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.


Background

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.


Issues

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.



Recommendation

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.