In commodity futures markets, investors agree to pay a price today for the unknown cost of goods some time in the future. The City of Beverly Hills does not play the futures market, at least to my knowledge.
So it surprised officials of this affluent city of 35,000 people in the West Los Angeles area to realize they had inadvertently saved $20 million in a construction deal signed last year with a private developer to build a parking structure, a city-owned retail building and a public park next to a luxury hotel. Although the deal raised a furor and led to a ballot referendum, there is little doubt that Beverly Hills was the big winner in the end. And although many of the circumstances that surround this deal are unique to this fastidiously maintained city, there is at least one aspect of the deal that other cities may want to study closely.
Beverly Hills is one of the rare California cities that does not have a redevelopment agency. Most of the time, the city seems largely unbothered by this deficiency, insofar as few, if any, of the city's neighborhoods could be described as blighted. One notable exception is a block of derelict buildings, several of them red-tagged since the 1994 Northridge earthquake, situated on a prominent corner of the Golden Triangle, the city's high-rent commercial district. The most visible is the old Beverly Theater, a lovable anachronism of the 1920s festooned with Taj Mahal domes. The 1994 earthquake was the proverbial final curtain call for the Beverly Theater and its neighbors, and all the buildings have been closed for more than 10 years.
For 10 years, the property owner and the city studied a variety of different options to replace the empty buildings. The notion of a department store was shot down by local businesses as a traffic monger, while the city was unenthusiastic about the idea of an office building, which would add only $500,000 in property tax revenues to city coffers. For city fiscal purposes, the “highest-and-best” solution would be a luxury hotel, which could generate transient occupancy tax and other revenues in the $5 million-range annually.
Beverly Hills is a community with a comparatively small inventory of luxury hotel rooms (defined here as renting for about $300 a night) and consultants, such as the Los Angeles office of PKF Consulting, state the city's high-end hospitality market has an unmet demand that the proposed 214-room Montage would not dilute.
As it happens, the city owns about 48,000 square feet immediately north of the Montage site. In entitlement negotiations with the developer, the city decided the most efficient way to develop the city's parking lot into a park and a neighboring retail building would be to hire the developer to build it as part of the hotel project. The city tallied its own expenses at $32.27 million, including $15.50 million for the underground parking structure, $9.96 million for the park and related improvements and $6.63 million for the 20,000-square-foot retail building.
In the final deal approved in November 2004, the developer agreed to build the improvements for the capped amount. The developer also agreed to convey the parking garage to the city upon completion. In addition, the developer agreed to an extra-ordinary 5% increase, on top of the city's existing rate of 14%, in the transient occupancy tax rate. That 5% overage would be applied directly to repaying the city for the cost of the garage construction.
A February 2005 report from Keyser Marston Associates Inc. indicates that the Montage project would easily generate the money the city needed to pay off its part of construction. After the hotel income “stabilizes” in 2007, revenue from the parking garage is expected to be $1.03 million annually, while commercial rent from the retail building would be $506,000. The hotel's contribution toward the garage cost would be $1.14 million, and the net bed tax would be $1.79 million. Property tax, sales tax and other tax revenues would be $795,000. The total: $5.26 million per year, an income stream as rich as the flourless chocolate cake at Spago Beverly Hills.
This deal infuriated some local businesses, especially the Peninsula Hotel, which accused the city of “subsidizing” a rival hotelier and raised enough signatures to force a referendum vote on the development agreement. The referendum failed by about 600 votes at the March election (see CP&DR Election News, April 2005).
The city had yet a further victory. With the cost of steel and other construction materials rapidly escalating, the Montage developers now believe that the cost of building the city's improvements will run at least $20 million more than the city's capped contribution, and that amount continues to grow with time.
“We had no idea we were going to do so well,” confessed Deputy City Manager David Lightner.
With Beverly Hills' apparent success with the Montage, can other cities follow suit and remove blighted buildings without the aid of a redevelopment agency? Probably not. Beverly Hills is one of a very small number of cities where the resort market is strong enough to justify tying the financing of a major public project to a hotel that charges something in excess of $400 a night, plus another $80 a night in bed tax.
One aspect of the deal that is replicable, however, is the use of a fixed bid. That is when the public sponsor of a project says, in effect, “We will contribute $32 million, and no more, to this project. What can you developers give us for that amount?” Although the deal between Beverly Hills and the Montage was not a fixed bid per se (there was no competitive bidding from other developers), the deal does show the advantages of capping one's expenses. The developer, who stands to gain the most financially, should shoulder the greatest risk, as well.
Now, futures trading on the part of cities and other public agencies is a bad idea as a general rule. On the other hand, with the price of building materials steadily climbing, cities could do a lot worse than to a sign a deal for projects to be built tomorrow at today's costs. Just ask the people trying to build the new San Francisco-Oakland Bay Bridge.
