There was a Planning Commission meeting last evening and there were a handful of humdrum/slamdunk items that, from my perspective, shouldn’t even be going in front of the Planning Commission, but somehow ended up there anyways. These projects included a beloved church being approved to continue its mission rehabilitating adults with substance abuse and mental illness challenges on its own land with no physical alterations to its building, approving a property owner to build housing on his own land within the requirements of our ordinances, and approving a capital improvement budget that… really Planning Commission has no say over other than to say each project vaguely fits within the broad parameters of our General Plan. I mean, I guess the last one is somewhat important if Public Works was proposing to take a bulldozer to the Norma Herzog Community Center or rip up a neighborhood park for a public parking garage, but since none of those are in the works, it was all very pro forma.

But then there was the lightning rod item: One Metro West. It’s baaaaaack, and it’s got its hat in its hand, looking for some favorable amendments to its development agreement.

Well, ok, Rose Equities didn’t just sit idly by. When Measure K’s parcel map was released no one was surprised it included One Metro West, and Rose Equities ponied up a $49,500 donation to the Yes on Measure K effort just for good measure. It was a good bet. The Costa Mesa voters passed Measure K in 2022 by the slimmest of margins.

Now, with the dust settled, Rose Equities has come back to the city with two material changes to its development agreement: first, that, thanks to Measure K, it be exempted from the public vote that Measure Y would have required, and second, that it be allowed to pay its development fees in two tranches (with the second tranche bearing a 3% interest rate) instead of one upfront lump sum payment. Both proposals were unanimously approved by the Planning Commission with the exception of Commissioner Jon Zich, who ardently opposed the motion. Several public commenters also accused the city of acting like a doormat for developer interests. But I don’t think it’s that simple.

Did Rose Equities do an end run around Measure Y?

With respect to the vote exemption, Commissioner Zich was having none of it:

“If the city is so darned excited about [this project], then put it on the ballot like it should have been, and let’s find out how excited they are. And if they are, it will be approved and it will get built… let’s not be afraid to follow the law. This is an insult.”

But is it an insult? Setting aside the politics of Rose Equities successfully lobbying for the inclusion of One Metro West in Measure K and then donating generously to help it passage, let’s look at the practicalities. Let’s say that the city insisted on an interpretation of its ordinances that Measure Y applied to the project and One Metro West could not move forward without a public vote. What would happen next? Well, if I were Rose Equities, I would simply withdraw the project and resubmit it under the new law — if it did that, how could the city possibly sustain the argument that Measure Y applied to the project then?

However, doing so would open the door to all kinds of retrades with respect to the original development agreement. One line item that was discussed at Planning Commission was a mysterious $3 million fee levied on Rose Equities for the funding of “economic recovery and community enhancement” — clearly a fee imposed with COVID-19 and our glaring deficiencies regarding Westside neighborhood parks front of mind. We are now solidly past the pandemic and the parks the development agreement had in mind both received generous state grants in the interim. So what would be the City’s justification for exacting that fee now?

Another consideration is affordable housing. As proposed, the development agreement requires One Metro West to include 106 affordable units, including 67 low-income and 39 very low income units. This is actually more generous than the minimum requirements set by our recently passed inclusionary housing ordinance, which would have only required 106 low income units — meaning the city could lose the deeply affordable units it negotiated back in 2021.

So Commissioner Zich can feel insulted if he wants. But the reality is that insisting on Measure Y being applied to this entitlement would only waste everyone’s time and money on a duplicative application. Worse, doing so probably wouldn’t have netted the city anything in return. And I don’t think there is any reasonable case that this sets a “bad precedent”. There are no other developments that got entitled under Measure Y only to be liberated by Measure K before it put shovels in the ground. At the end of the day, Rose Equities won the vote that matters. So let’s move on.

But can’t we at least be mad that One Metro West will get to split its development fees into two payments, and pay a really low 3% interest rate?

Well, I suppose you can. But personally I think allowing One Metro West to split the fees into two tranches makes sense. Let me explain.

On its face, that 3% rate seems absurdly low: 1 year treasuries are offering at least 5% returns at the moment, and 5 year treasuries are offering at least 4.5%. How could the city be offering to “finance” the development fees at a rate lower than treasury rates? At the very least, couldn’t the city collect all of the fees up front and then dump the funds into treasuries, netting a more favorable return for the taxpayer dollar?

Unfortunately I don’t think it works this way. It was too bad that no one from Costa Mesa finance department was on hand to help explain why the 3% rate was selected. Though I’m sure we’ll get color on this decision when these changes go to the City Council for a final vote, I’ll hazard a guess: the city may not want to exact an interest rate higher than “cost recovery”, i.e., the estimated rate of inflation compared to the original fee. Recall that prevailing interest rates are set by the market, i.e., the investors’ appetite for risk. They don’t reflect simply the sum of the mechanical cost of floating the bond and the opportunity costs of not having that money in the lender’s pocket. These costs can be much lower than the interest rate the market will bear depending on the lending environment. So it may be hard for the city to justify imposing a higher interest rate if it has to justify that rate on the basis of on cost recovery alone.

And besides, there may be good reasons for Rose Equities to want to split the payments — for example, it might be necessary for the project to get underway on time. As well described in this paper, imposing up-front development fees impose a cost on the developer that is greater than the benefit bestowed on the city. That’s because at the beginning of construction, those fees disproportionately have to come out of the equity financing for a project (which is very expensive) versus its debt financing, blowing up the cost of “carrying” those expenses over the building phase. See this table for an example 50 unit project paying $1 million in fees:

As you can see, if the city charges just the rate of inflation, the city gets the same $1 million under all three scenarios. But paying that $1 million can result in hundreds of thousands of dollars of extra carrying costs to the developer if the fees are paid earlier in the process compared to later.

In our case, while you have to take the applicant’s own words with a giant grain of salt, One Metro West stated that paying all the fees up front was “challenging to the financial feasibility of the community’s first phase.” To me this implies that the whole development might be in jeopardy. If that’s true, then it would be silly to insist that Rose Equities pay these fees up front only to see them abandon the project all together. Then the city gets no fees and we would be left with a big hole to make up in our RHNA numbers, which in part rely on One Metro West going forward.

But maybe the financial risk to the project is being overstated by Rose Equities. Even so, Costa Mesa should get in the habit of allowing developers to defer fees when practicable, preferably by establishing a formal deferred fee program. Doing so would encourage development while putting in guardrails up front that ensure the city gets the money its owed. It would also help to pace out the receipt of development fees so that the money doesn’t come in big, lumpy chunks, which can be hard to spend given our ongoing staffing challenges.

Costa Mesa should be learning everything it can from its One Metro West experience

While every real estate development project is “unique”, hopefully the city is learning all it can from this experience. One piece of good news is that the city likely got its inclusionary housing ordinance “right”, at least in the sense its obligations can be shouldered by very large projects. It also is yet another example — as if we need another — that the public vote requirement is an absolute nonstarter even for big, compelling projects with deep pockets.

And finally, instead of leaving each developer to its own devices to negotiate its fee payment schedule in a bespoke development agreement (an approach that inevitably favors very big developers with very expensive lawyers), the city should be stepping in and providing rules around these deferrals up front. Maybe it would be a good time to add this to the in lieu fee discussion that will finish out our inclusionary housing ordinance. If we ever get around to that.

One final note: Welcome, Commissioner Martinez! I was thrilled to see newly minted Commissioner David Martinez take the dais. He came armed with incisive, relevant questions and even managed to make Staff squirm a bit when he corrected them on at least one occasion. You love to see it.