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development, and the remainder is the land residual. The decision to pursue the project depends on
whether the developer can acquire the land at a favorable price.

Within the model RKG created a land value override where the model user can input their own land
value assumption. This allows the user to test financial feasibility based on the different land costs,
since they may vary significantly based on development size and underlying zoning.

To determine construction costs, RKG interviewed several developers and utilized the March 2021
Marshall & Swift Valuation Services booklet to build out customized per square foot construction
costs for traditional townhouse, stick, and stick over podium construction. RKG assumed that new
construction would have either “excellent” or “good” interior or exterior finishes. Construction costs
are adjusted by using a local Nashua multiplier supplied by Marshall and Swift. The Marshall and
Swift numbers are an industry standard based on market data. However, in conversation with local
developers the price of materials and labor has been rising quickly since the start of the COVID-19
pandemic, and the Marshall and Swift data does not capture these pricing changes. RKG therefore
factored into the Marshall and Swift construction cost number adjustments based on the price inflation
identified by developers.

Within the model the appropriate construction cost is applied to the development based on its type
and size. RKG quantified the costs for the three different construction styles, and these costs can be
assigned to the typologies (Fee Simple, Multifamily Stick, and Multifamily Podium) the City of
Nashua wants modeled. RKG assumed for this model that all projects would take one year to
complete, and construction would begin in 2021. Appendix 1 has more detailed information about
construction costs.

Within the model two types of parking costs were included: surface and structured podium parking.
The types of parking have dramatically different cost estimates. Surface parking is by far the cheapest
option for parking. Typically, this type of parking is done on smaller projects which have sufficient
land area to accommodate the parking requirements under zoning. Structured podium parking
typically occurs in multifamily developments which are constrained for space.

The parking calculations are based on the number of parking spaces required by the city based on the
total number of residential units and typology. The City of Nashua requires two parking spots for
every single family or townhome and requires 1.5 spots per multifamily unit. Appendix 1 has more
detailed information about parking costs.

Financing

Development financing is possibly the most important element of any real estate deal. The ability to
secure long-term financing at an affordable rate allows a developer to complete their project. Different
types of financing are available depending on the scale of the project. For very large projects, financing
might be obtained from a national bank, institutional investors, or a debt fund. These types of entities
invest capital in projects for investors, and typically provide favorable interest rates given the track
records of large-scale developers.

Smaller scale developers utilize traditional bank financing as the main source of funding. Local banks
typically act as partners with smaller scale developers and provide funding to projects which meet
their lending standards and risk profiles. Lending at the small scale is very much relationship based.

Modeling the financing component of development requires assumptions to be made about the
equity, loan terms, and interest rates. As part of the data collection process, RKG interviewed several
local developers who provided reality-based data regarding project financing.

The equity investment on the part of the developer which is required to obtain financing is dependent
on many factors, some of which include: financial wherewithal, experience, project type, etc. Lenders
require developers to contribute funding towards the project. The percentage of equity required is a
variable within the model that can have a significant impact on the overall financial return. Typically,
if a developer can secure financing which requires a smaller percentage of equity contribution, then
the overall project return will be greater because the initial out-of-pocket cost will be less. The benefit
to the developer is that they minimize their risk when they do not have to contribute large amounts
of equity. For the modeling exercise, the default equity requirement was set at 25% for both owner
and rental developments, this value can be changed within the model by the user.

The length of the loan is dependent on the type of project under construction. For for-sale units, the
loan is repaid once the units have sold. In this case, the loan period might last for 1 or 2 years
depending on the time it takes for a project to be constructed and the units sold. For rental projects,
the loan term can be variable. Developers have different exit strategies depending on their investment
philosophies; some developers will hold a project for 10 years and then sell it, while others just build
and hold the property. For the analysis, the model was calibrated to assume as a default that the loan
for a for-sale development would be two years, and that for rental properties the loan term would be
20 years.

Financial institutions provide funding based on the viability and potential success of a project, and
the interest rates charged are evaluated against the developers financial standing and ability to
complete the project. A range of interest rates could be charged to a developer depending on their
track record, development program, or equity contribution. The higher the interest rate, the greater
the overall cost to the developer. Small fluctuations in interest rates can have large impacts on the
project financial return because the cost of debt service can substantially increase, thus rendering a
project infeasible. Some developers contribute greater amounts of out-of-pocket equity as a means of
lowering the interest rate on the loan. The default model assumptions for interest rates were 5.5% for
rental developments and 5.0% for ownership developments. The higher interest rate for rental
developments was used because the loan term is longer than that of the ownership developments.

Density Bonus
Density bonus is a regulatory tool that provides a developer the right to build a greater number of
units than the existing underlying zoning dictates in exchange for some public benefit (in this case,

the inclusion of income-controlled housing units). This incentive works well in cases where a
community is focused on building lower cost housing without providing substantial cash incentives
to developers. In other words, the density bonus provides a developer with an incentive to create units
at deeper levels of affordability, in exchange for the ability to build more market rate units.

The key concept of the density bonus is to entice the developer to build affordable units at deeper
levels of affordability, while at the same time offering an incentive for the developer to regain lost
value from the creation of the affordable units by supplementing with market rate units. Within the
model that RKG produced, it is possible to adjust the density bonus to test the implications on the
financial feasibility of the project. Density bonus units tend to have greater importance on smaller
projects which, from a financial perspective, may not be viable without the addition of market rate
units above by-right thresholds.

For the purposes of this analysis, RKG tested how many bonus density units would be required to
make the financial return of the proposed inclusionary policy equal to the by-right scenario for each
tested development program.

Cash Payment/Payment in Lieu

As a method to capture the full value of affordable units that do not get built under the inclusionary
ordinance, RKG created the financial feasibility model to include a cash payment amount for fractional
units. The cash payment amount is applied to fractional units which result from applying the
appropriate inclusionary percentage across Tier’s One, Two, and Three. The modeled scenarios do not
round any of the units, rather it prescribes each full unit be built, and any fractional piece be captured
by a cash payment. This protects the developers from having to incur a cost greater than the policy
requires, as having to build a full affordable unit for a fractional calculation (i.e., 0.5 units) will have a
greater financial impact than a cash contribution equal to the fractional value of the net value
difference between a market rate unit and an income-controlled unit.

Within the model there is an affordable unit and cash payment calculator which determines both the
number of affordable units and potential payments in lieu based on the assumptions made in the
model. The model also calculates the dollar value of the payment in lieu of an affordable unit using
either: Total Residential Development Cost Limits ($200,000); construction hard costs, or the value gap
approach.

As part of the modeling process, three options were explored regarding the value of the cash payment
amount for fractional units. The first option was a generic fee of $200,000 per unit. The second option
was to use the construction hard costs for developing the affordable unit. The construction hard costs
can be defined as the cost of construction for the actual unit, which excludes the price of the land.
Utilizing this cost method enables the city to match the cost of building the unit with payment amount
requested.

The third approach towards determining the payment amount is to utilize the “value gap” approach.
The value gap is the difference between the value of a market rate unit and that of an affordable unit.
The value of a rental unit is determined by the net operating income and the capitalization rate; for an

INC WSIO NARY ZONING ANALYSIS 1 5

ownership unit it is determined by the sales value of the unit. In the case of affordable units, the
amount of rent or sale price is limited to the target income threshold of the inclusionary zoning policy.
This results in lower revenue to a developer. This loss of revenue translates into a loss of value (hence,
the value gap) and negatively impacts the overall financials of a developer because the cost of
construction and land to build either an affordable or market rate unit are essentially the same. As
part of the modeling process, an option was created to utilize the difference in value due to the loss of
revenue in determining the fee amount to charge for fractional units.

Table 6 presents an example case of the calculation of the payment-in-lieu across the affordability tiers
for a development that has 25 units, utilizing the value gap approach.

Inclusionary Percentage

Calculated Units Based on IZ Perce
Whole Units

Fractional Units

Cash P nt Amount on Fractional

Total Project Units
Inclusionary Units
Market Rate Units
Cash P ent in Lieu

Source: RKG Associates, Inc.

From a financial standpoint, the calculated fee in-lieu payment is added to the initial cost of the
development, which ultimately influences the overall financial return. Depending on the project size,
a large fee in-lieu could have a detrimental impact. Typically, asmall project tends to be more sensitive
to greater upfront costs because small dollar amount changes can have an outsized impact as
compared to larger projects.

SCENARIO ANALYSIS

Development Programs

To test the model and the underlying development assumptions, RKG ran eight development
scenarios. Table 7 presents the model calibration for each of the eight scenarios. The scenarios were
chosen by the city to understand the impact of the IZ changes on prototypical developments. One key
difference in terms of development costs is that of parking; in multifamily scenarios podium level
parking was assumed for developments located in the Downtown subarea.

INC WSIO NARY ZONING ANALYSIS 1 6

Number _ of Inclusionary
Scenario Tenure Unit T Location Units e
1 Ownershi Single Fam Suburban 100% Surface 10 10%
2a Rental Multifam Amh 100% Surface 2 10%
2b Rental Multifam Downtown Podium 2 10%

Ownershi Townhome Suburban 100% Surface 1
Rental Multifam Amherst/Exit1 | 100% Surface 12 20%
b Rental Multifam Downtown Podium 12 20%
a Rental Multifam Amherst/Exit1 | 100% Surface 20%
b Rental Multifam Downtown Podium 20%
Source: of Nashua, and RKG Associates Inc.

Comparative Scenarios

The financial analysis conducted by RKG provides key insights regarding the relative impact on
development finance resulting from the creation of an IZ ordinance. RKG modeled each of the eight
scenarios by calibrating the model with market-tested assumptions. For each development program,
RKG Associates analyzed four different scenarios. These scenarios include:

CURRENT MARKET/BASELINE SCENARIO
First scenario uses the current market conditions assumptions collected during the analysis to ensure

the model is properly calibrated with accurate assumptions. The baseline scenario provides an
assessment of how a project would perform (financially) based on market averages for acquisition,
construction, operation, and reversion.

TARGET RETURN SCENARIO

The second scenario adjusts the land acquisition cost to have the proposed development program
achieve the target IRR return levels (20% for ownership development and 15% for rental projects).
Within real estate development, the only true cost/revenue variable is the cost of the land. Vertical
construction costs, debt/equity requirements, and operational revenues are established by the market.
For example, rents cannot be inflated for market rate units to offset the rent/price losses of income-
controlled units. Thus, this scenario adjusts the land costs to reach the return threshold for the
proposed development.

INCLUSIONARY POLICY SCENARIO

The third scenario measures the financial impact of the model inclusionary zoning policy (detailed
earlier) on the target return scenario. This analysis was done to understand the fiscal impact of this
proposed policy on a project that met the minimum return threshold. Instances where this scenario
returned a lower IRR indicate the policy creates a financial disincentive, while instances where this
scenario has a higher IRR than the target return scenario indicates the policy creates a positive
financial impact.

INCLUSIONARY/BONUS DENSITY SCENARIO
The final scenario calculates how many additional market rate units (the bonus density) would be

needed above the baseline unit count for the inclusionary zoning scenario to meet the minimum return
threshold. In other words, RKG calculated how much bonus density would need to be granted for an

inclusionary zoning project to not adversely impact the return of the developer or the inherent value
of the land. This effort was done to understand the feasibility of a non-financial incentive (additional
units) could be applied to minimize impact to the local real estate market and return expectations.

Interpreting Results

The financial model calculates the basic go/ no-go decision a developer must make about a potential
project. The decision to pursue a project comes down to overall financial return and risk exposure. If
there is confidence that the desired returns will be reached, then the project will be pursued, otherwise
the project will not be undertaken.

From a financial perspective, the model calculates outputs that can be helpful when determining
whether a developer or a lender will choose to go forward with a project. Of these outputs, both the
Internal Rate of Return (IRR) and Net Present Value (NPV) are industry standard financial viability
metrics for a given project. While these are important metrics, they are not the sole arbitrators of
financial viability, as project risk assessment and developer track record are also important factors.
The IRR and NPV when examined together, offer significant insight to both a lender and developer.
The IRR is the calculated annual return on investment, taking into consideration net operating income,
investment holding period, and sales value. The NPV is the present value of all future cash flows (both
revenues and expenditures) for the project based on an expected return rate (discount rate) and over
the course of the determined holding period.

Based on the size of the initial upfront capital investment in a project, small percentage changes in the
IRR can have dramatic effects on the net present value. The decision factor for not pursuing a project
is if the IRR does not meet the required rate of return, or if the NPV is below zero. It is possible that a
project results in a positive NPV and a lower than desired IRR. In cases such as this, the decision
process becomes more nuanced as the developer would have to get comfortable with realizing a lower
return. Within the development industry, IRR return thresholds of 15% for a new construction rental
project and 20% for new construction ownership units.

Analysis Limitations

The undertaken analysis is not without limitations. The financial model is based upon assumptions
which were collected through developer interviews, market research, and professional judgement.
These assumptions are the main drivers of the financial model. The developments that are modeled
in this analysis are prototypical developments that could potentially be found in Nashua, and not
actual developments. While all the assumptions that drive the model can be customizable, RKG
calibrated the model such that the base assumptions are the default. There are countless permutations
that can be modeled, but RKG in consultation with the city, chose to model prototypical developments
with relatively standardized inputs.

The model is not able to test every variable or possibility, rather it can be used as an ordinance tool to
help inform the decision-making process. The model output helps show the relative impact of
ordinance changes on development financial feasibility.

INC WSIO NARY ZONING ANALYSIS 1 8

10-UNIT SINGLE FAMILY OWNERSHIP DEVELOPMENT

The 10-unit single family ownership development scenario offers an assessment of how inclusionary
zoning could impact the existing development landscape for smaller-scale ownership projects. Table
8 presents the results of the four scenarios tested. Under the current market/baseline scenario
assumptions, a 10-unit single family development yielded a 42.80% IRR assuming the market-quoted
$65,000 land value per unit. This return is more than double the expected return of 20% but only a net
present value of $228,295, meaning the smaller scale of the project creates greater sensitivity in
calculating the return levels. Adjusting the land costs to achieve the expected 20% return on
ownership projects resulted in a per-unit cost of $89,971. Effectively, this differential shows how
market assumptions can create variability in the financial performance of a real estate deal.

To understand financial sensitivity toward the model inclusionary zoning policy, RKG tested
inclusionary zoning requirements of 10% of the units to be priced at 80% of AMI. Under the scenario,
that means one of the 10 new units would be required to be sold at a fixed price affordable to a
household earning 80% of AMI. This single change reduced the IRR of the project from 20% to slightly
below 2% with a net present value of -$191,545. In short, requiring incomed-controlled thresholds in
smaller, homeownership projects have a substantial impact on the financial feasibility of the project.

That said, the inclusionary/bonus density analysis revealed that allowing the developer to build an
additional unit (11 instead of 10), provided sufficient value to return the project to the minimum return
threshold. In other words, implementing a 1:1 bonus ratio for each unit required to be income
controlled created a sufficient financial benefit to mitigate the financial impact of the affordable unit.
As seen in the table, the IRR for this scenario is 21.62% and the NPV is $18,017.

25-UNIT MULTIFAMILY (STICK) RENTAL DEVELOPMENT

The 25-unit multifamily (stick) rental development scenario reveals how inclusionary zoning could
impact smaller rental housing development projects outside downtown Nashua. Table 9 presents the
results of the analysis. The market-based assumptions under the current market/baseline scenario
yields an IRR of 13.58% based on the market pricing assumption of $50,000 per unit land value. This
return is less than the expected return of 15% for rental projects, and well below current market
expectations of 20%+. To reach the 15% IRR return level requires a land price of $36,803 per unit (as
detailed in the second scenario). In other words, the market is not strong enough to support a market
rate only project at the anticipated land values for smaller multifamily projects. Land costs need to be
reduced (either through greater density and/or a financial inducement) to meet market return
expectations

RKG Associates applied the model inclusionary zoning policy to the second scenario to understand
developer sensitivity toward inclusionary zoning. Under the scenario, 23 market rate units and two
affordable unit at 80% AMI would be required. As seen in the table, the impact to the developer of
having to provide the affordable unit is negative, resulting in an IRR of 14.34% and a NPV of -$108,064.
The reason the NPV is negative is because of the loss of revenue (the value gap) between delivering a
market rate unit versus an affordable unit. From the developer’s standpoint, the inability to realize

INC WSIO NARY ZONING ANALYSIS 1 9

full value from the affordable unit, which has a similar cost to that of a market unit, results in a
financial loss.

The Inclusionary/Bonus Density Scenario reveals that a 1:1 bonus density would result in having an
IRR that met the proposed minimum return threshold. The table reveals that adding one market rate
unit would nearly achieve the expected financial return (IRR of 14.93% and NPV of -$11,689.

INC WSIO NARY ZONING ANALYSIS 2 0

Table 8. 10-Unit Ownership Development

Inclusionary 80%

Inclusionary AMI W/ Adjusted
No Inclusionary | 80% AMI W/ | Land Value and
Adjusted Land | Adjusted Land | Bonus Market
No Inclusionary | Value Value Units

Location Suburban Suburban Suburban Suburban

Unit Style Single Family Single Family Single Family Single Family

Unit Type Owner Owner Owner Owner

Construction Type Fee Simple Fee Simple Fee Simple Fee Simple

Construction Cost $165 $165 $165 $165

Number of Units 10 10 10 "1

Market Rate Units 10 10 9 10

Affordable Units oO 0 1 1

Parking Surface Surface Surface Surface

Special Permit No No No No

Inclusionary % 0% 0% 10% 10%

Inclusionary Treatment No Inclusionary | No Inclusionary Proposed Proposed

Inclusionary Units O 0 1 1

Payment in Lieu so so so so

AMI Split 0 O 80% 80%

IRR 42.80% 20.01% 1.84% 21.62%

NPV $228,295 $127 ($191,545) $18,017

All costs $4,665,797 $4,915,502 $4,915,502 $5,177,723

Land cost $650,000 $899,705 $899,705 $899,705

Land cost per unit $65,000 $89,971 $89,971 $84,559

Average cost per unit (inclusive of land) $466,580 $491,550 $491,550 $486,628

Hard cost construction (exclusive of land) | $401,580 $401,580 $401,580 $402,069

Return on Cost (ROC) 15.52% 9.65% 4.97% 10.07%

INC WSIO NARY ZONING ANALYSIS 2 1

Table 9. 25-Unit Multifamily (Stick) Rental Development

No _Inclusionary

Inclusionary 80%

Inclusionary 80%
AMI W/ Adjusted
Land Value and

Adjusted Land | AMI W/ Adjusted | Bonus Market

No Inclusionary Value Land Value Units
Location Amherst/Exit 1 Amherst/Exit 1 Amherst/Exit 1 Amherst/Exit 1

25-Unit 25-Unit 25-Unit 25-Unit
Unit Style Multifamily Multifamily Multifamily Multifamily
Unit Type Rental Rental Rental Rental
Construction Type MF - Stick Only MF - Stick Only MF - Stick Only MF - Stick Only
Construction Cost $185 $185 $185 $185
Number of Units 25 25 25 26
Market Rate Units 25 25 23 24
Affordable Units oO oO 2 2
Parking Surface Surface Surface Surface
Special Permit No No No No
Inclusionary % 0% 0% 10% 10%
Inclusionary Treatment No Inclusionary No Inclusionary Proposed Proposed
Inclusionary Units 0 O 2 2
Payment in Lieu so so $18,219 $18,219
AMI Split oO oO 80% 80%
IRR 13.58% 15.08% 14.34% 14.93%
NPV ($239,329) $13,268 ($108,064) ($11,689)
All costs $6,626,402 $6,296,489 $6,296,489 $6,409,734
Land cost $1,250,000 $920,087 $920,087 $920,087
Land cost per unit $50,000 $36,803 $36,803 $35,885
Average cost per unit (inclusive of
land) $265,056 $251,860 $251,860 $249,990
Hard cost construction (exclusive of
land) $215,056 $215,056 $215,056 $214,105
Return on Cost (ROC) 7.08% 7.45% 7.29% 7.44%