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06/14/96 Ground Lease ConsiderationsTo: Al Thelen, Interim City Manager From: Lawrence Gallagher, PECDD Director Subject: Kalispell City Airport - Ground Lease Considerations Date: June 14, 1996 This Memorandum is in response to your request for amplification and clarification of Financing Options discussed in THE -KALISPELL CITY- AIRPORT/ATHLETIC COMPLEX REDEVELOPMENT PLAN. The Plan presents the financing options on pages 31-42, with the specific reference to Option 2: LAND LEASE beginning on page 31. When the document was completed several months ago, I wrote: "The City may want to consider a combination of revenue enhancement measures which could include a combination of outright sale, partial ground leases or even a participation in redevelopment projects. The City has a successful track record and experience in forming public/private partnerships where it uses its authority to encourage the maximum private utilization and investment in land in exchange for a "public interest" participation in the project. From 1987 through the end of FY 95, the City has received over $2.6 million in principal and interest on its UDAG loan to the Kalispell Center Mall; LP and the PV of the mortgage it holds on the project is over $2.7 million. It should carefully consider the advantages of creating another redevelopment project for the Airport. The City could stimulate a project at the Airport that would continue to pay dividends long into the future." AI Thelen, Interim City Manager Page 2 June 14, 1996 I have added emphasis to the first and to the last two sentences of that paragraph to focus the ensuing discussion of options available to the City Council and the important objective of keeping all the options open until a full evaluation can take place. I don't believe that can be accomplished between now and the adoption of an ordinance creating the Airport/Athletic Complex Urban Renewal Plan. In the discussion of the land lease option on page 31 of the REDEVELOPMENT PLAN ANALYSIS, I acknowledged MDOT's admonishment to "avoid selling any land" which is generally good advice - that is if you can finance airport capital improvements without cash from the sale of land or adequately secured ground rent annualized at full market rates. (By secured, I mean a land lease not subordinate to a heavy first mortgage and/or secured with personal guarantees similar to the personal guarantee the City has with the Kalispell Center Mall Limited Partnership. If ground rent (lease revenue) is pledged as security for any borrowing, the lender or bond buyer will discount it, demand a high debt coverage ratio plus a funded reserve even greater than that which may be demanded for an ad valorem tax increment pledge as security. The City's real estate appraiser raised valid questions and issues during their discussion of the land lease alternative for the industrially zoned property along Airport Road. Rather than paraphrase their advice, the following is the summary paragraph of their discussion: "The potential for leasing to someone for construction other than that which would be related to the city airport was examined. Assuming a ground lease at the lower end of the proposed range, $0.075/SF/YR, a one acre parcel would have a lease amount of 43,560 X $0.075 or $3,267/YR. At a 10% capitalization rate this would suggest a site value of $32,670 ($0.75/SF). This would compare with a 1.06 acre industrial site sale at $32,500. The implication is that there is little if any incentive to a lessee to lease rather than purchase, unless he could invest the capital at a return of more than 10%. In addition an owner would have the benefits of any increase in value with the ownership, whereas on the lease he would likely be faced with increased lease payment in later years. The potential for leasing other than for airport related uses thus appears minimal." Al Thelen, Interim City Manager Page 3 June 14, 1996 Once again, I have added emphasis to the appraiser's written opinion and will add further emphasis by reiterating my observation: "The relevance is that developers evaluate and measure not only the return on money invested in real estate but also the return of it, and, like all investors, they seek maximum growth and appreciation and whenever possible a tax shelter or deferral. Paying ground rent has lost some of the appeal it used to have. Nonetheless, the alternative is available. One final observation: The City should consider its cost of capital and the return of and on capital invested in public projects. Generally, it should not consider leasing public land at rates far below what it has to pay to raise capital for other public improvements or projects or at rates below what it receives on temporary surplus or reserve funds held and invested for later use unless there is a greater public benefit. Other public benefits "necessary and in the public interest" recognized by statute include safety, employment and private investment opportunity, and an improved tax base among other things to be considered." However, "... instead of outright sale, the possibility of a long term lease for private use may be considered as an alternative. City staff concurs with the admonishment to avoid selling land essential for airport use or future expansion but not necessarily land with a higher and better use for private redevelopment, i.e., Parcels 11 & 12 - adjacent to U.S. Hwy 93." "Using an arbitrary 6% to 10% capitalization rate would indicate that Parcel 11 - Haven Ballfields, should generate from $45,000 - $75,000/YR, or $0.25/SF/YR - $0.42/SF/YR in ground rent, depending on the nature of the lease arrangement. Parcel 12 - Daley Ballfields, using the same cap rate assumptions, should generate lease revenues ranging from $75,657 to Al Thelen, Interim City Manager Page 4 June 14, 1996 $126,096/YR, or $0.10/SF/YR to $0.17/SF/YR in ground rent. If both parcels were leased at the top rate, the combined lease income could reach $200,000. However, developers and lenders in Montana and Kalispell generally dislike land leases for redevelopment even though land costs seem to be at an all time high in the market. Perhaps the mood will change." The OPTION 2: LAND LEASE discussion in the Plan concludes: "Because the City of Kalispell does not have a local government charter, it is restricted by state law as to the procedures and limitations on selling or leasing public land. The City Attorney should advise the Council on statutory limitations, suffice it to say, flexibility and participation are not possible - unless the City adopts an urban renewal plan and project for the area." The City Council has the legislative authority to adopt Ordinance No. 4256, "A RESOLUTION FINDING THAT AN AREA OF BLIGHT EXISTS WITHIN THE AREA OF THE KALISPELL CITY AIRPORT/ATHLETIC COMPLEX REDEVELOPMENT PLAN ANALYSIS AND THAT REHABILITATION, REDEVELOPMENT OR A COMBINATION THEREOF, WITHIN SUCH AREA IS NECESSARY IN THE INTEREST OF THE PUBLIC HEALTH, SAFETY, MORALS OR WELFARE OF THE RESIDENTS OF THE CITY OF KALISPELL," without finalizing how it will dispose of or elect to lease land. What it must do is find that the Airport Plan and Project is necessary and in the public interest and that a sound financing plan exists. As presented, the Plan under consideration offers ample evidence that a sound financing plan exists with alternatives. The ultimate test of the Plan will be the City's ability to generate the capital required to implement the Plan.