OVERSIGHT BOARD AGENDA: 4/28/16 ITEM: 6.4 SUCCESSOR AGENCY TO THE REDEVELOPMENT AGENCY OF THE CITY OF SAN JOSE MEMORANDUM CLARA'S APPRAISAL ON LAND UNDERNEATH THE HILTON HOTEL RECOMMENDATION Adopt a resolution directing Successor Agency staff to either: a. Reject the County of Santa Clara's ("County") request to acquire the real property underneath the Hilton Hotel at its appraised value and offer such real property for sale using an open solicitation process; or b. Request a second appraisal be commissioned by the County for such real property with the requirement that the real property be appraised by a company qualified in the valuation of long-lived financial assets. BACKGROUND The Successor Agency owns the real property situated under the Hilton Hotel (300 South Almaden Boulevard) (the "Hilton Land"). Pursuant to the Dissolution Legislation and the Long Range Property Management Plan the property must be sold. On September 17, 2014, Successor Agency staff sent a letter to all affected taxing entities requesting their interest in purchasing certain Successor Agency owned properties using the Direct Sale process approved by the Oversight Board. In October 2014, the County of Santa Clara (County) responded positively indicating its interest in acquiring the Hilton Land, together with other interests of the Successor Agency. The County subsequently hired Valbridge Property Advisors/Hulberg and Associates Inc. ("Valbridge"), one of eight Oversight Board approved appraisers, to complete an appraisal for the property. OVERSIGHT BOARD APRIL 22, 2016 Subject: Report on County of Santa Clara's Appraisal of Real Property Underlying the Hilton Hotel Page 2 Valbridge's appraisal of the Hilton Land is $96,000 as of August 15, 2015. A copy of the appraisal report is attached to this memorandum as Attachment A. On January 12, 2016, the County Board of Supervisors ("Board of Supervisors") approved a delegation of authority to the County Executive for the purchase of the Hilton Land.1 County staff has requested that the Successor Agency prepare a Purchase and Sale Agreement for the Hilton Land. ANALYSIS County staff followed the Oversight Board approved Disposition Process for Direct Sale acquisition of assets. However, Successor Agency and City staff ("Staff') do not believe that the appraisal prepared by Valbridge for the Hilton Land is reflective of the fair market value of the property. As such, we do not believe that the Successor Agency should sell the Hilton Land to the County at the value indicated in the appraisal prepared by Valbridge. The Hilton Land is encumbered by a long-term ground lease ("Ground Lease") which was originally executed in February 1991 and has been subsequently amended. The Ground Lease was originally signed in February 1991 and was amended several times. The current tenant under the Ground Lease is West Hotel Partners, L.P. The Ground Lease provides for a first class hotel with a ground rent of One Dollar ($1.00) per year. The initial lease term is 55 years, expiring March 12, 2046 and it includes four (4), 10-year options which could extend the term another 40 years. Given the low rent for the land, it is likely that the options will be exercised. The likely lease term, therefore, will extend to March 12, 2086. There are approximately 70 years remaining on the Ground Lease term. Staff has analyzed the discounted cash flow approach ("DCF") utilized by Valbridge for the valuation of the Hilton Land and agrees that Valbridge's use of a current site valuation of $10.4 million is reasonable. We believe, however, that the discount rate of 9.5% utilized by Valbridge in its DCF may be substantially higher than that which would be used by potential purchasers of the property. Staff notes that this discount rate is only marginally lower than the discount rate (10%) utilized in the Carneghi and Partners appraisal of the Central Place Garage and criticized by Oversight Board members as being too high (for an asset with substantially more operational risk than the Hilton Land). Staff also believes that the land value growth rate (2.5%) utilized by Valbridge may be lower than a growth rate that would be used by potential purchaser of the property. The challenge of valuing the Hilton Land is the nature of the asset - one that produces no income until 2086 - 70 years from today, at which point the property has a large reversionary value. In 1 Report to the Santa Clara County Board of Supervisors - http://sccgov.iqm2.com/Citizens/Detail LegiFiIe.aspx?ID=79519 OVERSIGHT BOARD APRIL 22, 2016 ' Subject: Report on County of Santa Clara's Appraisal of Real Property Underlying the Hilton Hotel Page 3 order to appropriately value this asset, staff believes it is necessary to consider the types of buyers who would have interest in such an asset - trusts, endowments, and entities with extremely long-lived liabilities which they are trying to asset match. These investors are likely to have a very different approach to valuation of this asset than the types of real estate investors that are reflected in the surveys utilized by Valbridge. The following two charts highlight the sensitivity of the valuation to changes in discount rates and the land value growth rate. The first chart shows changes in valuation at different discount rates assuming a 2.5% annual growth in land valuation (consistent with the Valbridge appraisal) The second chart shows changes in valuation at different discount rates assuming a 3% annual growth rate in land valuation. Discounted Hilton Land Value 2.5% Annual Land Value Escalation 3,000,000 2,500,000 2,000,000 = 1,500,000 (0 > 1,000,000 500,000 0 9.50% 9.00% 8.50% 8.00% 7.50% 7.00% 6.50% 6.00% 5.50% 5.00% Discount Rate OVERSIGHT BOARD APRIL 22, 2016 Subject: Report on County of Santa Clara's Appraisal of Real Property Underlying the Hilton Hotel Page 4 Discounted Hilton Land Value 3.0% Annual Land Value Escalation 3,000,000 2,500,000 2,000,000 w |i,s oo,ooo pp ed A raiS > 1,000,000 Value T 500,000 0 9.50% 9.00% 8.50% 8.00% 7.50% 7.00% 6.50% 6.00% 5.50% 5.00% Discount Rate Fundamentally, however, staff believes that the DCF approach is inappropriate for the valuation of the Hilton Land, and more insight may be gained from the application of option valuation modeling techniques. Such techniques are commonly used in the financial markets and can be used effectively in the valuation of options to purchase and/or develop real estate (see Attachment B, "Options in Real Estate Valuation" from The Appraisal Journal. summer_2013). Staff believes that appropriate application of such techniques would lead to a significantly higher valuation of the Hilton Land than seen in the DCF analysis. It is worth noting that the implication of the Valbridge analysis is that the value today of having the right to control the Hilton Land seventy years from now is less than 1% of today's land valuation. Finally, we note that the Comity Assessor's Office has assessed the Hilton's possessory interest (the right to use the land for the term of the Ground Lease) at $5,341,551. As discussed above, Valbridge has concluded that the total value of the Hilton Land as of the appraisal date is $10.4 million. As this total value should be the sum of the possessory interest and the present value of the reversionary interest (the right to control the Hilton Land at the expiration of the Ground Lease in 2086), this assessment implies a valuation today of the reversionary interest of approximately $5 million. In conclusion, staff believes that the assumptions utilized in Valbridge's DCF analysis do not take into account a more diverse group of potential buyers, that their methodology may be inappropriate for the nature of the asset, and that the appraisal therefore does not represent the fair market value of this asset. Conclusion Based on the review and analysis of the Valbridge appraisal report by City and Successor Agency staff, staff is of the view that the current appraisal does not accurately reflect the fair market value of the Hilton Land. Two options are presented for the Oversight Board's OVERSIGHT BOARD APRIL 22,2016 Subject: Report on County of Santa Clara's Appraisal of Real Property Underlying the Hilton Hotel Page 5 consideration. These options include rejecting the County's request to acquire the asset and proceeding with an open solicitation process or allowing the County to commission a second appraisal by a firm qualified in the valuation of this property so the issues raised in this staff report can be adequately addressed. Approval of one of these two options will ensure that the Hilton Land is sold at fair market value based on the unique nature of this asset. COORDINATION This item was coordinated with the City Finance Department and the City Attorney's Office. /s/ /s/ JULIA H. COOPER RICHARD A. REIT CHIEF FINANCIAL OFFICER MANAGING DIRECTOR Attachments For more information, contact Derek Hansel, Assistant Director of Finance at (408) 535-7041. Appraisal Report Hilton Hotel Site 300 South Almaden Boulevard San Jose, Santa Clara County, California 95110 Report Date: August 19, 2015 FOR: County of Santa Clara Jenny DeAngelis 70 West Hedding Street, 11h Floor San Jose CA 95110 Valbridge Property Advisors | Hulberg and Associates, Inc. One North Market Street San Jose, CA 95113 408.279.1520 phone Valbridge File Number: 408.279.3428 fax CA02-15-0288-001 valbridge.com One North Market Street San Jose, CA 95113 408.279.1520 phone 408.279.3428 fax valbridge.com August 19, 2015 Yvonne J. Broszus, MAI 408.279.1520 x7135 [email protected] Jenny DeAngelis County of Santa Clara 70 West Hedding Street, 11h Floor San Jose, CA 95110 RE: Appraisal Report Hilton Hotel Site 300 South Almaden Boulevard San Jose, Santa Clara County, California 95110 Dear Ms. DeAngelis: In accordance with your request, we have performed an appraisal of the above referenced property. This appraisal report sets forth the pertinent data gathered, the techniques employed, and the reasoning leading to our value opinions. This letter of transmittal is not valid if separated from the appraisal report. The subject property, as referenced above, is located on the southeast corner of South Almaden Boulevard and West San Carlos Street and is further identified as Assessor’s Parcel Number (APN) 264-29-109. The site measures approximately 1.08 acres or 47,250 square feet. The subject is a rectangular site in the San Jose Downtown Core with a prime corner location next to the San Jose Convention Center. The site is under a long-term ground lease. We have appraised the leased fee or land owner’s interest in the property. The rent during the remaining lease term, which will likely extend another 71 years (through the exercise of options) is only $1 per year. The value of the land owner’s interest, therefore, is mostly tied to the future value of the land upon expiration of the lease, discounted to the present day. We developed our analyses, opinions, and conclusions and prepared this report in conformity with the Uniform Standards of Professional Appraisal Practice (USPAP) of the Appraisal Foundation; the Code of Professional Ethics and Standards of Professional Appraisal Practice of the Appraisal Institute; and the requirements of our client as we understand them. © 2015 VALBRIDGE PROPERTY ADVISORS | Hulberg and Associates, Inc. Jenny DeAngelis County of Santa Clara Page 2 The County of Santa Clara is the client in this assignment. The intended user(s) of this report are the County of Santa Clara and the Oversight Board. The intended use is for decision making purposes regarding a possible purchase of the property by the County. The value opinions reported herein are subject to the definitions, assumptions and limiting conditions, and certification contained in this report. The acceptance of this appraisal assignment and the completion of the appraisal report submitted herewith are contingent on the following extraordinary assumptions and/or hypothetical conditions which may have impacted the assignment results: Extraordinary Assumptions:  None. Hypothetical Conditions:  None. Based on the analysis contained in the following report, our value conclusions are summarized as follows: Value Conclusion As Is Value Type Market Value Property Rights Appraised Ground Leased Fee Effective Date of Value August 13, 2015 Value Conclusion $96,000 Respectfully submitted, Valbridge Property Advisors | Hulberg and Associates, Inc. Yvonne J. Broszus, MAI Norman C. Hulberg, MAI Director Senior Managing Director California Certified License #AG019587 California Certified License #AG003542 © 2015 VALBRIDGE PROPERTY ADVISORS | Hulberg and Associates, Inc. HILTON HOTEL SITE TABLE OF CONTENTS Table of Contents Cover Page Letter of Transmittal Table of Contents ....................................................................................................................................................................... i Summary of Salient Facts ....................................................................................................................................................... ii Aerial and Front Views ............................................................................................................................................................ iii Location Map ............................................................................................................................................................................. iv Introduction ................................................................................................................................................................................. 1 Scope of Work ............................................................................................................................................................................ 3 Regional and Market Area Analysis .................................................................................................................................... 5 City and Neighborhood Analysis ..................................................................................................................................... 10 Site Description ....................................................................................................................................................................... 15 Subject Ground Lease ........................................................................................................................................................... 20 Improvements Description ................................................................................................................................................. 21 Subject Photos ......................................................................................................................................................................... 22 Assessment and Tax Data ................................................................................................................................................... 23 Market Analysis ....................................................................................................................................................................... 25 Highest and Best Use ............................................................................................................................................................ 27 Appraisal Methodology ....................................................................................................................................................... 29 Land Valuation ......................................................................................................................................................................... 30 Leased Fee Valuation ............................................................................................................................................................ 48 Summary of Valuation .......................................................................................................................................................... 59 General Assumptions and Limiting Conditions .......................................................................................................... 60 Certification – Yvonne J. Broszus, MAI ........................................................................................................................... 66 Certification – Norman C. Hulberg, MAI........................................................................................................................ 67 Addenda .................................................................................................................................................................................... 68 Glossary ................................................................................................................................................................................. 69 Qualifications ...................................................................................................................................................................... 75 Qualifications of Yvonne J. Broszus, MAI ................................................................................................................. 76 Qualifications of Norman C. Hulberg, MAI .............................................................................................................. 77 Information about Valbridge Property Advisors Office Locations © 2015 VALBRIDGE PROPERTY ADVISORS | Hulberg and Associates, Inc. Page i HILTON HOTEL SITE SUMMARY OF SALIENT FACTS Summary of Salient Facts Property Identification Property Name Hilton Hotel Site Property Address 300 South Almaden Boulevard San Jose, Santa Clara County, California, 95110 Latitude & Longitude 37.329293, -121.890634 Assessor's Parcel Number 264-29-109 Property Owner Successor to San Jose Redevelopment Agency Zoning DC FEMA Flood Map No. 06085C-0234H Flood Zone X Land Area 1.085 acres Building Area 284,500 s.f. No. of Hotel Rooms 353 rooms Year Built 1991; renovated circa 2007 Valuation Opinions Highest & Best Use - As Vacant High rise development with hotel, office or residential use Highest & Best Use - As Improved Existing use Reasonable Exposure Time 9 to 12 months Reasonable Marketing Time Less than 12 months Value Conclusion As Is Value Type Market Value Property Rights Appraised Ground Leased Fee Effective Date of Value August 13, 2015 Value Conclusion $96,000 Extraordinary Assumptions:  None. Hypothetical Conditions:  None. © 2015 VALBRIDGE PROPERTY ADVISORS | Hulberg and Associates, Inc. Page ii