Guide to Value Capture Financing for Public Transportation Projects (2016)

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32 Through effective partnerships [between] transit agencies, local government, and others, and under the right conditions, all parties are in a position to reap the financial gains conferred by well-planned and well-managed TOD (Cervero et al., 2004). The cornerstone of successful value capture implementation is the clear identification and artic- ulation of the economic opportunity and competitive advantage associated with (1) maximizing the character, quality, and yield of projects nearby transit, such as TOD, and (2) embracing a value capture strategy that optimizes benefits for public and private developers. This chapter focuses on how to structure the opportunity for value creation and how to frame the case for public and private participation in value capture. 5.1 Incorporating Risk Value capture projects are subject to a number of risks that reflect the exigencies of the infra- structure development, construction, and operations as well as those typical of the real estate industry. Table 8 identifies a number of typical risks to which value capture projects are subject. Project delay is a risk common to many large transportation projects and occurred in several cases described in this guide. Delays are often costly due to project cost inflation. Furthermore, delays impose an opportunity cost since developers cannot develop or can only partially develop the real estate assets related to the value capture project. Additionally, risks associated with the various revenue streams that are used for a project are also common. Some of this risk can be managed through risk sharing strategies such as backstops from public agencies other than the project sponsor. In the Denver Union Station project (as will be further discussed in the case study in Appendix C), multiple public partners were involved, and the City and County of Denver provided a backstop for the project’s Rail- road Rehabilitation and Improvement Financing (RRIF) loan, sponsored by the Denver Union Station Project Authority. The sources of repayment for the RRIF loan included funds from the Regional Transportation District (RTD), tax increment revenues, a levy on property tax revenues, and lodger’s tax revenue. The challenge in using creative backstops is that the current financial market limits its acceptance of backstops to those that are clearly investment grade (as discussed in Chapter 6), including property taxes, sales taxes, and gas taxes. In the future, the market may become more comfortable with backstops based on future real estate revenues or other innovative funding sources with strong historical examples of the stability of such cash flows and appropriate finan- cial structuring that give a high degree of confidence in the availability of these revenues in downside cases. C h a p t e r 5 Articulating the Business Case

articulating the Business Case 33 5.2 Business Case for Transit Agencies and Local Governments For transit agencies and local governments, the core issue related to the business case for value capture is how to use value capture to help fund a transit project while demonstrating to public and private stakeholders that value capture is the most appropriate tool for funding the project. Table 9 illustrates some of the questions that a transit agency or local government might address when articulating the business case for a project. 5.3 Business Case for Developers Developers will participate in value capture to the extent that the cost of such participation is more than offset by realizable market value or competitive advantage. Although the premium afforded by proximity to transit is often substantial, the TOD investment opportunity may be tempered by higher costs, complexities, and risks. Typical Value Capture Project Risks Developer Impact Transit Agency, Local Government Impact Comments Transit project delay            ➂                          Affects all parties. Transit project cost overrun Transit agency usually takes responsibility for project delivery; however, higher costs could lead to project delay or change in project scope. Transit project scope change (i.e., stations changed, reduced service, phasing instituted) Depending on nature of change, this could have a minor or major impact on all stakeholders. Expected zoning and land use changes not enacted, including up-zoning Major impact to developer; others affected if they depend on development revenues. Major economic downturn resulting in lower TIF monies or lower special assessments Could affect local government if funds were to be used as a backstop for TIF or bond holders who took on risk associated with a special assessment district. Major economic downturn resulting in lower rents or value of development parcels Major impact to developer; others affected if they depend on development revenues. Real estate project delay Major impact to developer; others affected if they depend on real estate revenues or ridership from development. Higher transit operating costs Impact to transit agency; could affect developer if service subsequently curtailed. Higher real estate project operating costs Impact to developer; impact to transit agency and local government if this results in real estate project financial distress. Key:  = less impact;  = more impact. Source: FHWA, 2013. Table 8. Typical value capture project risks and impact on stakeholders.

34 Guide to Value Capture Financing for public transportation projects It is important for transit agencies and local governments to note that “many developers embrace TOD as a concept; however, there is a general agreement that TOD offers little help when it comes to securing conventional debt financing. Loan decisions . . . are governed by fun- damentals, not urban planning concepts” (Cervero et al., 2004). In most cases, the real estate project itself needs to be financially sound before a developer will move forward. Where transit investments will create opportunities for developers, effective value cap- ture strategies must demonstrate the potential to create more value for developers—or reduce risk, uncertainty, and competitive disadvantage—than they cost. Direct customers of developers, such as homeowners and business owners, may realize prospective real property value increases only in the distant future when properties are sold or refinanced. This may make it difficult for them to underwrite the cost of higher operating and ownership costs associated with value capture instruments such as special assessment districts in the short- and medium-term. Some part of that value created by transit infrastructure may be considered as premium in the sense that real estate assets near transit command higher prices than those of competitive prop- erties not similarly served by transit and complementary amenities. Premium prices reflecting consumers’ increased willingness to pay for transit accessibility have been demonstrated through numerous academic and real estate market price studies. To the extent that price premiums are sufficient to offset elevated predevelopment land acquisition costs and any development, construction, or finance cost disadvantages with respect to competitive submarkets, a portion of the value reflected by that premium can be captured by the public to help pay for the transit development without creating competitive disadvantage. Element Key Questions to Be Addressed Transit Does the project clearly support a demonstrated transportation need? Is the project in congruence with the needs of the transportation network (i.e., create a needed connection)? Could the project be built without value capture? Is other public funding available? Planning and regulation Does the project comply with long-range transportation and land use plans? Does the project address economic development needs within the area? Are regulatory issues adequately addressed? Potential for value to be generated Are TOD alignment opportunities economically compelling? Is land publicly or privately owned, and is land assemblage1 required? Have station locations been determined? To what extent will the planning process reveal the station locations, affecting purchase negotiations? Potential for value to be captured by value capture mechanisms Is enabling legislation in place for value capture mechanisms? Of the value capture mechanisms that are allowable, which are most favorable for the scope, scale, and projected value of the project? Is there high potential for strong political opposition? Private partner interest Have developers proposed joint development or made serious inquiries? Is there strong interest at industry forums? Will developers consider reduced land prices in return for density bonuses? 1) Land assemblage involves the joining of contiguous lots to make a larger parcel of developable land. Government agencies, such as transit agencies, may have a need for land assemblage in order to accommodate development of significant scale and footprint such as for housing and transit facilities. Table 9. Elements of a value capture business case for transit agencies and local governments.

articulating the Business Case 35 Most developers put together a business plan, either formally or informally, to justify their involvement in a real estate project involving value capture. This plan addresses many of the issues discussed here and throughout the guide from the developer’s perspective. Table 10 presents typical elements of a developer’s value capture business plan, covering the nature of the transit project, regulations, market interest in the value capture opportunity, and financial return. As discussed in Chapter 4, addressing planning and regulatory issues is usually a critical part of the developer business case. Obtaining certainty in this area—such as the allowable building density—is important for business planning, as is ensuring that the regulations affecting the real estate project will be commercially viable. For any real estate project, including one that involves value capture, developers want to know that there is strong market interest. Developers have a variety of ways to assess this, including the quantitative ways listed in the questions in Table 10. Developers also gauge the market through qualitative methods, including extensive and ongoing discussions with tenants, lessees, property owners, and other real estate market participants. The level of financial return—the payback on an investment in a project—varies among developers based on a number of factors. These can include legal structure of the invest- ment, tax treatment, investment horizon, and relationship of the project to other developer investments. Element Key Questions to Be Addressed Transit project scope and planned operations Does the transit service generate additional value for the land or real estate development? Does the transit service generate a level of foot traffic that makes the real estate improvement more desirable? Is the transit service permanent (i.e., a fixed guideway or significant BRT infrastructure investment) and therefore harder for the public to remove or relocate? Planning and regulation Does the project comply with long-range plans? Are regulatory issues adequately addressed? Nature of value capture opportunity Are TOD alignment opportunities economically compelling? Do station locations suggest particular opportunities given market conditions? Do zoning, land use regulations, and design standards (including increased densities and reduced parking requirements) foster TOD? Interest in market How strong is the land and lot availability and pipeline? Is there sufficient interest from possible tenants? Is TOD accepted in the market? Are housing prices and the prevailing rent burden positive for the market? Are retail and office inventories tightening and absorption rates increasing? Land ownership in the case of joint development Is land publicly or privately owned, and what assemblage is required? Have the station locations been determined? To what extent will the planning process reveal the station locations, affecting purchase negotiations? Is there an option for density bonuses or additional uses? Financial return Is the rate of return for the development expected to meet or exceed the developer’s requirements? Are the expected contributions of debt and equity from the developer (based on the financials of the project) in line with current market expectations? Source: Adapted from Long, 2011. Table 10. Elements of a value capture business case for developers.

36 Guide to Value Capture Financing for public transportation projects 5.4 Value Capture and Land Speculation Stakeholders should be aware of the extent of value capture opportunity that can be lost to speculators and opportunistic investors subsequent to the announcement of prospective proj- ects and prior to implementation. Since most public transportation planning activities include extensive public engagement and disclosure, opportunistic speculators or developers may acquire property or options or negotiate partnerships with landowners in anticipation of future value creation associated with transit development. The value of property near transit facilities rises over time as the transit project progresses to completion, as shown in Figure 14. The value of property continues to rise after transit proj- ect completion as the benefits of the facility are proven and ridership demand increases. The increased property value is expressed through the ability of the market to absorb higher prices, reflecting the value premium associated with transportation improvements. In the absence of early strategic partnerships, land speculators may realize much of the land- rent premium induced by prospective public investment by the time a transit agency or local government announces a transit project and station locations have been identified. Real prop- erty value premiums associated with transit begin to materialize even before transit project development takes place. If transit agencies have committed to station locations prior to secur- ing strategic value capture partners, value premiums may be capitalized into land costs by the time developers become engaged. Land value capitalization begins as investors and speculators respond to announcement of plans and continues as progress toward project implementation proceeds (Knaap, Ding, and Hopkins, 2001). Such investors/speculators may have no long-term interest in or commitment to the resulting development, in which case, value is lost to the ultimate developer, its customers, and ultimately to the public through the loss of value capture potential. An increase in land acquisition costs resulting from pre-transit speculation is one of the many reasons that transit agencies must partner with developers to maximize the opportunity for value capture. Early strategic partnerships between transit agencies and developers can allow for: • Highly market-informed consideration of station locations and development potential, • Land assemblage prior to significant land-rent speculation, and • Negotiation of mutually beneficial design standards and value capture mechanisms. Commencement of Service Transit Project Announced Post-Transit Value/Creaon Pre-Transit/Speculaon Time (Years) Va lu e (D ol la rs ) Figure 14. Transit value creation and speculation.

articulating the Business Case 37 Where possible, value capture mechanisms should be structured early in the project develop- ment process, prior to the transit agency’s commitment to or design of station locations. Early accommodation of value capture strategies provides developers with maximum potential con- trol and design of sites, thereby allowing transit agencies to realize the maximum possible value capture. Transit agencies can jump-start the value creation process not only by participating in early conceptual planning, approving TOD-supportive station-area plans, engaging with the local government, and partnering with the developer, but also by funding predevelopment such as site and infrastructure planning and entitlements.1 Maximizing value capture requires that potential value induced by public investment in transit infrastructure not be wasted or go unrealized. This has implications for the enticement of private investment and development and for the local government and other public-entity interests. The greater the extent to which value can be created and captured for public benefit, the more the local government may be able to invest and reinvest in TOD value creation—or even include additional infrastructure amenities that make the deal more attractive for private partners. The example of the Hong Kong MTRC is unique because the transit agency received develop- able land from the Hong Kong Special Administrative Region (HKSAR, the local government body) for free or at costs below market value. It subsequently sold those properties to develop- ers as stations and other transit amenities were developed, retaining some shareholding rights, which allowed MTRC to benefit from the appreciation of land values. This unique access to property and HKSAR’s unique monopoly on land, in general, explains why MTRC is one of a handful of transit agencies worldwide that covers its costs and is able to share profits with its public and private shareholders (see more in Appendix D).