MODELLING HISTORIC PRESERVATION TAX INCENTIVES
by
Debra Gail Wong
B.S. University of California, Berkeley
(1977)
Submitted to the Department of
Urban Studies and Planning
in Partial Fulfillment of the
Requirements of the
Degree of
MASTERS IN CITY PLANNING
at the
MASSACHUSETTS INSTITUTE OF TECHNOLOGY
June 1985
0
Massachusetts Institute of Technology 1985
Signature of the Author:
ban Studies and Planning
Department of
28, 1985
May
~
I'
Certified by:
C~etgnan, Thesis Cpnmittee
Accepted by:
'fChairmavM.C.P Committee
JUL 111985
(date)
(date)
MODELLING HISTORIC PRESERVATION TAX INCENTIVES
by
DEBRA GAIL WONG
Submitted to the Department of Urban Studies and Planning
on May 28, 1985 in partial fulfillment of the
requirements for the Degree of
Masters in City Planning
ABSTRACT
This thesis develops a methodology to facilitate a public policy position on how to
identify the proposed tax law changes that will have the most detrimental impact on
historic preservation. It examines existing and proposed tax law changes that affect
decisions to rehabilitate or demolish and replace historic properties and discusses
prior analytic work by others on Federal tax incentives for historic preservation. A
computer model using discounted cash flow measures, was designed to evaluate the
effects of changes in the tax laws on economic returns from rehabilitating or
replacing a historic structure.
An actual rehabilitation case located in Boston, was modelled for comparison of
existing and proposed tax variables, between a rehabilitate and replacement choice.
The model results showed that for the case studied under the existing tax system
with the historic preservation tax credit, rehabilitation resulted in an economic
advantage over replacement. Under the fully proposed tax system, demolition and
replacement of a historic structure showed a more favorable return on investment
over rehabilitation.
The thesis concludes with suggested future improvements and applications of the
model and proposes a framework for -making a policy position with respect to the
proposed Congressional tax law changes.
Thesis Supervisor: Philip B. Herr
Title:
Adjunct Professor of Urban Studies and Planning
ii
ACKNOWLEDGEMENTS
I wish to thank my Committee of Phil Herr, Gary Hack, and Mark Schuster for
their guidance and encouragement thoughout this effort. I wish to especially thank
Phil for his perserverance, patience, and generosity of his time in developing the
model with me and helping me keep my perspective throughout this time.
I wish to thank the following for their assistance, time and contribution of
information:
Peggy Drury, Director of the Policy and Research Division of the
National Trust for Historic Preservation, Chris Carla, formerly of the Boston
Redevelopment Agency, the Massachusetts Office of Senator John Kerry, and Adler
and Adler, publishers of the 1984-5 Historic Preservation Yearbook,.
I wish to thank Ed Merchant and Avis Vidal of the Harvard Kennedy School of
Government for providing me with the basic framework for this effort and raising my
interest in this subject area.
I especially wish to thank all my friends and family in Juneau, Boston, and San
Francisco for their support and understanding.
Special thanks to Tena and Mark
Terner, Walter Rask, Ed Richardson, Ric Lamb, and Bob Link whose encouragement
and sense of humor helped me through this time. And thanks to Bupper Herr, for just
"being there."
Finally, special thanks to Georgette Wright and Winelle Brown for their support
in the production and word processing of this thesis.
iii
TABLE OF CONTENTS
PAGE
ii
THESIS ABSTRACT ...........................................
ACKNOWLEDGEMENTS .......................................
Chapter I.
A.
B.
C.
Chapter II.
A.
B.
C.
Chapter III.
A.
B.
C.
D.
E.
Chapter IV.
A.
B.
C.
Chapter V.
A.
B.
C.
111
INTRODUCTION.................................I
Problem Statement
Objective
Development of the Hitch Model and Analysis
FRAMEWORK ...................................
5
A Summary of Historic Preservation Tax Incentives
A Comparison of Existing Tax Provisions
and Proposals Before Congress
Existing Research and Analytical Work
THE HITCH MODEL .............................
14
Applications
Model Design and Format
Hardware and Software Requirements
Description
Model Structure and Assumptions
CASE ANALYSIS AND FINDINGS .................
30
Project Background
Hypothetical Redevelopment Case
Case Study Conclusions
CLOSING COMMENTS AND NEW DIRECTIONS ..... 38
Design Issues
Critique and Additional Information Needs
Further Applications of the HITCH Model
REFERENCES ................................................
43
APPENDICES
A.
B.
C.
D.
E.
Analysis Summaries of Tax Variable
Alternatives .....................
Project Exhibits..................
Formulas Used ...................
Applications of BRA Land Residual
Value Analysis ...................
-HITCH User Manual and Diskette ...
iv
.............
0
0
.............
0
0
.............
0
0
.. 45
.. 47
.. 62
.. 64
.. 69
LIST OF TABLES AND EXHIBITS
PAGE
TABLES
Table 2.1
Table 2.IA
Summary of Historic Preservation
Tax Incentives ......................
.6/7
Table 4.1
Summary of Project Assumptions ......
.. 32
Table 4.2
Summary of Tax Alternatives .........
.. 34
Table 4.3
Summary of Tax Proposal Consequences
.. 34
EXHIBITS
Exhibit I
Preliminary Project Costs ..................
..... 18
Exhibit II
Income Analysis...........................
..... 19
Exhibit III
Amortization Schedule .....................
..... 21
Exhibit IV
Setup ....................................
..... 22
Exhibit V
Depreciation Estimate .....................
..... 24
Exhibit VI
Summary of Operating Income and Expenses ..
24
Exhibit VII
After Tax Sales Proceeds...................
25
Exhibit VIII
Analysis Summary .........................
..... 27
FIGURE
Figure 4.1
Comparative Summary ...........................
V
35
CHAPTER I
INTRODUCTION
A.
PROBLEM STATEMENT
The U.S. Treasury Department under the Reagan Administration has proposed
radical changes in the existing income tax system in an effort to simplify methods of
income tax assessment. The Treasury plan (known as Treasury Proposal II) proposes
to close loopholes for upper-income and corporate taxpayers, to reduce the overall
maximum tax bracket, and to greatly simplify computation of income taxes while not
affecting the amount of revenue returned to the Treasury ("revenue neutrality").
In response to the Treasury tax proposals, two other major tax proposals have
been introduced by the 1985 Congress: the Bradley/Gephardt Fair Tax Act of 1985
(H.R. 800/S. 409) and the Kemp/Kasten Fair and Simple Tax Act of 1985 (H.R.
777/S.325).
If any of the three tax proposals are adopted, the tax treatment of historic
building rehabilitation and of new construction in real estate will change. All three
proposals remove the historic preservation tax incentives now afforded to historic
rehabilitation.
In addition, the major tax law changes will alter tax treatment of
real estate property, whether historic or not through changes in the tax treatment of
capital gains, in the length of depreciation recovery periods of income properties,
and a reduction of the maximum income tax rate.
B.
OBJECTIVE
In this thesis, I propose to develop a model for evaluating two questions:
1.
From a public policy standpoint, what aspects of the proposed tax law
changes are most critical in encouraging retention of historic buildings
versus their demolition and replacement? By using a model to test a
variety of kinds of projects, an understanding of those sensitivities can be
clarified, helping in forming a position on the proposed tax law changes.
I
2.
From the standpoint of a developer faced with an option to purchase a
historic property for the purpose of developing an income producing
project, how should that purchase decision be made in light of the proposed
tax changes? Rehabilitation and redevelopment choices can quickly be
tested under an array of different assumptions about tax law change, and
the expected return under that array can be analysed under a variety of
decision analytic techniques.
DEVELOPMENT OF THE HITCH MODEL AND ANALYSIS
The first task undertaken was to identify an actual case in which the
rehabilitation/redevelopment
choice could be measured under the present tax
system, including historic preservation tax credits, and compare the effect of
proposals which would eliminate the historic preservation tax credit and make other
potentially significant changes. I chose a project which was completed in 1983-4: the
rehabilitation of the Warren Chambers, a 55,000 square foot office building
qualifying for a 20% historic tax credit, joined with the concurrent redevelopment of
three adjacent parcels for a contextually compatible 245,000 square foot office
building known as the 399 Boylston Street building. The income property is located
in Boston, Massachusetts.
A financial analysis model called HITCH (Historic
Investment Tax Credit Helper) was constructed using the actual project costs and
operating income and expenses.
A seven-year pro-forma was developed using
expense and income inflation assumptions based on Boston experience.
The pro-
forma was used to calculate a series of cash flows which would then be incorporated
into a net present value and an internal rate of return calculation.
A second set of assumptions was developed to simulate the Treasury's proposed
tax law changes.
The assumptions about the Treasury proposal include: 1.)
elimination of all the historic preservation tax credits, 2.) revising the treatment of
capital gains, 3.) lengthening depreciation to more closely approximate the economic
life of an asset, and 4.) reducing the maximum income tax rate from the current 50%
to 35%.
2
The financial analysis model evaluating the actual Boston case was then
adapted to allow analysis of the case by easily changing tax variables, and to
generalize it for use on any project, not just this case.
While constructing the
HITCH model in March, I ran a series of alternative computer models developed for
the National Trust for Historic Preservation and replicated a land residual value
model prepared by the Boston Redevelopment Agency. This was done in order to
determine how well other analytic models could answer the research questions I have
posed above.
After the HITCH Model was fully operational, I analyzed the effects of tax law
changes on the actual case. Then, I constructed a hypothetical redevelopment case
and modelled alternative tax law assumptions. The actual case and the hypothetical
redevelopment cases were compared against each other for six different tax
alternatives and the results summarized.
Chapter II provides background on the relationship of tax law and historic
preservation. It summarizes past tax laws including their tax incentives. The second
part of Chapter II briefly discusses the existing analytical work that is or has been
done by others for its potential applicability in determining the effects of changes in
tax law on historic rehabilitation projects.
Chapter III presents the HITCH Model and its uses and applications for public
and private decision making. This chapter also details the tax variable assumptions
and provides a short review of the basic real estate financial analysis concepts used
in the model.
Chapter IV applies the model to the two cases, the actual Boylston
Street project case, and the hypothethical replacement and renewal alternative. A
comparative analysis and summary is presented using the Boylston Street case.
Chapter V offers a framework and methodological approach to evaluating tax system
3
choices and decisions on rehabilition versus redevelopment of a given site. It then
evaluates the process of design of the model and poses additional improvements and
applications of it.
4
CHAPTER II
FRAMEWORK
This chapter summarizes the past tax laws affecting tax incentives for historic
preservation and describes the existing and proposed tax treatment of rehabilitation
of historic properties. The second part of this chapter summarizes several analytic
efforts which attempt to address choices on rehabilitation versus replacement.
A.
A SUMMARY OF HISTORIC PRESERVATION TAX INCENTIVES
Prior to 1976, Federal tax laws inadvertently discouraged rehabilitation of
older properties through treatment of both depreciation and demolition costs.
Explicit tax incentives for historic preservation in the United States date back to the
Tax Reform Act of 1976.
The Tax Reform Act of 1976 effectively provided the first special tax
treatment
for the rehabilitation of historic properties, created an economic
disincentive for demolition of certified historic structures, and enabled donors to
claim a charitable contribution deduction without relinquishing their interest in the
property.
The Revenue Act of 1978 eased certification of historic structures located
within certified historic districts, increased tax benefits for certified rehabilitations
in general, and contained provisions to prevent the use of tax benefits for minor
rehabilitations, thereby encouraging serious and substantial rehabilitation.
The pivotal point for existing tax incentives was the 1981 Economic Recovery
Tax Act of 1981 (ERTA). 1 ERTA substantially increased tax incentives specific to
rehabilitation of historic properties as well as real estate investment in general.
Table 2.1 and 2.1A summarizes the specific tax provisions from prior to TRA 1976 to
the current tax provisions affecting rehabilitation of historic property.
5
TAB.E 2.1
S U NN AR Y 0 F
HISTORIC
T AX
CERTIFIED
Tax Incentives
INCENTIVES
HISTORIC
Residential
PRESERVATION
ST RUCTURES
Non-Rsidential
OTHER
41 Year
Buildinp
ST RUCTURES
3 Year
21 Year
Buildings
Buildings
TAX ALTEMATIVES
1. Rapid Amortization
TM 1976
60-month rapid amortization of costs
ERTA 1981
Repealed 66-month amortization of costs
Not allowed Not allowed Not allowed
M
A
Repealed
2. Investment Tax Credit
evenue
Act of 1978
ERTA 1981
3.
Not available
10% of rehabilitation costs
25% of rehabilitation costs
25% of rehabilitation costs
Straight line only
Straight line only
19% of rehabilitation costs
29% of rehabl5% of rehab
costs
costs
NA
aximus Depreciation
Prior to TM 1976
TR 1976
Straight-line only
N
15% Declining balance method
N
125% declining
balance with
remaining useful
life of 26 years or
Straight
line method
Revenue Act of 1978
2M6% Decl. balance method
A
156% Decl. balance method
N
Straight
line method
ERTA 1981
15 year ACRS recovery period
15 year ACRS recovery period
166% of reduction in
No reduction in depreciation basis
N
depreciation basis
TEFRA 1982
Tax Red. Act of 1984
One half of ITC reduced from depreciation basis
-
No change
-
18 year ERS recovery period
18 year ACRS recovery period
4. Demolition Costs
Prior to TM 1976
Allowed Expense
T. 1976
Deductions not peritted, must be added to non-depreciable
account for land
Allowed Expense
New construction on' site previously occupied by D6 subject
to straight line depreciation only.
6
Allowed
Expense
Allowed
Expense
Allowed
Expense
TABLE L IA
SUNNARY
OF
T AX
CERTIFIED
HISTORIC
PRESERVATION
INCENTIVES
HISTORIC
Charitable Contributions
Residential
ad Certification
Requirements
22-May-85
STRUCTURES OTHER
Non-Residential
46 Year
Buildings
STRUCTURES
30 Year
Buildings
29 Year
Buildings
CHARITABLE CONTRIUJTIONS
Prior to TRA 1976
Only allowed donation of owner's entire interest in
property donated.
TRA 1976
Allows partial contribution to qualifying charitable
organization if given exclusively for conservation purposes.
ERTIFICATION
REUIRENTS
TRA 1976
Defined as a structure listed in the National Register,
located in a Registered Historic District.
Revenue Act of 1978
Structure must be certified
as having historic significance and the rehabilitation must be certified
as being consistent with the
historic nature of the
structure.
Structure must be certified
as having historic significance and the rehabilitation must be certified
as being consistent with the
historic nature of the
structure.
None,
however
to
qualify
75% of
the
external
walls
must be
retained.
7
B.
A COMPARISON OF EXISTING TAX PROVISIONS AND PROPOSALS BEFORE
CONGRESS
The following discussion of existing and proposed tax provisions are combined
for comparison purposes.
1.
Historic Preservation Tax Credit
The present system provides for a three-tiered investment tax credit of 25%,
20%, and 15% of rehabilitation costs, based on age and certification status of the
structure deductinle from the taxpayer's taxes.
Any of the current tax proposals
would eliminate investment tax credits of all kinds, including this one. The Reagan
administration's rationale in eliminating the tax credit is that the National Park
Service,
which
administers
the
certification
of
historic
structures
and
rehabilitations, has no budgetary responsibility for the tax credits granted and
therefore has no incentive to evaluate overall feasibility.
2.
Depreciation
In the existing system, real estate income properties are allowed to be
depreciated at an accelerated recovery period of 18 years. The accelerated recovery
rates are generally shorter than the actual "economic" lives (the rate at which the
asset actually decays or wears out) of the property.
The Treasury proposal would
provide percentages for depreciation that would approximate the time it actually
takes for an asset to depreciate.
For the purposes of the model, real estate is
assumed to have an economic life of 30 years. 2
3.
Capital Gains Treatment
Currently, capital gains are taxed, based on 40% of the residual gain on the
sale of a property and the taxpayer's marginal tax rate. If the taxpayer is in a 50%
tax bracket, his/her capital gains tax would be 20% of the residual gain. The
Treasury is considering a capital gains tax in which only the amount of the residual
8
gain exceeding inflation would be taxed at the ordinary income rate, while the reduction to 40% of the capital gain would be eliminated. 3
This provision effectively
reduces the overall capital gains liability.
4.
Maximum Income Tax Bracket
Currently, the maximum tax rate is 50% of taxable income.
proposes to lower the maximum tax bracket to 35%.
The Treasury
This would effectively lower
the amount of tax shelter typically found in real estate investments such as
mortgage interest, expenses, etc. Reducing the tax shelter of real estate investments
will reduce incentives for both rehabilitation and new construction
5.
Interest Deductions
Currently, taxpayers are allowed to deduct all the interest on mortgages and
other forms of permanent financing from their income.
One proposal under
would prohibit deductions for interest on
non-recourse 4 loans
consideration
(mortgages,
permanent financing, etc.) and indexing deductions for mortgage
interest, limiting the deduction of interest for permanent financing to only the
portion of interest in excess of inflation.
This tax alternative was not modelled
because at the time of this writing, it has not been determined what form this
disallowance might take, and the likelihood of eliminating personal and corporate
interest deductions seems very slim.
C.
EXISTING RESEARCH AND ANALYTICAL WORK
Several analytic efforts have been made which attempt to address questions
about choices to rehabilitate or replace historic structures and the effects that
changes in the tax laws would have on those choices. The National Trust for Historic
Preservation is examining the impacts of removing the historic tax credit on a
national, macro level and on a project-specific basis. Elesa Bentsen wrote a Ph.D
dissertation documenting her mainframe model which measured the effects of
historic preservation tax incentives on the profitability of two projects. The Boston
9
Redevelopment Authority developed an analytic model using residual land value
analysis as a means of assessing the impact on rehabilitation on residual land values.
1.
National Trust for Historic Preservation
PRIME Model--The PRIME model (Preservation and Rehabilitation Impact
Estimator) was developed for the National Trust for three purposes: to serve as an
investment decision model; to assess the national impacts of the tax credit program
and to serve as a mechanism for communities to assess the local benefits of historic
preservation investment and reinvestment.
The PRIME model was designed to address the following questions:
1.
For how many buildings does a change in the tax law sufficiently shift the
economic incentives so that preservation, rather that demolition, becomes
economical?
2.
For buildings for which preservation is economically feasible, to what
extent is ;he level of investment per building affected by a change in the
tax law?"
There are three principal differences in how the PRIME model in addresses the
question of how the proposed tax law changes will affect rehabilitation choices.
First, PRIME only considers certified rehabilitation projects and not the many other
rehabilitation projects benefiting from current incentives.
Secondly, PRIME only
measures effects of eliminating the certified rehabilitation tax credit, and not the
effects of other major tax reform proposals now before Congress.
PRIME also differs in scope and focus.
It is a national model which uses an
aggregated data base of 7,000 projects to generate the analysis.
The focus is
different, a user cannot evaluate an individual project on PRIME.
INVESTOR SOFTWARE--The National Trust acquired an interactive software
program to evaluate internal rates of return on individual historic preservation
projects. It is their hope that data generated by INVESTOR can be used to evaluate
the effects of 15% and 20% rehabilitations and that data generated by INVESTOR
could eventually be used by PRIME to include non-certified rehabilitations.
10
INVESTOR, while producing an internal rate of return,6 is a software program
designed to generate tax reports for income taxes and is used by certified public
accountants, rather than analysts.
It is not possible to measure the effects of the
proposed tax law changes using INVESTOR. The software program has been updated
to include the most recent Treasury proposals, however, it is not available. Finally,
the current software is not capable of allowing individual changes of the tax
variables, and it is expected that new editions of the software will also not have the
flexibility to alter or model a number of tax variable configurations.
2.
Bentsen Model
In 1983, Elesa Jo Bentsen analyzed federal tax incentives and other non-tax
variables for rehabilitation projects for a Ph.D in Accounting at the University of
Texas, at Austin. One of the objectives of the analysis was to gain expert familiarity
with the tax laws affecting profitability of rehabilitation projects and use of
discounted cash flow techniques for real estate projects in general.
Bentsen designed a mainframe computer model to evaluate the effects of tax
and financing variables on one rehabilitation project, using internal rates of return as
her primary evaluation measure.
The Bentsen Model only measures tax variables from the pre- and post-ERTA
tax laws.
It was developed on a mainframe computer system, and is not
accessible.
3.
Boylston Street Zoning Study
In 1984, The Boston Redevelopment Authority (BRA) undertook a zoning and
urban design study of the Boylston Street area between Arlington Street and
Massachusetts Avenue, covering an eight city block area in Boston, Massachusetts.
The zoning study covered both physical and economic factors affecting development
on Boylston Street.
The economic analysis attempted to measure the economic
consequences of altering allowable floor area ratios (FARs) and uses controlled by
11
zoning. The result by which the economic consequences were measured against, was
a residual land value stated as a cost per land square foot. By comparing residual
land values generated by different development alternatives, one can then make a
purchase choice.
The Boston Redevelopment Authority's residual land value model evaluates only
before tax benefits of a development project.
With some modification of the
program, the tax credit can be incorporated into the analysis, but the after tax
effects of capital gains treatment, depreciation, and maximum income tax brackets
cannot be evaluated with this model.
An analysis of Warren Chambers and 399
Boylston Street using that model is presented in Appendix D.
Finally, there are a number of real estate investment templates that have been
developed for Lotus 1-2-3.
To be useful for these purposes, the software must be
flexible enough to allow tax variables to reflect the changes proposed by the
Treasury or by Congress. None of the templates based on available capsule reviews' 7
appeared to facilitate that.
Availability, scope of analysis, and differences in the focus on evaluating
impacts of future tax law changes contributed to the decision to construct a separate
model.
12
lAn analysis prepared by Thomas A. Coughlin III, Esq., Former Assistant General
Counsel, National Trust for Historic Preservation detailed provisions of pre-ERTA
tax incentives for historic preservation and in Elesa Bentsen's doctoral dissertation
on An Examination of Federal Tax Incentives for the Rehabilitation of Historic
Property contains an extensive analysis on pre and post-ERTA tax incentives for
historic rehabilitation.
2 Source:
Joseph Dowley, Chief Counsel, House Committee on Ways and Means,
John Colvin, Chief Counsel, Senate Committee on Finance, Ben Hartley, Legislative
Attorney, Joint Committee on Taxation; conference panelists for the State Historic
Preservation Officials annual conference titled, "Preservation, Capitalizing on
Success", March 25, 1985
3 Source:
Wall Street Journal, "Capital Gains: Tax Plan would Aid Some Investors
Others", Paul Blustein, April 15, 1985 (!)
Hurt
but
recourse means that the security of a loan or mortgage is held by the asset
itself, rather than by the individual. The individual's other personal and business
assets cannot be "seized" upon non-payment of the loan or mortgage. Because the
individual's assets are not "seizable", the IRS does not regard the individual to be
"at risk" of loosing his/her assets in the even in the case of non-payment of the
debt.
4 Non
5 Source:
Decisions Confronting Owners of Older Buildings: An Economic Choice
Model by Richard Holden for the National Trust for Historic Preservation.
may have a technical flaw, in that the program does not deduct land value from
the basis for depreciation. This causes an erroneous depreciation basis to which'the
internal rate of return calculation is sensitive.
6 1t
7 Source:
Lotus Computing for Managers and Professionals, May 1985.
13
CHAPTER III
THE HITCH MODEL
This chapter discusses capabilities and applications of the HITCH (Historic
Investment Tax Credit Helper) model for public policy and private investment
decision making.
model.
That is followed by a discussion of the design and format of the
The chapter is then concluded with a description of the model and its
underlying analytical assumptions.
A.
APPLICATIONS
The HITCH model is designed to evaluate the effects of changes in the tax laws
on economic returns from rehabilitating or replacing a historic property. The
comparison has several potential applications.
1.
Public Policy
The model has been designed to facilitate developing a policy position on the
proposed tax law changes. It can be used to identify which of the proposed tax law
changes
are
most
critical
in encouraging
retention
versus demolition
and
replacement of historic structures.
2.
Evaluation of Project Alternatives
The HITCH model can be used by city governments in facilitating project
development decisions for both rehabilitation and new construction projects alike.
The model can also be used to evaluate proposals for publicly leased properties to
private developers.
If a public agency is faced with evaluating the financial
feasibility of a project, and is trying to negotiate provision of public amenities by the
developer, the model can be used to evaluate the reasonableness of the developer
proposal.
14
3.
Evaluation and Documentation by Private Investors
HITCH can also be used as an evaluative tool by modelling a series of project
alternatives under different tax variable assumptions to evaluate a purchase and
rehabilitation decision. An additional benefit to an investor is, the model's ability to
generate documentation of project analysis in a format that would facilitate
evaluation by lenders.
B.
MODEL DESIGN AND FORMAT
1.
Organization
The HITCH model was organized to resemble a manual financial analysis
consisting of eight exhibits.
The organizational formats of the exhibits were
designed from a combination of several sources. Formats for Exhibits I, II, and IV
come from the project submittals from the developers of Warren Chambers and 399
Boylston, the case used for detailed analysis. The analysis formats in Exhibits VI and
VII are derived from a case analysis published by the Harvard Business School, called
the Angus Cartwright Case. The amortization schedule was developed from "public
domain" software (in this case, a Lotus 1-2-3 template) published in a national
computing and software periodical.1 The formats of depreciation schedule and the
analysis summary were developed by the author using course materials and secondary
research sources.
2.
Format
While the formats of the exhibits may on first glance may appear to be
"borrowed" from previous analysis, substantial modification of the analysis was done
to retain flexibility for single and mixed use developments and for tax and economic
variables.
The structure of the file enables the user to isolate inputs which are
project-specific and not tax sensitive. The tax analysis inputs are manipulated in a
separate analysis file. Finally, the model facilitates inputting as a through the use of
highlighted ("unprotected") cells and "protected" cells elsewhere, drawing attention
15
to the places where entries are to be made and protects against inadvertent
overwriting of the formulas embedded within the model. Should a user attempt to
make an entry into a protected cell, the system will make an audible signal and
prevent the user from making the entry.
Once a user has imported the project data from the inputs (PROJIN) file to the
analysis (PROJTX) file, it takes very little time to model any variety of existing and
proposed tax alternatives and economic variables. The model does not require that
the user have an intimate knowledge of the inner workings of the tax law changes (or
existing tax system for that matter), however, the user should have a conceptual
grasp of the existing and proposed tax system variables. Detailed instructions and a
diskette of the model are included in Appendix E.
C.
HARDWARE AND SOFTWARE REQUIREMENTS
The HITCH model runs on Lotus 1-2-3 spreadsheet software.
Operating the
model assumes a novice level of understanding of Lotus 1-2-3 and requires the use of
an IBM Personal Computer or an IBM compatible computer.
HITCH occupies
approximately 50,000 bytes on a 5-1/2" floppy disk. There is enough room to store
three or four more projects on one disk.
D.
DESCRIPTION
HITCH consists of two analysis files, PROJIN (Project Inputs) and PROJTX
(Project Tax) which operate sequentially.
PROJIN includes all actual project
characteristics and prepares a before tax cash analysis.
PROJTX uses inputs
generated by the PROJIN file and generates a series of after tax cash flow
analyses.
PROJIN analyses only the first stabilized year costs and income, while
PROJTX projects from the first year "setup" out to a choice of five, seven, ten,
fifteen and twenty year holding periods.
16
E.
MODEL STRUCTURE AND ASSUMPTIONS
This section describes the basic structure of HITCH and the underlying real
estate financial analysis methods used by the model. It is organized by the exhibits
produced by the model. Formulas are presented in Appendix C.
The first task the user must undertake is to assemble as much information as
possible on characteristics of the project. These include hard and soft costs, rents,
operating expenses, probable financing mechanism and term. At the top of the work
sheet, the user enters project assumptions which include: project name, the holding
period in years, the cap rate and the historic tax credit percentage.
1.
Exhibit I PRELIMINARY PROJECT COSTS
Exhibit I is a compilation of hard (in the ground) and soft costs. Hard costs are
typically expressed as a cost per square foot.
Soft costs are those costs that
"support" the project from conceptual design to working drawings, marketing to
property management, and project financing costs.
The key item entered in this
exhibit is the percentage of the hard costs attributable to rehabilitation, the only
cost element eligible for the historic tax credit.
If new construction is being
analyzed that percentage is zero. The sum of soft and hard costs represent the total
project costs.
2.
Exhibit II INCOME ANALYSIS
Exhibit II is an income analysis of the project. User inputs include: unitized
rents (per month for residential and per square foot per year for commercial and
retail use), the number of units and/or square feet, vacancy rates and the annual
percentage rent increase.
The annual rents are computed by use and then totalled.
The square footage, number of residential units, the gross and net rents are then
totalled.
17
F I NAN CI AL
A N AL Y S
I
S
P R 0 J EC T
PROJECT NOE: (up to 5 letters)
CASE ASSLPTIONS:
Holding Period in Years
Cap Rate
Tax Credit Percentage
EXHIBIT
I-PREL
I N P UT S
yrs.
5
23-May-85
I N I NARY PROJECT COSTS
Project Component NameI
Building/Shell Cost
Land Acquisition
Project Component Name 2
I
TOTAL
$
$
S
S
$0
Hard Costs
Gross square feet
x amount per square feet
___s.f.
Total z
90
Percent Attributable to Rehabilitation
Tenant Improvements
Contingency (5 Total Hard Costs)
Off-site development costs
S
s. f.
a
$S
$8
$
S
.5
$8
$__________
S.
_____
.5
58
I
5
$8
$8
$8
$___________
=
I
$$
TOTAL HARD COSTS
Soft Costs
A/E
Space Planning/Schteatics
Working drawings
Surveys, testing
Marketing
Legal/Accounting
Leasing Commissions
Nortage Broker's Comission
Insurance During Construction
Interim Real Estate Taxes
Construction Loan Origination Fee
Interest on Construction Loan
Contingencies,
Dveloper Fee
Impact or Linkage Payments
$
$
$
$
$______
$
$_____
$_____
$_____
$_____
$
$
S_____
$_____
S___
8
I$
_
ERR
ERR
I
I
_
$9$
$0
9
ERR
I__
ERR__ERR
.
ERR__
-ORUncategorized Soft Costs
TOTAL SOFT COSTS
$8$
TOTAL PROJECT COST
Cost per S.F.R.A.
ERR
I
Cost per S.S.F.
18
8
ERR
ERR
*
ERR
ERR
I
23-May-,85
EXHIBIT I11
INCOME ANALYSI S
Proj. Com. 01
Total Proj. Co.
TOTAL
B
_
U
U
Total OFFICE Rental
U
#
s.f.
s.f.
First Floor Retail
X Rent per square foot
_S_
$0
$
Total ETAIL Rental
Miscellaneous Rental (storage, parking, etc)
X Rent per square foot or per unit
Total MISCELLAEOUS Rental
Total
s.f.
s- f-.
s.f.
s.f.
Office Area-Square Feet
Basement Mechanical
=Total Rentable Aea
X Rent per square foot
2
Use: (
0
s.f.
s.f.
_
S_
9
)
Total Rent Number Units
#
U
Total Rent
Total Rent
Residential Rentals
Studio/Efficiencies
Number Units
Rent/month
One-Bedrooms
m
S
S______
$U
$__U_ _ _
#
U
#
Rent/month
Two Bedrooms
Rnt/month
Three Plus Bedrooms
Rent/month
Total IESIDENTIAL Rental
#
$U
$_
#
#
$ _S
$
9
6
fross Potential Rent
Vacancy Rate
NET POTENTIL
S
$0
$0
0
U0
U
S
$U
$0
U
U
0
%
ENT& Increase
5
Total Square Feet Non-Residential
Average rent/square foot
Number of Residential Units
Average Rent/unit
I
9
ERR
ERR
09
19
$0
U
I
ERR
$0
3.
Exhibit III AMORTIZATION SCHEDULE
Exhibit III is an amortization schedule for the permanent financing portion,
2
using a fixed rate, level payment mortgage . User inputs include the percent of
total project costs financed or the actual amount.
The amortization schedule is
capable of calculating principal, interest and mortgage balances for an indefinite
period of time.
The first 25 years are displayed on the worksheet and if the
mortgage is less than 25 years, a series of zeros will appear when the loan is fully
retired.
4.
Exhibit IV SETUP
Exhibit IV is the first stabilized year setup.
Remaining user inputs include
operating expenses, replacement reserve, the real estate effective tax rate, and
annual increases of operating income and expense and replacement reserves.
The
real estate taxes are computed by multiplying the effective tax rate by the total
project cost. Annual increases in real estate taxes after the first year are tied to
the annual rate of increase for income from Exhibit II.
Exhibit IV is the end of the PROJIN file. The analyses which are tax-sensitive
are located in the PROJTX file, described below.
5.
Exhibit V DEPRECIATION
The model will determine whether the the project will qualify for straight line
or accelerated recovery methods of depreciation: if there is office and retail income
present in Exhibit II, use of straight line depreciation is assumed whether or not
there is residential income.
If the user determines that two or more depreciation
methods must be used, it is recommended that the analysis of the project be run
separately and that pooled items such as mortgages and the historic tax credit be
prorated between them. The depreciation "basis" is the total project cost less land,
less half for 25% historic "certified" tax credit projects, or 100% of the historic tax
credit for 20% and 15% tax credit projects.
20
The depreciation recovery period in
N
W
W
-~
U~ CA A- t.J hi
.-.
.J 0'
CA A
t~.J hi
'Ii
S-c
S
1"y.j
i7i
II I
I
EXHIBIT IV
Y E A R 1 S ET U P
Net Revenue
-Operating Expenses
Percent Annual Increase
(X % Operating)
-Replacement Reserve
23-May-85
Project Component I
%Ann. Incr.
%
%
TOTAL
Project Component 2
$0
$9
_
%$
$0
$
$6
$
$0
-Real Estate Taxes
(Effective Tax Rate)
5
$6
NET OPERATING INCOME
$6
$6
$6
$6
-Finance Payments
$6
ERR
-Lease payments
$
$E
ERR
BEFORE TAX CASH
FLOW
22
years is set at the current period of 18 years unless the user makes a change, and the
declining balance factor is similarly set at 175%.
Straight line depreciation is
computed by dividing the depreciable basis by the number of recovery years. 3
6.
Exhibit VI SUMMARY OF OPERATING INCOME AND EXPENSES
Net revenues carried over
Exhibit VI contains the multi-year year proforma.
from Exhibit II are automatically projected out through to the horizon year.
Principal paid is carried over from Exhibit III.
carried over from Exhibit VI.
The depreciation deductions are
Taxable income is computed from those.
Taxable
income, minus annual income taxes, plus the historic tax credit (in the first year),
added to the before tax cash flow represents the after tax cash flow.7.Exhibit VII
7.
Exhibit VII AFTER TAX SALES PROCEEDS
Exhibit VII computes the after tax proceeds of sale. The asking sales price is
determined by the net operating income in the year of sale, divided by the cap rate
entered by the user in the Analysis worksheet.
"Net book value" is the difference
between the original purchase price (total project costs) and the sum of the annual
depreciation deductions taken over the holding period.
deducted
from
the
asking
sales price
resulting
The net book value is
in a gross gain
on sale
(appreciation).
Recapture--If the project is an income producing residential property, the
Accelerated Recovery System (ACRS) method of depreciation is used.
Upon sale,
the difference between ACRS and straight line depreciation is "recaptured", that is,
taxed at ordinary income rates. If the project is not residential, the investor would
not usually use an ACRS method of recovery because all of the ACRS depreciation
would be subject to recapture.
For a residential income property, the recaptured
excess depreciation is deducted from the gain on sale to avoid double taxation, the
result yielding the net capital-gain. For a non-residential income property, the gross
gain is the net capital gain.
23
EXHIBIT Y
DEPRECIATION
E STIATE
S T IK A T E
Depreciation Basis
Depreciation Method
#1 Straight Line
0
1
175. W%
4E ACRS
Basis Period in Years
1&
Year
ACRS Basis
ACRS Deprec.
S/L Deprec.
Allowed depreciation
Recapture
EXHIBIT VI
SUMMARY
OF
2
$6
U
U
U
U
23-May-85
OPER ATING INCONE
Permanent Financing:
Amount
Term
Interest
Annual Debt Service
U
I
L.8%
ERR
1
$6
-Operating Expenses
-Replacement Reserve
-Real Estate Taxes
U
R
6%
U
so
S
3
2
4
5
U
$6
U
U
U
U
6
$
U
U
U
U
o
$6
$
$6
U
U
U
U
ERR
U
TOTAL OPERTIN EXPENSES
U
U
U
EX PENSES
Uo
TOTA !ET REVEUES
U
U
U
U
U
U
U
U
Developer Equity:
Tax Credit Percentage:
Historic Tax Credit:
Depreciable Basisz
A
E
Y
AND
5
4
3
1
U4
$6
U
U
U
NET OPERATINIE E
$
-Finance Payments
-tease Payments
ERR
ERR
ERR
ERR
$
U
$
U
MRE
ERR
ERR
ERR
ERR
ERR
so
Uo
Uo
9
U
U
$
$6
TAXABLE INCOE
ERR
ERR
ERR
ERR
ERR
Income Tax Liability
ERR
ERR
ERR
ERR
ERR
ERR
ERR
ERR
EM
TAX CASH FLOW
ERR
+Principal Paid
-Depreciation
Tax Credit
$
Uo
ERR
AFTER TAX CAS FLOW
to
After Tax Sales Proceeds
Internal Rate of Return Cash Flows
2
a
ISO)
ERR
ERR
24
3
ERR
4
ERR
5
ERR
EXHIBIT VII
AFTER
TAX
ET
23-May-85
SALES
PROCEEDS
OPERATING INCOME
$9
ASKIN6 SALES PRICE
$8
Oeig. Purchase Price (Total Project Cost)
$8
- Depreciation
$0
NET BOOK
VALUE
$8
GAIN ONSALE
$6
ACRS Depreciation
- Straight Line Depreciation
$0
Excess Depreciation
X Marginal Tax Bracket
$0
5%
Excess Depreciation Recapture
$8
Gain on Sale
$8
$0
- Excess Depreciation
to
CAPITAL GAIN
$8
X Capital Gains Tax Rate
20M
CAP. GAINS TAXLIABILITY
$8
Sales Price or Refinancing
-Income Tax
-Nortage Balance
$8
$8
AFTER TAX PROCEEDS ONSALE
$8
25
The capital gain is currently taxed at 40% of the investor's marginal tax rate.
It is customary in real estate financial analysis to assume that the investor is in the
maximum income tax bracket (unless the user is the investor and knows better). If
the investor is in the 50% income tax bracket, the capital gains rate is 20%. The
capital gain is multiplied by the capital gains rate to arrive at the capital gains tax
liability. The after tax sales proceeds consist of the asking sales price in the year of
sale, minus income taxes (recapture tax and/or capital gains taxes) and the remaining
mortgage balance.
Exhibit VIII ANALYSIS SUMMARY
8.
The analysis summary contains all the modelling components.
It is in this
portion of the worksheet that sensitivities can be tested for both tax and economic
variables.
Exhibit VIII also calculates the pre-tax measures of return described
The after-tax analysis capabilities of the model are the ability to test the
below.
sensitivity to proposed tax changes in the historic tax credit; the treatment of
capital gains; depreciation; and maximum income tax rates. A user can choose any
combination of these economic and tax variables to test effects on a project in
question. Mechanically, HITCH also responds to the tax variable choices as well as
inflation rates (the inflation rate is used for calculating the proposed capital gains
treatment) and holding periods. The assumptions about the existing and proposed tax
system were discussed at the end of Chapter II.
The bank/appraiser cap rate is used to determine the asking sales price as
described under the discussion of Exhibit VII above.
Before Tax Measures of Return--HITCH will provide a set of before and after
tax measures of return in the PROJ_TX work sheet.
The measures and their
definitions are as follows.
1.
Capitalization Rate--The initial (first stabilized year) net operating
income divided by the total project costs.
26
EXHIBIT VIII A N A L Y S IS
S
Analysis Name
Project Name:
UMM
A RY
23-May-85
Your Choice
Proj
TAX SYSTEM ATTRIBLTES
(1 for Existing, 2 for proposed)
Historic Pres. Tax Credit
Capital Gains Treatment
Depreciation System
%aximum Income Tax System
1
I
1
1
-58%
18
Maximux Income Tax Rate
Maximum Depreciation Term (Years)
ECCDMIC ATTRIBUTES
Inflation Rate (%)
Bank/Appraisor Cap Rate (N)
6.*0
13.55%
10DEL VARIABLE CHOICES
Estimated IRR
48.n
Holding Period (years)
Discount Rate
5
12.00
BEFDRE
TAX
ASURES OFRETURN
Capitalization Rate (a)
Cash on Cash Return (b)
Increase In Value c)
ERR
ERR
ERR
ATER TAX EASUES OF RETUR
Net Present Value d)
Actual Internal Rate of Return (e)
ERR
ERR
Definitions
(a)
(b)
(c)
(d)
Net operating incose/Total project cost
Year I Before tax cash flow/Equity
Future sales price-Total project cost/Total project cost
The present value of cash flows are compared with the
initial investment.
(e) The discount rate at which the present value of a project
Filename:PROJTX
27
I
2.
Cash on Cash Return--The before tax cash flow in the first stabilized year
divided by the investor's initial in vestment (equity).
3.
Increase in Value--The difference between the initial purchase price and
the anticipated sales price at the end of the holding period, divided by the
initial purchase price.
The after tax measures of return generated by the PROJTX worksheet include
discounted cash flow measures of return, namely, net present value (NPV) and the
internal rate of return (IRR). 4 Net present value is the sum of the total stream of
after tax cash flows discounted by a predetermined discount rate. The discount rate
in real estate analysis can be considered an opportunity cost to alternative
investments, that is, the potential return from other alternative investments which
are available to the investor.
return.
This is considered the investor's required rate of
Net present value can be used to determine whether to proceed with the
project. If the NPV is negative, the project is not feasible. Conversely, if the NPV
is positive, then the project is considered to be feasible. NPV can also be used as a
comparative measure, the larger NPV 'among a choice of project alternatives
identifies the most favorable alternative.
The internal rate of return enables analysis and evaluation of a series of
project alternatives.
The internal rate of return is the discount rate at which the
Generally the project with the highest IRR
present value of a project equals zero.
would be considered the best alternative to pursue.
The advantages of using the
internal rate of return measure is that it reflects the time value of money; is able to
reflect changes in economic and tax variables; and is a widely accepted measure of
return in the investment community. Its primary disadvantage is that it assumes the
investor can find an opportunity to reinvest his/her resources at the same rate of
return, which may not be the case.
28
l"Analyzing Real Estate with 1-2-3" by Stan Trost, IBM PC Update, 12/84.
2 See
Appendix B for formulas.
3 1bid.
4 Ibid.
29
Chapter IV
CASE ANALYSIS AND FINDINGS
This chapter describes the actual Warren Chambers and 399 Boylston Street
rehabilitation and presents the assumptions and findings of the hypothetical
replacement alternative.
The next section presents the modelling results and
analysis of six tax law alternatives for both rehabilitation and replacement.
A.
PROJECT BACKGROUND
Warren
Chambers
and
399
rehabilitation and new construction.
Boylston
are
a
single
project
combining
Originally Warren Chambers served as law
offices. The most recent use of Warren Chambers and the former 399 Boylston was
Class B office space and retail at ground level. Warren Chambers was also the film
location site of "The Verdict".
Originally, the site consisted of four structures, equal in width, consisting of
Warren Chambers, 399 Boylston, a dance studio, and a greenhouse structure (flower
stand). The Warren Chambers and 399 Boylston buildings shared access even though
structurally the buildings were separate.
A decision was made to restore Warren
Chambers, and to redevelop the site previously occupied by the former 399 Boylston,
the dance studio and the greenhouse structure. Apparently, the former 399 Boylston
building had serious mechanical system problems warranting demolition.
Rehabilitation of Warren Chambers and construction of 399 Boylston was
completed in 1984.
The new structure occupies the space previously occupied by
former 399 Boylston building, dance studio, and the greenhouse structure.
It was
designed to resemble the vernacular architecture of the Back Bay, characterized by
prominent bay windows.
buildings.
The new building is several stories taller than adjacent
However, the higher stories were stepped back and reflective glass was
30
used to "mirror" the sky line in an attempt to "camouflage" the additional stories.
Warren Chambers occupies 55,000 gross square feet and the new 399 Boylston
occupies 245,000 gross square feet.
The detailed HITCH model data and analysis of Warren Chambers and 399
Boylston are presented in Appendix B. The two buildings are analyzed together since
the project was developed under single ownership and financing. Project information
came from submission materials made available through the Boston Redevelopment
Agency.
The
data
modelled are
the
project estimates
prior
to project
implementation and may not have been reflected in the final result. Restoration of
Warren Chambers was estimated at $45/s.f. while redevelopment of 399 Boylston was
estimated at $60/s.f. Total project costs were just over $34 million. Rehabilitation
costs of Warren Chambers were eligible for a 20% historic preservation tax credit.
All the hard costs associated with Warren Chambers were assumed to be eligible for
the historic preservation tax credit.
B.
HYPOTHETICAL REDEVELOPMENT CASE
A hypothetical redevelopment project was constructed and run on the HITCH
model.
The project was assumed at an FAR of 10, the maximum allowable FAR in
Boston without requiring a zoning variance or other special administrative review.
The BRA Boylston Street Zoning Study recommends lowering the FAR on the north
side of Boylston Street to 8. For the purposes of this analysis, it is assumed that the
developer would have vested rights in the higher FAR.
The hypothetical project
characteristics are presented on table 4.1.
C.
CASE STUDY CONCLUSIONS
After modelling the actual project with and without the historic tax credit and
the hypothetical redevelopment project, six tax alternatives were modelled for the
rehabilitation and redevelopment alternatives. The alternatives are listed on Table
31
TABLE 4. 1
SUNNARY
OF
PROJECT
22-*ay-65
ASSUPTI
==
PROJECT CHRACTERISTICS
EX ISTIN6
MRREN D BPERS
PROJECT
399 DMYLSTMU
&oss Square Feet
245,
Land Square Feet
Development Cost (Hard)/s.f.
Soft Costs/% of Hard
Vacancy Factor
Rentable Net Factor-%of gross s.f.
aEDEY
HYPOT HET ICAL
R E D E Y E L 0 P N E NT
382,558
249-
38, 249
$45
$6.
68.4%
58.7%
55.1%
5.1%
5.1%
5.9%
88%
85%
835%
$6.
=
USES AM INCOE
Ren t
s.f.
s.f.
RI~nt
, ..
Rent
Office (includes mechanical prorata 35,86
$25 189,644
I 28 228,125
$3/s.f.
Retail
4,118
8
$44
11,872
I '46
16,u00
$48/s. f.
Basement Storage
5,658
$8
15,271
I S
21,0
on
$18/s.f.
Total Square Foot Rentable rear
216,787
45,574
32
257,125
4.2, Summary of Tax Alternatives.
The tax variables for the redevelopment
alternative consisted of only three model runs because as a new development, the
redevelopment alternative would not be eligible for the historic tax credit.
While the differences between internal rates of return are small, the actual
IRR results modelled are consistent with the eventual decision to rehabilitate Warren
Chambers and construct a new building at 399 Boylston. One could argue that the
slight differences in internal rates of return would not have been of enough
magnitude to base the investment decision on: it is doubtful that the developer went
though this exercise.
The relative IRR differences between rehabilitation and replacement would
have probably been more substantial had the whole project been rehabilitated. The
actual rehabilitation of Warren Chambers constitutes a small portion of the overall
project. Warren Chambers has just over one-sixth of the total square footage of the
entire project. Twenty percent of the hard costs associated with Warren Chambers
were assumed to represent the historic preservation tax credit. A second factor in
the small differences between the actual project internal rates of return and the
redevelopment internal rates of return, is that the actual square footage difference
between the actual Warren Chambers and 399 Boylston project and the hypothetical
redevelopment alternative is quite small.
A reasonable hypothesis would be that under the present tax system the
availability of the historic preservation tax credit would encourage rehabilitation
over replacement, and that the proposed tax system, which among other things would
eliminate the tax credit, would tend to encourage replacement.
The model results
for this case showed that this is true. Under the existing tax system, rehabilitation
was favored over demolition and replacement, while under the fully proposed tax
system, demolition and replacement would have been the preferred alternative.
33
TABLE 4.2
0F
S U MMA R Y
23-May-85
A L T E R N A TI V E S
13.55% Cap Rate
7 Years
Basic
Alt # System
T AX
Hist oric Pres.
Tax Credit
Depreciation Recovery Judged
Likelihood
Period Inyears
Yes
1 Existing
2 Existing
No
Yes
3 Existing
Rehab.
INTERNAL RATE 5 OF RETURN
Diff. %Change
Replace
18
10%
33.9%
33.5%
18
28%
32.5%
33.5%
30
25%
38.7%
38.3%
15%
29.3%
38.3%
4 Existing
No
30
5 Proposed
Yes
30
5%
34.7%
34.7%
38
25%
33.3%
34.7%
1n%
32.8%
32.6%
No
6 Proposed
Expected Value
9.4%
-1.1%
8.4%
-1.8%
.8%
-1.4%
TABLE 4.3
OF
SU MMARY
Basic
Alt 0 System
1 Existing
2 Existing
3 Existing
Historic Pres.
Tax Credit
Yes
No
Yes
Depreciation Recovery
7 fears 18 Years 15 Years 28 Years
Period Inyears
Rehab
Rehab
Rehab
Rehab
18
Replace
Replace
Replace
Replace
30
Rehab
Rehab
Rehab,
Rehab
Replace
Replace
Rehab
Rehab
Rehab
Rehab
Rehab
Replace
Replace
Replace
18
4 Existing
No
38
5 Proposed
Yes
38
6 Proposec
No
CONSEQUENCES
PROPOSAL
TAX
-
Replace
38
34
1.1%
Favors
Rehab
-3.3% Replace
1.2%
Rehab
-3.4% Replace
-0.1%
-4.3% Replace
Co mrp ar at iv e Su mm ary
Figwe
4.1
0. 2
0.2
E
I-
n is1r
.1a
0. CG
0
3
2
'
hob
4
Tax Aftrnati:
fitpa(ce
=
35
5
6
The next level of analysis would be to test the impacts of the availability of
the tax credit on the existing and proposed tax system. Under the existing system
without the tax credit, model results of the case showed preference toward
replacement, as could intuitively be predicted.
However, under the proposed tax
system, but retaining the historic preservation tax credit, model results showed
indifference between rehabilitation over replacement.
One possible application of Table 4.2 would be to assign probabilities to the
occurrence of each of the tax proposals and arrive at an expected value for the rate
of return, evaluated across all the possible tax system alternatives. This would allow
an investor to evaluate choices between rehabilitating or redeveloping a property,
based on his/her perception about the judged likelihood of a certain tax proposal
being adopted.
Using the hypothetical probabilities presented in the summary,
redevelopment would be slightly preferred over rehabilitation.
If the tax alternatives were compared with each other, alternative 4,
elimination of the tax credit and lengthening of depreciation, reflects the worst
possible combination of tax law changes from the perspective of encouraging
rehabilitation.
It is important to realize that institutional actions may be affected by changes
in the tax law which may not necessarily be reflected in internal rates of return.
Real estate development is a very time-sensitive industry and the overall social and
political climate may have more of an impact on development decisions to proceed
with a project of "good currency", such as rehabilitation, over spending more time to
pursue approval of a new construction project.
Another issue that may not be reflected in an internal rate of return analysis is
that discount rates or expected rates of return may not fully reflect the prospect of
obtaining very large front-end cash benefits, which historic tax credits provide. The
premise behind development economics is to be as highly leveraged as possible (in
36
other words use O.P.M., other people's money). The prospect of having a very large
front-end tax credit, quickly made liquid may have a disproportionate weight in a
developer decision.
Table 3, Summary of Tax Proposal Consequences, is a summary of the
preferred choices between rehabilitation or replacement over four holding periods (7,
10, 15, and 20 years). Generally, the preferred development outcomes appear to be
consistent across holding periods with the exception of retaining the existing tax
system, repealing the historic preservation tax credit, and lengthening depreciation.
Mid-term holding periods of seven and ten years tended to strongly encourage
replacement, while the longer holding periods of fifteen and twenty years tended to
encourage rehabilitation.
Tax law changes are likely to encourage longer holding
periods, of some benefit to the interests of preservation.
37
CHAPTER V
CLOSING COMMENTS AND NEW DIRECTIONS
This chapter discusses and critiques the model design process. It also proposes
further applications and improvements to the HITCH model.
A.
DESIGN ISSUES
There are several design issues that bear mention. They deal with application
of the model as a comparative tool, simplicity versus complexity, and overall general
comments about the design of the model. It is entirely possible that a much simpler
analytic approach could have been used to assess the effects of tax law changes on
choices between rehabilitating or replacing a historic structure, thereby considerably
shortening the model.
A conscious decision was made to apply the real estate
financial analysis techniques as a means of gaining further grounding in these
techniques and testing their applicability to public policy analysis.
A secondary benefit of using traditional real estate finance techniques, as
mentioned earlier, is the ability to provide full documentation of the financial
characteristics of a proposed development project for lenders and other public
participants in the development process.
Operationally, the model is not a comparative one.
However, to make one
would make the model confusing. With several more hours and assistance from an
experienced person proficient in "macros", it would be possible.
This would be
achieved by the addition of several horizontal rows in the pro-forma that would show
the existing and proposed tax system effects on taxable income and after tax cash
flows. There is a disadvantage to this, creating confusing documentation of before
and after tax cash flows and would obviate the objective of providing reasonable
documentation to lenders and the like.
38
A second approach to facilitating comparisons would be to simultaneously
present, duplicate exhibits side by side, one depicting the existing tax system and the
The disadvantages to this are visual and
other depicting the proposed system.
operational.
It is not possible within the present conventional sizes of personal
computer monitors to view the pro-forma as a whole.
would duplicating the existing system in each run.
Operationally, the model
This would also slow down the
calculations considerably, and the file storage on a diskette would be inefficient.
The model in its present form eliminates this redundant storage.
Documentation of the process would not be complete without words of wisdom
to persons who may wish to construct a model of this type on their own. The model
was developed incrementally. At one point the model was composed of one file and
took up less memory storage than the smaller of the two present files. A decision
was made to make the analysis a model, that is, a tool that others besides the author
could use.
Part of the organizing philosophy in separating the non-tax dependent
project characteristics from the after tax cash analysis was to facilitate speed and
ease of use.
Finally, assembling a model of this type is not without its caveats. Much of the
model is driven by macros which are a very simplified programming language, for
which debugging can be very time consuming. Some of the "bells and whistles" such
as creating alternative holding periods took an inordinate amount of time (several
very full days with the help of a person experienced in writing macros) to get the
model to operate correctly.
B.
CRITIQUE AND ADDITIONAL INFORMATION NEEDS
As mentioned in the previous chapter, limitations are inherent in models
themselves. It would be ideal if one could be able to construct the tax variables in a
manner that could account for all possible changes in the tax law. The disadvantage
of developing a model of this type is that it requires the user to construct his/her
39
own tax assumptions, obviating an objective of not requiring tax expertise on the
part of the user.
The author recognizes a concern that the model does not account for limited
partnerships and other joint ownership arrangements.
A tax proposal that was not
discussed (because it was beyond the scope of this effort) may effectively eliminate
syndication of limited partnerships to such an extent that other "creative" financing
arrangements may have to be invented. The Treasury Department proposes to limit
the number of investors in limited partnerships to only "sophisticated investors".
That means that they must meet certain net worth or securities licensing
requirements.
Combined with potential limitation of interest deductions to the at
risk (recourse) portion of an investment, limited partnerships may no longer remain a
viable financing alternative.
Like all models, variables and assumptions need to be simplified to a point that
the model is flexible enough to handle a number of predetermined scenarios.
Simplification of these assumptions can sometimes be unreal.
The model should be modified to include the following improvements: allowing
for the use of more than one mortgage since, larger projects typically have more
than one lender and financing terms; the ability to have more than two project
components for larger scale mixed use projects; adding components to the income
analysis to include hotel, restaurant and entertainment uses; and finally, the addition
of another depreciation schedule so that residential and non-residential uses can be
modelled simultaneously for mixed use projects.
C.
FURTHER APPLICATIONS OF THE HITCH MODEL
The purpose this thesis was to develop a model which could lead to answering
the public policy question of if and how the proposed tax changes will most adversely
affect developer decisions to purchase and rehabilitate older properties. This thesis
does not attempt to identify for all potential rehabilitation projects which tax
40
proposals may or may not encourage purchase of older properties for the purpose of
rehabilitation. It is my belief, however that this question can be answered through
use of the HITCH model, in a revised and updated form, by modelling a series of
representative projects by type of tax credit used, by overall size, and by location.
One characteristic of a thesis effort, as opposed to an ongoing research effort
undertaken by a public agency in attempting to address a pending Congressional
action, is that it and its products are time dependent. It was necessary to "freeze"
the time at which assumptions would be modelled.
Unlike a policy draft, one does
not have the liberty to respond to changes in Congressional proposals after a certain
point in time.
It is recognized that any creativity on the part of the Congress or
Treasury Department could render the model useless as well. On May 28, 1985, the
due date for this document, a third major revision of the Reagan Administration
Treasury tax proposals will be released to the public. As of the date of this writing,
the Administration has not fully developed the form of their tax proposals.
In order to effectively use the model for public policy analysis, the model
should be modified to account for the most current tax proposals. Then, the model
should be tested as to its adaptability to other projects by modelling a second
project. When project-specific limitations of the model are corrected, and the model
is made flexible enough to accomodate other projects, the survey form should be
designed and sent to a small sample of historic rehabilitation projects to test the
effectiveness of the survey form itself. Survey return and completion rates of the
surveys can be used to determine the effectiveness of the surveys. After identifying
limitations to the survey, a sample of projects can be identified and then surveyed
with the objective of obtaining empirical project data.
Another policy question that could be addressed given major modifications to
the model, would be evaluation of the effects of tax law changes on land values,
determining the residual land value based on after tax benefits. One would adjust
41
tax benefits and the model would essentially "work backwards" to arrive at what
would be necessary to pay for the land and building shell given the historic
preservation tax incentives and other tax factors affecting real estate. Then, after
modelling a series of actual projects "backwards" to arrive at residual land values,
one could begin to identify trends that would substantiate conclusions on the impact
on land values of the availability of historic preservation tax incentives.
42
REFERENCES
Bentson, Elesa Jo Weir, AN EXAMINATION OF THE FEDERAL INCOME TAX
INCENTIVES FOR THE REHABIITATION OF HISTORIC PROPERTY Ph.D
dissertation for the University of Austin, Texas, May 1983
Boston Redevelopment Agency, BOYLSTON STREET ZONING STUDY:
REPORT, City of Boston, Boston, MA March 22, 1985
INTERIM
Chittenden, Betsy, A PROFILE OF THE NATIONAL REGISTER OF HISTORIC
PLACES, National Trust for Historic Preservation, Preservation Policy Research
Report #5229, Fall 1984
Esenwein, Gregg A., A COMPARATIVE ANALYSIS OF THE BRADLEY/GEPHARDT
AND KEMP/KASTEN TAX REFORM PROPOSALS Library of Congress Congressional
Research Service Major Issues System Issues Brief, Washington, D.C. 1/10/85
Esenwein, Gregg A., A COMPARISON OF THREE MAJOR TAX REFORM
THE BRADLEY/GEPHARDT, KEMP/KASTEN, AND TREASURY
PROPOSALS:
PROPOSALS Library of Congress Congressional Research Service, Washington, D.C.
Frebruary 21, 1985
Fitch, James Marston, HISTORIC PRESERVATION: CURATORIAL MANAGEMENT
OF THE BUILT WORLD Mc Graw-Hill Book Company, New York, NY 1982
Gravelle, Jane G. A COMPARATIVE ANALYSIS OF FIVE TAX PROPOSALS:
Congress,
EFFECTS OF BUSINESS INCOME TAX PROVISIONS Library of
12/84
D.
C.
Washington,
Service,
Research
Congressional
Greater Boston Chamber of Commerce, BOSTON GUIDE TO DEVELOPMENT
Harvard Business School Case Services, ANGUS CARTWRIGHT CASE Cambridge,
MA November 1981
Harvard Business School Case Services,
PROPERTY Cambridge, MA July, 1983
FINANCIAL
ANALYSIS
OF REAL
Harvard Business School Case Services, NOTE ON FORMS OF REAL ESTATE
OWNERSHIP Cambridge, MA May, 1979
Harvard Business School Case Services, NOTE ON TAXATION Cambridge, MA
September 1984
Holden, Russell, DECISIONS CONFRONTING OWNERS OF OLDER BUILDINGS: AN
ECONOMIC CHOICE MODEL, National Trust for Historic Preservation, Preservation
Policy Research Report #5051 Washington D.C. March 1984
Kiefer, Donald, TAX REVISIONS: AN ECONOMIC OVERVIEW Library of Congress
Congressional Research Service Major Issues System Issues Brief, Washington, D.C.
Updated 3/5/85
Lynch, Kevin, WHAT TIME IS THIS PLACE? MIT Press, Cambridge, MA 1972
Massachussetts
Historical
Commission,
43
CRITERIA
FOR
EVALUATION
OF
NATIONAL REGISTER NOMINATIONS, Boston, MA
Massachussetts Historical
DISTRICTS, Boston, MA
Commission,
ESTABLISHING
LOCAL
HISTORIC
National Park Service, 36 CFR Part 67, HISTORIC CERTIFICATIONS PURSUANT
TO THE TAX REFORM ACT OF 1976; THE TAX REFORM ACT OF 1976; THE
REVENUE ACT OF 1978; THE TAX TREATMENT EXTENSION ACT OF 1980; AND
THE ECONOMIC RECOVERY TAX ACT OF 1981
National Park Service, REVIEW OF REHABILITATION WORK UNDER SECTION 212
OF THE ECONOMIC RECOVERY ACT OF 1981
National Park Service, STANDARDS FOR REHABILITATION AND GUIDELINES
FOR REHABILITATING HISTORIC BUILDINGS April 1982
National Trust for Historic Preservation, ECONOMIC BENEFITS OF PRESERVING
OLD BUILDINGS, Washington, D.C.
National Trust for Historic Preservation, THE HISTORIC PRESERVATION
YEARBOOK-1984-85 Adler and Adler Publishers, Washington, D.C. 1985
National Trust for Historic Preservation, OLD AND NEW ARCHITECTURE:
DESIGN RELATIONSHIP The Preservation Press, Washington, D.C. 1980
A
National Trust for Historic Preservation, PRIME IS AN ECONOMETRIC MODEL,
Washington, D.C. 1984
National Trust for Historic Preservation, TAX INCENTIVES FOR HISTORIC
PRESERVATION prepared by the Assistant General Counsel, Washington, D.C.
September 1984
San Francisco Department of City Planning, DOWNTOWN URBAN DESIGN PLAN,
San Francisco, CA 1984
Sirmans, S.F. and Jaffe, A.J. THE COMPLETE REAL ESTATE INVESTMENT
HANDBOOK: A PROFESSIONAL INVESTMENT STRATEGY, Prentice-Hall, Inc.,
Englewood Cliffs, N.J. 1984
Trost, Stan, " Analyzing Real Estate with 1-2-3 ", IBM PC UPDATE December 1984
Witherspoon, Robert E., TECHNICAL BULLETIN #71 MIXED USE DEVELOPMENT:
NEW WAYS OF LAND USE, Urban Land Institute, Washington, D.C. 1976
Wong, Ken, BUILDINGS OF COMPROMISE: 53 STATE STREET M.C.P./M.Arch
Thesis 1982 for the Massachusetts Institute of Technology, Cambridge, MA
44
APPENDIX A
ANALYSIS SUMMARIES OF TAX VARIABLE ALTERNATIVES
45
S U AM A R Y
Basic
Alt 6 System
0
F
TAX
Depreciation Recovery Judged
Likelihooid
Period In years
Historic Pres.
Tax Credit
31.7%
-. 4%
25%
29.8%
28.4%
1.5%
15%
28. 1%
28.4%
-4.3%
5%
32.35
31.9%
.4%
25%
31.1%
31.5%
In%
3X.6%
38.4%
19%
2 Existing
No
18
20%
3 Existing
Yes
38
4 Existing
No
38
5 Proposed
Yes
38
No
38
Expected Value
S U AMA R Y
Basic
Alt I System
0
F
T AX
Historic Pres.
Tax Credit
% Change
31.2%
18
Proposed
Diff.
Reolace
.8%
Yes
6
IINTERIL RATES OF ETUR
Rehab
31.7%
I Existing
Rehab.
Replace
10%
38.6
29.8%
.8%
2 Existing
No
18
29%
29.62
29.8%
-4.2%
3 Existing
Yes
38
25%
27.45
26.4%
1.0%
4 Existing
No
38
15%
26.511
26.4%
5 Proposed
Yes
38
5%
6 Proposed
No
38
25%
In%
Basic
Alt ISystem
TAX
Historic Pres.
Tax Credit
Rehab
-2.5% Replace
3-May-OS
2 3-My-85
Favors
2.5%
Rehab
4.6% Replace
.1%
6.2%
Rehab
38.0%
.1%
.2%
Rehab
29.9 S
29.5%
-4.4%
28.6 5U
28.4%
Rehab.
-1.4% Replace
3-May-OS
23-*ay-85
13.555%Cao Rate
INTERAL RATES OFRETURN
Diff. %Change
Replace
Yes
18
18%
29.77
28.8%
I.8%
2 Existing
No
18
28%
28.71
28.8%
-. 2%
3 Existing
Yes
30
25%
26.4 1
25.4%
1.9%
4 Existing
No
38
15%
25.51
25.4%
.1%
5 Proposed
Yes
38
5%
28.92
28.2%
8.6%
6 Proposed
No
38
25%
27.9
28.2%
-. 3%
198%
27.6
27.3%
46
1.1%
Rehab
1 Existing
Exoected Value
-1.9% Replace
3.6%
A L T E R N A T I V E S 29 Year
Depreciation Recovery Judged
Likelihood
Period In years
Rehab
4.5%
Diff. % Change
18
F
-1.3% Replace
INTERWL RATES OF RETURN
Depreciation Recovery Judged
Likelihood
Period In years
Yes
0
Rehab
2.4%
4.8%
1 Existing
S UM M A R Y
Favors
13.55% Cap Rate
A L T E R N A T I V E S 15 Years
Expected Value
23-May-85
13.55% Cap Rate
16 Years
ALTERNATIVES
2.8%
Favors
Rehab
-. 5% Reolace
3.8%
Rehab
.5%
Rehab
2.2%
Rehab
-1. 1%Replace
APPENDIX B
PROJECT EXHIBITS
1.
Actual rehabilitation of Warren Chambers and 399 Boylston
2.
Hypothetical redevelopment alternative
47
EXH3BIT IV
Y E A R I S ET U P
Net Revenue
-Operating Expenses &
Percent Annual Increase
IX%Operating)
-Replacement Reserve
-Real Estate Taxes
(Effective Tax Rate)
23-May-85
Project Component
I
Project Component 2
TOTA.
$1,049,817
$5,641,741
$6,690,557
65
$182,296
$867,148
$1,949,444
0.8%
$11,394
$54, 197
$65,591
2.50%
$148,575
$761,875
$850,450
% Ann. Incr.
NET OPERATING INCOME
$4,017,521
$797,552
-Finance Payments
$4,725,072
$3, 683,23
-Lease payments
$3
BEFORE TAXCASH FLOW
$9
$0
$1,641,869
48
FINANCIAL
ANALYSIS
PROJECT NAPE: (up to 5 letters)
PROJECT
INPUTS
Boyls
MASE
ASSLMPTI DS:
Year of Sale
7
Cap Rate
1LN%
Tax Credit Percentage
2. IN
EXHIBIT
- P REL I
NI N A R Y
P R0 J E CT C0 S T
Project Component Name 1
23-9
I
Project Component Name 2
$6 S1,5,0
$6 I
Building/Shell Cost
Land Acquisition
$8
TOTA
1
$3,586, M
$3,5M6,80
Hard Costs
Gross
1
square feet
x amount per square feet
Total a
245,0
M
$6.
$45
In I
2,475,000
$14,70,
000O
$17,175,806
6%
Percent Attributable to Rehabilitation
Tenant Isprovements
Contingency (%Total Hard Costs)
Off-site development costs
$175,3M
$6
TOTA HRD COSTS
7.=7%
1
$50,M
$75.,0
M
$6
$15,956,3M $18,70,0N
$2,751,M
M
Soft Costs
$5MM
$4,M
$126, 00
925, 3M
A/E
Space Planing/Schematics
Working drawings
Surveys, testing
$27,00M
$11 ,in
Marketing
sing M
Legal/Accounting
Leasing Commissions
Mortage Broker's Commission
Insurance During Construction
Interim Real Estate Taxes
Construction Loan Origination Fee
Interest on Construction Loan
Contingencies
Developer Fee
Impact or Linkage Payments
I
$256, 3M
$86, 000
$7,M
$2 ,M66
I
$75, 3M
$75,3M
$56,3M
$256,3M
15,0WM0,
$656, 3M
$456, M
I
$6
Uncategorized Soft Costs
TOTA
FT COSTS
$8,625,M $19,318,M
$5943,
TOTA PROJECT COST
Cost per S.F.R.A.
Cost per 6.S.F.
45,574
$2,675,3M
I
$34,6189,M
$139
I
216,77
$131
$131
$19
I
245, M
$115
$113
49
EXHIBIT II
INCOME ANALYSI S
23-May-85
Comp.
#1
Total
Comp.
#2
Office Area-Square Feet
Basement Mechanical
=Total Rentable Area
35,686
728
35,866
185,573
4,871
189,644
X Rent per square foot
$25.68
$28.88
$695,156
Total OFFICE Rental
First Floor Retail
4,118
X Rent per square foot
X Rent per square foot
Rent/month
One-Bedrooms
Rent /month
15,271
$8.88
$18.8
Two Bedrooms
Rent/month
Three Plus Bedrooms
Rent/month
Total RESIDENTIAL Rental
Total Rent Number Units
0
$6
$8
a
6,265, 182
15,990
$474,888
$8
639,688
28,921
$152,718
45,26
Number Units
8
32
$4.00
5,658
Total ASEENT Rental
Residential Rentals
Studio/Efficiencies
V5, 318,
$164,728
Basement Storage
TOTAL
225,458
11,872
$4.88
Total RETAIL Rental
Total
Total Rent
$197,910
Total Rent
$8
$6
$8
$8
$8
$6
9
$8
8
$8
$8
$8
0
$8
1
$8
S
$6
so
$6
$8
$8
8
$8
8
$8
$6
Gross Potential Rent
Vacancy Rate
5%
NET POTENTIAL RENT
& %Increase
6%
Total Square Feet Non-Residential
Average rent/square foot
Number of Residential Units
Average Rent/unit
$1,185,878
$5,937,622
$7,842,692
$1,949,817
$5,64,741
$6,698,557
45,574
$24
216,787
$8
$8
$27
262,361
$27
8
50
$8
EXHIBIT III
AMORT IZATION
S CHE D UL E
23-May-85
80%
$27,214, 4M6
13. W%
Percent Financed
Aount
Interest Rate
25
Term
$396,934
Monthly Payment
Annual Payment
$3,683,293
Year
Principal
$154, 311
$175,611
$199, 851
$227, 437
$258, 831
$294,558
$335, 216
Interest
$27,214,400
$3,528,892 $27,6,089
$3,587,592 $26, 884,478
$3, 483, 352 $26,684,627
$3,455,766 $26, 457,190
$3,424,373 $26,198,359
$3,388, 646 $25,963,881
$3,347,987 $25,568,585
$3,361,716 $25, 187,698
$3,249,059 $24,752,953
$3,189,133 $24, 258,882
$3,129,935 $23, 6%,614
$3,643,323 $23, 56, 734
$2,954,999 $22,328,53M
$2,854,483 $21, 499, 81$
$381,487
$434, 145
$494,071
$562, 269
8639, 88
$728, 204
$828,720
$943, 116 $2,748,693
$1,873,290 $2,689,913
$1,221,439 $2,461,765
$1,39, 37 $2,293,166
$1,581,907 $2,191,2%
$1,8, 262 $1,882,941
$2,048, 757 $1,634,447
$2,331,551 $1,351,652
$2,653, 381
$3,019, 634
$3,436,442
51
Balance
$1,929,822
663,569
$246,762
$20,556,70
$19, 483, 41$
$18,261,971
$16 871,934
$15,29,027
$13,489,765
$11,441,869
$9,169,457
$6,45,076
$3,436, 442
$0
EXHIBITV
EST
DEPRECIATION
IMATE
$36,023,00
1
Depreciation Basis
Depreciation Method
$1 Straight Line
175.00%
2 ARS
Basis Period in Yews
18
S/L Deprec.
Allowed depreciation
$1,667,944
$1,667,944
EXHIBIT VI
SUMMARY
OF
23-Nay-85
0PER ATINS INCON
Permanent Financing:
mount
$27,214,406
25
Tem
Interest
E
AND
$6
$1,667,944
$1,667,944
$6
$6
S
EXPENSES
$6,863,606
Developer Equity:
Tax Credit Percentage:
Historic Tax Credit:
21%
$495,666
$,23,66m
13.0% Depreciable Basis:
Anual Debt Service
$1,667,944
$1 667,944
$1,667,944
$1,667,94
$6
$6
*6
*6
$e
*6
$6
$1,667,944
$1,667,944
7
$36,823,6NO
$3,023,666 $3, 823,60W $3,023,
$1,667,944
$1,667,944
Recapture
5
4
3
2
1
Year
ARS Basis $3,023,06 $3, 823,00
$6
so
R Deprc.
$3,683,263
Y
E
A
R
4
5
7
1
2
3
$6,696,557
$7,691,991
$7,517,516
$7,968,561
$8,446,675
$9,490,684
$1,149,444
$1,112,411
$65,591
61,179,155
$65,591
$65,591
$1,249,965
$65,591
$1,324, 899
$65,591
$1,48,656
$65,591
$856,458
961,477
$955,566
$1,612,966
$1,673,674
$1,266,386
TDTA OPEATINE EXPENSES
$1,965, 485
$2,679,479
$2,26, 312
$2,328,395
$2, 464,163
$2,76, 627
WERTIN6 INCOE
MET
$4,725,72
$5,612,512
$5,317,198
$5,649,166
$5,962,511
$6,736,057
$3,68320
$3,683,23
$6
$3, 683, 263
$6
$6
$3, 683, 23
$0
$3,683,293
$9
$1,641,869
$1,329,319
$1,633,995
$2,299,30
$3,646,853
$175,611
TDTL ET REVEMES
-Operating Expenses
-Replacement Reserve
-Real Estate Taxes
-Finance Payments
-Lease Payments
BEFDE TAX CASH
FLOW
+Principal Paid
-Depreciation
TAXABLE INCPE
$1,956,962
U
$0
$258,831
$335,216
$1,667,944 $1,667,944
$1,667,944
$516,455
$896, 194
$1,714,125
$62,951
$258,228
$45,997
$857,663
$1,551,644
$1,698,735
$1,854,211
$2,189,791
$154,311
$1,667,944
$1,667,944
$199,851
$1,667,944
(471,764)
($163,024)
$165,92
227, 437
U
Income Tax Liability
Tax Credit
($235,882)
495,00
$1,772,751
FTER TAX CASH FLOW
($81,512)
$1,416,821
$18,968,133
After Tax Sales Proceeds
Internal Rate of Return Cash Flows
a
(*6U83, 60)
1
1
$1,772,751
2
$1,416, 821
52
3
$1,351,64
4
$1,698,735
5
$1,854,211
7
$21,157,924
EXHIBIT VII
AFTER TAX
23-4ay-85
SALES
PROCEEDS
NET OPERATING INCOME
ASKIN6 SALES PRICE
$6,738,957
$49, 668,314
Orig.
$34,818, W0
Purchase Price (Total Project Costs)
- Depreciation
$18,697,667
NET BOOK
VALUE
$24,81,333
GAIN ONSALE
$25, 657,981
ACRS Depreciation
- Straight Line Depreciation
$10807,667
$0
Excess Depreciation
X Narginal Tax Bracket
$0
Excess Depreciation Recapture
$8
505
25,657,981
$8
Gain on Sale
- Excess Depreciation
CAPITAL GAIN
$25,657,981
28%
X Capital Gains Tax Rate
CAP. GAINS TAXLIABILITY
$5,131,5%
$49, 668, 3:4
Sales Price or Refinancing
-Income Tax
-Nortage Balance
$25,56E,58
ONSALE
AFTER TAX PROCEEDS
$18,%8,133
$5,131,596
53
EXHIBIT VIII
ANALYSIS
SUMMARY
23-May-85
Existing
Boyls
Analysis Name
Project Name:
TAXSYSTEM ATTRIBUTES
(1 for Existing, 2 for proposed)
Historic Pres. Tax Credit
Capital Gains Treatment
Depreciation System
Maximum Income Tax System
1
1
I
I
Maximus
Income Tax Rate
Maximum Depreciation Term (Years)
595
18
ECONOMIC ATTRIBUTES
Inflation Rate ()
L%
Bank/Appraisor Cap Rate (%)
13.555
NODLM
VARIABLE CICICES
Estimated IRR
4
Holding Period (years)
7
12.*%
Discount Rate
EFORE
8.0%
TAXEASURES OF RETURN
Capitalization Rate (a)
Cash on Cash Return (b)
Increase In Value (c)
17.59%
15.31%
461%
AFTER TAXEASURES OF RETURN
Net Present Value (d)
Actual Internal Rate of Return (e)
$9,732,666
33.92%
Definitions
(a) Net operating income/Total project cost
(b) Year I Before tax cash flow/Equity
(c) Future sales price-Total project cost/Total project cost
(d) The present Value of cash flos are compared to the
initial investment.
(e) The discount rate at which the present value of a project
Filename:BOYLSTX
54
S
I
F
I
NAN CI AL
A N AL YS
IS
PROJECT WP@E:(up to 5 letters) Renew
CAE ASSLWPTIONS:
Year of Sale
I NP U T S
7
13.68
Cap Rate
Tax Credit Percentage
EXHIBIT I -
P R 0 J E CT
P REL
I MI
I.38%
N A R Y P R 0 J E C T CO S T
23-Nay-45
Project Component Nase 2
Project Component Nave I
$
Building/Shell Cost
Lard Acquisition
$3_5_ $0
$3, 500, M0
I
$___
_
$3,500,
006
Hard Costs
Gross square feet
x amowunt
per square feet
Total a
s.f.
I
15f,6
v18,
$18, 150, M00
Percent Attributable to Rehabilitation
=%
I
Tenant Improvements
$706,0
M
Contingency (M Total Hard Costs) $1,l89,
S
Off-site development costs
TOTAL
IMRD
362,50
$
S
S
$19,939, M
COSTS
$790,60M
$
$1,889,888
.
$8 $19,939,80M
I
Soft Costs
$
A/E
Space Planning/Schematics
Working drawings
Surveys, testing
Marketing
Legal/Accounting
$
-OR
__
so $119_____
$__$1990,40
$
I
0
ERR
ERR
1124
$105
$______
Leasing Commissions
$______
lortage Broker's Commission
Insurance During Construction
Interis Real Estate Taxes
Construction Loan Origination Fee
Interest on Construction Loan
Contingencies
Developer Fee
Impact or Linkage Payments
$
$-
$
$-OR-
-OR-
I
Uncatagorized Soft Costs
TOTAL SOFT COSTS
$6 511,963,468
TOTAL PROJECT COST
Cost per S.F.R.A.
Cost per 6. S.F.
$31,982,401
257,125
$124
$115
55
$6 S31,962, 460
1
1
*
ERR
$124
3
ERR
S105
EXHIBIT II
INCOME
23-May-85
Como.
#1
ANALYSI S
228,125
$40.88
$
$18.86
$
$8
$219,@00
Total Rent Number Units
#
Number Units
_
$_
$
$64,00
21, M8
s. f.
21, M0_
Total BASEENT Rental
Total RESIDENTIAL Rental
$0
$640,8NO
Basement Storage
X Rent per square foot
$6,163,500
16,906
ws.f.
16,08
Total RETAIL Rental
ent/month
220,125
$8
$6, 163, 5W
First Floor Retail
X Rent per square foot
TOTAL
$
$28.8N
Total OFFICE Rental
Three Plus Bedrooms
Rent/month
Total
s. f.
s-f.
8
229,125
Office Area-Square Feet
Basement Mechanical
=Total Rentable Area
X Rent per square foot
Residential Rentals
Studio/Efficiencies
Rent/month
One-edrooms
Rent/month
Two Bedrooms
Comp. #1
Total
Total Rent
Total Rent
$
$8
__
$212, M!
#
$_
__
$_$_
#
$
$
_0-_
$
_8
$0
so
$$
908$_$8
$8
8
Gross Potential Rent
Vacancy Rate
5%
ET POTENTIAL ENT & % Increase
5%
257,125
Total Square Feet Non-Residential
Average rent/square foot
Niumber of Residential Units
Average Rent/unit
$27
$8
56
0
$?
$8
$7,013,5M8
$2 $7,813,504
$6,662,825
$
0
ERR
68
$6,662,825
257,125
$27
80
EXHIBIT III
AMORT I ZAT ION
SC
HEDULEE-
23-May-85
80%
PERCENT FINNCED
$25,521,920
AMUtT
13. W%
25
$287,845
INTEREST RATE
TERN
MNTHL.Y PAYMENT
PAYMENT
ANNUAL
$3,454,143
Year
Principal
Interest
Balarce
$25,521,92
$164, 690
$3,389,428 $25, 377, 266
$3,289,453 $25,212,516
$187, 422
$213,293
$242,734
$276,239
$314, 369
$357,762
$3,240,858
$3,211,409
$3,177,984
$3,139,774
$3,0%,381
$144,714
$3,266,728 $25,625,094
$24, 811, 881
$24,569,067
$24, 292, 828
$23,978,459
$23,62a,697
$487, 145 $3, 46, 998 $23,213, s2
$463,344 $2,990,799 $22, 753, 28
$527,381 $2,926,842 $22, 222,987
$688,885 $2,854,S57 $2!, 622, 822
939, 95
$682,917 $2,771, 226 $22,
$777,181 $2,676,9%1 $20, 162, 724
$884,458 $2,569,685 $19,278, 67
$1,86,541 $2,447,601 $18, 27 1, 725
$1,145, 477 $2,308,666 $17, 126, 248
$1,383,598 $2,158,553 $15, 822, 659
$1,483,528 $1,970,615 $14,339, 131
$1,765,840 $12, 65, 828
$1,688, 33
$1,921,343 $1,532,8008 $10,729,485
$2,186,551 $1,267,592 $8,542, 934
$965, 777 $6,054,569
$2,488, 366
$622,3Z1 $3,222,727
$2,831,841
It
$231, 415
$3,222, 727
57
EXHIBIT IV
YE A R 1 S E T U P
Net Revenue
-Operating Expenses &
Percent Armal Increase
(X %Operat ing)
-Replacement Reserve
-Real Estate Taxes
(Effective Tax Rate)
23-fay-85
Project Component I
% Ann. Incr.
Project Component 2
6%*1,028,580
5%
2.50%
$_$1,08,
5,20
m
$797,560
$797,56a
$a
$8
$4,771,765
$3,454,143
-Finance Payments
-Lease payments
50
$65,00
$4, 771,765
NET OPERATIN6 INCOE
,6$0,25
0
$6,662,825
*
S
$0
$1,317, 622
FLOW
BEFORE TAX CASH
58
EXHIBIT V
D E P R E C I A TI 0N
Depreciation Basis
Depreciation Method
$1 Straight Line
E S T I M AT E
$28, 42, 4m6
1
175.W%
2 ACRS
Basis Period in Years
18
Yeair
AcRS Basis
IS Deprec.
1
$6
S/L Deprec.
Allowed depreciation
OF
$1,577,911
$1,577,911
$
$6
234-ay-65
OPERATIN6 INCOME
Perianent Finarcing:
mount
Torm
Interest
Annal Debt Service
$25,521,929
25
13.0%
$3,454,143
4
$1,577,911
$1,577,911
$6
U
$1,577,911
$1,577,911
$6
AND
5
7
$28,w42, 4@P $28, 462, 4w
128,4w2,4
$$
$6
$1,577,911
$1,577,911
Recapture
EXHIBIT VI
SUMMARY
3
2
$28,42,466 $28,42,46 1 28,42, 4
$6
$1,577,911
$1,577, 911
to
$1,577,911
$1,577,911
6
$8
S
EXPEN.SES
Developer Equity:
Tax Credit Percentage:
Historic Tax Credit:
Depreciable Basis:
$6,38,486
6%
$6
$28,42,40
E
A
R
2
3
4
5
7
$6,662,825
6,95,966
$7,345,765
$7,713,053
$8,98,715
$8,928,823
$1,628,566
$65,0
w
$797,56
$1,896,216
$68,258
$1,155,623
$1,224,966
$1,458,947
$71,663
$75, 246
TOTAL OPERTING EXPENSES
$1,891,66
2,6m3, 874
$2,677,407
NET OERTING ICOME
$4,771,765
Y
1
TDTAL NET EVENES
-Operating Expenses
-Replacement Resrve
-Real Estate Taxes
138
$949,967
$1,298,458
$79,68
$1,W6,961
$2,123,424
$2,259,112
2, 384,367
$4,99,93 $5,222,341
15,462,940
$845, 414
$89,
$87,116
$1,131,354
$5,714,339 $6,251,416
U
$3,454,143
-finance Payments
-Lease Payments
$3,454,143
$9
$6
DFOR TAXCAS FLOW
$1,317, 622
$1,537,956
$3,454, 143
$6
$1,768,196
$144,714
$1,577,911
($115,574)
TAXABLE INCOE
Incme Tax Liability
($57,787)
$3,454,143
$0
$2,266,1% $2,797,273
$2,668,796
U
$164,696
$187, 422
$213,293
$1,577,911
$1,577,911
61,577,911
$124,729
$377, 769
644,179
U
Tax Credit
$0
$9
U
-4rincipal Paid
-Depreciation
$3,454,143
$3,454,143
$242,734
$1,577,911
$314,369
$1,577,911
$925,619
$1,533,731
$462,589
$766,865
$1,797,687
2,63,467
U
$62,364
$188,83
$322, 9
a6
ATER TAXCAS FLW
$1,375,411
$1,
475,586
$1,579, 344 $1,686,78
After Tax Sales Proceeds
$17, 417,254
Internal Rate of Return Cash Flows
1
($6,386,40)
1
2
$1,375,411 $1,475,586
59
4
3
$1,579,344 $1, 686,70
5
$1,797,687
7
$19,447,661
EXHIBIT VII
TAX
AFTER
23-May-85
SALES
PROCEEDS
NET OPERATING INCOME
SALES PRICE
$6,251,416
$46,135,908
Or-ig. Purchase Price (Total Project Cost)
$31,902,4
$9,467,467
- Depreciation
VALUE
NET BOOK
$22,434,933
GAIN ONSAE
$23,780,974
$0
ACRS Depreciation
- Straight Line Depreciation
$9,467,467
Excess Depreciation
X Marginal Tax Bracket
$8
Excess Depreciation Recapture
$6
58%
$23,76,974
Gain on Sale
W
- Excess Depreciation
$23,796,974
CAPITAL GAIN
X Capital Gains Tax Rate
20%
CAP. GAINS TAXLIABILITY
$4,746,195
Sales Price or Refinancing
-Income Tax
-fortage Balance
$46,135,968
ONSALE
ATER TAX PROCEEDS
$17,417, 254
$4,748,195
$23,978,459
60
ANAL YS I S
EXHIBIT VIII
S U MMA R Y
23-May-85
1 FAR Proposed, All
Renew
Analysis Name
Project Name:
TAX SYSTEM ATTRIBUTES
(U for Existing, 2 for proposed)
I
1
I
I
Historic Pres. Tax Credit
Capital Gains Treatment
Depreciation System
Maximum Income Tax System
Maximum Income Tax Rate
Maximum Depreciation Term (Years)
595
18
EIOOlIC ATTRIBUTES
Inflation Rate (%)
Bank/Appraisor Cap Rate (%)
13.55%
VARIABLE CHOICES
MODEL
40.0
Estimated IRR
7
Holding Period (years)
N2.%
Discount Rate
BEFORE TAX EASURES OF RETURN
17.91%
2.65%
44.62%
Capitalization Rate (a)
Cash on Cash Return b)
Increase In Value (c)
ATER TAX
ASURES OF RETURN
Not Present Value (d)
Actual Internal Rate of Return (e)
S9,N5,975
33.54%
Definitions
(a) Net operating income/Total project cost
b) Year 1 Before tax cash flow/Equity
(c) Future sales price-Total project cost/Total project cost
(d)The present value of cash flows are compared with the
initial investment.
(e) The discount rate at which the present value of a project
Filename: RENEWTX
61
IS
APPENDIX C
FORMULAS USED
(1)
The "Cap" Rate
The cap rate is one of several appraisal valuation methods used to determine
the sales value of a property. In housing, asking sales prices are typically based on a
combination of market price and inflation, in income property, asking sales prices
are based on income. One appraisal method is based on market data on comparable
properties which have recently been sold. Sometimes it is difficult to use this
method, especially when the development is being introduced to an area i.e. Copley
Place in Boston. The other appraisal method uses cap rates which can be derived by
two methods. The mortage equity analysis derives a cap rate or equity dividend rate
by the following:
(Percentage financed X Mortage constant)
plus
(Equity X Required rate of return
= Equity Dividend Rate or Cap Rate
The original purchase price and the sum of the depreciation over the holding
period is subtracted from the gross sales price to arrive at what is called "net book
value". The net book value is deducted from the asking sales price resulting in a
gross gain on sale.
(2)
Amortization Payment
Level payment or direct reduction mortgage:
pmt=
PV
1-( 1+i )-n
i
pv
pmt
n
=
=
=
=
mortgage interest rate for period considered
starting principal balance
annual financing payment
number of periodic payments
62
(3)
ACRS Depreciation
If n = 1:
Dn
= (O/Yn) d
If n > 1:
= (Bn
D
n
n1
where,
n
Bn-1
/Y
=
) (d)
n)
n-
Dn-1
-
2
= year analyzed
Dn = depreciation taken in year n
0
= original basis
Yn = years remaining in ACRS recovery
d
= declining balance factor (1.75)
Bn = basis for depreciation in year n
(4)
Net Present Value (NPV)
.
x
ATCF .
+
-
1
x ATSP
)n
(5)
interest
1
=
j
=year
ATCF
= after tax cash flow
ATSP
= after sales proceeds
Internal Rate of Return
Discount rate at which NPV = 0
63
APPENDIX D
APPLICATION OF THE RESIDUAL LAND VALUE ANALYSIS
It is possible to use the land residual value analysis approach used by the Boston
Redevelopment Agency (BRA) to test the sensitivity of the tax credit on the
profitability of a project using land residual value as a measure.
First, a hypothetical case was constructed, using an actual project located on
Boylston Street. The building was four stories, containing almost 8,000 square feet
on a lot of 2,800 square feet, with at FAR of 2.8. The building is of good quality and
condition, but not worthy of landmark status or protection. A "neutral" FAR was
identified which would neither protect or "harm" it in terms of demolition or
redevelopment, established as a benchmark or threshold. The capitalized value per
land square foot (l.s.f.) was calculated to be $309; values below this amount would
encourage retention of the existing structure and values exceeding this amount would
tend to justify demolition and redevelopment of the site.
Total supportable
development costs are derived by the first year's net operating income divided by the
expected return on total project costs. The capitalized value per land square foot is
the difference between total supportable development costs and the actual
development costs, divided by the total square footage of the land.
The BRA then estimated development costs, gross income and operating
expenses for five different FARs and two different uses to arrive at comparative
residual land values. Their analysis indicated that for this same site on Boylston,
Redeveloping the site to an FAR of 9, resulted in a residual land value in excess of
the threshold limit of $309/l.s.f. followed by new construction of residential units to
an FAR of 8. Residential conversion resulted in a slightly lower land residual value
that the threshold limit.
Data from the Warren Chambers and 399 Boylston case were applied to the
land residual analysis approach and yielded the following results below.
The two buildings occupy 7,204 and 23,045 square feet of land, respectively.
The actual acquisition price for Warren Chambers was $152/l.s.f. for 399 Boylston,
$208/l.s.f. The aggregated cost per l.s.f. was $165/l.s.f.
First, the 1984 land residual value of $309 1l.s.f. resulting from a "neutral" FAR
was deflated yielding $271/l.s.f. in 1981 dollars . Applying the above analysis to the
estimated development costs and projected income, Warren Chambers yielded a
residual land value of -$16/l.s.f. while 399 Boylston yielded $202/l.s.f.
Given the discounted, criteria threshold of $271/l.s.f., one would conclude that
it would not be economic at to purchase, let alone rehabilitate, Warren Chambers.
However, restoration of 399 Boylston would be feasible. The calculated, aggregated
land residual value of $162/1.s.f. would tend to suggest retention of both sites while
continuing their existing use.
The primary limitation to the analysis as presented above is that it does not
account for the historic tax credit associated with the rehabilitation of Warren
Chambers. The estimated 20% historic tax credit of $495,000 was added to the land
residual as an after tax cash proceed in year one (1). At $25/square foot (s.f.) rental
for Class A office, this yielded $52/l.s.f. with the tax credit as opposed to
64
-$16/l.s.f. If the office space could be rented for the same amount as 399 Boylston
(to $28/s.f.), the tax credit would raises the land residual value from $97/l.s.f. to
$166/l.s.f.
With the historic tax credit and the same differential rent structure of $25 and
$28/s.f. for Warren Chambers and 399 Boylston, respectively, the land residual value
supported rehabilitation of both Warren Chambers and 399 Boylston. Even by
increasing the rent of office space in Warren Chambers to the equivalent of 399
Boylston, restoration and reuse of Warren Chambers was still justified given a
discounted threshold land residual value of $271/l.s.f.
The next step was to look at the effects of changing rents and development
costs for 399 Boylston and assume rehabilitation rather than renewal. First a total
gross square footage of 100,000 was assumed. The previous buildings that occupied
the 399 Boylston consisted of one four to five story-structure, two two-story
structures, and one one-story semi-permanent structure. At market rents of $25 and
$28/s.f. and rehabilitation costs ranging from $45-55 for rehabilitated office space,
residual land values ranged from $510-$935/l.s.f. Land residual values as such would
suggest making a renewal decision in favor of rehabilitation.
'Source: U.S. Bureau of Labor Statistics, Boston All Urban
Consumers 1981 CPI=266.7
65
WA R R E N
C HA NB E R S
23-May-85
Assumptions
Acquisition
Construction Start
Operating Start
Land Square Footage
Total Above Ground 6SF
Total FAR GSF
Office BSF
Retail and Lobby GSF
Basement Storage 6SF
Net Factor, Office
Net Factor, Retail
Office NSF
Retail NSF
Basement Storage NSF
Total NSF
Building Construction ($/6F)
Garage Construction ($/SF)
Soft Costs (%of Hard)
Contingency (%of Hard-incl.ten.impr.)
Office Rent ($/NSF)
Retail Rent ($/NSF)
Basement Rent (S/NSF)
Vacancy Factor
Office 0/N ($/NSF)
Office/Retail RE Taxes ($/NSF)
Garage Expense (%of Revenue)
Required Return
Land Residual Value
1981
1982
1982
7,264
48,181
55,0
43,212
4,970
6,819
82.86%
82.86%
35,886
4,118
5,658
45, 574
$45
na
68.40%
11.11%
$25. "
$48.00
$8.00
5%
$4.88
$4.42
na
12.59%
Acquisition Price
$1,500,M0
Construct ion Cost
Garage Construction cost
$2,475, W
Soft Cost
$1,693,608
Contingency 0 11% Hard Cost
Total Development Cost
TDC/Building GSF
$275,88W
$5,943,M
$198
Gross Income:
Office
Retail
Basement
Total
$895,150
$164,728
$45,2W8
$1,105,870
Vacancy
Effective Gross Income
$1,849,817
Expenses
0/N
Real Estate Taxes
Garage
Total
$182,296
$281,437
$0
$383, 733
M0I
$666,683
ROTPC Required
12.5ft
TDC Supportable
$5,328, 667
TDC
$5,943, ON
Land Residual
66
($55,254)
($614, 333)
Residual Value/LSF
($85)
Residual Value/LSF W/ITC
($17)
3 99 B 0 Y L S T 0 N
23-Nay-85
Land Residual Value
Assumpt ions
1 Acquisition
2 Construction Start
3 Operating Start
4 Land Square Footage
5 Total Above Ground BSF
6 Total FAR 6SF
7 Office 6SF
8 Retail and Lobby 6SF
9 Basement Storage 6SF
10 Net Factor, Office
11 Net Factor, Retail
12 Office NSF
13 Retail NSF
14 Basement Storage NSF
15 Total NSF
16 Building Construction (M/6SF)
17 Barage Construction ($/65F)
18 Soft Costs (%of Hard)
19 Contingency (%of Hard-incl.ten.impr.)
28 Office Rent ($/NSF)
21 Retail Rent ($/NSF)
22 Basement Rent ($/NSF)
23 Vacancy Factor
24 Office O/N ($/NSF)
25 Office/Retail RE Taxes (/NSF)
26 Garage Expense (5 of Revenue)
27 Required Return
1981
1982
1982
23,045
227,752
245,8w
214,326
13,426
17,248
88.48%
88.43%
189,644
11,872
15,271
216,787
$6
na
58.67%
8.56%
$28.8
$48.8S
$1. N
5%
$4.N
$3.24
na
12.59%
Acquisition Price
Construction Cost
Garage Construction cost
Soft Cost
Contingency 6 8.5%Hard Cost
Total Development Cost
TDC/Building 6SF
$3,500, w0
$14,780,M0
$8,625,808
$1,250,8M
$28,875,8ON
$115
Bross Income:
Office
Retail
Basement
Total
Vacancy
Effective Gross Income
$5,318,832
$474, 888
$152,710
$5,937,622
($296,881)
$5,640,741
Expenses
0/N
Real Estate Taxes
Garage
Total
$867,148
$781,875
N8
$1,569,823
N01
$4,071,718
ROTPC Required
TDC Supportable
$32, 573,743
TDC
$28,875, 90
Land Residual
Residual Value/LSF
67
$4,498,743
$195
WRREN CPWERS AND 399 BOYLSTON
23-May-85
Assumpt ions
Acquisition
Construction Start
Operating Start
Land Square Footage
Total Above Ground 6SF
Total FAR 6SF
Office 6SF
Retail and Lobby SSF
Basement Storage 6SF
Net Factor, Office
Net Factor, Retail
Office NSF
Retail NSF
Basement Storage NSF
Total NSF
Building Construction (5/SSF)
Garage Construction (/6SF)
Soft Costs 4%of Hard)
Contingency (Mof Hard-incl.ten.iimpr.)
Office Rent (W/NSF)
Retail Rent (S/NSF)
Basement Rent (/NSF)
Vacancy Factor
Office 0/N (/NSF)
Office/Retail RE Taxes (S/NSF)
Garage Expense (%of Revenue)
Required Return
Land Residual Value
1981
1982
1982
38,249
276,878
257,794
18,284
23,922
87.45%
87.45%
225,450
15,990
28,921
262,361
$57.25
Acquisition Price
$5,0on0M
Construction Cost
$17, 175,888
Garage Construction cost
Soft Cost
$18,318,888
Contingency 8 11% Hard Cost
Total Development Cost
TDC/Building 6SF
$1,525, ON
$34,018,98
$113
Gross Income:
Office
Retail
Basement
Total
Vacancy
8.78%
$27.44
Effective Bross Income
$46.08
$9.46
Expenses
0/N
5%
$4.88
Real Estate Taxes
Garage
$3.24
na Total
12.51%
No1
ROTPC Required
($352,135)
$6,690,557
$1,049,444
$903,312
$0
$1,952,756
$4,737, 81
12.5%
TDC Supportable
$37,902, 411
TDC
$34,818,888
Land Residual
68
$6,285,182
$639, 6w
$197,910
$7,42,692
$3,884,411
Residual Value/LSF
$128
Residual Value/LSF W/ITC
$145
Appendix E
HITCH USER MANUAL
Use of the HITCH model requires the use of an IBM PC or PC compatible
computer such as a Compaq, with internal memories capable of running Lotus 1-23. The instructions provided assume two floppy disk drives, but, a computer with a
hard disk can also be used.
You should have a Lotus 1-2-3 system disk and user's manual as well. If you
have never used Lotus 1-2-3 before, go through Lesson B of the Lotus 1-2-3 tutorial,
paying particular attention to correcting cell entries.
Follow the Lotus 1-2-3 instructions up to the point where an empty worksheet
appears on the screen. Then retrieve the PROJIN file. This is done by a series of
commands:
/
File,
Retrieve, "PROJ IN", return
There are several universal rules to keep in mind.
These are
1. On the screen display, there will be highlighted areas.
"unprotected" cell locations where inputs will be entered. The remainder of the
worksheet will be displayed in the normal intensity. If you attempt to enter an input
in a "protected" cell location, you will be prevented from doing so and the program
will audibly and visually indicate that you have tried to make an entry into a
"protected" cell location.
2. All percentages are entered as decimals. To enter 5%, enter ".05".
3. As you are entering data, you will see a "CALC" notation located in the
lower right hand corner of the screen.
The work sheet is set in a manual
recalculation mode to speed entries (the file is quite large and slows down entries if
it calculates after each entry). Press the F9 function key to have the model
calculate up to where you are at any point you wish.
4. Throughout the model, you will see "ERRs", especially in the empty
template. This means that that cell is trying to manipulate a formula and is
referencing to another cell which has either a zero or nothing in it. "ERR" will also
appear in the "Estimated IRR" unless a percentage has been entered within 20
percentage points of the actual IRR. When both worksheets are complete with the
requested information, the "ERRs" should disappear upon pressing the F9 function
key.
PART I PROJIN FILE
Exhibit I PRELIMINARY PROJECT COSTS
The first entry is the project name. You can then proceed to the remainder of
Exhibit I. There is room for two project components. If you have mixed uses or
more than one building, you should list the costs separately. Under "contingency",
you have a choice of either entering for each, a percentage of hard costs or
overwriting the formula with your own amount. The soft costs are detailed out, but,
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you may simply skip the details and enter aggregate soft costs under "uncategorized
soft costs". Exhibit I will total hard, soft, and total project costs by component and
for the project as a whole.
Exhibit II INCOME ANALYSIS
Exhibit II, Income Analysis will provide you with a compilation of net potential
rent. For office, retail and miscellaneous uses enter the square feet of rentable area
and the rent per square foot per year. For residential uses, enter the monthly rents
and the numbers of housing unit types (number of bedrooms). The model will
calculate the annual rents.
After you have provided rental and unit information, the model will be able to
calculate gross potential rent. When you enter a vacancy rate (Reminder: enter as
".05" for a 5% vacancy rate) the model will be able to calculate the net potential
rent. You should also provide the estimated annual percent increase in rents you
anticipate. Exhibit II will provide a summary of the total non-residential square
footage and provide the rent/square foot and calculate an average rent/unit.
Exhibit III AMORTIZATION SCHEDULE
The amortization schedule calculates the amount financed if a percentage of
total project costs is provided. You may overwrite the formula and enter the amount
if you wish. The monthly and annual payment will be provided. The schedule will list
by year the principal paid, interest paid, and balance.
Exhibit IV SETUP
Setup is the first stabilized year pro-forma. It is here that annual operating
expenses, replacement reserve, the effective real estate tax rate, and lease
payments are entered. The annual finance payment will be carried down from
Exhibit III. The annual increase in operating expenses and the replacement reserve
are also entered in this exhibit. Annual increases in real estate taxes will be tied by
the model to the percentage of annual increases in net revenue.
At the bottom following Exhibit IV, there will be a series of input text labels
and numbers. These all "copy" from the above exhibits and are grouped together to
facilitate the import procedure you will choose when you are in the PROJ TX file.
Please do not revise or alter the data in this section. If you wish to make revisions,
please do so in the appropriate exhibits.
Upon completion of the PROJ IN file, the user will save the file by pressing
ALT F. The file will then be saved under a name created from the six letter project
IN".
name that which the you entered above in Exhibit I plus
PART II PROJTX FILE
The PROJ TX file is the analysis file. It contains Exhibits V through VIII, of
which Exhibit VIII is the analysis summary in which you will manipulate tax
variables.
After retrieving the file, you will see a menu. Upon moving the cursor to
"IMPORT" and then hitting the return key, you will view a file directory of all files
on the disk, including the file just saved previously under the project name followed
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by the suffix, _IN. You should then select the applicable input worksheet file for the
project you want to analyze. Upon completion of the import procedure, you will be
asked to select the number of years you want analyzed. You have a choice of five,
seven, ten, fifteen and twenty years for the analysis. The model will then do a
multi-year analysis of the project.
The next exhibit that will appear on the worksheet is Exhibit VIII, the Analysis
Summary. Exhibits V through VII are bypassed by the macro as there are no inputs
made to them. Described below are Exhibits V through VII. They can be viewed on
the screen by moving the cursor around.
Exhibit V is the depreciation estimate. The model will choose the type of
depreciation depending on whether the project is soley residential or not. It takes a
conservative approach and will choose straight line depreciation if there is any other
income from other uses besides residential in Exhibit II Income Analysis.
Exhibit VI is the year by year pro-forma which projects income and operating
expenses over the number of years you have chosen for the analysis.
The
calculations in the pro-forma will respond to changes in tax variables regarding
presence of a historic tax credit, depreciation and the maximum income tax rate.
The cash flow analysis presented in Exhibit VII calculates the after tax
proceeds of sale. It is capable of responding to changes in the treatment of capital
gains and the maximum income tax rate for the existing and proposed income tax
system.
When the analysis is complete, you will see "Tax Attributes". It is here that
you will input the economic and tax variables.
The economic variables include the inflation rate (for the purposes of
calculating capital gains under the proposed tax system), the "cap" rate, the
estimated or "guessed" internal rate of return (IRR) and the discount rate (the
developer's required rate of return). Lotus 1-2-3 will not produce an internal rate of
return until it is started or "guessed". The Lotus 1-2-3 method of calculating IRR is
an iterative one and has to begin the calculation with a "guessed" IRR. The actual
IRR will show an "ERR" until it is within 20 -percentage points of the actual IRR.
Again, the "guessed IRR must be entered as a decimal: 40% must be entered as .40.
Up to now you have used the model more as an accounting tool. In order to
model the existing and proposed tax system, you would manipulate the variables like
a "toggle". For the existing tax system variables, the "toggle" is set a 1, for the
proposed tax system, the "toggle" is set at 2.
Tax variables are set at or "defaulted" at the existing system. These include
four variables: presence of a historic preservation tax credit if there is qualifying
rehabilitation work; a capital gains tax rate based on 40% of the investor's marginal
tax rate; depreciation using the accelerated cost recovery system for residential
properties and straight line for all other uses with a recovery period of 18 years, and
finally a maximum tax rate of 50%. The proposed tax system assumptions include:
no historic preservation tax credit, straight line depreciation with a 30 year recovery
period for both residential and all other income generating uses, the residual capital
gain in excess of a published inflation rate by the Treasury taxed at ordinary income,
and the maximum ordinary income tax rate lowered to 35%.
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A visually effective way to see how changes in tax variables effect the project
economics is to "window" the screen. First line up, using the cursor the tax variable
inputs (top of Exhibit VIII) at the top of the screen. Then move the cursor to just
below the "Maximum Depreciation Term". Then "window" it through the following
commands:
/
Worksheet Window
Horizontal
The cursor will then be positioned in the upper window. Press the F6 function key to
move to the lower window. Then scroll the lower worksheet until you can see the
actual internal rate of return. Return to the upper window using the F 6 key again
and start changing the tax variables while simultaneously watching the changes in
the internal rates of return. If an "ERR" appears, you will need to readjust the
"estimated IRR" as it is now more that 20 percentage points off of the actual IRR.
To remove the window, follow the same command sequence as above up to where you
will see choices for Vertical, Horizontal, Unsync, and Clear. Choose Clear.
Once you have imported project data from the IN file, you may vary the years
of the analysis without re-importing. First invoke the menu macro: ALT M, then
move the cursor to Years. You will then have a choice of five, seven, ten, fifteen
and twenty years. Point the cursor to the number of years you wish to analyze and
then strike the Return key.
Printing
The print output has been set up to fit on an 8-1/2" by 11" page in a compressed
typeface. Unless you have a letter quality printer with compressed type fonts, it is
recommended that you use a dot-matrix printer for printing exhibits. You may have
to change the "setup string" according to your printer and you will need to consult
your printer manual and Lotus 1-2-3 manual for further instructions on this. For
EPSON 80s, the setup string is "\015 " and for the OKIDATA 92, the setup string is
"\029". The model's setup string is defaulted for the EPSON printer.
If you wish to print each or some of the exhibits use the print macro. This is
done by pressing ALT, then P for print. You will then see a choice of exhibits. As
you move the cursor for each exhibit, the second line will read "Print Exhibit I
PRELIMINARY PROJECT COSTS" or whichever exhibits you have moved the cursor
to. You would then press the return key on whatever exhibit you wish to have
printed. If your printer is turned on and the paper is lined up correctly, printing
should begin immediately.
If you happen to have the luxury of a printer capable of printing on 14-inch
wide paper, you may be able to print Exhibits V and VI showing all the years up to 10
or 15 years instead of the macro's use of five years plus a horizon year. Instead of
using the print macro, you would manually define the print ranges by "pointing" the
range or using the actual range boundaries. The Lotus 1-2-3 manual will provide
instructions on manually printing out the full exhibit.
GOOD LUCK!!!
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BIOGRAPHY
Debra Gail Wong, 31 was born and raised in the San Francisco Bay area of
California. She received a Bachelor of Science in the Conservation of Natural
Resources at the University of California, Berkeley in 1977. From mid 1977 to fall
1983, she lived in Anchorage and Juneau, Alaska. She worked in a number of
professional positions in the areas of energy and transportation infrastructure
planning. In her most recent position with the State of Alaska Department of
Transportation and Public Facilities, she served as an Associate Transportation
Planner from December 1979 to August 1983. While at the Massachusetts Institute
of Technology, she served as a teaching assistant for a graduate level planning and
architecture studio in site planning.
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