Hard times at Site A

Is the Site A project at Alameda Point – long-described as the “catalyst” for the redevelopment of the former Naval Air Station – in trouble?

It’s not an idle question.

Two deadlines – the original closing date of December 12, 2016, and an extended closing date of April 11, 2017 – for conveyance of the land for Phase 1 of the project from the City to the developer have come and gone.  And now the developer, Alameda Point Partners, wants to change both the timing and the location for building some of the housing units planned for the site.  (The total number of units, however, will remain the same.)

The stated reason?  “Dramatically increasing construction costs” have “prevented” APP from “achieving the margins necessary” to enable it to meet the conditions set by the Disposition and Development Agreement between APP and the City for transfer of the Phase 1 land.

We’ll discuss the problems the developer has encountered (and its proposal for solving them) in a moment.  But even if APP finds a solution (and Council approves it), one conclusion is inescapable:  the project the developer will deliver will be different from the one Alamedans have been expecting – and it will be delivered on a schedule different from the one they originally were presented with.

That is, of course, assuming that APP will be able to deliver any project at all.  And on that score, neither the developer nor the City planners are offering any ironclad guarantees – only cautious optimism.

“It is fair to be concerned,” Joe Ernst, the St. Paul native and Alameda resident who speaks for APP, told the Merry-Go-Round.  “The Bay Area is clearly in a part of the market cycle where costs continue to rise rapidly because of the large number of projects under construction and in the pipeline.  But it is this same large number of projects (i.e., increased supply) that is putting downward pressure on rents and sale prices for new product.  And this current relationship between cost and revenue undercuts the land value necessary to support infrastructure development.  Alameda is not immune to these market forces.”

Nevertheless, Mr. Ernst continued, “we remain optimistic and committed to working with the City and all stakeholders, and we continue to invest time and resources because we believe we can find a solution to this challenge.”

In a similar vein, Jennifer Ott, the City’s Chief Operating Officer for Alameda Point, told us:  “While the Site A development is facing serious economic uncertainty, we are hopeful that APP working collaboratively with the City on a number of fronts will minimize that uncertainty and allow the project to move forward.”

Now, we regard both Mr. Ernst and Ms. Ott as honorable people who will do their best to see that, even if the development plan for Site A changes, APP will give Alamedans a project they can be proud of.  Yet, maybe because we are skeptics at heart, we think it’s necessary to take a hard look at the economic realities.

Under the DDA, the developer’s primary obligation is to construct the “backbone infrastructure” – i.e., streets, storm drains, sewers, and utilities – for the project on the land it buys from the City (which in turn acquired it from the U.S. Navy).  The developer also is obligated to “cause the construction” of the “vertical improvements” – i.e., the residential and commercial buildings – on the site.  (In addition, as the City’s publicists are wont to emphasize, APP has agreed to contribute funds toward construction of a new sports complex and a new ferry terminal.)

As Mr. Ernst suggested, the two obligations are interconnected:  the developer obtains the funds to pay for construction of the backbone infrastructure by selling individual “blocks” to third parties who will build them out using a design approved by the Planning Board.  (The developer, or its constituent partners, also may choose to develop one or more parcels itself.)  Higher construction costs and lower expected rental or sales revenues result in lower land values, and lower land values reduce the amount buyers are willing to pay – and thus the amount APP will receive and be able to use to cover infrastructure costs.

The land-use diagram below shows the parcels making up Site A, of which seven (blocks 1a, 1b, 3, 6, 7, 8, 9, and 11) are designated for residential use.  To date, APP has submitted, and the Planning Board has approved, designs for 124 townhomes on blocks 6 and 7; 128 units of “affordable housing” on block 8; and a seven-story building containing 221 residential units and ground-floor retail space on block 11.  It also has obtained design approval for four retail buildings on block 10 and for a waterfront park north of the Seaplane Lagoon.

This week, Mr. Ernst provided us with a few details about APP’s travails that caused it to miss the deadlines in the DDA.

Start with the Phase 1 infrastructure costs.  Mr. Ernst said that APP had solicited bids from six firms capable of undertaking such a large task.  Three firms declined to bid, saying they were too busy with other projects.  Another submitted a bid that, according to Mr. Ernst, reflected a lack of any real interest.  Only two firms sent in detailed bids, and APP selected Pleasanton-based DaSilva Gates.  The construction contract has not yet been submitted to Council for approval, but the price is higher than the cost APP had budgeted for.

On the revenue side of the ledger, Mr. Ernst reported that APP has had a tough time finding “national merchant builders” for the townhomes planned for blocks 6 and 7.  Three different firms signed contracts for these parcels, only to insist on a price reduction after they had completed their due diligence.  APP declined to cut the price, and it now has entered into a contract with a fourth firm – but the due diligence period for that deal isn’t over yet.  In addition, UDR, a real estate investment trust, has agreed to buy block 9 and build 186 apartments there, but it is still working on a design to present to the Planning Board for approval.  (UDR also has agreed to loan APP $30 million for infrastructure costs and to provide equity funding for the developments on blocks 10 and 11.)

Mr. Ernst told us – and the pro forma submitted to Council in May 2015 shows – that APP originally expected about a 15 per cent margin on Phase 1 of Site A.  This margin, he said, was “not fat by any stretch of the imagination for former Navy base redevelopment accompanied by sea level rise and tying old systems into new.”  But increasing costs and declining land values reduced the Phase 1 margin to only five-to-six per cent.  And even this lower margin, Mr. Ernst said, was “very soft”:  “At this particular point in time ‘soft’ means revenue is less predictable or committed because costs are growing at a faster rate than rents/sales prices for product, thus having the potential for further downward pressure on those revenues.”

APP’s solution, presented in an April 12 letter to the City signed by Bruce Dorfman, representing APP’s residential development partner, is to revise the development plan for the project.

Originally, Site A was going to be developed in three phases.  The first phase would include 654 of the 800 housing units planned for the project as well as the four retail buildings in block 10.  The second phase would encompass the rest of the residential development – townhomes and apartments totaling 146 units located immediately south of Ralph Appezato Memorial Parkway – as well as a hotel and two blocks of retail stores.  And the third phase would consist of about 300,000 of square feet of commercial space on three parcels located immediately south of West Tower Avenue.

APP now proposes to change the development plan in two major ways.  Phase 1 and Phase 3 would be combined into a new Phase 1.  In addition, the 146 housing units planned for Phase 2 would be moved up to Phase 1, and their location would be shifted from south of RAMP to one of the parcels south of West Tower that had been designated for commercial use.  In Mr. Dorfman’s letter, APP suggests putting a “standalone teacher housing multi-family building” with 70 units on this parcel; the rest of the new housing units, Mr. Ernst told us, would be townhomes.  The new Phase 2 would consist solely of commercial and retail development, with 180,000 square feet moved to south of RAMP to accommodate the re-location of the housing units.

(To visualize these changes, look at the land use diagram shown above and swap blocks 1a, 1b, and 3 with block 15.)

The expected completion dates would change as well.  The milestone in the DDA for completion of the original Phase 1 was December 11, 2019.  Under APP’s proposal, Phase 1a, which contains the original 654 housing units, is scheduled for completion by June 30, 2021.  Phase 1b, which contains the “shifted” 146 units, is scheduled for completion by April 1, 2023.  But, as a result of combining Phase 1 and Phase 3, the date for completion of all vertical construction moves up from April 4, 2030 to April 4, 2027.

The revised development plan, Mr. Dorfman’s letter maintains, would allow APP to spread the backbone infrastructure costs “across a larger vertical development program to offset the higher construction costs.”  To put it more simply, by selling more parcels to residential builders sooner, APP would be able to generate more funds to pay for infrastructure.  The extra revenue would allow APP to build the infrastructure now not only for the original Phase 1 but also for the original Phase 3.  This expanded scope, the letter states, would “directly benefit” the adjacent Main Street Neighborhood.

(The revised plan also tackles a problem that has troubled those of us who regularly attend meetings of the Restoration Advisory Board.  The area where the 146 housing units were originally planned to go lies over a “plume” containing contaminated groundwater.  This land is not scheduled for transfer from the Navy to the City until 2020, and, once the transfer occurs, the land will be subject to use restrictions that will make residential development more expensive.  By relocating the 146 units from the parcels south of RAMP to block 15, APP is able to offer residential builders a more attractive site.)

Will the revised development plan solve APP’s financial problems and put the Site A project back on track?  Naturally, the developer thinks so.  And there are reasons to respect its resolve.  Mr. Ernst confirmed that APP already has spent $15 million at Site A (on items like architectural, engineering, and legal fees; payments to the City required by the DDA, and expenses for petroleum clean-up), and it surely doesn’t want to write off that investment.  Moreover, according to Mr. Ernst, the revised plan is expected to restore margins to their original levels, since the “incremental increase in value (revenue) is greater than the cost of taking on more infrastructure.”  Even so, APP appears willing to accept lower margins to keep the project going.  “[I]f we can stabilize margins, even at lower levels, we can move this forward,” Mr. Ernst told us.

Still, if the upward trend in costs and the “downward pressure” on revenues continue, there may come a point at which the economics of the project no longer make sense.  And then what would APP do?  We know what route Donald Trump would take, but Mr. Ernst never used the “B” word in any of his communications with us.  Nevertheless, one wonders how long APP – which is, after all, a profit-seeking enterprise – would keep throwing good money after bad.  And what developer would want to take over a project that smelled like a money-loser?

Then there is the issue of what the City would (or could) do to save the day.  We keep hearing about the “surplus” in the General Fund, but the current Council – when it’s not devoting its attention to impeaching the president or stopping the Dakota Access pipeline – has prioritized spending the City’s money on such things as hiring additional public-safety workers whose unions fund Council campaigns.  (Only three new sworn firefighters to inspect buildings?  Why not go back to pre-recession staffing levels?)  The politicians may see no benefit in helping out APP, since Mr. Ernst has contributed only infrequently (and modestly) to Council candidates –- although he is a regular financial backer of State Assemblyman Rob Bonta – and we can find no record of any contributions at all made by Mr. Dorfman.

Perhaps, if it becomes necessary, the construction unions who benefit from the project labor agreement the City required APP to sign can get their representatives on Council to come to the developer’s aid under the guise of protecting jobs for working families.  But we suspect APP would be asked to make further “concessions” to organized labor as the price of getting any assistance from the City.

Of course, there is another way in which APP could generate more revenue, and it’s the slogan of groups like Renewed Hope:  build more housing!  For this “solution” to work within the 1,425-unit cap imposed by the Navy, the City would have to jettison any thought of residential development outside Site A and the Main Street Neighborhood.  Alternatively, we suppose the City could ask the Navy to raise the cap voluntarily.  Maybe Council could send Vice Mayor Malia Vella and Councilman Jim Oddie to Washington to explain why Alameda, which Council declared a “sanctuary city” at their behest, deserves a break from the Trump administration.

For his part, Mr. Ernst told us that APP has no plans to ask the City to allow it to build more than the agreed-upon 800 housing units at Site A.  But we imagine the possibility at least has occurred to him and his partners.  In the meantime, they’re hoping that Council will see fit to redo the deal.

Sources:

Disposition and Development Agreement: Site A DDA Final Executed + Exhibits

May 2015 pro forma: 2015-05-19 Ex. 8 to staff report – Annual Cash Flow Analysis

April 12, 2017 APP letter to City: 2017-04-13 APP letter to City of Alameda

 

About Robert Sullwold

Partner, Sullwold & Hughes Specializes in investment litigation
This entry was posted in Alameda Point, Development and tagged , , , , , , , . Bookmark the permalink.

2 Responses to Hard times at Site A

  1. Excellent overview. I, too, hope the council sees fit to redo the deal. The alternative – starting over – would be reckless, in my opinion. We’ve waited patiently for Catellus to deliver a completed project on the Bayport/Lannding property for over 15 years. We should be no less patient with Site A.

    The option alluded to above that the city may somehow be able to help “save the day” by backfilling the financing, however, is currently prohibited by the fiscal neutrality ordinance. In other words, the city general fund, or the bonding ability backed by the general fund, was deliberately firewalled long before APP came on the scene. I can’t seem to find that ordinance referenced in the DDA link above – the document is an unsearchable photocopy. But there is this statement in a report prepared by the city’s financial consultant regarding the APP/Site A/DDA: “Additionally, the City has a fiscal neutrality policy with regard to Alameda Point, which means that any infrastructure or improvements at Alameda Point must be funded from sources at Alameda Point, and on an ongoing basis the project must be fiscally neutral (it must generate at least as much annual tax revenue to the City as it costs annually to serve). The DDA enforces the City’s fiscal neutrality policy and requires the Developer to take steps to ensure continued compliance, including mitigation through special taxes. There is no economic subsidy provided under the DDA, and no incremental costs associated with the DDA other than those reimbursed by the Developer through deposits.”

    Not only is the city currently prohibited from helping build the project, the city has protected itself from future burdens on the general fund for upkeep of the new infrastructure.

    The one contribution that the city can make to help Site A is time. Hopefully they will.

  2. Steve Gerstle says:

    The only things certain in Alameda are more traffic and taxes.

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