Keystone Opportunity Zones on the Downtown Philadelphia Office Market Presented by K i Young Lee Pan o te Preechyanud Takahiro Su z uki Public Expenditure Analysis April 30, 2005

Agenda Introduction Costs Benefits Synthesis Conclusion

Introduction

What’s a KOZ? Initially started in 1999 Specific areas with greatly reduced or no tax burden for property owners, residents, and business Designed to attract development where little or not activity existed beforehand Business must expand employment by 20% or must make capital investments of at least 10% of the gross revenue of the business in the pervious year Over 23,000 new job created, over 20,000 jobs were retained 12 regional KOZ in Pennsylvania 4 different expiration year: 2008, 2010, 2013 and 2018

KOZ – Legislature KOZ Act 92 of 1998 Initiate KOZ to foster both private business and residential reinvestment in Pennsylvania area to regain the economic stability of communities. Original KOZ’s expire in 2008 KOEZ Act 119 of 2000 Initiated Keystone Opportunity Expansion Zone (KOEZ) to enable numerous area that missed inclusion in the original KOZ KOEZ’s expire in either 2010 or 2013 depending on the choice of the local zone KOIZ Act 217 of 2002 Empowered the Governor by executive order to propose Keystone Improvement Zones (KOIZ) by no later than January 1,2003. Approval of the political subdivisions was required by June 1, If no approval from political subdivisions, proposed zone would not be designated.

KOZ on Downtown Philadelphia Designed for the Cira Centre at 30 th Street Station and one is under consideration for One Pennsylvania Plaza at 17 th and JFK Blvd. Source: maps.google.com

KOZ on Downtown Philadelphia Designed for the Cira Centre at 30 th Street Station and one is under consideration for One Pennsylvania Plaza at 17 th and JFK Blvd. Source: maps.google.com One Pennsylvania Plaza 56 Occupied Floors; 1,346,000 Sq.ft. Office Tower

Philadelphia Economic Environment Decrease in population growth since 1970 Philadelphia Population Growth ( ) 1,400,000 1,500,000 1,600,000 1,700,000 1,800,000 1,900,000 2,000, Year Population

Philadelphia Economic Environment Employment shows positive sign at the end of last year’s quarter

Philadelphia Economic Environment Office Vacancy rate is constantly high compare with other cities, and it has the highest negative change in vacancy rate last year

Existing CBA analysis Developer – Pro KOZ Central City District – Anti-KOZ $ Millions

Differences among two models E-consultant Pro-project CCD Anti-project Standing  City of Philadelphia Benefits during construction period  City tax revenue All construction workers are from Philly Counts indirect benefits  City tax revenue Only half construction workers are from Philly Does not count indirect benefit Benefits after construction  Incremental city tax revenue increase because of new business inflow Many tenants are from outside Philly  Incremental city tax revenue increase because of new business inflow Most of the tenants in the new building are from Philly itself Costs after construction  Incremental city tax revenue decrease because of relocation Empty property in Philly will be replaced in one year  Incremental city tax revenue decrease because of relocation Empty property in Philly will be replaced at the current speed (100,000 sq ft./ year) Parameters  Constant parameters

Our model Using economic equilibrium which the Wharton’s model used Include initial benefit from construction (direct and indirect effects) Standing is city of Philadelphia

Costs

Decrease of Tax Revenue Property tax Business income tax Environmental Cost Cost Construction Period Operation Period KOZ expired Environmental Cost

Environment Cost Environmental construction cost of both building is $0.1 per sq.ft Environmental operation cost of both building is $0.01 per sq.ft. Environmental operation cost will annually increase 4% Calculation Environmental construction cost :Total square of feet *0.1 Environmental operation cost: Total square of feet *0.01

Result of Cost in Each Period $Millions

Loss of tax revenue (cont.) S D S’Rent $/sq.ft KOZ buildings Amount of office space

Loss of tax revenue KOZ Existing offices NO-TAX !! Decrease of Tax revenue Assumption

Loss of tax revenue (cont.) Net Operating Income = Revenue – Cost Revenue = Rent/sqf × Square feet Cost = Cost/sqf × Square feet Assume constant $7.5/sqf Property values = perpetuity of net operating income = NOI/r r = market rate of return Assumption Calculated from economic model

Loss of tax revenue (cont.) Rent ($/sqf) V = Vacancy rate (%) S = Total stock of office space (sqf) E = Total office employment (millions of employees) From empirical data, α = β = 8.03

Loss of tax revenue (cont.) KOZ entails tax exemption Philadelphia City Taxes Business Privilege Tax (BPT) 2.3 mills on gross receipts 6.5% on taxable net income Net Profits Tax (NPT) % of profits Real Property Tax $8.624 per $100 of assessed value Use & Occupancy Tax (U&O) $4.62 per $100 of assessed value Based on companies’ profits Based on property values

Loss of tax revenue (cont.) Amount of tax on companies’ profits = $9.05/sqf × Square feet Assume constant $9.05/sqf

Benefits

Increase of Tax Revenue Commercial Tax Property Tax Benefit Construction Period Operation Period KOZ expired Increase of Tax Revenue From direct construction cost Indirect direct effects of construction Increase of Tax Revenue Wage tax from incremental new employees Wage tax from maintenance workers Sales tax revenue

Result of Benefit in Each Period $Millions

Increase of Tax Revenue During Construction TAX the Business Privilege Tax ( BPT): levied as 2,300 miles on gross receipts and 6.5% on taxable net income the Net Profit Tax (NPT) :Resident: %, Nonresident: % Assumptions This model is from Center City District Philadelphia city government will have a contract with local company in Philadelphia When city have net employment from direct and indirect, we assume that 50% of people are from nonresident and resident We assume that 50% of development costs were labor and the taxes generated by construction jobs over 2.5 years We assume that 25% of all pre-development costs consisted as well as of taxable labor and calculated a total tax benefit to the city Construction Cost: OPP-$325 per square of foot, Cira- $300 per square of foot

Increase of Tax Revenue During Construction period Wage tax revenue on Construction Labor$2.179$4.2927$ Wage tax revenue on Labor & soft costs$7.100$7.8600$ Total$9.279$12.157$ Short-term employment Source:Gilen

Increase of Tax Revenue During Operation Wage tax from incremental new employees Assumption This model is from E-consult Opp: 1.58 s/q, Cira: s/q OPP project will produce from 1178 to 1535 Job and Cira will produce from 548 to 714. Therefore, Both project will produce from 1726 permanent jobs to 2249 permanent jobs Wage will annually increase 4% Net Profit Tax (NPT) :resident: %, nonresident: % Average salary: $65,000 Calculation Average salary*0.5*(resident tax+ nonresident tax)* Number of employees.

Increase of Tax Revenue During Operation Wage tax from maintenance workers Assumption There are net increase of low level employment from this project such as maintenance like cleaning, security officer, and electricity Average salary : $35,000 Number of Employees in Cira:80 Number of Employees in Opp:160 Calculation Average salary* Salary *0.5*(resident tax+ nonresident tax)* (Number of Employees in Cira+ Number of Employees in Opp )

Increase of Tax Revenue During Operation Sales tax revenue Assumption There are net sales tax increase from low-level employment and office workers. we assume that they will spend 30% of their salary in Philadelphia. They will pay 7% of sales tax, however, 6% will belong to Pennsylvania state government, and 1% will belong to Philadelphia. Calculation 1% sales tax* ( Number of employees of office worker* their salary+ Number of employees of office worker*their salary)

Synthesis

CBA

Synthesize Social discount rate: 4%, 8%,12% NPV: 15 Year (With Koz), 40 Years ( Without Koz) IRR: 15 Year (With Koz), 40 Years ( Without Koz) Break even: 4%, 8%,12% Sensitivity analysis: Inflow employment (30%, 60%, 90%)

Synthesizing Scenario Neutral ScenarioOptimistic Scenario Office Employment Remain constant at 173,000 people Increase sufficiently to fill any vacant and/or new space Interest Rate (Capital Rate) Constant at 8.25%Decline by 6.67% Total Square Footage of Office Space Falls to sqft Either stay at 37.9 sqft or increases Source:Gilen

NPV( 0.04%) Neutral 30% Neutral 60% Neutral 90% Optimistic 30% Optimistic 60% Optimistic 90% NPV 40-$23.82$52.18$128.18$33.667$94.27$ NPV15$ $ $ $ $ $

NPV( 0.08%) Neutral 30% Neutral 60% Neutral 90% Optimistic 30% Optimistic 60% Optimistic 90% NPV 40-$ $ $ $ $ $ NPV15-$ $ $ $ $ $

NPV( 0.12%) Neutral 30% Neutral 60% Neutral 90% Optimistic 30% Optimistic 60% Optimistic 90% NPV 40 -$ $ $ $ $ $ NPV15 $ $ $ $ $ $

Internal Rate of Return (IRR) Neutral 30% Neutral 60% Neutral 90% Optimistic 30% Optimistic 60% Optimistic 90% 40 Years 3.53%4.98%6.37%4.38%5.91%7.40% 15 Years 73.98%71.2%68.30%71.81%68.89%65.84%

Time spent to reach break even point Years Years Years Years Optimistic 90% Optimistic 60% Optimistic 30% Neutral 90% Neutral 60% Neutral 30% Social Discount Rate 36 Years 2039

Conclusion

Feasibility of the project Generate deficit according to sensitivity analysis, except in the case when social discount rate is 4% Depend on employees inflow from outside Philadelphia as the model states that in normal social discount rate (8%), it needs about 90% on inflow employees from outside Philadelphia Without tremendous inflow employees and strong economic base, the city should not implement this program

Future tasks More proper economic models This model only considers the relocation of office spaces from existing office space to the KOZ buildings. (The economic model only consider the real state market in Philadelphia Chronological prediction is not clear Additional empirical research for demand and supply regarding office space market in the downtown Find clear benchmark for environmental cost Option Value Analyze Secondary Market Effect Real estate Market (Apartment, Housing and other areas ) Other Industries ( Construction, Material, and other areas )

Other problems of KOZ The program benefit big corporation such as Comcast, not small or medium business (Regressive tax effects) KOZ reduces the amount of property taxes part of which is a major revenue of school district

If KOZ is not implemented…. Fire Department: 96 more firemen employed Police Department: 91 more police officers hired Transportation: 12.3 miles of city streets resurfaced Recreation: 21 community recreation center hold School District: 135 new school teachers hired

Q&A