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HomeMy WebLinkAboutWaterfront Hilton Market Value Rent Adjustment pursuant to t �. Dept. ID ED 13-19 Page 1 of 2 Meeting Date:7/15/2013 d '0 -/ CITY OF HUNTINGTON BEACH REQUEST FOR SUCCESSOR AGENCY ACTION MEETING DATE: 7/15/2013 SUBMITTED TO: Honorable Chair and Successor Agency Board Members SUBMITTED BY: Fred A. Wilson, Executive Director PREPARED BY: Bob Hall, Deputy Executive Director SUBJECT: Approval of Waterfront Hilton Market Value Rent Adjustment pursuant to the Waterfront Ground Lease Agreement with Mayer Corporation Statement of Issue: Pursuant to the Waterfront Ground Lease Agreement, in the 24th year, the Successor Agency and Mayer Corporation are required to approve the Market Value Rent adjustment to the ground lease. The Successor Agency is requested to approve the increase in the Waterfront Hilton lease. Financial Impact: Effective January 1, 2014, the land lease will increase from $147,287.57 to $225,000 for the Hilton Parcel. In addition, Parcel C rent will also increase in the same amount. Recommended Action: Approve the Hilton Market Value Rent Adjustment, pursuant to Section 2.2(b) of the April 28, 1989 Waterfront Hilton Lease. Alternative Action(s): Do not approve the Land Lease Adjustment and direct staff as necessary. Analysis: The Huntington Beach Successor Agency (Agency) and the Waterfront Hotel LLC (Mayer) have an existing Ground Lease, originally entered into in April 28, 1989. The Ground Lease provides for Market Value Rent Adjustment ("Reevaluation") at different years of the Lease. The first Reevaluation is at year 24, to be effective in January 2014. The Lease sets forth that six (6) months prior to the effective date, the City and the Mayer's are to begin negotiations regarding the Reevaluation (June 2013). In April 2010, as part of negotiating a Fifth Implementation Agreement to the Ground Lease, the City and Mayer worked towards the Reevaluation of the property. The Reevaluation is based on a Fair Rental Value of the premise, based upon an appraisal. The Lease Agreement sets forth the methods for the Fair Rental Value adjustments; however, it can be interpreted differently. In 2011, both the Agency and Mayer Corporation obtained appraisals for the property. The Mayer Corporation used a "Residual Land Value" based on a new hotel and start up (discounted) period, to calculate the revised ground lease. The Agency utilized a "Ground Lease Capitalization and Allocation Method" calculate the revised ground lease. Both the Agency and Mayer Corporation disagreed with the other's methodology. As stated in the Ground Lease Agreement, Section 2.2(b) Lessor and Lessee shall meet and endeavor to agree upon the "Fair Market Value" of the Premises and shall jointly agree upon an Item 14. - 1 xB -224- Dept. ID ED 13-19 Page 2 of 2 Meeting Date:7/15/2013 appraiser. As a result, staff, Keyser Marston and the Mayer Corporation reviewed the two different appraisal methods and it was determined that a revised methodology should be utilized. The Agency and Mayer Corporation jointly issued a letter engaging an agreed upon Appraiser to render an opinion regarding the Ground Lease Rate Adjustment. The jointly approved methodology for calculating the Fair Rental Value as set forth in the lease is based on a Residual Value, utilizing actual operating expense and revenue of the Waterfront Hilton, with no start up period. The Reevaluation is an obligation of the lease, it does not create the need for the Successor Agency or Mayer Corporation to enter into a new or additional agreement. Therefore, based upon the Appraisal by PKF Corporation, as reviewed by Keyser Marston, it is recommended the revised lease amount be established for January 2014. The increase as determined by PKF Corporation is $225,000, a 52.5% increase in the rent. In addition, the Parcel C Lease amount is based upon the Lease amount of the Hilton Parcel; therefore Parcel C lease will also increase to $225,000. Thereafter, the annual lease is increased every January by Consumer Price Index (CPI) (for both the Hilton and Parcel C lease). The next Reevaluation of the Fair Rental Value is in year 44 of the Lease. Environmental Status: Not applicable Strategic Plan Goal: Enhance Economic Development Attachment(s): 1. Market Value Rent Adjustment analysis by PKF Consulting dated June 26, 2013 2. Analysis by Keyser Marston Associates regarding Market Value Rent Adjustment HB -225- Item 14• - 2 ATTACHMENT # 1 PKF CONSULTING June 26, 2013 USA Mr. Robert L. Mayer, Jr. The Robert Mayer Corporation 8951 Research Drive Irvine, California 92618 Mr. Bob Hall Deputy City Manager/Economic Development Director City of Huntington Beach 2000 Main Street Huntington Beach, California 92648 Dear Messrs. Mayer and Hall: In accordance with your request, we have completed our analysis of the existing land lease between the Hilton Waterfront Beach Resort (Parcel A) and the City of Huntington Beach with regard to the potential "Market Value Rent Adjustment" in the 25th year (January 1, 2014) as dictated by the terms of the lease. This analysis included a review of the specific terms of the lease which specify the manner and assumptions under which such potential Market Value Rent Adjustment is to be calculated. In performing this analysis we have also reviewed an estimate of the cost to reconstruct the existing structure and facilities to the level mandated in the lease, and a valuation of these proposed improvements. In doing so, we have been able to conclude to the potential lease payments as mandated by the Market Value Rent Adjustment on January 1, 2014, given the current and projected market conditions. The original proposal agreement and scope of services as fully defined in the "Engagement Letter for Consulting Services" have been provided as Addendum C of this report document. This letter report sets forth our conclusions and is designed for your internal use. It is subject to the attached statement of assumptions and limiting conditions. Lease Terms The Hilton Waterfront Beach Resort is subject to a 99 year land lease that commenced on April 15, 1989 and terminates on December 31, 2086 (the "Lease"). The Lease provides for fixed annual rent payments which were initially set at $89,723 per year in the first year of operation of the hotel, plus an annual inflation adjustment based on the CPI (except from PKF Consulting USA 1 865 S.Figueroa Street,Suite 3500 1 Los Angeles,CA 90017 TEL: 213-680-0900 1 FAX: 213-623-82401 www.pkfc.com HB -227- Item 14. - 4 Mr. Robert L.Mayer,Jr. and Mr. Bob Hall The Robert Mayer Corporation and City of Huntington Beach 2 2009 to 2010) with a maximum increase of 25 percent over any five-year period and 10 percent in any year for the first 24 years of the term of the Lease. The following table details the current and future projected lease payments through 2013. Hilton Waterfront Beach Resort Lease Year Payment* 2009 $138,510 2010 138,510 2011 139,203 2012 144,117 2013 147,288 *Per the lease terms, the payments are adjusted annually based on the CPI,with an adjustment not less than 0.0% nor more than 10.0% in any one year or 25.0% in any five-year period. The 2009 CPI declined, resulting in no adjustment for the 2010 rental payment. Lease payments for 2013 were estimated based on a letter dated January 13, 2013 between Mr. Bob Hall and Mr.Glen Shorr. However, commencing in the 25th full year of the lease (January 1, 2014, the "Revaluation Date"), the rent is subject to a "Market Value Rent Adjustment" per Section 2.2(b) of the Lease. The new "Fair Rental Value" as defined in said Section shall be equal to the product of the "Market Value of the Fee" (of the land) multiplied by the "Market Rental Value" of the land at such date, as those terms are specifically and uniquely defined in the Lease. The new Fair Rental Value is subject to on-going CPI adjustment as previously described. Additionally, the Fair Rental Value cannot be any lower than the most recent payment made before the revaluation date. Pursuant to the terms of the Lease, not later than July 1, 2013, Lessee and Lessor shall endeavor to agree upon the Fair Rental Value, and failing to agree, an arbitration process shall occur. That arbitration process begins with the parties attempting to agree on a single appraiser (who is required to be a member of the American Institute of Real Estate Appraisers) who shall determine the Fair Rental Value as defined in the Lease. Failing to agree on a single appraiser, each party may then appoint a separate appraiser, and if those separate appraisers agree within 10 percent of each other, the average figure is used, and if they do not agree within 10 percent of each other, a process is provided to select a third appraiser who shall determine which appraiser's opinion is most reasonable under the criteria set forth in the Lease. In this analysis, we determined the most probable conclusion relative to the January 1, 2014 Market Value Rent Adjustment given (1) the criteria and definitions established in the Lease for determining the Fair Rental Value, and (2) the current economic, cost, and value parameters as they relate to the subject hotel. Huntington Beach, California Item 14. - 5 HB -228- Mr.Robert L.Mayer,Jr. and Mr.Bob Hall The Robert Mayer Corporation and City of Huntington Beach 3 Market Value of the Fee per Lease Pursuant to Section 2.2(b) of the Lease, the Market Value of the Fee is the value of the fee interest in the land subject to the then current and actual use of the premises, as permitted or required by the Lease. The use of the premises is a high-rise 290-room nationally branded, first-class, full-service hotel with appropriate ancillary facilities and amenities including a restaurant, meeting space, swimming pool, fitness center, and at least two levels of underground parking facilities. It should be further noted that Article VII and Article XX of the Lease explicitly require that the property be operated as a first-class, nationally branded hotel. Section 2.2(b) also provides that the "Market Value of the Fee" is "not the rental value therefore"; from which we conclude that the valuation approach should not be based on capitalizing an imputed rental revenue stream (which would result in a circular calculation if the rent is based on the value of the land, but the value of the land were also to be based on the rent). Therefore, we conclude that the appropriate interpretation of the Lease requires us to determine the Market Value of the Fee to be the value of the land if vacant and offered for sale with the requirement that the land is to be developed with a hotel equal to the previously described existing use. We are aware of one pending sale of hotel related land in Huntington Beach within the proposed Pacific City project to be developed by R.D. Olson, which is reportedly under contract to be purchased for approximately $50,000 per hotel guest room, or a total of $10.0 million based on the plans for a 250-room hotel. We have not relied on this pending sale in our analysis for the following reasons: • It has not closed and therefore is considered speculative at this time. • We have been informed by Mr. Olson that he is purchasing the site with substantial infrastructure improvements already completed, which would not be the case in replicating the existing Hilton hotel. • Unlike the required program to replicate the existing Hilton hotel with two levels of underground parking per the Development and Disposition Agreement, the development plans for the proposed R.D. Olson project do not include any underground parking at the site. Therefore, although we have analyzed this pending sale and considered it in our conclusions, due to the differences between the two projects and the material gap between construction costs and value of the replicated subject property, it does not change our conclusion that the value of the leased fee interest, under the specific terms of the lease would not increase materially from our conclusions as set forth in the body of this report today and the January 1, 2014 Market Value Rent Adjustment date. Huntington Beach, California BB -229- Item 14. - 6 Mr. Robert L. Mayer, Jr. and Mr. Bob Hall The Robert Mayer Corporation and City of Huntington Beach 4 Thus given the absence of meaningful comparable sales transactions and the specific requirements stated in the ground lease, the "land residual" approach to determining the "Market Value of the Fee" is the most appropriate methodology. In order to determine the potential fee value of the land value of the subject site given the abovementioned criteria from the Lease, a land residual valuation approach is used wherein we have compared the potential market value of an exact replication of the existing Hilton Hotel against the cost to build such a hotel. The excess of the value of the hotel (if any) over the cost to construct the hotel would be attributed to land value. Our assumptions and sources of data used to arrive at a hypothetical land value in 2014 are as follows. • The proposed 290-room Hotel would feature facilities, amenities, and services similar to that of the existing Hilton Waterfront Beach Resort. • At the January 1, 2014 valuation date, the subject hotel would be considered to be operating at or near a stabilized level. • Stabilized levels of operation in terms of occupancy and average daily rate are based upon the performance of the existing Hilton Waterfront Beach Resort, and the subject's competitors. • The estimates of revenues, costs and expenses are based on the proposed facilities and services and the operational characteristics thereof. The basis for our projections is the operating results of lodging properties with similar characteristics (including the existing Hilton Waterfront Beach Resort) that are believed to operate with efficient management and proper control over costs and expenses. • In our valuation of the proposed Parcel A Hotel we have utilized a 10.0 percent discount rate, which is reflective of projected market conditions in 2014 based on current data, including recent transactions and various investor surveys, and our projection of moderately improved economic circumstances by 2014. • Cost estimates to replicate the Hilton Waterfront Beach Resort have been prepared by O'Connor Construction Management Inc., a third-party cost estimating firm. • Finally, per Section 2 of Attachment No. 2 to the Engagement Letter it must be noted that it is our express understanding that for the purpose of this engagement the land residual analysis would be based upon the performance of the existing hotel and would not assume a "new hotel." Specifically the language contained therein notes "The income capitalization technique shall be based on the existing stabilized hotel operation as projected by the Consultant for January 1, 2014, and shall not assume a ramp-up of revenue that would exist Huntington Beach, California Item 14. - 7 HB -230- Mr. Robert L. Mayer,Jr.and Mr. Bob Hall The Robert Mayer Corporation and City of Huntington Beach 5 for a theoretical new hotel that would commence operation on or about that date." Estimated Operating Results Based on the above assumptions and data we have projected the subject's estimated operating results for the ten years of operation from January 1, 2014 to December 31, 2023. These estimates are presented in the following tables. Estimated Rooms Revenue Average Annual Rooms Year Daily Rate Occupancy Revenue 2014 $240.00 76.0% $19,308,000 2015 247.00 76.0 19,871,000 2016 255.00 76.0 20,515,000 2017 262.00 76.0 21,078,000 2018 270.00 76.0 21,722,000 2019 278.00 76.0 22,365,000 2020 287.00 76.0 23,089,000 2021 295.00 76.0 23,733,000 2022 304.00 76.0 24,457,000 2023 313.00 76.0 25,181,000 Summary of Estimated Annual Operating Results Total Net Operating Ratio to Year Revenue Income Total Revenues 2014 $30,008,000 $6,006,000 20% 2015 30,892,000 6,628,000 21 2016 31,866,000 6,881,000 22 2017 32,770,000 7,049,000 22 2018 33,765,000 7,279,000 22 2019 34,769,000 7,501,000 22 2020 35,865,000 7,784,000 22 2021 36,893,000 7,985,000 22 2022 38,011,000 8,248,000 22 2023 39,142,000 8,494,000 22 For a full detail of the subject's historical and projected operating results please see Addendum A. DISCOUNTED CASH FLOW ANALYSIS Estimated Market Value of the Hotel To appropriately value the proposed development we have utilized a discounted cash flow analysis. The value through this analysis reflects the present value of the income for each year of the holding period, as well as the present value of the net proceeds of the sale of the property in the terminal year, with these amounts discounted back to present value at a market derived discount rate. Presented in the following table is our estimate of the present value of the projected net Huntington Beach, California HB -231- Item 14. - 8 Mr. Robert L.Mayer,Jr. and Mr.Bob Hall The Robert Mayer Corporation and City of Huntington Beach 6 operating income of the subject for the holding period. Hilton Waterfront Resort Valuation- Discounted Cash Flow Unrounded Number of Projected 10.00% Present Period Months NOI PV Factor Value 2014 12 $ 6,006,000 0.909091 $ 5,460,000 2015 24 6,628,000 0.826446 5,477,686 2016 36 6,881,000 0.751315 5,169,797 2017 48 7,049,000 0.683013 4,814,562 2018 60 7,279,000 0.620921 4,519,686 2019 72 7,501,000 0.564474 4,234,119 2020 84 7,784,000 0.513158 3,994,423 2021 96 7,985,000 0.466507 3,725,061 2022 108 8,248,000 0.424098 3,497,957 2023 120 8,494,000 0.385543 3,274,805 Reversion 107,775,030 0.385543 41,551,939 $85,720,036 ROUNDED $85,700,000 Value of the Reversion To estimate the value of the subject using a discounted cash flow analysis, it is assumed that the property will be sold at the end of the tenth year of a typical ten-year holding period. The value of the property at that time is estimated by capitalizing the expected or anticipated net operating income of the property in the eleventh year. The reversion year is adjusted to reflect the real estate taxes that would occur upon the sale. Net Proceeds Upon Sale (Reversion) To obtain the net proceeds upon sale of the property, we have deducted a sales commission of 1.5 percent. Our calculation of the proceeds upon the sale is outlined in the following table. Value of the Reversion Year 11 NOI Before Property Taxes $ 9,942,000 Terminal Capitalization Rate 8.000000% Effective Levy Rate 1.086420% Combined Cap Rate 9.086420% Indicated Value at Reversion(Fee Simple Interest) $109,416,030 Less Selling Costs (1,641,000) Net Reversion $107,775,030 Cost of Construction Presented in the table on the following page is a detailed breakdown of the costs required to replicate the existing Hilton Waterfront Beach Resort. As prepared by O'Connor Huntington Beach, California Item 14. - 9 HB -232- Mr.Robert L. Mayer, Jr. and Mr.Bob Hall The Robert Mayer Corporation and City of Huntington Beach 7 Construction Management Inc., the cost to replicate the existing Hilton Waterfront Beach Resort is approximately $123.4 million. The estimate includes all construction costs, design and permit costs, financing, and working capital. The total figure of approximately $123.4 million includes all hard and soft costs as well as a contingency. It should be noted that this amount does not include the cost of land. General Cost Summary Element Total Cost 01 Parking Level &Entry Level $26,723,710 02 Ballroom Level &Guestroom Tower 61,234,078 03 Site Work 4,726,235 04 Off-Site Work 1,400,194 A)Total Construction Cost $94,084,218 05 FF&E $9,287,674 06 Permits& Fees 2,906,210 07 A/E Design Fees 6,946,157 08 Testing&Inspection 400,000 09 CM Services 1,881,684 10 Owner Insurance,Taxes&Legal Fees 1,280,347 11 Operating Supplies 274,550 12 Start-Up Working Capital 250,000 13 Construction Period Interest 6,039,659 B)Total Project Soft Cost $29,266,282 TOTAL PROJECT COST(2013) $123,350,499 As the above stated project costs are in current (2013) dollars, we must appropriately inflate these figures to 2014 dollars so that they are directly comparable. to our estimated market value of the replicated hotel. The following chart details this inflation, assumed to be at a rate of 3.0 percent per annum. Escalated Escalation Projection %Increase Cost To 01/2014 3.0 $127,051,014 Finally, the inflation adjusted costs do not include the developer's entrepreneurial profit. Entrepreneurial profit is not an estimate of the general contractor's profit, which has already been accounted for, but is an additional profit to the developer for combining the factors of production in the development of a property. To accurately estimate entrepreneurial profit, the actual sales prices of recently developed hotels need to be compared to the cost of developing those hotels. Unfortunately, we have not been able to identify any new hotels, which have recently sold within the local market. Accordingly, the extraction of entrepreneurial profit is not possible. However, based on discussions with market participants, we were able to estimate a typical level of entrepreneurial profit for a hotel such as the subject. Profit margins vary widely, depending on many factors such as supply and demand, financing packages, and the negotiating ability of the developer. Based on conversations with hotel developers, under normal market conditions, the profit margin for a hotel would typically Huntington Beach, California HB -233- Item 14. - 10 Mr. Robert L.Mayer,A and Mr. Bob Hall The Robert Mayer Corporation and City of Huntington Beach 8 range from 5.0 to 15.0 percent of total development costs. It is our opinion that an entrepreneurial profit conservatively estimated at 5.0 percent of total costs is appropriate for the subject, which equates to $6,352,551 ($127,051,014 x 5.0 percent). This charge is typical of the profit and overhead required by developers of lodging facilities. It is important to remember that inclusion of entrepreneurial profit in the Cost Approach is necessary as it reflects a theoretical amount needed to attract a developer to construct a property. Therefore, as shown in the table below the total final anticipated cost to replicate the existing Hilton Waterfront Beach Resort is approximately $133.4 million. Final Summary Element Total Cost Total Project Costs(2013) $123,350,499 Inflated to 2014$'s 127,051,014 Entrepreneurial profit(5.0%) 6,352,551 Total Cost to Replicate in 2016 $133,403,565 Rounded $133,400,000 Conclusion of Market Value of the Fee per Lease In order to determine the hypothetical "Market Value of the Fee" of Parcel A in 2014 (per the terms and criteria of Section 2.2(b) of the Lease) we calculated the value in 2014 of a replicated, first class hotel similar to the existing Hilton using a discounted cash flow analysis. We then estimated the cost to replicate such a hotel using cost figures provided by O'Connor Construction Management Inc. Theoretically, any value in the hotel develop- ment above and beyond the cost of construction would be attributed to value of the underlying land. However, as can be seen in this exercise, the estimated cost to construct a hotel development similar to the existing Hilton is significantly greater than the value of such a building. This does not come as a surprise; the cost to construct first-class, full-service high-rise hotels often exceeds the value, which is why very few of these types of projects have been constructed in recent years in the U.S. except in limited circumstances of very high-value gateway locations, large-scale convention center-related projects and/or developments with significant economic assistance from governmental and/or redevelopment agencies. Therefore, we concluded that the "Market Value of the Fee" of Parcel A land is de-minimis at best. In other words, it is our opinion that in following the requirements of the Lease to estimate the "Market Value of the Fee" for the 2014 Revaluation Date, we have concluded that such "Market Value of the Fee" is equal to or near zero. Market Rental Value per Lease In order to calculate the 'Fair Rental Value" under the Lease, it is also required to determine a Market Rental Rate, that is, the "...then current average annual percentage return obtained by owners of land for land similar to the Premises, which shall in no event be less than six percent nor more than fifteen percent". Land subject to long term triple-net Huntington Beach, California Item 14. - 11 HB -234- Mr.Robert L.Mayer, Jr. and Mr. Bob Hall The Robert Mayer Corporation and City of Huntington Beach 9 leases for various commercial uses have in past years transacted frequently (however, with the current financial crisis and lack of commercial financing, few transactions are currently occurring). As such we have also relied upon investor surveys. The following table summarizes prevailing land lease capitalization and discount rates obtained from a third-party source. The former reflect initial rates of return on appraised values for vacant land proposed for development. They do not address increases in land lease payments or the reversion but may include percentage rent. The latter are internal rates of return being achieved by landowners on improved properties. As such, they include changes in land lease payments, percentage rent where applicable, and the reversion of the entire property at the termination of the lease. Total lease terms range from 40 to 99 years, while fixed rent periods range from one to 10 years. Generally, short-term (1-3 years) fixed rent periods auto-adjust based on a national reference rate such as the Consumer Price Index, while long-term (5-10 years) fixed rent periods are based on appraised values but are often subject to negotiation and/or arbitration. RealtyRates.com INVESTOR SURVEY-Year-End 2012 LAND LEASES Capitalization Rates Discount Rates Property Type Min. Max. Avg. Min. Max. Avg. Apartments 1.8% 10.5% 6.0% ;4.4% 11.0% 7.0% Golf 2.6 15.2 8.8 ; 5.2 15.7 9.8 Health Care/Senior Housing 2.7 11.9 6.6 : 5.3 12.4 7.6 Industrial 2.2 10.5 6.3 :4.8 11.0 7.3 Lodging 2.3 14.5 7.1 :4.9 15.5 8.1 Mobile Home/Rv park 2.1 11.9 7.1 ;4.7 12.4 8.1 Office 2.2 10.5 6.7 ;4.8 11.0 7.7 Restaurant 3.2 15.2 7.9 ; 5.8 15.7 8.9 Retail 2.1 11.2 6.3 4.8 11.7 7.3 Self-Storage 2.3 10.5 8.43 4.9 11.0 9.4 Special Purpose 3.0 16.1 8.0 ; 5.9 17.9 8.8 All Properties 1.8% 16.1% 7.2% ;4.4% 15.7% 8.1% Types of properties and risk classes vary considerably, but for hotel leased fee uses, discount rates today typically would be in the range of 4.9 percent to 15.5 percent, with an average of 8.1 percent. Further it should be noted that the lower range of the spectrum represents higher quality properties with a lower risk class. Therefore, given the subject site's location and explicit development requirements as stated in the Lease, it would be appropriate to utilize a discount rate within the lower end of the range. As such given today's economic climate and market conditions that the appropriate "Market Rental Value" for the property would be 7.5 percent in 2013. Given existing trends and the expectation for a moderate recovery in commercial financing availability by 2014, we project that an appropriate "Market Rental Value" for the property would decrease by 50 basis points and thus be determined to be 7.0 percent in that year. Again, in other words, it is our opinion that in following the requirements of the Lease to Huntington Beach, California HB -235- Item 14. - 12 Mr. Robert L. Mayer, A and Mr. Bob Hall The Robert Mayer Corporation and City of Huntington Beach 10 estimate the "Market Rental Value" for the 2014 Revaluation Date, we have concluded that such "Market Rental Value" would be 7.0 percent. Fair Rental Value and Market Value Rent Adjustment per Lease As explained previously, commencing in the 25th full year of the lease (January 1, 2014, the "Revaluation Date"), the rent is subject to a "Market Value Rent Adjustment" per Section 2.2(b) of the Lease. The new "Fair Rental Value" as defined in said Section shall be equal to the product of the "Market Value of the Fee" (of the land) multiplied by the "Market Rental Value" of the land at such date, as those terms are specifically and uniquely defined in the Lease. The new Fair Rental Value is subject to on-going CPI adjustment as previously described. Additionally, the Fair Rental Value cannot be any lower than the most recent payment made before the Revaluation Date. As we have analyzed, the "Market Value of the Fee" in 2014 is very likely to be determined to be essentially zero, and therefore multiplying that times a "Market Rental Value" of 7.0 percent would result in a rental payment of zero. However, per the terms of the Lease, the Fair Rental Value cannot be reduced below the most recent annual payment. As shown in the table on page 2 of this letter report, the annual rental payment in 2013 is expected to be $147,288; therefore as of the Revaluation Date of January 1, 2014 this would be the minimum ground rent paid in the 2014 calendar year. Conclusion It is our opinion that in interpreting and following the requirements of the Lease to determine the Fair Rental Value for the 2014 Revaluation Date, we have concluded that an increase in the rental rate as of the Revaluation Date of January 1, 2014 could not be mathematically justified given that there is not any value attributable to the land. Given our arrival at this conclusion, that a Fair Rental Value cannot be determine by the specific terms and requirements of the lease, we have opined on a rent adjustment which we believe to be equitable to the lessor and lessee. Based on our understanding of preliminary discussions between the parties involved, we are of the opinion that based on our understanding of "Fair Rental Value" and these discussions, an annual rental payment in 2014 of approximately $225,000 is appropriate. In 2015 and thereafter until the 44th anniversary of the Lease, the rental payment would be subject to CPI adjustment per the terms of the Lease, and then an additional revaluation is scheduled to occur. We find this reasonable from the City's position as it reflects a significant increase above current rent collections. Specifically, this equates to a 52.8 percent increase over 2013 ground rent. We appreciate the opportunity to work on this assignment and look forward to answering any questions you may have regarding our findings and conclusions presented herein. Huntington Beach, California Item 14. - 13 xB -236- Mr. Robert L.Mayer, Jr. and Mr. Bob Hall The Robert Mayer Corporation and City of Huntington Beach 11 Sincerely, PKF Consulting USA By Bruce Baltin Senior Vice President Huntington Beach, California HB _237_ Item 14. - 14 ATTAC H M E N T #2 KEYSER MARSTONASSOCIATES ADVISORS IN PUBLIC/PRIVATE REAL ESTATE DEVELOPMENT July 5, 2013 AD',E10Rk IN. Fred Wilson City Manager AMMDAIAI HOUSP,`C; City of Huntington Beach 2000 Main Street Ifl Huntington Beach, California 92648 A. (l RRY KINA i} TlmolllYC,Bs111 k,Ii EP+MI hl"'K Re: Hilton Waterfront Beach Resort— Market Value Rent Adjustment ICI II Nt Kill DAVIL�11oFtsXAk Dear Mr. Wilson: V:MIli.fif,+N'1.I1f D In accordance with your request, Keyser Marston Associates, Inc. (KMA) reviewed the RkU 61kw,,,k,"D,Si1,1"LI6I, ground lease re-evaluation analysis that was prepared by PKF Consulting USA (PKF) for KlViN F.EN(iMWv, Parcel A of the Hilton Waterfront Beach Resort. These appraisal was jointly jk1it L,Roml.Y commissioned by the City of Huntington Beach (City) and the Robert Mayer Company (Mayer). The purpose of the KMA review is to assist the City in establishing the ground PAM.C,MARRA lease payment obligation that will be imposed commencing on January 1, 2014. BACKGROUND STATEMENT The City and Mayer entered into a ground lease agreement for the Hilton Waterfront Beach Resort (Hilton) property on April 15, 1989. Under the terms of the ground lease agreement, the first year ground lease payment obligation for Parcel A was set at $89,723. Each year thereafter, the payment obligation increases by an amount equal to the percentage change in the Consumer Price Index (CPI). The ground lease calls for a "Market Value Rent Adjustment" to be made in the 25th year. This adjustment is to be based on an appraisal prepared by a member of the American Institute of Real Estate Appraisers that is collaboratively selected by the City and Mayer. The requirements imposed on the Market Value Rent Adjustment are spelled out in Section 2.2 (b) of the ground lease. The fundamental requirements can be described as follows: 1. The ground lease payment cannot never be less than the most recent payment made before the Market Value Rent Adjustment. 500 SOUTH GRANDAVENUE,SUITE 1480)1,LOS ANGELES.CALIFORNIA 90071 PHONE2136228095> FAX 213 622 5204 1307004;F"- 1N�" %1V.UYSERMA ST+: N.I✓OM HB -239- 1406s.c Item 14. - 16 Fred Wilson July 5, 2013 City of Huntington Beach Page 2 2. The "Market Value of the Fee" is the value of the fee interest in the land based on the current and actual use of the property, not the highest and best use of the property. 3. The valuation is to be made based on an analyses of land sales for development of comparable hotels, and an estimate of the residual land value based on the income approach to valuation. 4. An important requirement is that the valuation must be based on the replication of the Hilton. This is comprised of a 290-room nationally branded first-class, full- service hotel that includes a restaurant, meeting space, a swimming pool, a fitness center and two levels of subterranean parking. 5. The City and Mayer agreed that the projected operating results should be based primarily on the actual operational characteristics of the existing Hilton without the ramp up to stabilization period that would typically be ascribed to a new hotel development. 6. The appraiser is required to establish the "Market Rental Rate" that is then multiplied times the Market Value of the Fee to arrive at the ground lease payment obligation. Under the terms of the ground lease, the Market Rental Rate must fall between 6% and 15%. In accordance with the ground lease terms, the City and Mayer collaboratively hired PKF to undertake the evaluation. PKF submitted an analysis dated June 26, 2013 that concluded that the property generates a negative land value. Based on that conclusion, the Market Value Rent Adjustment for Parcel A would be equal to the 2013 ground lease payment of$147,288 plus the annual CPI adjustment. In the Conclusion section of the analysis, PKF recommended that the ground lease payment for Parcel A be set at a negotiated value of$225,000. Subsequently, the City requested that KMA review the analysis, and recommend a ground lease payment amount to be assessed commencing on January 1, 2014. ANALYSIS It is important to note that KMA was not engaged to appraise the Hilton property. Rather, KMA was engaged to review the PKF analysis, and to recommend a ground lease payment amount. The salient features of the PKF analysis are summarized in the following sections of this letter. Item 14. - 17 1307004;HB:KHH HB -240- 14066.005/026 Fred Wilson July 5, 2013 City of Huntington Beach Page 3 Land Sales Comparison Approach to Valuation The PKF analysis acknowledges that the adjacent Pacific City site is anticipated to be sold for the subsequent development of a nationally branded first quality hotel. However, PKF concluded that this prospective sale should not be used in the valuation analysis for the following reasons: 1. The sale has not yet closed, so it is speculative to ascribe a sales price to the transaction. 2. The prospective purchaser has indicated that the current property owner has agreed to provide infrastructure improvements as part of the sale. 3. The developer of the hotel project will not be required to construct subterranean parking. PKF concluded that even if the Pacific City land sale is considered, the adjustments required to make it comparable to the Hilton are so extensive that the use of this land sale would not alter the valuation conclusion derived from their residual land value analysis. The PKF analysis further concluded that there are currently no meaningful comparable sales transactions available for use in the analysis. Income Approach to Valuation Under the income approach to valuation, the land value is estimated by comparing the market value of an exact duplicate of the Hilton to the cost to construct the hotel and it's amenities. The results of the PKF analysis are summarized in the following table: Market Value of the Hotel $107,775,000 Construction Cost + Profit 133,000,000 Residual Land Value ($25,225,000) As can be seen in the preceding table, the PKF analysis concludes that the costs to construct the Hilton exceed the value of the Hilton. As a result, the residual land value is a negative land value. 1307004;F"— BB -241- 1406s.c Item 14. - 18 Fred Wilson July 5, 2013 City of Huntington Beach Page 4 PKF Conclusions The PKF analysis concluded that there are no meaningful comparable sales transactions, and thus the income approach to valuation is the only viable methodology for establishing the property's value. The PKF income approach to valuation resulted in a negative number. Based on this conclusion, and under the terms of the ground lease, the Market Value Rent Adjustment would be equal to the 2013 ground lease payment plus the annual CPI escalation. PKF was also asked to establish the Market Rental Rate, which is the percentage by which the Market Value of the Fee to is multiplied to arrive at the "Fair Rental Value" of the property. PKF concluded that the Market Rental Rate should be set at 7%. This falls within the range of 6% and 15% identified in the ground lease. The Conclusion section of the PKF analysis states that given the negative residual land value identified in their analysis, an increase in the ground rent cannot be mathematically justified. However, they went on to conclude that in their professional opinion, a compromise rent adjustment to $225,000 would be equitable to both the City and Mayer. KMA RECOMMENDATIONS KMA has a long history of assisting cities and redevelopment agencies in negotiating hotel development transactions. It has been our experience that the costs associated with developing first quality hotels often exceeds the value supported by the hotel. Given the ground lease requirement that the valuation be based on an exact duplication of the Hilton, it is necessary to consider the premium costs associated with high-rise construction and two-levels of subterranean parking. When those factors are weighed against the actual operating performance of the Hilton, it is our opinion that the income approach to valuation will yield a negative value. KMA understands and accepts the PKF conclusion that the income approach to valuation is currently the only reasonable methodology for establishing the Market Value of the Fee. However, it is important to consider that an adjacent property is anticipated to be sold for hotel development in the near future. This sale could potentially be used as a value indicator when properly adjusted to reflect the characteristics of the Hilton. However, given the timelines for the Market Value Rent Adjustment, it is likely that the sale of the Pacific City property will not close soon enough for the transaction to be included in the analysis. 1307004;HB:KHH Item 14. - 19 HB -242- 14066.005/026 Fred Wilson July 5, 2013 City of Huntington Beach Page 5 If the analysis is limited to the income approach to valuation, the Fair Rental Value of Parcel A is equal to the 2013 ground lease payment plus the annual CPI adjustment. This results in an estimated payment of approximately$150,000. Comparatively, the PKF analysis is suggesting a ground rent payment of$225,000, which represents a 50% increase over the amount determined under the Market Value Rent Adjustment terms identified in the ground lease. It is the KMA recommendation that the City agree to set the January 1, 2014 ground lease payment for Parcel A at $225,000. Under the terms of the ground lease, the ground lease payment for Parcel C will also be set at $225,000 as of January 1, 2014. These ground lease payments will then increase annually based on changes in the CPI until the 44th year of the ground lease term. At that time, the ground rent payment will be re-evaluated based on the property's then current fair market value at the highest and best use. KMA appreciates this opportunity to assist you with this engagement. Please do not hesitate to contact me with any questions or comments related to this analysis. Sincerely, KEYSER MARSTON ASSOCIATES, INC. Kathleen Head 1307004;F— HB -243- 1406s.c Item 14. - 20