DATE: November 17, 2015
SUBJECT:
Title
ORDINANCE GRANTING FINAL FORM LEASE BETWEEN THE DISTRICT AND LPP LANE FIELD, LLC FOR THE LANE FIELD SOUTH HOTEL PROJECT LOCATED IN THE CITY OF SAN DIEGO, FOR A 66-YEAR TERM, WITH CONDITIONS
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EXECUTIVE SUMMARY:
LPP Lane Field, LLC (Developer) has an option to lease agreement (Option) with the District for development of a 400-room hotel on the Lane Field South site (see Attachment A: Site Map). Since the Option to Lease (Option) agreement was approved at the December 2014 Board meeting, LPP Lane Field, LLC (Developer) has been working diligently to progress the design of the hotel tower, secure their equity and debt financing and a hotel brand, and prepare the Option to be exercised and start construction by the end of 2015.
The Developer is currently in final negotiations with InterContinental Hotels Group (IHG) to manage and brand the hotel as an InterContinental hotel, which is their signature brand. With InterContinental as the brand for all 400 rooms, the overall economics of the project for the District have improved from what was originally anticipated when the Option was approved in December 2014 resulting in increases in the projected rent the District is estimated to receive immediately upon completion of the project (see Hotel Brand discussion below for more detail).
The Developer has also executed an equity term sheet with China Orient Asset Management (COAM) which is a state-owned asset management company with assets in excess of $36 billion, to provide approximately 88% of the required equity with the Developer and IHG providing the balance. In addition, a debt term sheet has been executed with PNC Bank (PNC) to secure approximately $114.4 million in financing for the project.
While the overall cost of the project has increased by approximately $11 million, the Developer, and its partners, have absorbed most of these increases. To help further offset these increased costs and lower loan proceeds, the Developer has requested waivers to the performance bond and security deposit requirements outlined in the Option, which are further analyzed below in the Project Guarantees section, and have no direct economic impact to the District. After review, staff believes the District has adequate assurances that the project will be constructed through the completion guaranty and financial backing of the equity partners and lender to recommend waiving the performance bond and security deposit requirements. As such, staff recommends the Board consent to the final form lease, which includes these waivers.
One of the conditions of the Option was that the Developer receive Board approval of the execution-ready lease (Lease) by December 31, 2015. The Option stated that the Lease shall be in substantially the same form as the Lane Field North lease with exceptions that include all economic provisions, project specific provisions for construction and assignment language and any other items that are mutually acceptable to both the District and the Developer. The economic provisions were previously approved by the Board when the Option was granted in December 2014 (see Attachment B: Lease Information Summary), and are included in the Lease.
In accordance with the Option, the Lease was modified to update the project description, assignment paragraph terms and other minor modifications requested by the Developer’s potential lenders, equity partner and hotel management company. A new paragraph was inserted, at the request of the District, to address compliance with the Office of Foreign Assets Control Department of the Treasury (OFAC) related to representations and warranties that the Developer is required to make to comply with the United States Patriot Act and other homeland security requirements (see Attachment C: Proposed Final Form Lease)
Staff has reviewed the Lease and the Developer’s requests and determined that the modifications represent mostly clarifications or minor modifications to the Lease structure and represent little additional risk to the District in return for higher projected rent. Staff recommends the Board adopt the final form Lease conditioned upon the Developer fulfilling the remaining conditions in the Option.
RECOMMENDATION:
Recommendation
Adopt an Ordinance granting the final form lease between the District and LFS Development, LLC, for the Lane Field South Hotel Project located in the City of San Diego, for a 66-year term, with conditions.
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FISCAL IMPACT:
If the Option is exercised then the District may receive the following rents under the proposed ramp-up further described in the discussion below.
Compass Strategic Goals:
The proposed Lane Field South Hotel project consists of a hotel, retail stores and restaurants, and parking, thereby enhancing the public's experience of the North Embarcadero.
This agenda item supports the following Strategic Goal:
A financially sustainable Port that drives job creation and regional economic vitality.
DISCUSSION:
Background
The Lane Field Project (both North and South towers) has a long history, dating back to 2005 when the original Request for Proposals was issued for the site. Since then the project has encountered a number of challenges including a significant market downturn during the Great Recession. Through the years, the development team has worked closely with the District, the Coastal Commission, and the public to entitle a project that has received broad public support and ultimately included a 1.66-acre new public park at the foot of Broadway and Harbor Drive.
After extensive negotiations, LPP exercised their option to build the North hotel tower and the setback park/plaza on May 1, 2014. They are currently under construction and are on schedule to deliver the hotel project and associated retail and parking by February 2016. At the December 2014 Board meeting the District granted the Developer an Option to develop the Lane Field South project.
Requirement to Prepare a Final Form Lease
Per the Option agreement, the proposed lease for Lane Field South shall be in substantially the same form as the terms in the Lane Field North lease with exceptions that include the project description, all economic provisions related to rent, project specific provisions for construction, assignment language and any other items that both parties mutually agree to modify. The economic provisions were previously approved by the Board when the Option was granted in December 2014 (see Exhibit A), and there are no proposed changes to the economic terms. Moreover, the InterContinental pro forma is superior to the pro forma used to underwrite the Board’s original approval of the deal and should result in increased rents to the District.
Common District practice has been to include a fully negotiated lease agreement as an attachment to the Option itself. In projects of this size and complexity, there are typically modifications to the lease required by both the District and lessee that are requested near the end of the Option term once the debt and equity partners have had the opportunity to review the transaction. As such, staff attached a term sheet outlining the terms to the Option and has prepared the attached final form lease for approval at the November Board meeting.
Project Costs and Projected Rent
Cost Increases
When the Board consented to the Option in December 2014 the Lane Field South project was estimated to cost a total of $207 million. Since that time the overall cost has increased to $218.7 million. According to the Developer, the increase in cost is primarily attributable to increases in estimates to construct the underground parking garage, unanticipated development impact fees, and increases in furniture fixtures and equipment related to the InterContinental hotel brand specifications.
The InterContinental Hotel Brand
The Developer has submitted a draft hotel management agreement that staff is reviewing from InterContinental Hotels Group (IHG) to operate the Lane Field South hotel as the InterContinental San Diego. Staff anticipates bringing the management agreement to the Board for consent at the December Board meeting.
The Developer is currently negotiating with IHG to contribute an additional $9 million (key money) to mitigate some of the higher costs that have occurred with the progression of the design. In addition, IHG would be sharing in a credit enhancement facility of approximately $17.5 million with the Developer to secure financing for the project. The Developer has absorbed and mitigated most of the incremental increased project costs discussed above through the additional key money that IHG has agreed to put into the project.
Increase in Projected Rent to the District
When the Board approved the Option in December 2014, the anticipated net present value (NPV) of the District’s projected rental stream was approximately $41 million. Over the last year, the Hotel market has improved in the San Diego region and the Developer and IHG have revised their pro forma projections to reflect increased performance anticipated by the Lane Field South project. The updated pro forma shows an increase in the NPV of the District’s rental stream of more than $1 million for a total of more than $42 million. Below is a chart showing the difference in rental income over the first ten years of operations. In the first year alone, the District is anticipated to receive more than $120,000 in additional rent than what was originally anticipated.
Equity Partnership Summary (Including Financing Capital Stack)
The Developer has been arranging the debt and equity financing for the project which is summarized below in the sources table and is subject to further adjustments and reallocations as the project approaches closing.
China Orient Asset Management (COAM)
The Developer’s proposed equity partner is COAM. COAM is a solely state-owned non-banking financial institution that is 100% owned by the Ministry of Finance of China. COAM is one of four large asset management companies established by the Chinese government to mitigate financial risks, preserve state-owned assets, and promote the reform and development of China’s financial system. COAM has total assets in excess of $36 Billion, has over 40,000 employees and serves more than 8 million clients. COAM has a long term rating by Moodys of A3 and Fitch of A-, which are supported by ties to the Chinese government.
COAM would initially fund approximately 88% of the equity stake in Lane Field South which is estimated to be approximately $83.6 Million. Following close of escrow COAM is proposing to potentially transfer their interest into a fund that will be managed by either COAM, Portman Holdings or a combination of the two. The fund will hold two other assets, in addition to Lane Field South, including the Hotel Indigo in downtown Atlanta and a 400,000 square foot class A office building in Charlotte. COAM’s goal is to reduce their ultimate equity stake from 83.6% to approximately 16.7% by selling limited partnership interests in the fund to limited partner investors. This transfer and equity reduction would occur no later than 24 months following lease commencement. This structure is similar to private equity funds that own other District leaseholds, with the exception that COAM is placing the full amount of equity in the deal upfront and subsequently placing their equity into the fund. If there is a change of control in the fund manager it would be subject to the District’s approval. See Attachment D for an illustration of the fund structure.
LPP Lane Field, LLC (Developer)
The Developer is a partnership made up of Robert Lankford, Portman Holdings and Hensel Phelps Construction, Company Collectively they are funding approximately $11.7 million in equity with Portman Holdings as the managing member and funding the majority of their equity as shown in the sources chart above.
PNC Bank
PNC is proposing to arrange $114.4 million worth of construction financing for the project. They would underwrite approximately $65 million worth of credit and are arranging for other lenders to provide the balance of $49.4 million.
The overall loan-to-cost is approximately 52.3%. This is lower than originally anticipated by the Developer primarily due to lenders having overall concerns about the performance of a new luxury hotel in downtown San Diego, which resulted in more conservative underwriting.
Requested Changes to the Form Lease
The Option requires the District to negotiate in good faith with such equity partner and financial institution to amend the form of the lease to provide such terms as the respective parties may reasonably require to provide equity and debt financing for the construction of the project; provided that such amended terms will not include economic concessions by the District. Modifications were requested by the equity partner and financial institution related to the outside date associated with constructing the project and the structure of the equity investment which are further described in their respective sections below.
Project Guarantees and Security Deposit
Per the Option, the Developer and its partners are required to provide certain forms of guarantees related to the completion of construction and financial commitments through the Lease itself. They include a completion guaranty, performance bond, security deposit, and lease guaranty.
Some of the items listed above provide duplicative coverage to the District. For instance, performance bonds would only cover the cost of the actual construction contract itself which is predominantly related to the hard costs associated with a project, while the completion guaranty covers both the cost of the construction contract, plus all furniture fixtures and equipment, soft costs and other related costs associated with the project. Since there is a significant cost to the Developer associated with both the performance bond and the completion guaranty (approximately $1 million for each item) - and no additional revenue to the District or the Developer as a result - the Developer has requested a waiver of only the performance bond requirement to help mitigate some of the higher construction costs experienced elsewhere on the project as described below.
In addition, the Developer has requested a waiver of the security deposit requirement of $1 million, currently required in the Option. Since the Developer would receive a refund of the security deposit at completion of construction the actual cost savings to them is associated with the opportunity cost of capitalizing the $1 million in the partnership upfront and carrying the cost through construction.
Staff has analyzed the issues presented above and believes that the District has adequate coverage through the completion guaranty to recommend waiving the performance bond and security deposit requirements. While waiver of the performance bond requirement will result in loss of the financial backing of a bonding company, the completion guaranty is backed by the balance sheet and net worth of Hensel Phelps Construction Co., currently valued at more than $400 million.
Outside Date for Completion of Construction
PNC Bank’s credit department was not comfortable with the outside date for completion of construction that was included in the lease term sheet (30 months). Construction is anticipated to take approximately 24-28 months. To create a buffer and allow the Developer to continue towards completion of the project even if the timeframes have slipped, PNC has requested the time period for construction be extended to 38 months with two 12-month extensions. Staff has negotiated a price for each extension of $1.47 million for the first 12-month extension and $1.9 million for the second 12-month extension. These amounts are based on double the projected rent to the District during each respective extension period if the project was to be completed within its original schedule. In addition, to exercise the first 12-month extension the Developer must demonstrate that the entire amount of equity has been spent on the project (approximately $100 million) and that they are diligently pursing completion of construction. Failure to complete the project or diligently pursue it to completion will be a breach of the Lease.
While the request is unusual, in the current lending environment there were not a large number of lenders that were interested in underwriting a luxury hotel in downtown San Diego at terms attractive enough to incentivize this project to move forward. In considering the request in the context of the risk of the overall project, including the completion guaranty and ability of IHG to step in and cure certain items in lease, staff recommends agreeing to PNC’s request with the associated fees and conditions outlined above.
Conclusion
Based on the above analysis, staff recommends the Board consent to the Lease conditioned on the Developer fulfilling all conditions precedent and exercising the Option. If the Lease is approved, then Staff would return to the Board again in December 2015 to seek the Board’s consent to the assignment of the Option and Lease to the new legal entity, which will be a joint-venture partnership between the Developer and COAM. Staff would also seek Board consent for debt financing, and franchise and management agreements at the same time. Assuming all other administrative items are satisfied in the option, these would be the final Board approvals required to exercise the Option and begin construction on Lane Field South hotel.
General Counsel’s Comments:
The General Counsel’s Office has reviewed the proposed lease and approves as to form and legality.
Environmental Review:
The District originally approved development of the Lane Field site for hotel, retail and office use as part of the North Embarcadero Alliance Visionary Plan (NEAVP). The potential environmental impacts of the proposed uses were analyzed in the Master Environmental Impact Report (MEIR) for the NEAVP, which was certified by the District on April 25, 2000 (Resolution 2000-82). Pursuant to State California Environmental Quality Act (CEQA) Guidelines Section 15179, the Board adopted Resolution 2006-131 on August 8, 2006, which found that: (1) no substantial changes have occurred with respect to the circumstances under which the NEAVP MEIR was certified; (2) the MEIR is adequate for use in the review of subsequent projects; and, (3) the mitigation measures contained in the NEAVP MEIR and Mitigation Monitoring and Reporting Program adopted by the Board under Resolution 2000-82 remain in effect and are applicable for subsequent projects described in the MEIR. The District subsequently prepared an Addendum to the MEIR as the environmental review for a Coastal Development Permit (CDP) for development of the Lane Field North and South parcels with a total of 800 hotel rooms and 80,000 square feet of retail space. The District adopted the Addendum and approved the issuance of a CDP on January 8, 2008. The proposed Board action is not a separate “project” for CEQA purposes but is a subsequent discretionary approval related to a previously approved project. (CEQA Guidelines § 15378(c); Van de Kamps Coalition v. Board of Trustees of Los Angeles Comm. College Dist. (2012) 206 Cal.App.4th 1036.) Accordingly, the proposed Board action is merely a step in furtherance of the original project for which environmental review was performed and no further environmental review is required.
The District authorized issuance of a CDP for the Lane Field hotel project on January 8, 2008. The CDP was subsequently appealed by the California Coastal Commission (CCC). On January 8, 2009, the CCC determined the project complied with CEQA and approved the CDP for the Lane Field hotel project (A-6-PSD-08-04/A-6-PSD-08-101). Furthermore, on April 13, 2011, the CCC approved the CDP for the North Embarcadero Visionary Plan (NEVP) Phase 1 project, with the understanding that an amendment to the Lane Field CDP would be required to include the Setback Park in the redesign of the hotel development. On February 6, 2013, the CCC authorized an amendment to the Lane Field CDP to incorporate the Setback Park as part of the project (A-6-PSD-08-004-A1). In November 2013, the CCC authorized an extension to the Lane Field CDP to extend the expiration date to January 8, 2015 (A-6-PSD-08-004-E2). On September 22, 2015, the CCC authorized a second amendment to the Land Field CDP to modify the project description and Public Access Plan to relocate the publicly-accessible rooftop terrace from the Lane Field North Hotel to the Lane Field South Hotel, and add a publicly-accessible terrace and restaurant on the 4th floor of the Land Field North Hotel (A-6-PSD-08-004-A2). No additional action under the California Coastal Act is required at this time. Because the CCC has CDP jurisdiction over this project, LFS Development, LLC will be required to obtain written approval from the Executive Director of the CCC finding that the final plans for development of the Lane Field South project are consistent with the CCC’s previously issued Lane Field CDP.
Equal Opportunity Program:
Not applicable.
PREPARED BY: Jenner Smith
Program Manager, Real Estate
Attachment(s):
Attachment A: Site Map
Attachment B: Lease Information Summary
Attachment C: Proposed Final Form Lease
Attachment D: Fund Structure Diagram