MEMORANDUM 07-170
TO: Mayor Hornaday / Homer City Council
FROM: Walt Wrede
DATE:
SUBJECT: Preliminary Financial Analysis / New Court House
As you know, the Homer City Council is currently weighing
the advantages and disadvantages of building a new courthouse for the State of
This memorandum contains a preliminary, baseline analysis of what it might cost the City to build and operate a new courthouse. It is also intended to provide some insight into the annual lease rate the City might have to charge in order to meet its financial objectives. I would really like to thank Chuck Jay for the assistance he provided as we put this analysis together.
Building and site prep. (8,500 sq. ft. @ 400) $3,400,000
Engineering and Design (10%) $ 340,000
NOTE This number does not include infrastructure (roads and utilities); a potentially significant cost. It is possible that the infrastructure could be built using HART and HAWSP funds as part of the larger Town Center Development Project. It is also possible that the Legislature could fund the City’s CIP Priority entitled Town Center Infrastructure. That might be more likely if the City was building a courthouse for the State.
LOAN / BOND PAYMENT ANALYSIS
$3,740,000 x 6% @ 20 years $26,794 $321,534
Return on investment (11% Annual) $411,400
Return on Land (assumes one acre leased) $ 32,000
Annual Bond Payment $321,534
Insurance $ 12,000
Maintenance and Operations $50,000
Utilities $50,000
TOTAL
EXPENSES
$433,534
NOTE: It should be noted here that an 11% cap rate plus a moderate lease payment on the land is probably the minimum the City could charge for an annual lease in order to cover its expenses. There is essentially no profit margin. Eleven percent covers the cost of capital (6%); the return on investment. The remaining 5% (the return of investment) and the land lease revenues are all needed to cover other expenses.
DISCUSSION
The City could construct and operate a new courthouse within
the
In order to help the Council make this decision, it might be useful to focus on the primary reasons for doing this. For example, if the Council’s goal is long term financial gain, it would need to charge a lease rate high enough to bring a decent return on its investment and on the use of its land. (This analysis assumes a break even scenario) .It would also need to sign a lease that stipulated that the City owned the asset upon expiration of the term. Things to keep in mind are that the City would likely never be able to charge a lease rate that might make a return sufficient to reduce or restrain taxes, as some have suggested. Further, even though the City would likely finance this project with revenue bonds (revenue for bond payments identified and locked in) this would still contribute to the City’s cumulative indebtedness (although it is not likely to have a significant effect on the City’s bond rating).
On the other hand, if the Council wants to do this in order
to achieve community and economic development goals, we might look at this in
another light. For example, it could be argued that doing this would further
development of the
In short, the Council might want to construct the courthouse primarily to promote community and economic development goals and objectives it has already adopted. If so, it could be a little more flexible with the lease rate. In order to make this more attractive to the State, it could do things like lower the return on investment and land use, extend the term of the bond payments, use a triple net lease, allow the state to own the asset at the end of the lease term, etc. All of those things would decrease the lease rate. It is not unusual for a City to subsidize institutions or businesses it wants to stimulate or encourage. The City already does this with the college lease at the old school. (A lease for less than fair market value).
In the best of all worlds, the City could achieve its community and economic development goals and get a favorable return on its investment at the same time. We have no idea how much the Court System might be willing to pay for a lease unless and until the City articulates how much it needs and begins negotiations.
Finally, as you know, there are many good philosophical, political, and financial reasons for recommending to the Court System that the private sector be offered the opportunity to construct this building. Some of those reasons were discussed at the workshop so I won’t repeat them here. The City’s capacity for assuming responsibility for yet another capital project should also be a consideration. There are a number of possible scenarios under which the City could achieve its community and economic development goals by working closely with the State and the private sector.
In short, this is a policy call for the Council to make. As I have noted earlier, there are definitely advantages and disadvantages to doing this.
As noted above, this is a policy call that the Council must make after considering a variety of financial, economic, philosophical, and community development variables. Good arguments can be made on either side. Therefore, we offer the Council two alternative recommendations.
Alternative 1: Authorize the City Manager to enter into discussions with the Court System regarding the financial parameters (using the assumptions contained in this memo) under which the City would be willing to undertake this project. If the City and the Court System appear to have little prospect of reaching an agreement, recommend that the Court issue an RFP and provide an opportunity for the private sector to respond.
Alternative 2: Inform the Court System that the City
of