OZ Pitch Day - March 7, 2024
In this webinar, Erik Hayden makes the case for investing in Opportunity Zones in San Jose, especially in light of continuing migration to this important technology hub.
Interested In Learning More About This Opportunity?
You can visit the Official OpportunityDb Partner Page for Urban Catalyst Fund II to:
- View beautiful high-resolution images.
- Learn key details about fund and related projects.
- Request more information from the fund sponsor.
- Why many of Urban Catalyst’s investors are focused on sheltering capital gains from the sale of stock.
- A review of the tax incentives associated with Opportunity Zone investments.
- Macroeconomic trends that are poised to boost San Jose, led by tech migration.
- The importance of existing physical and transit infrastructure when planning ground up development.
- How San Jose stands out as a California city that has streamlined the preconstruction process and made it easier for developments to get off the ground.
- Return to office trends in San Jose, including at Zoom world headquarters.
- Google’s massive spending spree in San Jose, including plans for 7 million square feet of office space.
- Detailed discussion about the two projects in Fund II, which include an office building and an apartment complex.
- Why Urban Catalyst’s position as both a fund and a developer provides an advantage.
- The investment timeline for Urban Catalyst’s Fund II, including the fundraising period and targeted asset sale date.
- Opportunities for investors to earn bonus units in Urban Catalyst’s funds.
- Live Q&A with webinar attendees.
Featured On This Webinar
Industry Spotlight: Urban Catalyst
Urban Catalyst is a real estate equity fund focused on ground-up development projects in downtown San Jose. Urban Catalyst closed its successful Fund I in December 2020; that fund was a multi-asset real estate fund focused on ground-up developments consisting of office, mixed-use, student housing, senior housing and a hotel.
Learn More About Urban Catalyst
Jimmy: Erik, take it away.
Erik: Jimmy, great to see you. I’m gonna share my screen and go through a little presentation. All right. So, here at Urban Catalyst, we’re currently raising our second fund. Our fund is structured a lot like a traditional real estate equity fund. We’re focused on doing ground-up development projects in downtown San Jose, California. We’re also, of course, an Opportunity Zone fund, and that allows us to give the Opportunity Zone tax benefits to our investors. Just like any type of fund, you know, we have a lot of disclosures and risk factors to go through. You can read our PPM to find out all about those. But really, just to kick us off, you know, we’ve been featured in the news pretty prominently over the last couple of years. We’ve had over 250 news articles written about us, really just a lot of positive buzz about, you know, the real estate development projects we’re doing here in downtown San Jose. Probably most important of these, we were named by “Forbes” magazine as one of the top 20 Opportunity Zone funds in the country. So, there’s nothing like getting a little national validation from “Forbes” that we’re doing things the right way.
A little bit about the program. You know, in order to get the tax benefits associated with Opportunity Zone funds, you have to have a capital gains event. Here are the three, you know, primary ways that folks have capital gains events, the sale of stock, the sale of a business, or the sale of real estate. You know, it’s interesting, for over 70% of our investors here at Urban Catalyst, and we have over 700 investors now, the sale of stock was their capital gains event. And that really makes a lot of sense because before Opportunity Zone funds were created, there really wasn’t a way to shelter your capital gains from the sale of stock. Now we have the programs. We’re seeing a lot of folks that own stocks sell their stock and really diversify their portfolio into real estate.
Of course, once you have that capital gains event, you have 180 days to put your money into a qualified Opportunity Zone fund. That’s just letting everybody know, so no one runs out of time and misses out. And then there are two primary tax benefits associated with our program. The first is you’re able to defer paying taxes until 2027 on that initial capital gains event. So you get that deferral. And then the second benefit, which is really a lot better than the first one, is, after investors’ money seasons in our fund for 10 years, all of the profits from the fund itself are tax-free from a federal capital gains perspective. So, here at Urban Catalyst, our plan is to build these buildings, lease them up, stabilize them, you know, wait till we get to that 10-year mark, and then sell the assets and liquidate the fund. And that’s when we return the majority of the profits to our investors, and those profits are tax-free.
Just taking a step back, here are the Opportunity Zones in the San Francisco Bay Area. You can see those in green. And for this fund, as I mentioned, we’re focused on San Jose, and even more so in downtown San Jose. You can see there are four Opportunity Zones that cover almost all of downtown. And, you know, it’s interesting, when I first started Urban Catalyst, my plan was to create a real estate equity fund to do ground-up development projects in the downtown core, you know, mainly because of the overall macroeconomic trends throughout Silicon Valley all pointing towards downtown San Jose as the next place to do development on a large scale. And it was only after I started forming Urban Catalyst that I learned about the Opportunity Zone program, and that everywhere I was planning on building these buildings was already located in an Opportunity Zone. I thought, “Well, wouldn’t it be nice to be able to give my investors these additional tax benefits?” And so, that’s how Urban Catalyst became an Opportunity Zone fund.
And when I talk about those overall macroeconomic trends, what I’m really talking about is tech migration. Here is Silicon Valley, and obviously, everyone knows there’s lots of big tech companies here in the Valley. For this example, I’m just gonna use these five companies, which are now the five largest companies in the United States by market cap. And really, the story of these companies over the last 20 years, they’ve just grown, you know, exponentially. And as they’ve grown, they’ve expanded their office footprint, you know, all over the world, all over the country, but here in Silicon Valley, we’ve definitely seen a slow migration southward. Really, the beneficiary of that migration so far has been the city of Sunnyvale.
To give you an idea of the scale of this, I mean, really, Palo Alto and Mountain View are kind of, like, the center of the Silicon Valley universe. And right now, in the city of Mountain View, Google currently occupies 95% of the office space in the entire city. Very similar, here in Cupertino, Apple occupies 85% of the office space. And now, in Sunnyvale, Google and Apple combined have just over 50% of the office space. So you can see these companies definitely taking up a large share of what’s happening. But now, Sunnyvale, you know, development’s been going gangbusters for over a decade. Now the city’s almost completely built out. And it’s kind of interesting, when I first started Urban Catalyst, I would say, “And where is the next logical place that we expect these companies to continue to move?” Obviously, it’s downtown San Jose. But now we can just say all these companies have moved to San Jose. We’ve seen Microsoft and Apple take large land holdings. Amazon has an office in downtown San Jose. Google has been just the big story for downtown, and I’ll talk a little bit more about that. And then, as of Q4 of last year, Facebook took 1.2 million square feet of new office in Santa Clara, just a few miles outside of Santa Jose. So, tech migration is definitely occurring really as we had anticipated a couple years ago.
We’ve been developers here in the Bay Area for our entire careers. And when we do development anywhere, there are really certain things that we wanna see in these cities, and downtown San Jose has all of those things. The first is, you know, we wanna make sure that there’s demand for all of the different types of projects that we’re building. And that demand is really generated here by the Silicon Valley job engine. We wanna do business in a place where transit and physical infrastructure are already in place. Downtown San Jose is really the only true urban environment in Silicon Valley. Diridon Station is slated to be the largest train station on the West Coast. It already has a variety of mass transit options to connect to it, including Caltrain. And now, BART, which is the largest mass transportation system here in the Bay Area, is fully funded to connect through downtown San Jose and connect into Diridon Station. Also, San Jose State University, often overlooked, but it shouldn’t be, because with 35,000 students, it’s the second-largest university in the Bay Area behind Cal Berkeley.
Finally, you know, we wanna do business in a place where the local government wants to see development happen. Here in the Bay Area, most cities are anti-development, but that’s kind of the opposite here in downtown. In downtown San Jose, they wanna see development, and they wanna see it now. And a lot of these policies were put into place by Sam Liccardo, who is in this picture. Sam’s the mayor of San Jose. By the way, that’s me and my partner, Josh, with Sam in that photo. He’s the mayor. He’s been the mayor for eight years. Before that, he was the council member representing downtown for eight years. So he’s the one that’s really streamlined the pre-construction process, made it so much easier for developers to do business in downtown, and attracted developers like Urban Catalyst into the core.
To give everyone an idea of just the massive revitalization that’s currently happening here in downtown San Jose, I like to show this before and after slide. Here is the current skyline in downtown San Jose. If all of the projects that are currently in the planning process are built out, say, over the next 10 years, downtown San Jose should double or triple in size. You can see Urban Catalyst, both our Fund I and our Fund II projects, in red. Here’s my two-dimensional map of downtown. Sometimes it’s easier to understand a market looking two-dimensionally. This black line represents the Opportunity Zone. Urban Catalyst, our headquarters are right here. So, we’re right in the zone. We’re right next to Adobe’s world headquarters and Zoom’s world headquarters.
Little side note. Pretty interesting. Recently, two weeks ago, started getting some phone calls from some of my employees that there was nowhere to park, because Zoom had come back into the office, and we share a parking garage with them, and so our employees had to park up on the fifth floor instead of, you know, where they were used to when Zoom was not coming into the office. But always exciting to see big companies like Zoom coming back.
San Jose State University right here. This red dashed line, this is where that new BART line is running through downtown, a station here in the core of downtown and then connecting into that big train station, Diridon Station. And as I mentioned, Google has been the biggest story here in downtown San Jose over the last five years. And I’ll give you a little summary of what they’ve been up to. They’ve acquired over 80 acres of property, and they’ve spent more than $500 million on that acquisition. The plans that they had approved at city council last year showed them building 7 million square feet of office and roughly 6,000 residential units. At buildout, this will be Google’s largest campus on earth. And to give everyone kind of an idea of the scale of this, you know, San Jose, city of a million people, 10th largest city in America. Our downtown core has about 100,000 people. This campus alone is expected to bring between 40,000 and 60,000 people to the downtown every single day.
So, yeah, pretty exciting stuff with Google, but Google really isn’t the only story in town. Other big developers have flooded into the downtown over the last few years. Three notable ones, Boston Properties, Jay Paul, and Westbank. These three groups have spent over a billion dollars acquiring property, and they’re planning on doing millions of square feet of new development. Here are some examples of some of the pretty awesome architecture they’re planning in the downtown core. Jay Paul has already started on this project. It’s about half built. Boston Properties has already started on this project. You can see Westbank down here, really exciting architecture. They love putting trees on the sides of their buildings. But here at Urban Catalyst, you know, this is that wave of development that we saw coming to downtown, and our whole plan when we formed was to acquire properties, get in on the ground floor, you know, before these great development sites were scooped up by other developers or big tech companies. And really, that’s exactly what we did with the acquisition of our Fund I and Fund II projects.
In Fund I, a little bit of a recap. We have six projects in Fund I. You can see them there in blue. Here’s what those projects look like. We’ve already started construction on Paseo, and we start construction on the rest of these projects in the next 12 months or so. Overall, we raised $131 million for this fund over a two-year period. As Jimmy mentioned, we closed the fund in December of 2020. This fund is just going great. Pretty excited about all of these projects here in the downtown. Now, on to Fund II, which is our current offering. Fund II, we managed to acquire almost half of an entire downtown San Jose city block. You can see it here in orange. It’s right across the street from city hall. It’s right on Santa Clara street, which is, like, that main drag of the central business district. It’s right next to that future BART station. It’s really the epitome of transit-oriented development. And here is what Fund II looks like. Fund II consists of two buildings. On the left is Icon. Icon is a 500,000 square foot office building. And on the right is Echo. Echo is an almost 400-unit multi-family building. So, it’s an apartment building. There’s only going to be two projects in this fund. So, if you invest into Urban Catalyst, these are the two projects that you’ll be investing into.
And here’s a different rendering, or a different view. You know, when I like to talk about these projects, I like to talk about the demand, as to, you know, why did we decide to build multi-family and office in this location? And I’ll start here with Echo. Echo, of course, our apartment building. The demand for multi-family here in Silicon Valley is kind of a no-brainer. Here in California, in general, we have a housing crisis. It’s especially true here in Silicon Valley, and that’s because we’ve created six jobs for every housing unit that we’ve built for over 30 years straight. And that’s the reason we have some of the most expensive housing, both for sale and for rent, in the world. To give everyone an idea of just how intense this supply and demand issue is for housing in Silicon Valley, a recent statistic came out. If we wanted to build enough housing units so that we could have supply equal demand, we’d have to build around 150,000 housing units. Historically, we’ve never built more than 5,000 housing units here in Silicon Valley in a single year. So, that’s how far behind we are.
Now, while that’s horrible for society, and we should probably try and fix that problem a little bit more, it’s good for developers, because that means that we’ll have a high occupancy, and we’ll have, you know, rents that are high enough for us to build our buildings. Whenever we build multi-family, we build a lot of it. We like to put in really awesome amenities for our future tenants. This is our podium pool deck. You can see we have this really nice infinity pool with these cabanas. Behind it, wrapping the pool deck, this is a two-story amenity space. Over here is an indoor-outdoor fitness facility. This is a dining room and kitchen area. Over here we have a game room and movie room, and then out here on the lawn, we have some barbecue areas for our residents. And then up on the 26th floor, so, right on top of the building, this is our rooftop lounge. And so, we have some fire pits, couches. On the inside here, this is an office area for our residential tenants. This is their conference room that doubles as a dining room in the evening.
Now, on to Icon. You know, the demand for Icon and office here in the Valley is different than multi-family. And while demand for office has remained strong even throughout the pandemic, the big difference for us as developers is we can build office fast enough to meet the demand. So, whenever we build new office, it has to have certain components that we can really attract that top-quality tenant, and of course, this building has all three. We really don’t build buildings unless we are sure that we can incorporate all of these components. The first is, you know, the old real estate mantra, location, location, location. This is a great location in downtown San Jose. We kind of already talked about it, transit-oriented development and everything. But, you know, downtown San Jose, its competitive market area is all of Silicon Valley. And the way that downtown competes is that rents for office in downtown San Jose are about 50% of what rents are for office space in Palo Alto and Mountain View. So it’s significantly less expensive to locate your office, you know, your company here. Also, it’s one of the only places that you can get space at scale. It’d be a lot harder to get 500,000 square feet of office in Mountain View, because there just isn’t any space available.
The next thing that we look for is what I call functionality. You know, it has to be built right. And that includes, you know, making sure we have the right amount of parking, which this project has. We have these really big floor plates, almost 40,000 square feet of net rentable square footage per floor. That’s really what all the big tech tenants wanna see these days. We also have 14-foot floor-to-ceiling heights, with floor-to-ceiling windows, for that open, airy office feeling. And then we have a ton of indoor-outdoor amenity spaces, including some of these exterior staircases, these balconies, and you can see back in this rendering some of the nice rooftop decks that we’re planning. And then the last thing that is really necessary is what I call architectural aesthetic beauty. And that’s just a fancy way of saying you have to have a nice-looking building. We’re utilizing WRNS as our architect for this project. They’re one of the premier office architects here in Silicon Valley. In fact, they just finished doing Microsoft’s big campus up in Mountain View. And we’re really pleased with how this design has turned out.
What makes Urban Catalyst different than other Opportunity Zone funds is, you know, most other Opportunity Zone funds, their plan is to go out, raise a bunch of money, and then, you know, look all over the country to find developers that have projects in Opportunity Zones, so that they can, you know, form these partnerships. You know, here in Silicon Valley, we like to look at Steve Jobs and Steve Wozniak, and we think, did these guys go out, you know, raise a bunch of money, and then hire someone to build them a computer? The answer is of course not. They built a computer and then they took it out to the market. And that’s really exactly what we’re doing here at Urban Catalyst. You know, we’re the developers of all of our projects, and we have projects in our portfolio, and now we’re taking those projects out to the market.
Another thing that I like to talk about with all of our potential investors is, you know, you hear about Opportunity Zone funds, and you hear about the great tax benefits. And don’t get me wrong. We’re big fans of the tax benefits here at Urban Catalyst, but, you know, the biggest benefit you’re getting is you’re getting tax-free profits after 10 years. You know, there better be profits after 10 years, or really, what’s the point of the entire program? So, understanding the asset classes that are being built, the local market that you’re building these, you know, development projects into, and who the developers are, that’s what matters. Here at Urban Catalyst, we see ourselves as a solid fundamental real estate equity-funded development company, and we see the Opportunity Zone tax benefits really as just the icing on the cake for our investors.
A little bit about me. I’ve been a developer my entire career. I’ve done several billion dollars worth of projects here in the San Francisco Bay Area. A lot of focus in Silicon Valley and San Jose, in particular. In general, I built institutional-quality and scale projects, and really what that means is I build large, income-producing properties. Typical exit strategy is to sell out to a publicly-traded REIT or a large institutional investment, or equity group. Here at Urban Catalyst, we have five partners. We also now have 35 people that work here. And when I first formed Urban Catalyst, my whole plan was to create an all-star team of downtown San Jose developers. And really, that’s exactly what I did, bringing on Josh Burroughs and Paul Ring. I’ve known both these guys for over a decade. Josh is our chief operating officer. He spent 10 years working for a group called Barry Swenson Builder, as their lead developer, before joining Urban Catalyst. They focus primarily on a variety of different asset classes here in downtown San Jose, and so he got experience building all sorts of different types of things.
Paul Ring. Paul is our head of development and construction. He manages our 15-person team that builds all of our buildings. I had the really great pleasure of working with Paul when he was at the Core Company for 15 years, focusing exclusively on multi-family and below-market-rate housing here in downtown San Jose. I worked with him as a joint venture partner, got to watch him manage his team, and was just really impressed with his style, and so happy he’s managing our team here at Urban Catalyst.
Of course, we’re not just developers. We’re also fund managers. Morgan Mackles is our head of investor relations. I have known Morgan for over 25 years. He and I went to high school together. We’ve been friends for a really long time. Morgan has spent his career building scalable and repeatable sales processes. He’s done it for small and large companies, you know, startups all the way up to Fortune 500. And he’s the primary reason why we are so successful in our Fund I fundraise, and why we’re off to such a great start here in Fund II. And then, last but not least, Sean Raft. Sean is our chief administrative officer and general counsel. Obviously, he’s an attorney. He manages, of course, all of our legal teams, our finance partners, our accountants that do our tax and audit, our fund administrators. He does all of our compliance with the SEC, as well as the Opportunity Zone rules and regulations. Or kind of an easy way to say it, Sean really dots the i’s and crosses the t’s here at Urban Catalyst. So, these are the five partners, and combined, just the partners, we’ve done over $5 billion worth of ground-up real estate development in Silicon Valley. You can see the heavy concentration of projects in downtown San Jose.
Right now, I’m gonna switch gears a little bit, talk about our investment timeline. You know, every Opportunity Zone fund is a little bit different, so I wanna describe, you know, really, our business plan. Here in Fund II, we’re raising $200 million. We’ve now raised over $95 million to date, so we’re a little bit ahead of schedule in our fundraising timeline. You can see I put three years here for us to raise our fund, and that’s because in Fund I, we raised on average around $65 million a year. You know, you do that for three years, that gets you to around that $200 million goal. We put, you pay your taxes here in 2027, just as a reminder to everyone. That’s, of course, when you pay taxes on that initial capital gains event. And then here is when we anticipate selling our properties, in 2034. That’s after that 10-year hold, when investors get tax-free profits.
Now, 2034, it’s a long time away. We do plan on making distributions prior to the end of the whole period, the first time being in 2026. And the way that this works, sometimes I call this developer 101. We’re going to be starting construction on these projects in 2023. They’ll be complete in 2025, and they’ll be leased up and stabilized in 2026 and 2027. And once they’re leased up and stabilized, we go out and we get permanent financing. We take that financing, we pay off the construction loan, and then any excess refinance proceeds, we distribute those to our investors. Right now, we are targeting distributing 65% of our investors’ initial investment back to them in 2026 when we refinance the Icon project. That’s great because it’s a tax-free distribution. And our ultimate goal is that we’re able to distribute these funds to our investors, and they can use those funds to pay their taxes on their initial capital gains event in 2027.
Of course, this is where my attorneys always like me to say there are no guarantees associated with investing into Urban Catalyst. And please read our private placement memorandum to understand all of the risks associated with investment. But after our refinance event, you know, we’re gonna have stabilized assets. Those assets will be cash flowing from 2026, you know, through the remainder of the whole period before we sell the properties in 2034. This is also where I like to talk about what I call the third hidden benefit of the Opportunity Zone program. And really, it’s for Opportunity Zones that are structured as LLCs, as ours is. And the…you know, everybody likes about LLCs, you’re able to pass through losses to investors.
So, our fund, we plan on having losses almost every year, which is great. You know, you’ll get that on your K-1. And a lot of those losses, they come from the depreciation of our stabilized assets. I’m sure for those of you that own real estate, you already know this part, but most folks, of course, when they own real estate, they depreciate their assets every single year on their tax returns and they write it off. It’s gonna be no different here except we’re able to pass through that depreciation as passive loss to our investors. Now, kind of the bummer with real estate is when you sell it, the government wants you to pay back all of that depreciation, in what is called depreciation recapture. Everybody hates depreciation recapture. So, what’s really great for Opportunity Zone funds, and only for Opportunity Zone funds, when we sell our assets, there is no depreciation recapture. So all of those passive losses that you’ve received throughout the entire, you know, duration of the fund, not only do you not have to pay them back and you get to keep them, when we sell these assets, all of those passive losses, they convert from passive loss to active loss.
And active loss can offset things like ordinary income. So, you’ll be getting losses throughout this whole time from depreciation of stabilized assets. You can use them to offset all of this cash flow. We plan on having more losses than cash flow. You can use to offset other passive income, and if you don’t have it, that’s fine too, because passive losses, you know, they accrue and roll forward forever. So then when we sell the properties and they convert to active losses, you know, perhaps you can use them then.
So, here’s how all of that works when you put it all together. Also, wanna talk about our bonus units program. You know, this was a really popular program in our first fund, so we continued it here into our second fund. The way that it works, of course, if you invest into Urban Catalyst, what you’re doing is you’re buying our units. And, of course, you’re paid out based upon the number of units that you own. We give bonus units in three different ways. The first is our time incentive credit. This is really to reward investors for earlier investment. You can see we’re here in March, right at the end of March. You get 5.25% bonus units. You can see it goes down every month throughout the duration of the fundraising period. And what that would mean if you invested $100 into Urban Catalyst in March, you would get $105.25 worth of our units.
The second way that we give bonus units is our multiple ventures program. This is really a loyalty rewards program. This is if you’re an investor into another Urban Catalyst fund, you are able to get…multiple ventures, you get 4.5% bonus units. And then finally, our volume incentive program is to reward investors for more investment. Minimum investment size $250,000. Bonus units start at $300,000 and they go all the way up to $1.9 million. These three, of course, they add together. Also, another nice thing about the volume incentive program is that as soon as you meet our minimum, you can invest, you know, more throughout time, as long as our fund is still open. So, let’s say you did $250,000 this year because you had a nice capital gains event from the sale of some stock. You had 0% bonus units in the volume incentive program, no big deal. Next year, you sell some more stock, you get another $250,000, and bump all of your units up to this $500,000 2% range. So it’s cumulative. You know, with that, I’m gonna stop sharing and open it up to some Q&A.
Jimmy: Fantastic. Well, thanks, Erik. Always great hearing your presentation on Urban Catalyst. We do have quite a few questions from members of our audience here. And as a reminder, I don’t know, about three to five minutes from now, we’re gonna go to a lunch break here in the main session. Erik will be available in the other Zoom meeting, I’m gonna post a link to that in just a moment, for another 20 minutes of some live Q&A. You can ask him directly in the Urban Catalyst Fund Breakout session, but we’ll get a few going here in the main session before we boot you over there, Erik. Question number one. What do you see the impact of rising interest rates on your projects being?
Erik: Sure. I mean, rising interest rates are something that we always pay attention to, and when we do our underwriting we are somewhat conservative. You know, we’ve been underwriting at around 4.5% to 5% as far as interest rates for our construction loans. That’s a lot higher than what has been the industry recently, around 3% to 3.25%. Now, as far as our construction loans are concerned, higher interest rates don’t mean a ton. I mean, they add a little bit of additional construction costs. I mean, we’re building these $100 million buildings. A little bit of extra interest just adds to the total project cost, but it’s kind of insignificant. However, rising interest rates, they do affect cap rates for real estate. And cap rates, in general, go up when interest rates go up. So, when we go for our refinance event in 2026, or when we go to sell our assets in 2034, cap rates are going to determine what the value of those assets are. So if interest rates are still high and cap rates have followed along with that trend, it may decrease the values that we’re anticipating, but we do underwrite in today’s, you know, values, and we are somewhat conservative. We’re underwriting our office at a 4% cap rate, and we’re underwriting…sorry, our multi-family at a 4% cap rate, when we do our refinance on our exit, and we’re underwriting our office at a 5.5% cap rate when we do our refinance and our sale.
Jimmy: And another question related to current macroeconomic trends. This question is, are supply chain and inflation issues impacting your schedule and underwriting models at all?
Erik: So, supply chain hasn’t impacted us all that much. You know, we’re under construction on some of our projects in Fund I. So we do see some of that. However, you know, we plan out quite a ways in advance. And so, you can see a lot of the supply chain issues have already happened, and they’re fixing them. It hasn’t increased our cost, and it hasn’t impacted our schedule on our Fund I projects. Inflation does affect us. It doesn’t affect us as much as rising labor costs. We do build in construction cost inflation contingencies into our model. For this project, we have between 5% and 10% of our hard costs in a construction inflation contingency, which is pretty significant when you’re talking, you know, we have, like, $600 million in buildings we’re building.
Jimmy: Very good. I’m just posting the link right now in the chat for Erik’s breakout session. We’re gonna get going there in just a few more minutes, but we got a few great questions here. I’m gonna see if we can get to a few more before we close down the main session for lunch and open up that breakout session for you, Erik. Next question is, has all of the land been acquired for these projects, and how much of the total budget is allocated to land versus development?
Erik: Sure. So, there are four parcels associated with Fund II. We have closed escrow on three of the four parcels. We’re in a binding option contract to purchase the fourth parcel. Of course, we’ve already raised enough money to acquire. It’s really the tenant doesn’t want to sell until the end of this year. So, we’ll be acquiring that at the end of this year. Total land cost for our site is around $50 million. And I don’t know the exact percentage of land cost versus total project cost, but it’s pretty typical for high-rise development here in downtown San Jose.
Jimmy: Very good. Can you speak to how you approach factoring in rent increases in underwriting your projects?
Erik: Sure. So, when we do our initial underwriting, we underwrite in today’s market, which has been kind of challenging during COVID, because we did see multi-family rents go down here in San Jose during COVID. They’ve almost rebounded to pre-COVID levels, but not quite. They went down about 15%. They’re back about 10% so far. Now, that being said, we also put in what I would call the standard three and one, 3% rental increases, 1% expense increases. So, we build that into our models. And then we build in very typical, kind of similar to our multi-family, into our office, but that’s when we go out and we sign an office lease, we build in those rent escalations into a long-term lease.
Jimmy: Very good. I like this next question here. This person says, “I’m wondering if the Urban Catalyst fund is making any tactical pivots or adjustments in light of the current economic uncertainty/war/what this person refers to as ‘weak national leadership’.” Little political there, but…
Erik: You know, we haven’t made any major pivots on our Fund II project. You know, we planned this during COVID and, you know, having a vision to build a big office building when everybody was working from home was, you know, I wouldn’t call it a leap of faith, but it was something that where we understand the local market, and we understand how these tech companies are growing and really the strength of them. So, we didn’t pivot then. You know, the war hasn’t impacted us really very much. I hadn’t even thought that it would impact us as far as changing to our design. In Fund I, we have changed a couple of our projects, at least how our unit mix was designed in a couple of our multi-family projects, to make sure that, you know, we were meeting today’s demand. That’s really about it.
Jimmy: Very good. Few more questions here. We got a couple more minutes. How do you think about the hard questions that Opportunity Zones are oftentimes criticized for? For example, gentrification undermining the original intent for Opportunity Zones. What are your thoughts there, Erik?
Erik: Well, you know, development is a necessary thing in a healthy community. And everyone who is anti-development is going to say the words “gentrification” and “displacement.” The causes of gentrification and displacement primarily are the construction of office, because office brings jobs, and people wanna live close to their jobs, and they drive up the housing prices around these office buildings. And we’ve seen this happen throughout Silicon Valley, right? Where we’ve created all these jobs, and we haven’t built enough housing. Here at Urban Catalyst, we take a more holistic approach to our community. And, you know, it’s somewhat of a balance where we can have a win-win for what the community wants and needs, as far as the different types of projects and asset classes that we’re building, and our investors can still get the returns, you know, that are required to finance the projects.
So, that’s why you see in Fund I, I mean, we have 200,000-square-foot mixed-use office buildings. We have 175 key hotel rooms, an extended stay business hotel. We have a multi-family project, 200 units, a multi-family. We have a 800-bed student housing high rise. We have 165-key memory care assisted living facility, so a senior living facility. And then in Fund II, we have multi-family and we have office. I mean, I could have built a million square feet of office on the Fund II site, but we wanted to have a diversified portfolio of projects. So, we’re definitely working towards that community goal, and that kind of goes hand in hand with the intent of the Opportunity Zone program, but that’ll never stop, you know, people that will say, “Displacement and gentrification. We should never build anything ever again.”
Jimmy: Right. Right. No, good insight there. One really basic question, I accidentally closed out, and wanna make sure we answer is, will you invest in projects outside of San Jose, or is the scope of this fund limited to the city limits? I believe you’re just doing this one development in San Jose. Is that right?
Erik: Yeah. It’s just gonna be these two projects. We’re not, you know, a blind pool. We’re not out there trying to acquire projects or saying, “Oh, yeah, we’re looking at these areas.” You know, we’re local San Jose developers. We’re experts here. We’ve been doing business here a long time, and we’re doing more of the same, with projects that we know the asset classes, we know how to build them, we know how to, you know, make them successful.
Jimmy: Very good. Well, I do wanna…I know we’ve got some more questions. If you have questions for Erik, head over to that breakout session now. We’re gonna shut down the main session here for about 20 minutes or so, and then come on back for the afternoon session. But Erik, always a pleasure seeing you and hearing about Urban Catalyst. I’m gonna remove you from the stage now. And thanks again, Erik. Appreciate it.
Erik: Thank you, Jimmy. Great to talk to you.