CITY OF RANCHO PALOS VERDES
FINANCE ADVISORY COMMITTEE
JUNE 13, 2001
M I N U T E S
RANCHO PALOS VERDES FINANCE ADVISORY COMMITTEE
April 11, 2001
The meeting was called to order at 7:03 P.M. by Chair Butler at the City Hall Community Room, 30940 Hawthorne Boulevard, for the purpose of conducting the business pursuant to the Agenda delivered by mail to the Members. Present: Butler, Clark, Smith, Van Wagner, Wallace and Wolowicz. Absent: No one.
Roll call was answered as follows:
PRESENT: Butler, Au, Clark, Smith, Van Wagner, Wallace, and Wolowicz
ABSENT: No one.
Also present were Finance Director Dennis McLean, Accounting Manager Matt Burton, City Manager Les Evans, Director of Public Works Dean Allison, Minute Taker Teresa Takaoka.
APPROVAL OF AGENDA:
Chair Butler moved to amend the order of agenda items such that item number 7 would succeed item number 3 and item number 4 would succeed item number 6. Member Wolowicz moved, seconded by Member Au, to approve the agenda as amended.
MINUTES OF THE MEETING OF JANUARY 9, 2001:
Member Wolowicz requested that the minutes of January 9, 2001 be amended to correct the public comments regarding the proposed Long Point Resort Project (Long Pt. Project) as "being opposed to using City property for golf purposes", not to being opposed to the project itself. Member Wallace moved, seconded by Au. Motion carried.
LONG POINT PROJECT - ORAL UPDATE REGARDING NON-RECEIPT OF THE HVSI REPORT:
A draft of the report was received on April 6, 2001 and forwarded to the consulting firm retained by the City, Hospitality Valuation Services Incorporated (HVSI), for their review. Director McLean anticipates a first draft of a comprehensive report from HVSI to be completed in about two to three weeks. Chair Butler suggested that all Committee members consider meeting prior to the City Council's first meeting in May if this occurs. Members conferred and established that they are all available on April 30, 2001. Member Wallace made a motion and Member Smith seconded to meet at a Special Meeting on April 30, 2001. Motion carried.
Betty Strauss, 10 Pomegranate Road, commented about her research regarding the ownership of Destination Development Corporation, the developer of the Long Point Project.
Vi Quirarte, 29369 Quailwood, commented on statements made at the Planning Commission meeting of April 10, 2001 concerning the Long Point Project.
Gloria Anderson, 6818 Los Verdes Drive, commented on the Long Point Project.
George Gleghorn, 28850 Cestridge, commented on the Long Point Project.
Tom Redfield, 31273 Ganado Drive, commented on statements made at the Planning Commission meeting of April 10, 2001 concerning the Long Point Project.
STORM DRAIN PLAN:
Public Works Director Allison made a presentation regarding the storm drain plan of the City. Director Allison answered questions and concerns regarding funding and time constraints for repairing these projects.
DRAFT OF 2001 FIVE YEAR FINANCIAL MODEL:
Finance Director McLean gave an overview of the 2001 Five Year Financial Model (the 2001 Model). The Committee asked the Finance Director and City Manager questions and further discussed the 2001 Model. Member Wolowicz moved to accept the working draft of the 2001 Model and forward it to the City Council. He also moved to recommend to the City Council to continue the utility user tax at a rate of 3%, in light of the uncertainty of the state and national economic future, its potential impact on future revenue to the City, as well as the potential (and unknown) cost of storm drain repairs and improvements in the future. Au seconded and the motion carried.
Tom Redfield, 31273 Ganado Drive, commented on the utility user tax as well as the 2001 Model.
Gloria Anderson, 6818 Los Verdes Drive, urged Director Allison to take his storm drain presentation to the public.
There were no general public comments. All public comments had been incorporated into individual agenda items.
The meeting was adjourned at 9:02 P.M.
Chair, Finance Advisory Committee
Staff Assistant II (Minute Taker)
TO: HONORABLE CHAIR AND MEMBERS OF THE FINANCE ADVISORY COMMITTEE
FROM: DENNIS McLEAN, FINANCE DIRECTOR
DATE: JUNE 13, 2001
SUBJECT: REPORT BY HOSPITALITY VALUATION SERVICES INTERNATIONAL (HVSI) - PROPOSED LONG POINT RESORT PROJECT
Considering the length of time that has past since City staff, the public and the Finance Advisory Committee (hereafter referred to as the "FAC") has met regarding this matter, Finance Staff has provided a detail chronology herein, regarding the activities of the FAC, Finance Staff, as well as the City’s Financial Consultants in their respective roles reviewing the Proposed Long Point Resort Project (hereafter referred to as the "Resort Project").
The City’s consultant, Hospitality Valuation Services International (hereafter referred to as "HVSI"), has completed their limited study and issued their report, dated June 8, 2001. Due to the timing of its completion, Finance Staff has not had sufficient time to study its findings and conclusion. Therefore, the HVSI report stands on its own and is an attachment to this staff report.
Destination Development Corporation (hereafter referred to as the "Developer") has provided financial reports that purport that the City would receive approximately $4.7 Million of tax and fee revenue annually, in the event the Resort Project is built and operated. If so, the tax and fee revenue would be deposited into the City’s General fund, therefore, available to appropriate for normal operations of the City. Additionally, the monies could be appropriated for capital improvement projects (e.g. storm drain repairs and improvements) and/or the enhancement of program services (e.g. recreation facilities and activities).
For the sake of comparison, the total General fund revenue during FY 01-02 is anticipated to reach $12.7 Million. Therefore, the additional tax and fee revenue annually that the Developer asserts would result from building and operating the Resort Project would increase General fund revenue by nearly forty (40%) percent.
Proposed Use of Point Vicente Park for the Proposed Nine-Hole Regulation Length Golf Course
The Developers application includes the use of Point Vicente Park that surrounds City Hall, for six (6) holes of the proposed nine-hole regulation length golf course. The City has not decided to provide all of, or a portion of, the Point Vicente Park for the proposed golf course. The Planning Commission will consider this, as well as all other land-use issues, during its review while continuing its processing of the Developers application for the Resort Project. Planning Staff anticipates that the Planning Commission will complete its review leading to its recommendation to the City Council either during the month of August or September 2000.
In the event the City provides all of, or a portion of Point Vicente Park for golf, it would do so pursuant to a concession agreement between the City and the Developer. The agreement would include terms of payment for use of the City owned land, as well as protective covenants to ensure operational continuity of the golf course and other mitigation in the event the golf course ceases operation.
August 2000 - City Council Directs the Finance Advisory Committee to Review Financial Information Provided By Destination Development Corporation
The City Council directed the FAC to review the financial reports submitted by the Developer. The City Council specifically requested that the FAC review the financial reports provided by the Developer and if possible, recommend to the City Council: (1) whether or not the Developers basis for computing the projected tax and fee revenue is reliable; and (2) whether the projected revenue to the City is achievable.
August 2000 - Financial Reports Provided By Developer
As stated previously, the Developer provided financial reports prepared by Economic Research Associates (hereafter referred to as "ERA"), titled "Analysis of Fiscal Impact Long Point Development" and "Overview Analysis of Market and Economic Potentials Long Point Nine-Hole Golf Course and the Practice Range". The Analysis of Fiscal Impact Long Point Development report includes the representation that the operation of the Resort Project would generate the following annual tax and fee revenue to the City:
Transient Occupancy (TOT) Tax $3,989,906
CA Sales Tax 338,340
Utility Users (UUT) Tax 70,500
Property Tax 117,250
Golf Tax 212,500
The most significant source of the projected revenue would be derived from the City’s Transit Occupancy Tax (TOT) tax, based upon ten (10%) percent of projected gross occupancy rental revenue (commonly known as room charges). The projected gross occupancy rental revenue was based upon an Average Daily Rate (room charge) of $265. Both the projected gross occupancy rental revenue and the projected resultant TOT tax revenue were based on the Developers own assumptions, including projected Room Inventory, Occupancy Rate, Revenue Per Available Room (REVPAR) and other projected operating assumptions (hereafter referred to as the "Developers Assumptions").
August 8, 2000 FAC Meeting – Review of Financial Reports Prepared by ERA and Request for Developer’s Feasibility Studies for the Resort Project
Upon concluding its review and discussion regarding the Developers financial reports provided by ERA, the members of the FAC reached a consensus that it could not review the fiscal impact to the City without reviewing all of the appropriate feasibility studies associated with the Resort Project. The FAC requested the feasibility studies via a letter to the Developer, dated September 1, 2000. The letter also included several broad questions regarding the Resort Project to be answered before or during the Developer’s presentation during its next meeting on September 12, 2000.
September 12, 2000 FAC Meeting - Developer’s Assertion: Resort Project Is Not Feasible Without A Regulation Length Nine-Hole Golf Course as an Amenity and FAC’s Request for Additional Information
The Developer provided the FAC with a broad overview about the Resort Project during its September 12, 2000 meeting. When asked by a member of the FAC during the meeting, the Developer stated that the Resort project is not feasible without the proposed nine-hole regulation length golf course. Near the conclusion of the meeting, the Developer volunteered or members of the FAC requested the following information:
The meeting was attended by Robert Wetmore of Keyser Marston, one of the City’s Financial Consultants assisting staff during its processing of the Developers application for the Resort Project. Near the end of the meeting, Mr. Wetmore recommended that the City retain Hospitality Valuation Services International ("HVSI"), a consulting firm specialized in resort properties, to conduct a limited review the 1997 market feasibility study prepared by the Developers consultant, as well as the October 2000 update to it. Mr. Wetmore suggested that HVSI could independently attempt to answer the question whether or not golf is a necessary amenity, as well other relevant questions raised by both members of the FAC and Finance Staff, regarding the feasibility of the Resort Project.
November 14, 2000 FAC Meeting – Review and Discussion of Feasibility Information Provided By Developer And HVSI Scope of Services Letter
1997 Market Feasibility Study Regarding the Resort Project
The information volunteered or requested by the members of the FAC during its September 12, 2000 meeting was made available prior to the meeting, including the market feasibility study that was prepared for the Resort Project in 1997 by PKF Consulting (hereafter referred to as the "Developers Consultant"). It is noteworthy that the 1997 market feasibility study included the assumption that a regulation length eighteen-hole golf course would be included in the Resort Project as a necessary amenity. The Developers Assumptions (described previously in this report) were used in the preparation of both the 1997 market feasibility study, as well as the Analysis of Fiscal Impact Long Point Development report prepared by ERA.
The Developer’s pending application includes a regulation length nine-hole golf course, rather than the eighteen-hole golf course included in the 1997 market feasibility prepared by the Developers Consultant. Additionally, the Developer proposes to add a practice facility and golf learning center.
2000 Update to 1997 Market Feasibility Study
The Developer’s application to build the Resort Project includes a regulation nine-hole golf course, with adjoining practice facility and golf learning center, rather the eighteen-hole course included in the 1997 market feasibility study. As stated previously, at the request of the FAC, the Developers Consultant updated the 1997 study, titled "Summary Report on the Potential Market Demand for the Proposed Long Point Resort to be Developed in Rancho Palos Verdes, California", dated October 2000 (hereafter referred to as the "Bridge Update").
The Bridge Update appears to be silent regarding the impact on the feasibility of the Resort Project, if any, resulting from changing the Resort Project plan to include a regulation nine hole golf course, with adjoining practice facility and golf learning center, rather the eighteen hole course included in the 1997 market feasibility study, if any.
Upon request by the FAC and the City’s Financial Consultants, the Developer was directed to instruct its Consultant to consider the impact on the feasibility of the Resort Project, resulting from the changing the application to include a regulation nine-hole golf course, rather the eighteen-hole course. The Developer’s Consultant issued a letter, dated November 13, 2000, asserting the following:
"While we believe that an 18 hole course at the subject site [Long Point] would be preferable, a high quality nine hole course with an ocean orientation, driving range and learning center should be strong enough amenity for the hotel to enable it, along with its other attributes, to compete in the regional marketplace. It should be noted, however, that the aforementioned nine hole course would be a minimum to allow the property to compete effectively."
The November 13, 2000 letter (hereafter referred to as the "Nine Hole Update", did not include any statements whether or not any quantitative research was conducted to support the assertion that the Resort Project, with a regulation length nine-hole golf course, is feasible.
Scope of Services To Be Provided by the City’s Consultant, HVSI
The first draft of the HVSI Scope of Services letter was prepared by Mr. Wetmore of Keyser Marston, one of the City’s Financial Consultants for the Resort Project. Finance Staff presented the proposed HVSI Scope of Services letter to the members of the FAC during its November 14, 2000 meeting. Upon completion of the presentation, the members of the FAC made several suggestions, including several questions that should be asked of, and answered by HVSI, regarding the feasibility of the Resort Project. Several noteworthy excerpts included in the HVSI Scope of Services letter (attached to this staff report) follow:
"The issue that the city has raised is whether the use of the public land for the 9 hole golf facility is necessary for project feasibility. (Note: Within this context, "feasibility" refers to market feasibility rather than to financial feasibility testing in respect to development cost, rate of return, etc.). The range of response could be, as examples:
We would anticipate that a fundamental approach would be identification and evaluation of comparable projects.
The HVS report should specifically address these questions:
As discussed during the November 14, 2000 FAC meeting, Finance Staff does not feel it is necessary to review the Developer’s business plan, especially private business data (i.e. cost of land, mix of investment capital and debt financing, expected return on investment and profit/loss sharing). In accordance with the terms and conditions of a confidentiality agreement entered into between HVSI and the Developer, HVSI reviewed necessary financial projections and other available information prior to issuing its report, dated June 8, 2001 (attached to this staff report).
January 16, 2001 City Council Meeting – City Council’s Direction To Developer And City’s Consultant (HVSI)
During the January 16th meeting of the City Council, Councilmember Stern presented a staff report that included a recommendation to direct the FAC to analyze the financial implications to the Resort project resulting from the elimination of Resort Villas, Casitas and/or other facilities from the Resort Project. After completing its discussion, the City Council acted as follows:
The Developers Consultant shall conduct a financial analysis (and HVSI shall review the analysis) regarding the financial impact resulting from the elimination of Resort Villas, Casitas and/or other facilities from the Resort Project.
This request substantially pushed back the timeline for completion of the HVSI study. The additional time necessary for the Developer to complete the financial analysis requested by the City Council caused postponement of the date HVSI could conduct its review of the Developers Assumptions and financial projections at the offices of the Developer. It was not possible to package and ship all of its underlying records that were used to develop the Developers Assumptions and financial projections to the offices of HVSI. Nor would it have been prudent for the Developer to do so.
Therefore, both HVSI and the Developer, with Finance Staff’s concurrence, agreed to postpone HVSI’s site review of the underlying supportive information that was an integral part of the Developers Assumptions and financial projections. It was not cost-effective for HVSI to conduct the office review before and then again, after the Developer’s completion of its analysis of the financial implications resulting from the elimination of Resort Villas, Casitas and/or other facilities from the Resort Project. The office review was conducted by HVSI on May 9th.
FINDINGS AND RECOMMENDATION:
The report of HVSI’s findings, dated June 8, 2001, is attached hereto and made a part of this staff report. HVSI was under extreme time pressure to complete the attached report prior to this meeting, hence, the findings contained in the report might require amplification. The City’s Consultants are available to answer any questions the members of the FAC may have.
The Primary Questions Before the FAC
The primary purpose for of the review conducted by HVSI was to answer the primary question:
Whether the use of the City’s public land for the 9-hole golf facility is necessary for project feasibility?
HVSI’s opinion is included in the accompanying report.
Several Alternatives For The FAC To Consider:
Based upon HVSI’s answer (or non-answer) to the above question, as well as the other six questions contained on page 2 of the HVSI Scope of Services letter, Finance Staff recommends the members of the FAC consider all, or several of the following:
Finance Staff seeks direction from the FAC regarding how to proceed with the Committee’s review of the Resort Project. A Special Meeting of the FAC has been set for June 27, 2001, to be held in the Multi-Purpose Room at Hesse Park, beginning at 7:00 P.M. to enable the FAC to continue its review. Finance Staff anticipates the FAC will desire to continue the matter to the July 11th regular meeting of the FAC. Finance Staff stands ready to set additional Special Meetings of the FAC during the Summer to enable the FAC to complete review of the Resort Project and make a recommendation to the City Council during the month of August or September coinciding with the expected timeline of the Planning Commission.
June 8, 2001Mr. Robert J. Wetmore Vice President Keyser Marston Associates, Inc. 55 Pacific Avenue Mall San Francisco, California 94111 (415) 398-3050 (415) 397-5065 FAX
firstname.lastname@example.org Mr. Dennis McLean Finance Director City of Rancho Pales Verdes 30940 Hawthorne Blvd. Rancho Palos Verdes, California 90275 (310) 544-5212 (310) 544-5291 FAX email@example.com
Re: Long Point Resort - Rancho Palos Verdes
Dear Mssrs. Wetmore and McLean:
Pursuant to your request, we herewith submit our conclusions regarding the Long Point Resort, as proposed for development by Destination Development Corporation (Destination Resorts) at the Marineland Aquatic site in Rancho Palos Verdes.
Subject of the Consulting Assignment
The subject of this consulting assignment is the proposed full-service, luxury Long Point Resort and Golf Course. The proposed Long Point Resort has been designed to contain a total of 550 rentable units, comprised of 400 standard guestrooms and 50 casitas (with each casita divisible by three keys). Additionally, the proposed facilities include 32 villa units that would be sold off to individual investors and placed in a rental pool for hotel use. The site is expected to contain several indoor and outdoor food and beverage outlets, ±45,000 square feet of functional meeting space and 14,000 square feet of prefunction space, a full-service spa and fitness center, a regulation-length nine-hole golf course and practice facility, and several outdoor swimming pools and viewing decks. The site of the proposed resort is located in the city of Rancho Palos Verdes, California, and is situated on a cliff that offers dramatic views of the Pacific Ocean and the rugged Southern California coastline.
Assignment Objective and Overview
HVS International was retained by Keyser Marston Associates, Inc., as a subconsultant to provide consulting services to the city of Rancho Palos Verdes pursuant to an engagement letter dated December 15, 2000. The original scope of the assignment was to review PKF reports and, based upon the information and analysis contained therein, comment as to the reasonableness of the occupancy and average rate projections and to opine on the necessity of a nine-hole on-site golf course to render the proposed resort feasible.
During the course of our work, the objective of the assignment was expanded to include reviewing development pro formas prepared by Destination Resorts and rendering an opinion of the reasonableness of the pro formas and the resultant internal rate of return conclusions. Pursuant to a city council meeting on January 16, 2001, Destination Resorts prepared eight alternate development scenarios. The "base-case" scenario assumes that all 550 units are developed, as well as an additional 32 villas to be sold off to investors and placed in the hotel’s rental pool. A second scenario assumes the full complement of hotel rooms and villas, but with underground parking to conserve land. A third scenario assumes that the some of the east casitas are eliminated from the project, while the remainder of the east casitas are moved to another portion of the site, resulting in a 442-room hotel plus the villas. The forth scenario assumes that the east casitas are eliminated in their entirety, resulting in a 400 room hotel, plus the villas. These four scenarios were then each rerun assuming the elimination of the 32 villas, resulting in a total of eight development scenarios.
In order to assess the feasibility of the project under these scenarios, ERA was engaged by Destination Development Corporation to analyze the market support for the Long Point Resort Villa Project and to estimate likely unit pricing and sales pace for the 32 villa units. ERA’s findings are set forth in a report dated May 2001. PKF was also retained in a subsequent study to perform additional analysis to determine the impact on the hotel’s occupancy and average rate if the 150 casita rooms were eliminated from the development. PKF’s findings are set forth in a letter addressed to Michael Mohler of Destination Development Corporation dated April 2, 2001.
Based upon the findings of ERA and PKF, Destination Resorts prepared income and expense projections for the proposed hotel and golf course operations, as well as the villa development’s, sales and ongoing rental-pool operation. These projections then formed the basis for Destination Resort’s development pro formas setting forth the project’s projected internal rate of return, on both a leveraged and unleveraged basis. The leveraged internal rates of return, or projected equity yield, form the primary basis for our feasibility conclusions.
Scope of Work
During the course of this consulting assignment, we have completed a inspection of the subject site; met with both city officials and members of Destination Resorts; reviewed both the July 1997 and October 2000 studies of potential market demand, as well as the April 2001 letter prepared by PKF Consulting; reviewed the ERA May 2001 report, met with members of the development team (Destination Resorts) and their consultants (PKF Consulting); reviewed in detail Destination Resorts’ original eight development pro formas, as well as the results of an additional 64 development pro formas based upon varying assumptions and prepared at our request. Our work also entailed reviewing relevant information from our in-house database as it pertains to determining the reasonableness of the projections set forth in the most recent study set forth by PKF Consulting.
Specific Questions of the Original Study
As outlined in the original engagement letter, dated December 15, 2000, the consultants were asked to specifically address six questions regarding the proposed project. In the following text, each question is presented, followed by the response by HVS International.
In order to answer this question, HVS International reviewed both the 1997 and 2000 market studies presented by PKF Consulting, as well as data from our in-house databases. The consultants also requested additional information from PKF Consulting, regarding a more detailed analysis of the contribution of occupancy and rooms revenue provided by the various components of the proposed development (i,e., standard hotel rooms and casitas). Upon request, PKF Consulting provided detailed projections regarding the contribution of the standard hotel rooms and casitas and their relationship to the proposed subject property’s occupancy and average rate.
The average rates set forth in the PKF report forecast an average rate for the proposed Long Point Resort of $285 in 2000 dollars. PKF inflates the average rate by 3.0% per year throughout the analysis, resulting in the following average rate and occupancy forecast, assuming the resort was to open on July 1, 2003.
PKF Occupancy and Average Rate Projection
The income and expense pro formas prepared by Destination Resorts were based upon the following occupancy and average rates, assuming an opening date of January 1, 2005. The projected average rates expressed in 2000 dollars are set forth for comparison purposes.
Destination Resorts Occupancy and Average Rate Projection
Both the PKF and Destination Resorts projections stabilize at the same occupancy and average rate, but differ in terms of the pace at which stabilization will be achieved. PKF’s 2003 forecast is for a partial year (six months), which accounts for most of the difference in the first year’s occupancy levels. We note that PKF does not forecast a buildup in average rate to stabilization, while the Destination average rate assumes a discounting of rates during the initial years of operation. Based upon our understanding of new resort hotel operations, the current economic environment, as well as the level of stabilized average rate projected, it is our opinion that discounting of average rate during the initial years of operation will likely be a required course of action. Since we are commenting on the appropriateness of Destination Resorts’ development pro formas, we will comment on the reasonableness of their projected occupancy and average rate, as opposed to those projected by PKF.
Based on the information available, it is our opinion that the projections of occupancy and average rate set forth by Destination Resorts are reasonable, assuming that the current facilities plan for the proposed resort remains intact, including the nine-hole golf course, meeting space, spa, and proposed room inventory. No projection of occupancy and average rate were prepared by PKF or Destination Resorts assuming that the resort was built without the nine-hole golf course, so there was no comparative analysis for us to assess.
HVS International has reviewed the actual operating results of several comparable properties located in the Southern California region, including those listed as competitors in the PKF study. The projected average rate of the proposed development are comparable to the rates being achieved by other leisure and group-oriented destination resorts in the region.
The comparable properties described in the PKF market study (Four Seasons Biltmore, Four Seasons Aviara, Ritz-Carlton Laguna Niguel, Hotel Del Coronado, La Costa Resort and Spa, Ojai Valley Inn, and Loews Santa Monica) are group- and leisure-oriented, full-service properties (with the exception of the Loews Santa Monica, which has a significant commercial demand component) and are generally considered to be the premier meeting and group destinations in the Southern California region. While each of the properties differ slightly from one another in terms of their age, quality of improvements, quality of service, and location, each comparable property offers a unique amenity (i.e. the sweeping ocean views at the Ritz-Carlton Laguna Niguel or the world-class golf facilities at the La Costa Resort and Spa) that allows for its inclusion in this top-tier of meeting and group destinations in the region. Appropriately excluded from the analysis are the higher-rated boutique and golf resorts in Southern California, which obtain average rates in excess of $400, and the lower-rated resorts such as the Loews and Marriott resorts on Coronado, which attained a combined average rate of $185 in 2000.
Based on the unique location and dramatic views afforded by the subject’s location as well as a review of the proposed improvements of the subject site, including the proposed amount of meeting space and the nine-hole golf and practice facility, it is our opinion that the proposed subject property would have sufficient appeal to compete among the hotels described as comparables in the PKF market study.
Without the inclusion of the golf component of the proposed resort development, it is unlikely that the proposed subject property can achieve the occupancy projections set forth in the PKF study within the time frame presented in the report. This is not to say the development of a meeting-and-group-oriented resort is not suitable for the subject site. Rather, without an amenity such as a golf facility, it would likely take longer for the resort to develop the strong base of meeting and group demand required to successfully penetrate the market, which would potentially render the project unfeasible at this time. As support for this statement, HVS points to several resorts that were developed on Coronado Island (in San Diego County), the early operating histories of which reflect that which could be expected of the subject property in the absence of a golf facility. Both the Loews Coronado Resort and the Coronado Le Meridian (now the Marriott Coronado Resort) offer high-quality hotel improvements and feature spectacular waterfront views and well-designed meeting-and-group facilities. However, without true recreational and leisure amenities (such as the golf facility at the subject property) these resorts took several years to successfully penetrate the Southern California meeting and group market. It should be noted that both of these resorts are now achieving healthy market penetrations, but it took several years longer than similarly positioned competitors that offer golf or some other unique recreational amenity.
To illustrate the difference in average rate attainable by hotels without a golf course as compared with those of hotels with a golf course, we point to the actual performance of four resort hotels, all with a leisure and group meeting mix of business similar to that anticipated for the subject. The Loews Coronado and Marriott Coronado hotels, neither of which has an on-site golf course, attained a composite average rate of $185 in 2000. Contrast this rate with those attained by the Four Seasons Aviara Resort and the Ritz-Carlton Laguna Niguel, which averaged $312 in 2000. While the Ritz-Carlton does not have a golf course on site, it is marketed in conjunction with a separately owned golf course across the street. We also note that Four Seasons and Ritz-Carlton are luxury brands, while Loews and Marriott are considered to be upscale brands. The Destination Resorts brand is generally viewed as falling between the luxury niche and the upscale niche. The subject property will not have an established luxury brand identity, but it will have a unique location in the Los Angeles area with access to a densely populated area of potential corporate and individual consumers. The subject’s proposed average rate of $285 in 2000 dollars is only $27 below the composite average rate of the Ritz-Carlton and the Four Seasons. It is extremely difficult to make an objective analysis of the facilities, amenities, location, and market orientation of the competitive resorts to discern the impact of replacing an 18-hole golf course with a nine-hole course, or omitting an on-site golf course altogether. It is the general consensus of the consultants that the subject site offers a unique, superb opportunity to develop a resort within the greater Los Angeles area. We know that the presence of a marketable golf course enhances average rate and occupancy, and thus the overall feasibility and financibility of the project. While an 18-hole golf course would obviously be preferred, the physical constraints of the site make a regulation length nine-hole course (that can be played as 18 holes back-to-back) a worthy alternative. With the subject’s extraordinary location and views it is our opinion that even a nine-hole golf course would become an attraction that would enhance the overall resort ambience of the operation considerably.
Based on current market observations, it is unlikely that the performance of the proposed subject property will be negatively impacted to a significant degree by the decision to offer a nine-hole golf facility rather than an 18-hole facility. Given the views afforded by the oceanfront location of the proposed golf course facility, it is likely to be an attractive amenity even though it only offers a nine-hole layout. There are also advantages to offering a nine-hole layout (as opposed to an 18-hole layout) at a meeting-and-group meeting oriented resort. Specifically, a nine-hole course takes less time to play, so the property is likely to get higher golf participation from its group meeting guests who would only require a few hours of free time to play the course. This is in direct comparison to the estimated five hours required to play 18 holes at a normal resort course. Additionally, the proposed subject property will be able to offer a golfing experience at a lower price point than the subject’s competitors with 18-hole facilities. Ultimately, these two factors (less time requirements and a lower price for the golf experience) afforded by the golf amenity are likely to allow for the proposed subject property to more effectively penetrate the meeting and group market segment. Clearly, an adjacent 18-hole course would be preferable in terms of building consumer awareness—that is, to provide a stimulus for rapid market penetration and to maximize the resort’s average rate. However, it is our opinion that a resort with a nine-hole course will perform at a level closer to that of one with an 18-hole course than to one without any course at all.
It is our opinion that a further reduction in the scope of the proposed golf amenity would have a negative effect on the viability of the proposed subject property. While the previous response details our opinion as to the acceptability of a nine-hole course versus an 18-hole course, it is likely that a par-three course, or executive course would not offer a golf experience commensurate with the needs of the typical resort guest. Additionally, it is our opinion that a limited-scope golf amenity would likely have less appeal to local golfers, thus having a negative impact on the overall viability of the resort development. Again, the nine-hole golf course, while not as beneficial to the resort operation as an 18-hole golf course, still provides an attractive resort amenity that will facilitate the marketability of the proposed subject property.
The Ocean Trails development offers a unique opportunity for the operators of the proposed resort property to provide its guests with a high quality, 18-hole golf experience at a location that is within a ten-minute drive of the subject property. While it is our opinion that the existence of Ocean Trails will likely enhance the operation of the proposed resort, it is not a strong enough amenity to attract sufficient demand to the subject property in the absence of an on-site golf facility. The Ocean Trails golf course should be viewed as providing an additional amenity to resort guests, assuming that the currently proposed facilities are developed (including the nine-hole golf facility).
Assuming that the nine-hole golf facility is not developed as part of the subject resort, and that the developers are able to gain the cooperation of the owners of Ocean Trails in forming some marketing and packaging alliances, the Ocean Trails facility is not close enough to the resort to offer a seamless resort and golf experience. In our opinion, this would potentially limit the effectiveness of any joint marketing efforts. Ultimately, this would have a detrimental effect on the overall viability of the proposed subject property.
Review of Development Scenarios
As previously discussed, HVS International was asked to review the developer’s original eight development pro formas in order to render an opinion regarding the reasonableness of the internal rates of return. The scenarios provided by the developer presented an economic analysis of the proposed resort, golf facility and proposed villas, into a total project financial internal rate of return calculation.
For each of the eight scenarios outlined earlier in the Assignment Objective and Overview, the developer presented detailed financial projections, as well as a calculation of the internal rates of return, on both a leveraged and unleveraged basis. Destination Resorts assumed a 9% interest rate and a 50% loan-to-value ratio for both the construction loan and the permanent loan. While these loan-to-value ratios are at the low end of the typical range, we find that they reflect the norm for financing large projects such as the subject in today’s capital-constrained environment.
The following charts set forth the internal rate of returns derived from original development pro formas provided to HVS. The leveraged return is the internal rate of return on equity, while the unleveraged return is the discount rate that equates operating cash flow (i.e., net income before debt service and a return on equity) to the total invested capital (i.e., the total project cost). The leveraged rate of return is what is critical in this analysis because that is the benchmark or hurdle rate they upon which they base their investment decisions. The calculations presented by the developers provided the following results.
Internal Rates of Return – Eight Original Scenarios
Based upon our experience with hotel investments we find that investors generally require internal rates of return on equity in the range of 20% to 25%, with returns at the mid to higher end of this range required for proposed hotels with development risk. Only one of the scenarios set forth above generates returns above 20%. The base-case scenario, assuming development of 550 units and the 32 villas with surface parking, is the only scenario that generates an internal rate of return in excess of 20%. Given the current environment for financing new hotel development, these internal rates of return conclusions are not surprising. It is extremely difficult to render new full-service hotels, and particularly resort hotels of the subject’s caliber, feasible at any time, but even more so in the current investment environment. While interest rates are relatively moderate, the limited availability of construction and permanent financing requires a significant amount of equity capital for a project such as the subject to reach fruition. The debt that is available is at low loan-to-value ratios by traditional standards, reducing the ability to leverage equity into rates of returns in the low to mid 20s.
The internal rates of return on equity are reduced to an inadequate level when the higher-rated casitas are eliminated from the project or reduced in number. PKF estimates the average rate for the casitas at $370, as opposed to $253 for the standard rooms. With a reduced number of casitas or no casitas at all, the average rate is lowered to a point that does not sustain the development. Occupancy is also estimated to be two percentage points lower without the inclusion of the highly desirable casitas, resulting in a 15% reduction in the resort’s overall revenue without the casita units. The internal rates of return in the scenario assuming underground parking are reduced to an inadequate level, due to the increased cost of construction. Elimination of the villa units also reduces the internal rates of return to inadequate levels due to the absence of profit from sale of the units as well as on-going villa management revenue.
The assumed 50% loan-to-value ratio for both the construction loan and the permanent financing at a 9.0% interest rate appear to reasonable assumptions given the current market for hotel financing. With interest rates trending downward, and the possibility that when the developer is ready to obtain permanent financing loan-to-value ratios will have likely improved, we requested the developer to prepare additional scenarios based upon an 8.5% interest rate and loan-to-value ratios for the permanent debt of between 60% and 75%, to see what the impact was upon the equity returns if a lower interest rate and higher loan-to-value ratio were obtained. We also requested that the analysis be performed over an assumed ten-year development and holding period. The developer also provided us with another set of comparable scenarios, assuming sale of the asset as of the date of operational stabilization, which they indicated more accurately reflected the norms required by their equity investors. The internal rate of returns varied for the scenarios assuming sale upon stabilization, but the yields never reached a level high enough level to make a difference in our conclusions. A matrix setting forth the internal rates of return, as provided by Destination Resorts for the additional scenarios, are presented as an attachment to this letter. The following chart sets forth the internal rate of return calculations considering the additional loan-to-value ratio scenarios and an 8.5% interest rate for the permanent debt.
Internal Rates of Return - Additional Scenarios – 8.5% Permanent Loan
The internal rates of return generated for the additional scenarios were not materially different from those generated for the original eight scenarios. The additional holding period appears to have offset the higher loan-to-value ratios for the permanent loan. It is likely that the only variable that would significantly increase these rates of return would be the assumption of a higher loan-to-value ratio on the construction loan. We did not feel that it was appropriate to request such a scenario because we cannot see a return to higher loan-to-value ratios for construction loans of this magnitude for some time to come. We are at the end of the current development cycle for hotels and it will likely be several years or more before we see a favorable financing environment again. Predicating development of this project upon the opening of what are historically short windows in time for favorable hotel financing would render the completion date of this project difficult to predict. Missing the current development opportunity may set the project back for a number of years.
The HVS International review of the additional materials can be summarized in a discussion of the following four questions:
1. Is the proposed project, as currently designed, appropriate for the market?
It is our opinion that the proposed project, as currently designed, offers a complement of amenities that are appropriate for the current destination resort market in Southern California. While the subject site offers a unique and dramatic location, it would be difficult for the proposed subject property to successfully penetrate the market without a strong amenity base, such as the golf facility; the spa facility, which was not specifically addressed in this review; and the planned meeting, restaurant, and catering facilities.
In addition, the proposed development needs to be considered as a viable project from a financing perspective. In the current debt and equity market, capital is both very difficult to find, and becoming more expensive. Debt and equity sources are currently looking for projects that are financially sound, located in strong markets, and offer an amenity base that provides the property with a more diverse demand of base. The proposed resort, as currently designed, is likely to be more attractive to the capital markets, and ultimately more financeable, than if the proposed resort’s amenity base were reduced through the reduction of the golf facility’s scope, the elimination of the villas, or the removal of the casitas.
2. Do the development costs in the analysis appear reasonable?
HVS International reviewed the development cost estimate of the proposed resort, as prepared by Swinterton & Wahlberg, Inc., the contractor of record for the proposed subject property. Based upon our recent experience with several resorts under development the projected construction costs appeared reasonable; however, we note that we are not construction cost experts and the complexity of this project warrants advice from a professional cost estimator.
3. Do the operating projections as presented in the analyses appear reasonable?
A comprehensive review of the operating projections of the proposed subject property was completed on May 9, 2001. Upon review of the financial projections, HVS International concluded that the projections appeared reasonable. Based on knowledge gained in previous assignments concerning similar resort properties, the projected departmental expenses, undistributed operating expenses, fixed expenses, and overall profitability projections were in line with similar resort properties. We asked Destination Resorts a number of questions regarding the income and expenses, and were given very sound detail and reasoning leading us to believe that the pro formas were prepared in a thoughtful, accurate and reasonable manner.
4. Do the returns, as calculated by the developer, appear correct and reasonable?
The forecasts of income and expense for the hotel and golf course have been reviewed and are considered to very reasonable and in-line with actual income and expenses for comparable properties. The developer’s financial analyses under each scenario are comprehensive, accurate, and reasonable. As such, the calculations of the internal rates of return previously presented are considered to be well supported.
The developer’s operating projections and internal rate of return calculations are reasonable and supportable. It is our opinion that the proposed subject property, as currently designed (including the nine-hole golf facility and 32 villas), represents the most viable product for the subject site from the perspective of both market and financial feasibility. None of the additional development scenarios generated an internal rate of return adequate to attract the enormous amount of equity capital required to finance this project. The average rates for the project already appear to be at the upper end of the supportable range, and thus we feel that the developer is assuming a degree of operational risk in addition to development risk. The project will likely not attract equity and debt financing without the additional amenity of a regulation length nine-hole golf course. If the goal of the city is to preserve, at minimum, the portion of Point Vicente Park lying between Villa Capri and City Hall, then perhaps it might make sense to request that the developer see how they can reconfigure the project to maintain the golf course and as many of the casitas and villas as possible to maximize return on investment, while freeing up that portion of the city’s land. However, it appears from the financial analyses presented thus far that little room exists for such a reconfiguration of the project.
It has been a pleasure performing this consulting assignment for you. If you have any questions or concerns regarding this matter or the content of this letter, please do not hesitate to contact us.
Very truly yours,
Division of M&R Valuation Services, Inc.
Brian K. Rodgers
Assistant Vice President
Suzanne R. Mellen, CRE, MAI
OREA # AG003225
FINAL – A SIGNED COPY OF THIS LETTER MY BE VIEWED AT CITY HALL
TO: HONORABLE CHAIR AND MEMBERS OF THE FINANCE ADVISORY COMMITTEE
FROM: DENNIS McLEAN, FINANCE DIRECTOR
DATE: JUNE 13, 2001
SUBJECT: 2001 FIVE-YEAR FINANCIAL MODEL
Staff Coordinator: Kathryn Downs, CPA, Financial Consultant
April 11th FAC Meeting – Review Of 2001 Five Year Financial Model And Recommendation To The City Council
The Finance Advisory Committee ("FAC") reviewed the first draft of the 2001 Five Year Financial Model ("2001 Model") at its meeting on April 11, 2001. Upon conclusion of its review, the FAC acted to: (1) accept the 2001 Model: and (2) forward it to the City Council with a recommendation to continue the utility users tax at a rate of 3%, in light of the uncertainty of the state of the national and state economic future, its potential impact on future revenue to the City, as well as the potential (and unknown) cost of storm drain repairs and improvements in the future. During the meeting, the members discussed the possibility of reviewing the 2001 Model at a later date.
May 1st City Council Meeting – Significant Revisions To The 2001 Model
The 2001 Model was revised subsequent to the FAC’s April 11th review as follows:
The City Council further directed staff to clearly explain in the Budget Document that the monies transferred to the newly created funds are not appropriated for spending until the City Council approves appropriate CIP projects. The City Council has the discretion to transfer back the monies from the Roadway Beautification fund and Utility Undergrounding fund at any time, subject to a majority vote of the City Council.
Summary Of Other Significant General Fund Changes In The 2001 Model Subsequent To The FAC’s Review And Recommendation To The City Council During Its April 11th Meeting
During the course of completion of the FY 01-02 and FY 02-03 Budget Document, Finance Staff made several refinements, based upon new information provided from state, county and internal sources. Most of the revisions were immaterial, except for the changes directed by the City Council (described in the previous section), as well as several increases and decreases of General fund revenues and program expenditures. A summary of the material changes in the General fund follows on the subsequent page of this report.
Format of the 2001 Model
The 2001 Model includes the presentation of revenue, expenditures and ending fund balances for all funds for the FY 98-99 and FY 99-00. The financial statements for FY 98-99 and FY 99-00 were audited by the City’s independent auditors, who expressed an unqualified (clean) opinion regarding the fair presentation of the statements. Estimates of revenue, expenditures and ending fund balances are presented for the current fiscal year that will end June 30, 2001. The first two years of the 2001 Model include estimates of revenues, expenditures and ending fund balances based on the "working draft" of the budget. The remaining three years of the 2001 Model through FY 05-06 are based upon the assumptions described forthwith.
Significant Assumptions Considered during the Preparation of the 2001 Model (Unchanged):
The following assumptions (remained unchanged) and were used in the preparation of the 2001 Model: