August 17, 2004

SUBJECT:  Disposition and Development and Owner Participation Agreement with Fourth Quarter Properties XLVIII, LLC.

REPORT IN BRIEF

On December 2, 2003, the Redevelopment Agency designated practically all of Block 18 (Town Center Mall site) of the Downtown Specific Plan as a Master Development Area, and directed staff to solicit proposals for its redevelopment from current and prospective property owners. On April 27, 2004, the Agency selected as Master Developer for the site Fourth Quarter Properties XLVIII, LLC, a development entity formed by Forum Development Group and Lehman, ALI.

This report recommends that the Redevelopment Agency enter into the attached Disposition and Development and Owner Participation Agreement (DDOPA) with Fourth Quarter Properties. The DDOPA will require Fourth Quarter Properties, among other things, to: demolish the Mall, the former J.C. Penney building and the Mathilda Avenue parking deck; construct and operate an open-air mixed-use development, containing retail, office and residential uses; build, maintain, repair and replace certain public parking structures; build, maintain, repair and replace certain public streets; and build, maintain and replace a “Redwood Square” of at least 0.8 acres. The DDOPA obligates the Agency to pay Fourth Quarter $800,000 as its share of the demolition cost of the Mathilda Avenue parking deck.  The DDOPA also provides for Fourth Quarter to receive payments equal to all of the net new secured property tax generated by this specific development (“project tax increment”) up to a cumulative annual cap of $4.0 million, plus 50% any amount of over $4.0 million. When and if the property is sold by Fourth Quarter, the cumulative annual cap is reduced to $3.8 million, plus no share of any amount over $3.8 million. (At the time of preparation of this draft report, the concept of a cap was still under discussion between the Agency and the developer.) The DDOPA also provides for an exchange of land in equal amounts between the developer and the Agency, such that the Agency will own the land under the public streets and public parking structures.

The Redevelopment Agency of the City of Sunnyvale was established pursuant to provisions of the community redevelopment laws of the State of California by a resolution of the City Council on November 19, 1957. The Agency oversees only one redevelopment project, the Central Core Redevelopment Project. The area of the project is 184 acres, representing one percent of the area of the city and half of one percent of the city’s total assessed property value. 

Under California law, redevelopment agencies are granted two powers not otherwise available to cities:

·         Power to acquire property for the purpose of resale to a private developer, utilizing eminent domain if necessary.

·         Tax increment financing, whereby all increases in property tax (including portions that would normally go to the county, school districts and special districts) flow to the redevelopment agency for the sole purpose of paying back funds borrowed for land acquisition and public infrastructure improvements.

The primary activity of the Agency since its formation was to assist in the development of the Town Center Mall. On March 1, 1978, the Agency entered into a Construction, Operation and Reciprocal Easement Agreement (REA) with the Mall developer (Sunnyvale Town Center Associates, a limited partnership formed by Ernest W. Hahn, Inc.), Macy & Co., and Montgomery Ward; in 1995, the REA was amended to include J.C. Penney. Among the obligations of the Agency through the REA was the responsibility to construct the parking deck along Mathilda Ave.

In 1977, $16,800,000 of tax allocation bonds were sold to fund the acquisition of property, relocation, demolition and public improvements. Sunnyvale Town Center Associates subsequently purchased a portion of the site from the Agency for $5,500,000, and that amount of bonds was defeased. The bonds were twice refinanced. The current outstanding loan balance is $7,960,000. The debt service is fully covered by current tax increment receipts; the debt is scheduled to be retired in 2023.

Also in 1977, two issues of lease revenue bonds totaling $22,300,000 were sold to construct the parking deck along Mathilda Avenue. These bonds were twice refinanced. The current outstanding loan balance is $14,965,000. The debt service is fully covered by Agency loan repayments to the City, which payments are in turn fully covered by the Agency’s current tax increment receipts; the debt is scheduled to be retired in 2023.

Town Center Mall opened on September 26, 1979. After many years of apparently successful operation, Sunnyvale Town Center Associates decided to sell the property. On July 9, 1998, American Mall Properties (AMP) became the new owner. AMP proposed to expand the Mall, by adding 205,000 square feet of new retail space in an outdoor appendage extending to Mathilda Avenue along the McKinley Avenue alignment (extended); it also proposed to add an entertainment component in the form of a 4000-seat, 20-screen movie theater. On March 11, 1999, the City Council approved the expansion plans of AMP, and on December 3, 1999, the REA was amended to accommodate the AMP expansion plan. A major part of the amendment dealt with a land “swap” between the Agency and the developer, wherein the Agency deeded to the developer 5.33 acres of property, including certain properties fronting on Mathilda Avenue and approximately 1/3 of the parking deck centered roughly along the alignment of McKinley Avenue (extended); the developer deeded to the Agency 4.07 acres of property on the Sunnyvale Avenue side of the property where two new parking garages were planned, and paid the Agency $1,495,000, for the difference in the amount of land exchanged. (This amounted to approximately $27/sq.ft. for the 1.29 acre difference in the land exchange.)

In late 2002, American Mall Properties completed construction of the public parking structure at Sunnyvale and Iowa, funded by Mello Roos Community Facilities District Act Bonds. The debt service on these bonds is paid by the developer through a special property tax which is secured by a lien against the Mall property. Although AMP began some initial demolition of the parking deck and utility relocation, it was unable to proceed with implementation of the approved project due to difficulties in signing retail leases and bankruptcy of their primary lender, Finova. The Finova loan was purchased by San Diego National Bank, which, on May 14, 2002, recorded a Notice of Default against AMP. The default resulted in appointment by the court of a receiver, James Baron, who has since operated the Mall. On June 30, 2002, AMP defaulted on a payment of the Mello Roos bonds and foreclosure proceedings were initiated on behalf of the bond holders. On September 24, 2002, AMP filed for bankruptcy protection. AMP had been negotiating with Harvest Partners of Dallas, Texas, for Harvest to purchase and redevelop the Mall. That deal fell through, presumably because Harvest believed that it could acquire the property more cheaply and free and clear of liens if it purchased it through the bankruptcy sale. In the meantime, on January 18, 2003, the J.C. Penney store closed and the property was purchased by Harvest. Subsequently, Lehman ALI, who had a lesser loan on the Mall, acquired the major loan from San Diego National Bank.

On June 2, 2003, the Chief Building Official ordered that the second level of the parking deck along Mathilda Avenue be closed for safety reasons, noting that the structure “is rapidly approaching the end of its useful, safe life”. Attorneys for AMP immediately filed papers with the Agency, alleging that the Agency is responsible, under the REA and a related Parking Lease Agreement, for the repair and replacement of the parking structure. The Department of Public Works estimated that it would cost $15 million to replace the deck in kind (because the Agency owns only approximately 2/3 of the structure, its share of the replacement cost would be about $10 million). Such reconstruction, however, would be contrary to the desire of the developer and of the City to extend McKinley Avenue into Block 18; the more appropriate replacement of 2,400 parking spaces in an above ground structure would cost more than $30 million.

On December 2, 2003, in recognition of the many challenges facing the redevelopment of Block 18 (which challenges included multiple ownership of significant parcels within the block, the deteriorated condition of the parking deck, and the bankruptcy and closure of the Mall), the Agency designated all of Block 18 (except for the Bank of the West property) as a Master Development Area, and directed staff to solicit proposals from owners of property in the Master Development Area and from those who have contracts for purchase of property in the Area. Agency staff transmitted a Request for Proposal to all of the parties designated by the Agency, as follows:

          American Mall Properties

          Federated Department Stores

          Target Corporation

          Harvest Partners

          WHL Architects

          Forum Development Group

One proposal was received, from Fourth Quarter Properties XLVIII, LLC, a development entity formed by Forum Development Group and Lehman ALI. After thorough review of the qualifications and experience of the members of this development entity, and their ability to implement a large and complex mixed-use project, the Agency unanimously acted on April 27, 2004, to select Fourth Quarter Properties as Master Developer for the subject site. (By the time the Master Developer was selected, Lehman ALI had acquired the WHL Architects Building and the former J.C. Penney building from Harvest, giving Fourth Quarter Properties control over all of the private parcels needed to implement its proposal.) An Exclusive Negotiating Rights Agreement was executed between the Agency and Fourth Quarter Properties, and staff was directed to negotiate a business agreement whereby the project could be successfully developed.

Implementation Plan, Sunnyvale Central Core Redevelopment Project:

Goal 1 Meet the Agency’s Existing Financial and Administrative Obligations.

Objective 1.5 Continue to invest in downtown and encourage and nurture private investment in commercial developments.

Goal 2   Establish the downtown as the cultural, retail, financial and entertainment center of the community, complemented by employment, housing and transit opportunities.

Objective 2.1 Establish a 24-hour downtown with Class A office buildings around a vibrant retail district with easy parking and public transportation and easy access from a variety of housing types.

Objective 2.2 Continue public/private partnerships in the development of office, retail, housing, hotel and open space facilities.

Objective 2.3 Create a unique shopping, dining, entertainment experience in Downtown, combining new restaurants with small shops, major retail stores and theatre with easy, available parking and strong pedestrian connections to other parts of the Downtown.

Goal 3   Implement Specific Actions such as the Provisions of Public Improvements in an attractive and cohesive physical form, which clearly identifies Sunnyvale’s downtown.

Objective 3.2 Complete priority streetscape projects to facilitate an attractive pedestrian environment and to promote development on adjacent parcels.

Goal 4     Development and implementation of an overall parking strategy that meets the needs of retail, office, housing and visitor demand

Objective 4.1 Implement overall parking strategy that optimizes parking use based on office, retail, and entertainment peaks.

Objective 4.2 Replace existing public parking as required.

Goal 5        Increase housing opportunities.

Objective 5.2 Encourage mixed housing consisting of market rate and affordable housing in appropriate locations on transit corridors in or near the downtown.

Downtown Specific Plan:

Goal B.   Establish the Downtown as the cultural, retail, financial and entertainment center of the community, complemented by employment, housing and transit opportunities.

Policy B.3.

Improve the Town Center area by reinforcing connections into and through the mall and improve the quality of the tenant mix and the mall’s physical environment. 

Land Use and Transportation Element:

Action Statement C1.2.1 Promote Downtown as a unique place that is interesting and accessible to the whole City and the region.

Policy N1.12

Permit more intense commercial and office development in the downtown, given its central location and accessibility to transit

Action Statement N1.12.1 Use the Downtown Specific Plan to facilitate the redevelopment of downtown.

Socio-Economic Element:

Goal 5.1C Endeavor to maintain a balanced economic base that can resist  downturns of any one economic sector

Policy 5.1C.

Support efforts to establish Sunnyvale’s downtown area as a strong commercial center for the city.

Community Development Strategy Goals:

Tax Base: to retain and attract businesses which will provide a stable tax base to support City services

Retail Services: to retain and attract businesses which provide a variety of needed retail services for our residents at locations which are convenient for them.

In March, 2003, the Agency Executive Director (City Manager) appointed a negotiating team for the Agency consisting of Robert Paternoster, Director of Community Development; Mary Bradley, Director of Finance; and Jerry Keyser, Agency consultant in real estate economics. The team was supported by City Attorney Valerie Armento, and special redevelopment counsel Lee Rosenthal of Goldfarb and Lipman. The Agency set forth three major initial parameters or objectives for the negotiations:

     1.  To minimize risk for the Agency and the City

          The Agency warned that it did not want a repeat of the present situation, wherein the Agency is still paying back loans for the development of a Mall which has since closed.

     2.  To recreate as much of the historic public street grid as possible, but at no additional on-going cost to the City for maintenance and repair of the streets and other infrastructure.

     3.  To get out of the parking business

          The Agency wanted no responsibility for building, maintaining, repairing and replacing public parking facilities, noting the present problems with deterioration of the parking deck along Mathilda Avenue.

In subsequent meetings with the negotiating team, the Agency added three other parameters or objectives:

     4.   Although the Agency and City are willing to consider investing in the project an amount equal to some portion of the new project-generated secured property tax which flows to the Agency (the “project tax increment”), none of the new sales tax generated by the project or other revenues flowing to the City’s General Fund should be committed to the developer to support the project.

     5.   With regard to the payments to the developer, there should be a provision which prevents an unanticipated windfall to the developer, wherein the Agency would share any such windfall with the developer.

     6.   The developer should place underground as much parking as is feasible.

Summary of Proposed Agreement:

The negotiating team conducted a series of day-long negotiations with representatives of Forum Development Group and Lehman ALI, and met frequently during the course of the negotiations with the Redevelopment Agency in Closed Session. The negotiating team is pleased to report to the Agency that it has negotiated a proposed agreement which it believes meets all of the parameters and objectives set forth by the Agency. The main elements of that agreement are as follows:

·         The developer will demolish the Mall, the former J.C. Penney building, and the parking deck along Mathilda (Macy’s and Target will remain on their parcels, as well as the new parking structure at Sunnyvale and Iowa Avenues). In accordance with the existing Reciprocal Easement Agreement, the Agency will pay the developer for demolishing the Agency’s portion of the parking deck an amount of $800,000 (2/3 of the $1.2 million demolition estimate of the Department of Public Works, because the Agency owns 2/3 of the structure and the Mall owns the remaining 1/3).

·         The developer and the Agency will exchange land of approximately equal area (4.46 acres) and equal value as shown in Attachment A. The Agency will obtain fee title to the land where the public parking structures are located, and to all of the land under the new street grid, guaranteeing that the public will have perpetual control over these rights-of-way.

·         The developer will build, maintain, repair and replace all parking structures. A minimum of 5651 parking spaces will be provided (inclusive of the private parking spaces for the residential units), 1667 of which will be underground. The City, Agency, and developer will cooperate to provide Mello-Roos financing to “take out” the construction financing arranged by the developer for the public parking structures. This special financing, authorized by the State, will provide a lower interest rate to the developer. The developer will pay the debt service through a special tax on its property, which will be the sole collateral for the loan. The City and the Agency will bear no financial risk or obligation for payment of debt service. Should the property owner fail to pay the special tax for debt service on the bonds, the City may be obligated to participate in an accelerated foreclosure process on behalf of the bond holders. City costs for this process are ultimately recoverable from the developer. 

·         The developer will build, maintain, repair and replace all public streets in Block 18. The developer will also construct all sidewalks within the block and along the adjacent streets which bound the block; these sidewalks will be consistent with the Downtown streetscape standards, including new street lights, decorative paving, benches, waste receptacles, and street trees in decorative grates.

·         The developer will construct, maintain, repair and replace a “Redwood Square” of at least 0.8 acre, and make it available at no cost to the City for public events up to 15 times per year. The square is intended to remain open to the public at all times.

·         The developer will establish a private security force to provide a high level of security and traffic control for the project, such that the Department of Public Safety will not be required to provide routine patrol, but will respond to emergencies, crimes in progress and other events that are beyond the scope of routine patrol.

·         Upon approval of the City Council of a Special Development Permit, the Developer will build, lease and operate a mixed-use, open-air development consisting of approximately 1.0 million sq. ft. of retail (including a 2950-seat movie theater and existing Macy’s and Target stores), and 275,000 sq. ft. of office; and will enter into agreement with another developer or developers to construct up to 292 for-sale housing units.

·         In consideration for the above, and in particular for replacing the Agency’s Mathilda Avenue parking deck, for placing a substantial amount of the new parking underground, and for constructing, repairing and replacing public streets and other public amenities, the developer will receive annual payments[1] equal to all of the new project-generated secured property tax which flows to the Agency (“project tax increment”)[2] until the redevelopment project expires on November 26, 2025. The estimated present value of this tax increment is $38.0 million[3] . To protect against an unanticipated windfall to the developer, the payments will be limited to a cumulative cap of $4.0 million/year, plus an amount equal to 50% of any tax increment in excess of this limit. When and if the property is sold by Fourth Quarter, the cumulative annual cap is reduced to $3.8 million, plus no share of any amount over $3.8 million. (At the time of preparation of this draft report, the concept of a cap was still under discussion between the Agency and the developer.)

The negotiating team believes that the proposed agreement achieves all of the objectives of the Agency. Paramount among these is the minimization of risk to the Agency and the City. Under this agreement, the Agency and the City will borrow no money (no new debt), will construct no streets, parking facilities or other infrastructure, and will assume no additional responsibility for infrastructure maintenance, repair or replacement. Rather, the developer assumes:

·            All construction risk

      Because the developer is designing and constructing all improvements, including all public streets and public parking structures, the developer will be responsible for any and all cost overruns.

·            All financing risk

               Because the developer is financing the construction of all of the improvements, the developer assumes the risk that interest rates and other borrowing terms will become less desirable in the future.

·            All performance risk

      The amount of secured property tax increment generated by the project is dependent upon the developer’s performance in building a center of high value and maintaining that value through proper leasing and operation. Because the annual payments to the developer are based only on the amount of secured tax increment which the project actually generates each year (i.e., the Agency does not guarantee the developer any specific amount), the full risk for performance rests with the developer. This is particularly important should the project be forced to close down, as is the present case with the Mall.

·            All responsibility for maintenance, repair, and replacement

Unlike the present situation, where an argument can be made that the Agency is responsible for the repair and replacement of a deteriorated parking facility, the agreement clearly places sole responsibility for maintenance, repair and replacement of the parking facilities and of all of the public streets upon the developer.

The proposed agreement imposes two financial responsibilities upon the Agency and City. First, the Agency will reimburse the developer for the cost of demolishing the Agency’s portion of the Mathilda parking deck. Specifically, the Agency will pay the developer $800,000, which is its 2/3 share of the $1.2 million cost estimate of the Department of Public Works for demolishing the whole structure.

Second, the developer will receive annual payments equal to the secured property tax generated from Block 18 due to the construction of the project (“project tax increment”), up to a cumulative maximum limit of $4.0 million per year, plus an amount equal to 50% of the tax increment in excess of this limit. Keyser Marston, consultant to the Agency, has estimated the present value of the tax increment which is projected to be generated by this project to be approximately $38 million. Keyser Marston has also informed the Agency that a project of this proposed complexity and risk, which essentially rebuilds Downtown Sunnyvale, is not economically feasible without a contribution of this magnitude by the Agency. In partial return for the Agency’s contribution, the developer would:

Relieve Agency of parking deck replacement   cost	$10.0 million
Place 1442 new parking spaces underground	11.5 million
Construct streets and sidewalks	11.0 million
	$ 32.5 million

                                                                            

Disposition and Development and Owner Participation Agreement (DDOPA):

The Disposition and Development and Owner Participation Agreement (DDOPA) is the legal agreement between the Redevelopment Agency and Fourth Quarter Properties XLVIII, LLC, which provides for the redevelopment of Block 18 of the Downtown Specific Plan. It provides the mechanism for property transfers between the Agency and the developer, for construction by the developer of specified public and private improvements which constitute the project, and for certain payments to the developer to support the construction of the public improvements.

The DDOPA includes all of the elements of the proposed agreement summarized above. It also sets forth a required schedule for plan preparation, construction and completion. It requires that all contractors and subcontractors pay prevailing wages, pursuant to Labor Code Sections 1720 et. seq. and regulations of the California Department of Industrial Relations.

The DDOPA also requires the developer to be supportive of the existing Downtown business community, and to minimize negative impacts of construction activity upon these businesses. Specifically, the developer is required to meet at least monthly with Downtown businesses during construction, and to prepare and implement a construction mitigation program which will prescribe construction truck travel routes, location of construction worker parking, enforcement mechanisms to keep workers and suppliers out of retail customer parking spaces, and signs indicating that stores are open for business during construction. The developer is also required to invite a representative of the City to its regularly scheduled construction meetings with the contractor, to facilitate coordination with City agencies and to resolve construction issues affecting Downtown businesses and residents. The developer is required to make good faith efforts to attract local merchants to lease spaces in the new development. The developer is also required to be supportive of a business improvement or property improvement district, if one is formed to support Downtown businesses, and to work with the Downtown business community in producing special events, programs and advertising to promote the entire Downtown area.

A copy of the DDOPA accompanies this report. The DDOPA incorporates six other agreements as described below:

·         Public Street Maintenance Agreement: providing for the developer to operate and maintain the publicly owned streets and sidewalks within the boundaries of the project.

·         Public Parking Construction Lease: Agency lease to developer of parcels where public parking is to be constructed to allow developer to undertake construction; this lease will terminate upon completion of construction and purchase of the completed parking with Mello-Roos bond proceeds.

·         Operation and Reciprocal Easement Agreement: new reciprocal easement agreement between the Agency, developer, Macy’s and Target governing the relationships and rights of the various ownerships within the project.

·         Public Parking Facilities City Lease: Agency lease of the public parking to the City that is to go in effect when the public parking is completed and purchased with the proceeds of the Mello Roos bonds.

·         Public Parking Maintenance Agreement: providing for the developer to operate, maintain and replace the publicly owned parking within the boundaries of the project.

·         Interim Mathilda Parking Agreement: Providing for developer to operate and maintain the public parking closest to Mathilda prior to construction of the project.

Alternative Development Scenarios:

At the request of the Agency, staff and consultants have considered alterative scenarios for development of Block 18 should the Agency choose not to approve the DDOPA with Fourth Quarter Properties. Three possible alternatives have been identified and evaluated:

     1.  Do nothing

          Under this scenario the Agency would offer no financial support (such as transfer of tax increment) to support development. The parking deck would be demolished for safety reasons, and replaced with a surface lot at a cost to the Agency of approximately $3 million. This may result in the owner of the Mall property suing the Agency over its failure to meet its alleged obligations to replace the parking deck.

     2.  Rebuild the parking deck

          Under this scenario the Agency would agree to rebuild the parking deck or pay the Mall property owner the cost of rebuilding it (approximately $10 million). There would be no additional financial support to the developer, such as transfer of tax increment. Development would proceed as on any other privately owned site within the zoning requirements for the site (allows 1,007,876 sq. ft. of retail including Macy’s and Target, 282,000 sq. ft. of office, and 292 housing units).

     3.  Acquire property and offer it for development

          Under this scenario the Agency would acquire the property owned by American Mall Properties and Lehman ALI, using eminent domain, if necessary. This 24.81 acres would be combined with the 11.84 acres owned by the Agency, and a developer would be sought through a Request for Proposals, with development limited to that currently permitted by zoning. The Agency would require that the street grid be reestablished as in the Fourth Quarter proposal.

The table on page 14 compares these three alternatives to the current proposal.

Alternative Development Scenarios (.pdf), click here for the Table.

[1] Assumes developer would reimburse Agency for all costs of all land acquisition, but would require same financial support as current proposal. Less tax increment is available than for current proposal because of two-year delay in opening the center.