Tuesday, November 10, 2009

Should the City Purchase 4950 Research Parkway?

A number of issues should be resolved as the City of Lawrence, Kansas considers the purchase and operation of the builiding at 4950 Research Parkway.


The Lawrence Douglas County Biosciences Authority (LDCBA) proposes that the city purchase the property at 4050 Research Parkway for $2,900,000.

This purchase would be financed through issuing general obligation bonds.

LDCBA would operate as the property manager and leasing agent. The property would be leased, in part, to the firm CritiTech. Other firms would be sought to lease the remainder of the building.

The financial projections for the property anticipate that it would not generate sufficient income to cover the costs of operation and that the taxpayers of Lawrence and Douglas County would subsidize the property to cover the losses.


1. Purchase price

The proposed purchase price is $2,900,000. The financial projections for the property show the property generating a net operating income of about $12 per square foot. It also assumes a capitalization rate (net operating income / property value) of about 6 percent which is too low. Capitalization rates should reflect the cost of borrowing, the return on equity invested in such properties, and the risk associated with this type of space. This suggests a capitalization rate of 8 percent or higher. With a capitalization rate of 8 percent, the purchase price of the property should be $2,300,000, and this assumes that the building can maintain 89 percent occupancy. If the occupancy falls to a lower level, the value of the property will be lower, possibly much lower.

2. Identity of interest between the seller and the tenant

The purchase price becomes immediately suspect because one of the current owners of the property is a principal in the CritiTech firm which is to be a subsidized occupant of the property. The sellers have an interest in obtaining as high a price as possible for the property, even a price higher than it can command in the private market. CritiTech as an occupant has an interest in leasing the space at a low lease rate, even a rate that is below the market rate because it is subsidized. With no arm’s length separation between the seller and the tenant, the taxpayer cannot trust either the purchase price or the lease rate.

This suggests that the city should closely investigate the calculations of the purchase price and lease rates to ensure that the taxpayers are not being asked to provide more subsidies than are necessary.

3. Form of financing

The proposal is for the city to issue general obligation bonds to finance the purchase of the property. This obligates the city to cover all principal and interest payments on the debt if the property does not generate sufficient income.

It is more common for projects of this type to be financed with revenue bonds. With revenue bonds, the city promises only the revenues from the project for payment of the debt. Revenue bonds insulate the taxpayers from a heavy financial burden if the project fails.

This is a highly risky project. This risk will raise the interest rate on revenue bond debt, if the debt can be issued at all. If the project is too risky to be financed with revenue bonds, it suggests that the project is too risky for to be undertaken.

If the city wants to purchase this property, the city needs to explore financing mechanisms that minimize the risk absorbed by the taxpayers.

4. Projected occupancy

The financial projection for the property assumes that the project will achieve 89 percent occupancy after 4 years and will maintain that level of occupancy for the remaining 21 years of the bond financing.

This is an eleven year old property with a checkered history. The property’s occupancy levels over its life need to be detailed. It seems highly unlikely that this property will suddenly transform from a poor performing property to a fully occupied property and remain fully occupied for over two decades.

The city should closely examine the occupancy history of the property and should examine the market for such laboratory space. The market is saturated with facilities being offered to bioscience firms. It is unlikely that this property will attract firms from outside of Lawrence; all of the firms are likely to come from spin-offs of KU.

A compelling case needs to be made that KU will produce sufficient firms to maintain 89 percent occupancy in this property for over two decades, despite the fact that KU has not produced these firms in the past.

5. Property taxes

The LDCBA proposal states that the property will remain a taxable property. This is not correct. If the city is to own the property, it is not a taxable property. Under some circumstances, a tenant could be charged a lease rate that is high enough to cover the debt on the property and an amount that would be paid in property taxes had the property been taxable. This is usually referred to as a payment in lieu of taxes or PILOT.

The financial projection for the property shows a PILOT, but it also shows that the project will not generate sufficient revenue to cover its own costs. The losses are covered by the taxpayers.

It is disingenuous to claim that the property is on the tax rolls when it is publicly owned and will generate losses that must be covered by the taxpayers.

The proposal should not mislead the taxpayers into thinking that this property will be anything other than a subsidized property.


There is nothing wrong with the city exploring mechanisms to foster economic development in the biosciences. However, the city should exercise caution so as to not expose the taxpayers to unnecessary risk or unjustifiable costs.

This proposal merits further exploration, but there are many flaws and misrepresentations in the proposal. It can be seen as a starting point rather than an ending point. The city should negotiate for a better agreement. It is possible that a better agreement can be found that is mutually acceptable to all parties. The current proposal appears to be prohibitively flawed.

The City Commission should direct staff to study this property more closely and determine whether a feasible financial package can be constructed with minimal risk to the taxpayers.

Tuesday, October 27, 2009

What are reasonable expectations for local economic development?

What is economic development?

It is important to understand the definition of economic development. Economic development is expanding the total income of a community. Expanding the total income means attracting dollars into the community from outside the community. This can be through attracting tourists or new retirees, attracting new customers who live outside of the community to businesses already in the community, attracting new businesses to the community that sell their products or services outside of the community, or any action that raises the wages of the labor force by bringing dollars into the community.

The most essential ingredient for successful economic development is the maintenance and development of a high quality of living in the community. This means making the community a place where people what to live, where workers are well educated, and where firms want to do business.

Necessary ingredients for successful economic development


A community must have a appropriately trained labor force. Warehousing requires little or no training. Manufacturing usually requires a well-trained labor force. Professional services can require a highly educated labor force. Lawrence generally enjoys a highly educated labor force. In the U.S. 16% of adults did not complete high school; in Lawrence only 4% did not complete high school. In the U.S. 25% of adults have a college degree; in Lawrence it is 35%. We need to seek employment opportunities that match the composition of the labor force.

A community has to have the right quantity and quality of labor available. If the labor force is too small or not available, then the community will not be attractive. This is usually not a big problem as most new firms are looking for only a small number of employees. Douglas County contains 47,000 workers; most new firms will add fewer than 100 employees.

The labor in a community has to be competitively priced. Unfortunately, Lawrence excels in this dimension. Wages in Lawrence are low in virtually all occupations. Thus, wages are not held down by student labor; wages are low across the board. This makes Lawrence attractive to firms, but sadly it is making Lawrence unattractive to workers.


A community needs to have an adequate supply of appropriately serviced land available. Adequate means the right amount, not too much and not too little. Too often communities are led into preparing large quantities of land that only sits idle. It is unwise to develop more land than can be reasonable absorbed within a decade.

No self-contained community like Lawrence is going to attract an extremely large employer needing a very large site. Virtually all of the firms moving into Lawrence over the last two decades developed on parcels of 25 acres, more or less. While new land for future employment centers may be needed, it is doubtful that the number of acres needed cannot be accommodated by existing sites and by the Farmland Industries site. Remember that the University of Kansas remains the largest employer, and it has provided for its own growth. The community only needs to provide for the non-University growth.


A community is often called upon to provide financing for business expansion and development. As long as this is done in a way that minimizes or eliminates the risk to the taxpayers, this can be a successful tool to facilitate economic development.

Public sector loans can subsidize a development, but they cannot create demand for the product or service to be produced. It is important to remember that subsidized financing can help a good investment succeed, but it will not turn a risky investment into a safe one. Cautious underwriting is required.

Many things do not work:

Tax abatements

Property taxes comprise such a small portion of the operating expenses of manufacturing or research and development facilities that abatements cannot influence a successful firm’s location decision. Property tax abatements are a waste of scarce resources. They have failed in Lawrence, and they have failed elsewhere.

Speculative development

Building structures on a speculative basis is highly risky. Too often they sit empty and only lose money. This has been the case in Lawrence.

Equally, a community must avoid speculative provision of expensive infrastructure in the hope of attracting new development. Lawrence has often failed in this area as well.

Free land

The price of land in the Midwest is sufficiently inexpensive that it does not influence the location decision of firms. Note that Abilene provides free land but has a low job growth rate while Johnson County charges high land prices and has a much higher job growth rate.

Hasty planning

The amount of time it takes to plan and development a project in Lawrence is comparable to the time it takes in other communities. It is not true that Lawrence takes longer; this is a myth pushed by those who oppose careful planning. Good planning takes a reasonable amount of time in Lawrence, just like it does everywhere else.

Practical realities of economic development

Thousands of communities across the nation are engaged in economic development, yet only a few hundred firms will build significant new facilities in any single year. This means that the job growth rate in Lawrence will be driven the natural expansion and contraction of existing firms and only rarely will a new firm be added to the mix.

Manufacturing is declining in Lawrence as it is for the nation as a whole. While manufacturing jobs pay well, Lawrence is going to lose its share of these jobs, and the return of these jobs is not likely in the foreseeable future.

Lawrence should avoid repeating the mistakes that it and other communities have made in the past in the false belief that these efforts improve the competitive position of the city in attracting tourists, new residents, and new businesses. Lawrence should continue to improve the quality of its work force, seek to raise the wage levels of the work force, and seek to make Lawrence a community where everyone wants to live.

Saturday, February 28, 2009

Is it time to impose a long cooling off period on development?

Watching the market work and fail to correct itself.

Too often our elected officials subscribe to the false notion that all construction is good. They adhere to the "build it and they will come" theory of real estate development. This theory falsely holds the new supply creates demand. One need only look around Lawrence to see the error in this type of thinking. We have empty homes, apartments, retail stores, and offices throughout the community. In fact, demand ebbs and flows; the supply that can be supported is not a function of what we build but of the amount of demand that exists in the community.

The success of our real estate markets depends upon us keeping the supply in balance with the demand.

Why is this? The development industry is not good at pacing itself; it is prone to overbuilding. When it overbuilds, the taxpayers suffer.

We pay for the roads, utilities, plus police and fire protection for these excess developments. Example: Since 2000, the developers built over 3,200 home more homes than the population growth would support. The only good thing that you can say for the current credit market freeze is that it called a halt to the overbuilding spree.

We also suffer from the blight created by the reduced value to the neighborhoods surrounding the empty space. Example: North Lawrence is hurt by the blighting effect of the dead Tanger Mall.

We all lose directly through lost investment in redevelopment plans. Example: The empty $8 million parking garage in the 800 block of New Hampshire Street. The City built the garage on the promise that a developer would redevelop the surrounding area in mixed-use buildings. All that was built was the small building that contains PepperJax. The rest of the development was halted by the overbuilding that created too much competing space, mostly in the west side of town.

We lose indirectly through the diminished efforts to redevelop our downtown. Examples: The Hobbs-Taylor Building is unable to attract retail tenants and the redeveloped 600 block of Massachusetts Street has vacancies. These two attractive developments should be the most valuable space in town. Unfortunately, the City has done its best to hurt these investments in our downtown by approving excessive amounts of competing retail space elsewhere, more space than the spending in Lawrence will support.

Two quick facts show the pace of the overbuilding:

1. From 2000 through 2007, the builders built 800 homes per year when the population added only 400 households per year. Over and eight-year period, this was about 3,200 surplus homes.

2. From 2000 through 2007, the builders built over 160,000 square feet of retail space per year when the growth in retail spending would support only 50,000 square feet per year.
This shows that the construction industry was vastly oversized, and we are now paying for it.
We need a City Commission that will keep the construction industry in check. It is not that hard to keep the pace of growth of housing in line with the growth of population. The City simply needs to plan for the pace of growth, approving only as many subdivisions as are really needed. It is not that hard to keep the pace of growth of retail space in line with the growth in retail spending. The City simply needs to pace the growth, approving only as many new shopping centers as the growth in retail spending will support.

This has been made harder by the current City Commission’s excessive allegiance to developers. The City Commission has approved virtually every development approval brought before it when the market analysis told it that the city could not absorb all of the new space without harming existing developments. Because of this excessive amount of space both recently built and under construction, the city needs a long cooling off period.

The economic recession is having some positive effect in that is it slowed down the building spree. However, recession is too crude a tool for this job. The City Commission should have managed the pace of growth in real estate, keeping it in line with the growth in demand for that real estate. Having failed to do that, we must now recognize that it will be a long time before we will need any significant additions to the supply. We have too many single-family homes. We have too many apartments. We have too many retail stores. We must wait for the demand to absorb this space before adding to this damaging oversupply. If we fail to impose a cooling off period, the development industry will only repeat its mistakes as soon as the recession bottoms out and credit markets thaw.

We should learn from out mistakes and prevent future cycles of overbuilding. It is what good planning and good growth management is all about.