CRT 2016 #49 · Communication to the City Council · Sep 12 2016

Cambridge Inclusionary Housing Study Peer Review + Development Community Perspective August 15th, 2016

KEY TAKEAWAY: The primary concern on the part of the business community is that changing the inclusionary requirement to 20% will result in fewer affordable units, fewer market-rate units, and as a result higher prices for all housing in Cambridge

Interviews with land owners, representatives and developers

ISSUE #1: The “point-in-time” Rosen analysis performed for the City reflects a market at all-time highs and does not reflect a durable policy that will be able to withstand market shifts. In particular, several key assumptions are inaccurate or outdated including capitalization rates and land prices.

Primer on “cap rate” A real estate capitalization (or “cap”) rate is the ratio of net operating income to property fair market value. It is an indicator of what a property ‘yields’ in turns of a payback on investment. This number which typically ranges anywhere from 4.0 - 9.0% depending on the type of asset. A lower number represents a stronger property value.

Historic Multifamily Capitalization Rates Current “cap rates” reflect an extraordinarily strong market that is not sustainable over the long term SECONDARY PRIMARY PREFERRED (includes Boston, NYC, SF, DC, etc) 4% 5% 6% 7% ‘05 ‘06 ‘07 ‘08 ‘09 ‘10 ‘11 ‘12 ‘13 ‘14 ‘15 Cap rates that the Rosen report’s recommendations are based upon Cap rates that the Rosen report’s recommendations are based upon 4.25% Source: Real Capital Analytics, CoStar Group, Inc. Preferred market average 5.1%

Return on Equity Comparison Chart 1 2 3 Rental Rental Rental 300 units 300 units 100 units 17 stories 6 stories 4 to 5 stories SCENARIOS CAP RATE CURRENT 11.5% 4.75 8% 5% 17% RECOMMENDED 20% 4.75 1% -1% 10% The Rosen Study indicates that at 20% there is no room for the market to flatten to average levels without hurting residential supply. At 20% the high density housing types representing most of the new supply in Cambridge are not financially feasible. = Not Viable = Viable = Borderline Viable Return on Equity Legend

Historic land sale transactions $- $20,000 $40,000 $60,000 $80,000 $100,000 $120,000 $140,000 $160,000 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 Sale Price ($) / Residential Unit Average land prices for residential projects have moved well beyond prices used in the Rosen study, meaning that any ‘excess profits’ have been eliminated by the market Source: CBRE, developer interviews, City of Cambridge Assessor Database $50,000 to $85,000 used in Rosen Study

ISSUE #2: Projects will not get financed under the 20% policy and the production of housing supply will be severely impacted.

. Risk U.S. government- backed securities Deposit accounts & certificates of deposit Bonds Preferred stock Real estate investment trusts Mutual funds Options Real estate development Common stocks Futures Risk-free rate 0 Potential Return Real e estate a development evelop Developers and their capital partners require minimum levels of “risk-adjusted return” in order to pursue development projects to account for construction risk, lease-up, etc. Understanding Risk

20% policy LAND OWNERS DEVELOPER Target return stays the same Land value Land value CAPITAL PARTNER RESIDENTS Rent/ Home prices Rent/ Home prices ROLE IMPACT of 20% Existing policy Increase in inclusionary housing percentage= additional cost to developer, which gets absorbed by land owners Direct decrease Indirect increase

Current Policy at 11.5% requirement Multifamily 20%: Impact Multifamily: Increased IHP requirement lowers value of the real estate and pushes down land prices Hard costs Hard costs Hard costs Soft costs Soft costs Land Cost Real Estate Value Land Hard costs Lad Return Land cost Hard costs Soft costs Real Estate Value Return Land cost Land Owner Choices #1 Sell for a lower price to residential developer #2 Continue to operate property as is, no change #3 Sell to a higher bidder such as Lab/Office The land owner perspective

Vox on Two Fuse Cambridge Windsor at Cambridge Park Enumeral Forrester Research Genocea Dicerna Alewife Vox on Two Forrester R h Genocea Fuse Cambridge Windsor a Cambridg Park Enumeral Dicerna Alewife Research Genocea at e West Cambridge Demonstration Area: Alewife

Nuclea Genocea Forrester Research Nuclea Genocea Forrester Research West Cambridge Demonstration Area: Alewife Assumptions for Financial Model Site (Acres): Floor Area Ratio: Gross Square Feet: Units: Average Unit: Rent/Square Foot: Parking Ratio: Parking Spaces: Building Height Capitalization Rate: Land Price: Total Cost: RETURN ON EQUITY: 3.00 acres 2.60 340,000 364 700 SF $3.50 per SF monthly 1.0 per unit 364 (structured) 72 feet 4.75 $85 per GSF $406 per GSF -1.0% Residential at 20% = Metrics suggested by the Rosen report At current IHP levels of 11.5% the demonstration project has a positive return on equity of 5.1%. Under the 20% requirement it swings to a -1.0% return. This represents a value difference of $7 million dollars

Twenty20 Avalon NorthPoint Lofts Avalon NorthPoint Tango Condos Zinc Phillips Research/ Symantec Lechmere Zinc lips arch/ antec lips Phill Resea Syma Phill Lechmere Twenty20 Avalo NorthP Loft Avalon NorthPoint Tango Condos on Point s East Cambridge Demonstration Area: NorthPoint

East Cambridge Demonstration Area: NorthPoint Assumptions for Financial Model Site (Acres): Floor Area Ratio: Gross Square Feet: Units: Average Unit: Rent/Square Foot: Parking Ratio: Parking Spaces: Building Height Capitalization Rate: Land Price: Total Cost: RETURN ON EQUITY: 1.00 acres 5.0+ 263,000 300 700 SF $4.50 per SF monthly 0.5 per unit 150 (structured) 17 levels 4.75 $85 per GSF $557 per GSF 3.4% Residential at 20% At current IHP levels of 11.5% the demonstration project has a positive return on equity of 8.0%. Under the 20% requirement it swings to a 3.4% return. This represents a value difference of $10 million dollars = Metrics suggested by the Rosen report

ISSUE #3: The additional cost of the 20% requirement will bring down the price that developers can pay for available land thereby incentivizing commercial development (mainly lab/office) instead of residential.

ALEWIFE HARVARD CENTRAL PORTER KENDALL Source: Kendall Square Association Bio/Pharma IT/DATA ENERGY Cambridge has the most significant Lab/R&D market in the country

Office / R&D market Market continues to show signs of strength moving forward Source: CBRE, developer interviews, City of Cambridge Assessor Database - There are currently 20 tenants in the market seeking a total of 1 million square feet of lab space - Current vacancy rate at 4.6% for office / lab in Cambridge (lowest in 15 years) - Rent levels pushing to new highs: East Cambridge $60 - $80/sf and Alewife $42 - $48/sf - Record levels of venture capital coming into the market $1.8 billion in 2015 alone - Supply/demand imbalance for lab/R&D is at record levels with no signs of slowing

Cambridgeport Demonstration Area Chroma Cambridge Apts. Seres Therapeutics Sanofi Aventis Aileron Therapeutics Metabolix 130 Waverly

Sanofi Aventis Aileron Therapeutics Seres Therapeutics Metabolix Site (Acres): Floor Area Ratio: Gross Square Feet: Rent/Square Foot: Parking Ratio: Parking Spaces: Building Height Capitalization Rate: Land Price: Total Cost: RETURN ON EQUITY: Cambridgeport Demonstration Area Assumptions for Financial Model Office/Lab 2.5 acres 0.92 100,000 $68.00 per SF annual 2.5 per 1,000 SF 250(structured) 48 feet 6.00 $85 per GSF $602 per GSF 17% Lab assumes $15/gsf linkage fee It is more profitable to either renovate existing buildings for lab space or even build new lab buildings then it is to build residential projects @ 20% IHP in this zone

Increase the IHP percentage to a maximum of 15% Cambridge wide and revisit on a regular basis to adjust up or down to reflect market conditions. RECOMMENDATION:

1) Grandfathering: Residential projects that have begun the permitting process should retain the current IHP requirement. Moving forward IHP % should be set at special permit, not building permit 2) Phase-In: Increases in the IHP requirement should be phased in over time in order to allow the City to evaluate the impacts of reduced land values and reduced housing production 3) Offsets: The City should work with the business community to develop additional offsets to allow more projects to tap into the ‘density bonus’ program 4) Three bedrooms: The City can work with development community to draft a three bedroom unit requirement with offsets ADDITIONAL RECOMMENDATIONS:

Cambridge Inclusionary Housing Study Peer Review + Development Community Perspective August 15th, 2016