looking at the system, we like to look at different components and establish a set of buildings in Lawrence.  One area KU researches is in the life sciences area.  Cancer research is growing at KU and is one of the key areas.  There is also very robust research in bio fuels and bio chemicals and a growing field in bio energy.  There is a very good base of research that can be commercialized and grown in Lawrence.  Second one is incubator which LaVerne talked about.  It represents that first home for very early technologies.  Physical location is across the street from pharmaceutical research taking place.  Hopefully, we will have early stage research get into community realm and going into the incubator.  What we like to look at with the West Lawrence facility is that it can serve as home for the early stage components.  If we can get them in incubator and start generating early sales, we’d like to have them in the business and get them in the facility – labs are bigger, set up for commercialization and some kind of bio chemicals device.  We’re looking at bringing companies here that want to collaborate and hopefully want that Lawrence location to do that.  This building has the kind of facilities for existing companies and gives them the opportunity to collaborate with KU.  The technology/research part – we know that people are looking at it, working with mapping out with the community the technology part.  This represents a very full integrated system.  This facility can help us further develop/commercialize KU technology as a home for incubator based companies.    Regarding CritiTech, he spoke about the company conducting Phase I clinical trials at the KU Med Center and in Wichita – they have drugs under development and have potential to grow. 

Next, Novak spoke about other communities, specifically Madison, Wisconsin and West Layfette Indiana.  Madison has a 325 acre Research Park, managed by the University – public private group.   It consists of 36 buildings, 115 companies, and 3500 employees.  It is a very large and robust research park and working on Phase II.  Building square footage is 1.6 million square foot of building space.  All are on current tax rolls.  Of that 1.6 million, 110,000 square foot is incubator complex.  It started as 50,000 square foot facility with 90,000 square foot as the accelerator, intended to be home of companies coming out of incubator.  West Lafayette Indiana is the home to Perdue.  It is managed the same. Has 725 acres, 52 buildings, 162 companies, and 3100 employees.  105,000 square feet is the incubator, 28,000 square feet is the wet lab incubator, and 21,000 square feet is the accelerator – home for incubator companies.  This is a completely private facility.

These are two good examples of where these communities have gone.  This represents a path that we can generally take. 

Mayor Chestnut asked if anyone had questions for Novak.

Gaughan asked of the Madison facility, how much is University vs City?  Novak stated that the land started out as University of Wisconsin Farm Extension Site.  The University put in significant dollars to put in the roads and infrastructure.  All buildings stayed on tax rolls and the University put up the companies.  The University was key.  Novak was not sure how much the City put in.  Now there is a mix of private developers and they can come put in their own buildings.  The Foundation can put in buildings and lease it.  The Foundation owns 700,000 square feet of the 1.6 million.  That balance owned by private developers and it seems to be a good model.

McFadden asked how many companies are waiting for the incubator to open up.  Novak stated that he wasn’t sure but that the word is out and companies are starting to contact them.

Gaughan asked how much is exclusively bioscience.  How would you characterize west campus and entire research capacity in Lawrence?

Novak stated that 100,000 – 125,000 square feet would be a guesstimate of pure University research labs.

Stoddard stated that her role, along with that of Roger Zalneraitis, is to provide PIRC with some level of detail to provide PIRC information on the transaction.  Zalneraitis is the Economic Development Coordinator/Planner for the City and will be talking about the benefit cost model and analysis.  Stoddard then recapped the request from LDCBA and reminded PIRC that their role is to provide a recommendation to the City Commission, whether it is in support of the request or against the request.

Stoddard stated that LDCBA is requesting the acquisition of the West Lawrence Labs Building by the City and County and that LDCBA would lease the facility back from the City and County and provide subleases.  This would keep CritiTech in Lawrence.  Stoddard stated the purchase price of the building is $2.3 million, with an additional $600,000 in HVAC upgrades, making the total price of $2.9 million.

Stoddard addressed questions regarding the appropriateness of the purchase price at $132 per square foot for $2.3 million or $166 per square foot for $2.9 million. The new incubator facility on west campus was $270 per square foot, conservatively.  The cost to build this type of incubator lab is much more than the purchase price in the proposal.  For the proposed acquisition, the City would issue tax general obligation-backed bonds of approximately $2.9 million and the City and County would enter into a cooperative agreement and both entities would directly hold title to the building.  The structure of the proposed acquisition would consist of LDCBA leasing the building from the City and County and they would have specific requirements they would need to meet.

Stoddard told PIRC members that the terms of the bond issue and amortization schedule was in their packets and it would be structured so the principal on the bonds would be deferred the first five years and LDCBA would pay $25,000 a year to the city to meet the interest payments.  Beginning the sixth year, LDCBA would pay both principal and interest to the City.  The LDCBA would pay the first five years principal over the remaining 20 years of payment.  Based on the anticipated bond interest rate of 5½ %, the City and County would share $18,570 average each per year.  The amortization schedule is slightly higher in the early years and is based on 5½% interest rate.  If we go to bond market in January, and sell the bonds, the bond rate could be either lower or higher, but this is a pretty good estimate.  It is important to note the risk in the proposal.  The City and County would be assuming the risk that LDCBA would not have revenue to make their share of the bond payment, however LDCBA performance sheet those risks are reasonable.  The lab building currently is on the property tax rolls and would stay on the tax rolls and this provision would be written into the agreement.  Also, the City and County would require LDCBA to enter into agreement with CritiTech that states CritiTech would stay for a minimum of five years.  CritiTech would only be able to leave if the company is sold or outgrows after the first three years, and they would pay an exit fee to LDCBA.  CritiTech is indicating a commitment to stay the five year period. 

McFadden asked that the amortization schedule be clarified.  Is LDCBA’s share actually rent that has to be earned then they pay the City and County?  So if the building isn’t full with tenants or they don’t pay rent, then LDCBA wouldn’t be able to pay their amount.  Stoddard stated this was correct.  McFadden then asked if rent isn’t generated that there isn’t any other way to force them to pay it.  Stoddard stated this was correct.

Amyx stated that there would be rent from CritiTech in the first five years.  Stoddard stated this was correct.  Part of the reason for working with LDCBA for the first five years is to help them build occupancy in the building and the anticipated occupancy rate.  There are a couple options to consider, if for some reason revenue doesn’t materialize, there is an asset that is owned and the City and County could decide to do something else, possibly utilize it for other government purposes, find other tenants, or sell the asset.

Highberger asked how the $21.00 per square foot lease amount was determined.  Is the intent to lease to others at that rate or market rate?  Marilyn Bittenbender, Grubb & Ellis/The Winbury Group, stated the $21.00 per square foot amount is about a 30% increase over what they are currently paying, they will go to $21.00.  Triple net is where they pay taxes, insurance, maintenance, and utilities occupying 22% of the building and paying 22% of all those costs in addition to the rent fee.  If you assume that it eventually gets to 100%, then $21.00 per square foot is just plain income.  For life science space around the county, it ranges from $8.00 to $46, but buildings like this and based on all the perimeters we looked at, seems like $18 - $22 is where it should be targeted.  LaVerne said he wanted $21 and CritiTech said okay.

It was asked whether future rent will be negotiated or fixed at $21 per square foot.  Bittenbender stated her assumption is that it will probably be negotiated based on that particular tenant where they are in the process of growth, some flexibility in it.  Stoddard also informed PIRC that there will be a provision in agreement that least terms have to be approved.   Gaughan asked if each lease agreement would have to be approved by the City and County.  Stoddard stated yes in some manner, but all the details have not been worked out yet.

Gaughan asked if the HVAC upgrade and the utility item is a separate line item.  The cost for each tenant in doing the upgrade, we are lowering the cost of tenants to lease the space.  Is this the best use of $600,000?  Are there other things we should be doing instead?

Mayor Chestnut wanted to give some history to the group.  When the building was built, Oread Labs was utilizing the entire space.  The challenge now for anyone to occupy the 25% or less is they have to pay the full boat – a lot of overhead when you have a circulation system that vents the whole building at once, the utilities are huge.  Gaughan asked if there is nothing else we should be doing?

Novak stated that they have worked with a mechanical engineering company to do a complete utility analysis on the building and have identified four areas along with the air handling and boiler and that is included in the $600,000 upgrade.  Gaughan asked about other areas and Novak stated that the heat exchange and other small incremental improvements were noted as well.

Gaughan asked if we have an opportunity with one tenant and other upgrades are needed, is this the most efficient thing to do or other things to look at?  Novak stated that what they saw in the engineering study was the most for the money.

Morgan asked about the concern of neighbors of the exhaust noise that came from the building.  Bittenbender stated that the current owners have spent quite a bit of money on correcting that violation.

Zalneraitis went over the cost benefit analysis with the group along with the west Lawrence Labs cost flow projections.   He stated that CritiTech brings about 15 employees and $125,000 in discounted benefits for the City, $100,000 for the County.  If those employees leave town, it will have an impact.

Mayor Chestnut stated that there are a couple of things that are assumptions and that you aren’t making the assumption that the County is going to reappraise the building.  To some extent we are funding LDCBA.  Couple of things that cash flow models aren’t being shown in these benefits, most likely reappraisal.

Corliss asked how does the model take into account that some business will hopefully move on in the community but leave this facility.  Zalneraitis indicated this isn’t factored in. 

Mike asked what alternative financing methods are there to consider and why is this the one?   Zalneraitis stated that LDCBA.  What interest rate is LDCBA able to afford to pay and if we are going to assist them, what is the most efficient way for the City and County to assist.  General Obligation Bonds are the most efficient way to assist.  Revenue bonds are based on whatever LDCBA could earn (interest rate).  LDCBA is a City and County funded entity.

Stoddard stated that staff is positively recommending proceeding with this project.  The project helps meet our economic development goals and minimize risks involved because of ownership of asset.  The City and County Commissions authorized staff last week to create the documents necessary for the transaction.  Staff is working on that currently with bond counsel.  The City Commission would consider this item and recommendation from this body on December 8.  If approved at that time it would be considered again on December 15 for second reading.  The County will hear this item on December 16.  The role of PIRC is to formulate a recommendation for the December 8 City Commission meeting.

Morgan asked from a school board perspective since this isn’t a tax abatement, is there no ability for the school board to step in and take partial ownership?  Stoddard stated that was correct. 

McFadden wanted the board to be aware that if tenants can’t be found for the building that the City and County will be in the red. She wondered who is going to make up the difference.

Mayor Chestnut stated that when they look at this from a Commission level, there was a lot of information provided and he went and looked to see if it was a good calculated risk.  He stated that there are a lot of investments are going into biosciences right now; there is major funding and a tremendous amount of activity.  He is also encouraged that CritiTech is probably at a 7 or 8 on a scale of 1-10.

McFadden is uncomfortable with the assumptions being made and the cash flow projections.  She is cautious of not being able to find tenants.  Mayor Chestnut agreed, and stated that he’s at a point to where if this is not a situation that we have to support that we have to look at our whole funding of biosciences.  We made a commitment two commissions ago to fund the LDCBA.  He indicated that he wasn’t in disagreement with McFadden’s concerns; there were risks. 

Yulich stated that this transaction is part of a bigger picture.

Mayor Chestnut stated that he knows they have investors that will move them somewhere else – that will happen.  They are at a point right now where those investors have put a certain amount of money into that building.  If we had this opportunity five years from now, could cost $300 per square foot and no tenants.  He stated that he wished we could have more companies in the pipeline, but we don’t.  There are risks involved.

McFadden stated that the worst case scenario isn’t good and asked how do we generate money to pay the bonds if this doesn’t happen.  Mayor Chestnut stated that part of the bond and interest fund and would could continue to spend out of that fund which is supported by property tax and the Commission would have the ability to sell the building.

Mayor Chestnut asked for public comment.

Kirk McClure stated he has concerns in two areas.  Neither of these suggests this is a bad idea.  All of us are in favor of economic development and bioscience.  The issue is whether this is a well structured deal.  He stated that instead of the $2.3 million purchase price, the building was worth more like $1.75 million at his projection, but the tax assessor says $1.5 million.  The future suggests that occupancy will not be at 89%.   History says we’ll have more than two years of unoccupied space.  The assessor is assuming 55% occupancy.   We are being asked to pay too much for the asset.  He stated that asking to use general obligation bonds and passing 100% of the risk to taxpayers was not fair.  Normally economic development things of this type are some independent authority with revenue bonds backing the transaction.  The property has been for sale multiple times and hasn’t sold – it recently came out of bankruptcy.  Where is the mechanism to protect us when we say we can sell?  We want to make a handsome bid to make this happen, but it puts all the risk on the taxpayer.  He stated that we need to rethink the asking price and get it down.

McFadden asked if we could offer less for the building.  Mayor Chestnut stated that there has been ongoing negotiations – this is basically taking them out of their debt service.  They owe that much on the building.  That is based on buying it out of bankruptcy for $900,000 and the improvements the current owners made to the property.  There has been substantial investment into the building.  We felt like that we are at the place where we came to an agreement that is as good as we can do because they owe that much.  Since it is part of a community vision, then it’s a very good deal. 

Jo Scannell stated that she couldn’t be more against this idea.  The price is outlandish and the vacancy is unbelievable for a long time.  It is absolutely abhorrent to put the taxpayers under for 25 years.  It’s kind of déjà vu with the golf course all over again, at some point some people were so appalled at the cash flow of the golf course – can’t we sell it?  No was the answer.  She stated that she is really distressed about this.  She stated that all she has been thinking since I first talked to someone in the “know”, that this would be a wonderful investment that we all know about the banks that are too big to fail that this whole thing is too big to stop.

Jim Mullins stated that he is concerned we are paying too much for the building and that the occupancy rate is not going to be the projected 89%.  He stated that we were just buying people out of the building and we shouldn’t do that.  He stated that the City and County aren’t getting the best deal.  It should be purchased for $1.3 million and the general obligation bonds are not the best way, and while revenue bonds are higher interest rate, you have to share the risk, right now entirely on tax payers.  The risk needs to be shared.

Jo Scannell stated she sees a difference in buying land and buying a building.  How much staff are we going to have to add to take care of it?  I’m a landlord I know what is involved.  It’s such a bad idea.

Highberger asked McClure about how he derived the value of the building.  It appeared that he was using a lease rate that was lower than the one in the spreadsheet. 

McClure explained that his calculation was based on how much was left over after operating costs were accounted for.

Highberger asked if $21.00 was leased and weighted avg lease rate for the floor space, and if all of the utilities and other costs were paid on top of that.  Zalneraitis replied that McClure’s calculation should have used those lease numbers.

McClure said that he worked with Zalneraitis’ numbers – have to work out bottom line if it occupies 89% and at 8% cap rate, it’s worth $1.8 million.  If it falls below that it’s closer to tax assessor.  For it to be $2.3 million, 11 plus years before see payback.

Highberger asked if the lease payment of $21.00 per square foot is to be paid to LDCBA and whether it is net for them.  Are they responsible for utilities on top of that.  Zalneraitis indicated that some of the building is not rentable.  That will be factored into the value.  You can’t rent the share hallway, etc.

Bittenbender wanted the PIRC to know that CritiTech did not approach the City and County to purchase the building.  CritiTech recognized as one of the tenants that the ownership group could not offer the stability.  We approached the City and County with the challenge and what can we do.  CritiTech is paying for equipment in Wichita and that company has offered them space to relocate.  CritiTech does not want to leave Lawrence.  It was a joint meeting that created an opportunity for the proposal to come together.  It was being marketed for $2.95 million.  The HVAC system is going to be more efficient and the tenants will have more efficient utility bills.  Tenants always pay their own utilities either because separate metered or triple debt.  The tenants always pay pro-rated share of occupied square footage and pro-rated share of occupied areas.  CritiTech is paying 22% of all operating expenses.  CritiTech is not getting extra money to finish the new space, they are doing it on their own cost.

Amyx asked about GMP space in this area and how does this building compare in this region?  Bittenbender stated that it is the only building in the area with that type of space.   

The manufacturing space we have is unique and a tremendous bargain for the City and County.  She stated that if we don’t have this space, pipeline companies would go to Kansas City.  Thirteen companies have left because we didn’t’ have this building.

Amyx asked if they are close to being in the market regarding lease rates.  Bittenbender stated that at $21.00 per square foot we’re very competitive, and at $18 we are extremely competitive.  If we can retain those companies here and attract companies because we can offer base rate and reduced rate, it would get them excited about coming to Lawrence.

Amyx stated that he was more comfortable knowing that the lease rates were in the market.  These businesses as they develop, this is going to be a guess, how many types of business that have types of GMP space in this area and how far along do they have to be?  How far along does it have to be in this GMP space?

Novak stated that CritiTech started in 2001 or 2002.  If they were in the incubator, they would have some initial success and have potential clients to work with. And then at some point, one of their clients would need to ramp up and would need that GMP space.  It will take a few years to get there.  Amyx asked if this building enabled growing firms and keeping them in the community.

Novak stated that the advantage of this building gives us more flexibility.  We can have company access and pay for GMP space.  If the company doesn’t want the GMP space, it might be something they could be interested in.  They don’t have to use it to move into the building.

Bittenbender stated that the building was bought out of bankruptcy for $900,000 and that several hundred thousand dollars were spent on upgrades.  The building comes fully furnished for all office spaces and lab spaces, so all of that is included in the purchase price.

Mayor Chestnut brought it back to the PIRC and asked if there were other comments or questions for staff.

McFadden asked what is the duty of PIRC?  Do we look at this proposal independently, or as part of a larger community vision.

Mayor Chestnut indicated that PIRC hasn’t been particular active in this type of issue and that we’re trying to reconstitute this.  He stated that broader policy issues are ones that we should consider.  He suggested looking at the proposal that has been put before the committee.  Given the risks and the general back ground, do we think this is a wise investment for the community?  There are broader policy issues to be considered, but not by this group.

Corliss stated that PIRC’s role is to receive and review the request and make recommendation to the City Commission.  The city code is very broad and sets out the criteria for a tax abatement, but that subject isn’t being discussed tonight.

Amyx stated that there is a public process that needs to be followed that this is the only body that can make a recommendation at this time.

Yulich made a motion to recommend to the City Commission to approve the request from LDCBA for the City to cooperate in the acquisition of the West Lawrence Laboratories building at 4950 Research Parkway.  Burnside seconded the motion.

Highberger stated that it would like to amend the motion to make it contingent upon an appraisal.

Burnside stated that any appraisal key is assumption is absorption.  He stated that he had been fortunate to listen to Sam Campbell, Deciphera, and the pharmaceutical school, and that we haven’t done justice to the excitement.  He was not being critical, but was concerned that we haven’t heard enough excitement about it.  It’s critical that we keep this company here.  Absorptions are normally wrong.  He didn’t want to miss this opportunity.  An appraiser can influence the appraisal.  He stated that he didn’t believe the appraisal would be helpful. 

Morgan stated that the physical building appraisal is a small part of what is being evaluated.  This is very exciting and overdue.  He thought that one almost needed an appraisal of the whole process.  It is a legitimate request.

Yulich stated she hates to put decision into a 3^rd party appraiser.

Mayor Chestnut stated there was a motion on the floor.

Gaughan asked how would the determination of appraisal value impact the negotiations between LDCBA and the building owners?    Mayor Chestnut stated that honestly in the private sector, an appraisal is an instrument so that the financial company can see collateral.  Here the general obligation bond is the collateral. 

Highberger stated that he thought an appraisal was important. 

McFadden said she can’t get past the numbers.  There is broader value to the community than just long term.  She wants to make sure the committee understands the short term risk.

The motion passed 7-1 with Highberger against.