December 3, 2012

The Financial Terms And Plan To Rehab Pier 70's Historic Core

Pier 70 Building 115/116

The term sheet for the $58.5 million rehabilitation of San Francisco's 20th Street Historic Buildings, the historic core of the Pier 70 redevelopment project, is up for review by San Francisco’s Board of Supervisors this week.

Under the proposed terms, Orton Development will invest up to $14 million in equity in exchange for a 66-year ground lease for the six historic buildings. The Port will contribute $1.5 million to the project with the balance financed by way of debt and Federal tax credits.

Orton will earn a 14 percent per year return on their equity, paid by way of collected rents on the renovated buildings in which the City will eventually share. According to the Port, "the 14% return on investor equity in a real estate deal is on the low side of returns demanded by investors for at-risk developments."

The key words in that last sentence with respect to the proposed return: "equity" and "at-risk" (i.e., their money, the return of which is not guaranteed).

Orton's proposed uses for the six buildings once they have been rehabilitated:

Bethlehem Steel Office Building: Office with ground floor food service
Union Iron Works Office Building: Office
Union Iron Works Machine Shop: Manufacturing and light industrial or arts-related use
Union Ironworks Warehouse: Flex space with state-of-the-art data capabilities
The Powerhouse: Restaurant, meeting rooms, classrooms, and a gym
Building 14: Recreation or light industrial with retail and office

Assuming the term sheet and lease are approved, construction is slated to begin spring 2013 with first re-occupancy of the historic buildings in 2014.

That Pier 70's Show: Developer Lined Up For The Historic Core [SocketSite]
Proposed Term Sheet: 20th Street Historic Buildings Renovation [sfbos.org]
Let The Courting Begin For Pier 70’s Historic Core [SocketSite]

First Published: December 3, 2012 12:45 PM

Comments from "Plugged In" Readers

So this gets a higher return on investment than the Warriors are going to get, yet is considered "on the low side". Will this return gets as much uproar as the Warriors?

Posted by: sparky*b at December 3, 2012 1:46 PM

yup from me, it's just as ridiculous. It's ridiculous for any project. Why would the city ever agree to anything like this when they can just sell a bond? Is it because bonds have to be voted on, while this backhanded payout gets swept under the rug?

And don't get me wrong, I'm almost always pro-development. I would support this project as well as the Warriors stadium without these rates.

Why does anybody think these rates are OK?

Posted by: lyqwyd at December 3, 2012 2:40 PM

Obviously, if the city is guaranteeing the return, there's no real risk, and the rate is nonsense. So is there a possibility that they'll lose everything? Is it 14%-if-all-goes-well but zero otherwise? That would make some sense.

[Editor’s Note: Unlike under the proposed Warriors deal, no portion of Orton’s equity investment nor return is being guaranteed.]

Posted by: Alai at December 3, 2012 3:08 PM

What a bunch of naysayers...again. More fear-mongering.

Think of the architectural potential of restoring these great concrete and steel buildings: incredible spaces for the arts, theater, retail and housing.

Great change for continued growth to this part of SF.

Posted by: futurist at December 3, 2012 3:40 PM

What fear mongering futurist? Simple statements of fact. 14% is a ridiculous rate, no investor in the real market gets a guaranteed return like that. The "risk free" rate is typically somewhere around 2-4% depending on who you ask and when you ask it, but in no case is it in the teens as we are seeing in these projects.

Again I ask: Why should the city give these rates?

Posted by: lyqwyd at December 3, 2012 3:51 PM

lyqwyd "The "risk free" rate is typically somewhere around 2-4% depending on who you ask and when you ask it, but in no case is it in the teens as we are seeing in these projects"

No RE investor would consider a development deal with the potential of a 2-4% return. Double digit returns are expected and not out of line.

Posted by: K&L at December 3, 2012 4:13 PM

Exactly. @ lygwyd: Read the editors comments: there is no "guarantee" by The City.

I would suggest you look at the long term picture of architectural rehab, improvement of neighborhoods, and re-use of what is now a very abandoned waterfront.

Fear-mongering: projecting a negative attitude from the start that this will be a failure.

Posted by: futurist at December 3, 2012 4:45 PM

I think it is guaranteed for 20 years and then needs to be paid off faster if it hasn't been paid off yet.
Anyway it's not that much money so it should be a deal breaker to getting these fixed up. But it is a higher rate than the Warriors are getting.

Editor what is the difference between them, is it that this one is not guaranteed for as long as it takes?

Posted by: sparky*b at December 3, 2012 4:50 PM

Am I missing something? If the rehab costs $58.5M, Orton throws in $14 and the Port another 1.5, then were does the remaining $43M come from?

If it is the city kicking in the bulk of the rehab costs then it follows that they should reap the bulk of the benefits, not just the measly tax revenue. If the city can cough up $43M then it ought to be able to come up with the remaining $14M without needing to forgo 66 years of lease. I see that the city gets part of the rent as well but they're 2nd in line to collect after Orton.

I'm guessing that I'm guessing wrong here...

Interesting to see that the large workshop buildings are targeted to continued industrial use. Hopefully they can find a tenant who can afford those huge spaces.

I shot a brief written proposal over to the Port describing how those spaces could be converted into office space. It would have been pretty cool though would have cost a lot more for conversion.

Posted by: The Milkshake of Despair at December 3, 2012 5:30 PM

And you know those Christmas Tree Lot sales and PortaJohn rentals just be gravy, son.....

Posted by: soccermom at December 3, 2012 7:55 PM

I live near there and there is so much potential. The Dogpatch foodie district that is newly developing is at the entrance to this complex (Piccinos, Mr & Ms Misc, Olivier's Butcher, etc). I think this area is set to soar.

Posted by: dissent at December 4, 2012 9:34 AM

Can someone (Editor?) explain how voter-approved Prop D fits into the equation? As I remember it SF voted to have City funds dedicated to getting this project off the ground, and that developers would keep equity. Or something like that.

Posted by: PN at December 4, 2012 9:37 AM

@K&L & futurist

The city could get a loan for a much better rate. Developers take risks, which is why they expect higher returns. Why should the city / port pay 14% when it can get a loan for 4%? If the project can generate returns for 14% the city / port should just do the work themselves and reap these fantastic returns.

@futurist, who said the project would fail? Seems like you are just making stuff up.

Maybe I'm just missing or misunderstanding something which would explain it. But I've seen none of the supporters of these rates able to even come close to justifying them. Until they can, I will remain opposed.

Posted by: lyqwyd at December 4, 2012 10:37 AM

If this is such a great deal why couldn't there be an external equity investor? Does the city really need to be a venture capitalist?

It seems to me that the City and developer have not fully pursued other avenues of financing.

Posted by: anon at December 4, 2012 10:41 AM

I support this project but, I can not see how Orton can renovate 6 buildings for $14 mil???? It can cost more than $14 mil. to retrofit just one building alone. They are huge and in terrible disrepair.
$14 mil would give you a good scrubbing, a new roof and paint job on 6 buildings. That's it. Who's filling in the gap?

Posted by: ncydr at December 4, 2012 11:16 PM

"...the balance of funding is from Federal Preservation Historic Tax Credits and loans obtained by Orton.."

I was in a meeting where a rep from Orton said "we are going to cut a check for $58 million" for the project. If that is still true they could be the provider of the loans and beneficiary of the tax credits.

Posted by: Pietro at December 5, 2012 9:45 AM

So is that 14% on $14 million or $58 million? Interest alon is $2 million per year if $14 million, to $8 million on $58 million. That's no principle payments.

Posted by: lyqwyd at December 5, 2012 10:33 AM

No matter how many times lyqwyd repeats the mantra of "too much " it remains clear that he/she has no fre of reference other than opportunity cost or bonds or 401k or similar. Bud, you are out of your depth, loudmouth + novice. Give it a rest. This is about private money developing public land. Typical projections would normally be 3X 13 or 14 percent.

Posted by: Anew at December 5, 2012 2:29 PM

So your only response to my perfectly legitimate question is insults? Seems to be the only thing your side has in this matter. If you actually had a real response you would be able to explain it.

If a developer could make 3X what the city is offering why would they ever accept such a crappy deal? And if the real opportunity is 3X, it only makes it a bigger question as to why the city doesn't do the work itself and reap these phenomenal rewards.

Insult me all you want, it only shows the weakness in your arguments.

Posted by: lyqwyd at December 6, 2012 12:14 PM

Actually my response was more like, "because that is very much not how it is done." The "loudmouth" thing was ancillary. Apologies, and feel free to infer a more benign descriptor of someone who repeats the same rant over and over again without a knowledge base. Plenty of posters have told you that that us not how a private development if public space with a finite lease would ever, ever function, in three or four different threads. But you've ignored them each time. Always going back to your own understanding of investments. Well, sorry, your understanding is not applicable.

Now you're on about why doesn't the City do it? Are you quite deranged? Why doesn't the city begin to have a for profit development department? That's your "argument"? I think argument is pretty generous for that sort of baseless musing. I shudder to think about that nightmarish eventuality.

Posted by: Anew at December 6, 2012 2:48 PM

First I'm a loudmouth, now I'm ranting and deranged... the insults continue I see, no big surprise.

Another empty response to a simple question. The city already does for profit business, and public lands are already leased out without paying these rates, long term public land leases are common throughout the world so your claim of "that's how it's done", especially without any supporting evidence, is meaningless.

The city should either take a loan at a reasonable rate, or do the project itself and reap the rewards if there is so much to gain. If the developer wants the rewards, then they should also be taking the risks.

Posted by: lyqwyd at December 6, 2012 3:48 PM

The city doesn't do for profit development, actually. But if it did we would be talking about a bond measure, tax hike, both, or worse, plus very inefficient, costly, and lengthy construction. Yet ypu gripe about what will amount to a few years of free rent on decrepit property that will ultimately revert to the city, vastly improved. Your criticism is not in the conversation no matter how many times you say it.

Posted by: Anew at December 6, 2012 8:40 PM

The city owns property that it leases, so it already is in the real estate business. And it's irrelevant whether they are or are not, or they should or not, as I've mentioned many times they could finance the money much less expensively, which is the point.

If a 4% per annum bond would require a tax hike, then a 14% peyment would require a larger tax hike. A bond measure would require no tax hike, just some effort from our elected officials, which is exactly what I expect from them, not giving away our money to save themselves some effort.

The construction happens either way, with a bond we save millions per year, well worth the effort.

What I gripe about, and you seem completely unable to understand, is the city wasting money for no reason.

I'd be happy to give the city my house if they pay me 14% returns for decades, where do I sign up?

Why should the city pay 14% when it can pay 4% ?

Posted by: lyqwyd at December 7, 2012 10:30 AM

lyqwyd,

Perhaps I missed it, but I did not see anything in the proposed term sheet that indicates that the city will pay 14%. What I saw was that Orton is intending to make 14% from rents, etc. following the rehab of the property. This would seem reasonable given that the 14% is not guaranteed and their principal is at risk (perhaps high risk, who knows).

Posted by: Guest666 at December 7, 2012 11:04 AM

Hi Guest666, thanks for a insightful question, I was hoping somebody would try to move the conversation forward.

The way I look at it, Orton is giving the city a 20 year "loan" of $14 million dollars at 14% interest rate to build the project. There are some important extra details, such as the payments are based purely on the revenue that can be generated by the project, but on the other hand if it's not fully paid off in year 20 Orton still gets payments for up to 66 years, but no more than 50% of revenues.

If at the end of 66 years Orton doesn't get fully paid out, then they loose any outstanding money, of course this was after 66 years of appreciation at 14% so they will have done phenomenally well either way.

I understand it's not really a loan, but there are many similarities. Enough to me that it can be treated as a loan.

On the other hand the city could simply issue a bond for the $14 million and it would be a simple loan at 4%

Either way, the city is getting the funding for the $14 money, so the only difference is who gets to benefit from the project after it's completed, the city, or Orton?

As the city retains ownership of the land and structures, they are already in the for profit real estate development game, the real question is who gets the majority of the benefit for the next 66 years.

The other way I look at it is to take the city out of the question and pretend there was a private party doing this deal. They have two options: 1 is a loan at 4%, the other is a equity partner who gets paid first for 20 years, then a 50/50 split for the next 66 years.

A sane private investor would take the loan unless they believed the property would return less than the loan's interest rate over the lifetime of the deal. Otherwise they'd be giving up a lot of profit, for a very minor reduction in risk. If the project is likely to return less than the loan's interest rate, it's probably not even close to worth doing at all.

I could certainly have some flaws in how I look at it, so I'd be happy to see it from a different perspective, but I'm not very interested in the theory that "that's just how it's done"

Posted by: lyqwyd at December 7, 2012 11:33 AM

I think the key issue here is the risk factor. Perhaps 14% is not a realistic return, perhaps rents decrease dramatically and they can only make 5% or they fail to rent the space altogether and they lose money. Hopefully, the city did its' homework in evaluating bids and this was the best they could get in the present environment.

I understand your thought that the city could reap the rewards of developing the site, but I would have zero confidence that SF would be able to do so. We would have all sorts of political/social goals introduced into the process such that it would never make money and would likely become an albatross to be subsidized from the general fund.

Posted by: Guest666 at December 7, 2012 12:40 PM

In my opinion the risk is highly overblown, given that Orton is only putting $14 million out of $58 million (and I bet dollars to donuts that they will finance much of that $14 million).

Orton gets the paid for 20 years until they've been paid 14% on their 25% equity stake. I believe the port gets some money during this time, but I can't figure out how much. Still, the project would have such a dismal failure for Orton to not make these returns as to be unimaginable.

Think what private party would let a minor equity party get paid first? I can't imagine anybody that would sign up for a deal like that, particularly when they could easily finance the funds the partner is putting in at much more favorable rates.

And remember, even if they can't make their returns for the first 20 years, the still get up to 50% of the income for the next 46. Even if rents drop 5, or even 50%, they would still be making their 14% since they've only got 25% equity.

It's almost impossible to imagine a scenario where the buildings go un-rented for a significant enough of time for this to turn out to be a bad deal for Orton, especially given the buildings are already leased, and they are going to be significantly improved from their current state.

Honestly, I think there is almost zero risk to Orton.

I certainly understand the concern about SF actually managing the development, and I'm not opposed to an equity partner sharing in a reasonable way on the returns, but 14% is ridiculous. Those are the types of returns that investors dream of, and if you can achieve that over a number of years it can make your career.

If Orton was given a share of the profits based on their percentage of the equity stake that would be perfectly reasonable, but giving a minor equity partner first dibs on profits is a sweatheart deal .

Now I haven't read the whole term sheet, which is about 160 pages, and is a scanned image so unsearchable. Given that, it's certainly possible that I'm missing or misunderstanding an important part, but I've yet to find something that makes the 14% reasonable.

Posted by: lyqwyd at December 7, 2012 2:10 PM

Can someone explain this to lyqwyd? So that he can envision/compare why his imaginary return on an imaginary position wouldn't be as good? After you break it down for him he'll be sure to tell you you're wrong and he's right because that's how it should work, he feels.

Posted by: Anew at December 7, 2012 2:22 PM

lyqwyd,

Orten is taking out a loan for $42M. They are on the hook for that. They are on the hook for upkeep and maintanence. Then they pay the city 50% of rent revenue once they have been paid back on the $14M. The $14M payback comes out of rent credit; $200K/yr first year rent, which goes up with CPI.

Posted by: sparky*b at December 7, 2012 2:59 PM

@sparky

Thanks for the info, but I believe you are wrong on several counts, and/ or leaving some important details out.

Where do you see Orton taking out a loan for $42 million? I see $43 million in Tax credits and loans from the government. The tax credits basically mean Orton gets fully reimbursed for however much that portion is. I didn't find any details on the breakdown of how much was credit vs. loan, or the terms of the loans (usually quite favorable when they come from the gov).

They pay the city 50% of rent after they are repaid $14M plus 14% annual compound interest. Otherwise what's the point of the interset at all? The first year's interest would be just under $2 million.

Relatively minor, but CPI is only added to the base rent every 5 years, and no more than 20% increase, and some other terms which I can't tell who the benefit.

The most important information you left out were the tax credits (unless they are small) and interest payments. If the tax credits are small then the loan becomes significant, and I'd want to see the terms of the loan.

Is $200K a fair base rent? Office space in SF currently rents at about $45 per sq foot per year. I couldn't find an average, but found listings between $5 and $20 psf /year. The term sheet shows the total square footage of the buildings being rehabbed at about 316,000 (mix of office and industrial), which at $200K per year puts it at less than $1 psf / year. Does that mean the $200K is too low? Not necessarily, but certainly makes questioning it seem reasonable.

For me there are still way too many unanswered questions about the deal to just take it on good faith that it's reasonable, especially when the document is so difficult to work with. There's very little I've seen after digging in further that makes me feel comfortable with it. The only thing I'm certain of is that it's a good deal for Orton, or they wouldn't have signed on, but is it also a good deal for the city? Still haven't the foggiest idea.

What I see is a deal for Orton that is almost no risk, with 14% ROI.

Posted by: lyqwyd at December 7, 2012 4:13 PM

lyqwyd,

A few things you missed are:

$10.5M is available in tax credit if they get it all. So letthey are going to get a loan for $30something

The interest does not compound. Simple interest.

Finally the Port did there own cost on this project and came up with $144M and then revised the scope and came up with $106M. So it is a much better deal to pay high interest and get some rent later on a $56M job then to do the same job for $106M and then try to make money on the rent.

Posted by: sparky*b at December 7, 2012 4:42 PM

why do you assume they'll rent out the spaces year in/year out for decades? That risk is quite clear. You can't see the wood from the trees, lyqwyd.

Posted by: Anew at December 7, 2012 7:39 PM

@sparky

can you cite where this information is located in the document, particularly the simple interest, which makes it an entirely different calculation. Regarding it costing the port twice what another entity could do it for, I find those numbers highly suspect. Either the port drastically over-estimated to make this deal look more favorable, or Orton is drastically underbidding knowing that after it's improved they will be able to still make a profit knowing the real cost.

@Anew

Finally you have a somewhat usefull contribution. If the buildings are usable, they will be rented. There's certainly a vacancy loss as tenants will come and go, but typically that's between 5-10% and even in the worst case it would be no more than 20% if really poorly managed. So over the course of decades there would be a few years of vacancy, but that's true, no matter what, if they have any serious desire to rent the spaces.

Posted by: lyqwyd at December 9, 2012 7:31 PM

page 19 is where I saw the simple interest. Not sure where the port cost was, but they had other companies bid on it. The fact that it would cost the Port much more than a private developer should not come as a suprise.

Posted by: sparky*b at December 10, 2012 8:27 AM

Thanks sparky, I found the simple interest statement you referred to, (page 7-12 or 1049 as marked on the document).

With simple interest I withdraw my objections to the project.

One note: the port's numbers were based on a more extensive project, (found on the first sentence of the following page), but that's not a major issue.

Posted by: lyqwyd at December 10, 2012 11:01 AM

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