The Honourable Brad Duguid
Minister of Economic Development, Employment and Infrastructure
Eighth Floor, Hearst Block
900 Bay Street
Toronto, Ontario
M7A 2E1

The Honourable Dr. Reza Moridi
Minister of Research and Innovation
77 Wellesley Street West
12th Floor, Ferguson Block
Toronto, Ontario
M7A 1N3

December 8, 2014

Dear Minister Duguid and Minister Moridi,

We are pleased to submit to you for your consideration the Report of the Expert Panel on MaRS Phase 2. As directed in the Panel’s Terms of Reference, we have undertaken to help define and support a decision regarding MaRS Phase 2 that is in the long-term best interest of Ontarians and the provincial economy.

We appreciate the importance to the government of resolving the current vacancy challenge facing MaRS Phase 2 in a timely manner. Your government has the means to meet the challenge in a fiscally responsible manner. The solution requires the government to take its next leadership step in its creation of MaRS Phase 2 by making available additional financing to MaRS that will allow MaRS to complete the MaRS Phase 2 project and to immediately commence the execution of major leases in its pipeline of prospective tenants.

We have made a number of recommendations in our report. The essence of these recommendations is for your government to provide the financial assistance to MaRS to complete MaRS Phase 2 and, at the same time, ensure that the taxpayers’ interest in the project is fully protected and that all taxpayer funds are repaid, with interest, by MaRS. Further, the recommendations have been made after review and analysis of a number of risk factors including the higher cost of financing from MaRS ownership, capital impairment of Provincial loans and any adverse impact to the Provincial finances from a consolidation of the MaRS financial accounts into the Provincial accounts. We are satisfied that adequate provisions have been made and security provided by MaRS to mitigate these risks.

We trust that this advice will provide the government with a strong rationale to see its role as the sponsor of the MaRS Phase 2 project through to completion. We believe that the government should be confident that proceeding in this manner will unlock the potential of MaRS Phase 2 to become financially sustainable and a landmark for life sciences innovation in Ontario.

Sincerely
Michael Nobrega
Carol Stephenson

Introduction

The MaRS Discovery District (MaRS) is a not-for-profit charity that was established in 2001 to develop a world-class innovation and convergence centre (the MaRS Centre) in Toronto dedicated to improving Canada’s economic prosperity from innovation in the life sciences sector.

Figure 1 – MaRS Discovery District (Source: MaRS)

Figure 1 – MaRS Discovery District (Source: MaRS)

The three buildings in MaRS Phase 1 (aggregated at 720,000 square feet) are fully (98%) tenanted. The base construction of MaRS Phase 2 (780,000 square feet) was completed in January 2014 and is 30% leased. The lease-up of the remaining space is currently constrained by an agreement with Alexandria Real Estate Holdings (ARE), the private sector developer which won an international competition in 2007 to finance, construct and tenant MaRS Phase 2 under a 99-year leasehold arrangement with MaRS. Construction commenced in 2007 but was stopped by ARE in early 2009 following the 2008 credit crisis and stock market meltdown.

Following two years of legal discussions and negotiations with ARE to restart construction, a decision was made by the MaRS board of directors (the MaRS Board) and the Government of Ontario (the "Government" or the "Province") to recommence construction in 2011 with a $224-million construction loan from Infrastructure Ontario (the IO Loan), supported by a debt service guarantee (DSG) provided by the Ministry of Research and Innovation (MRI) to Infrastructure Ontario (IO). These two agreements underpinned the construction of MaRS Phase 2 and made the Province the de facto financial sponsor of the project. MaRS replaced ARE as the developer but, importantly, ARE retained approval rights for net rental rates for MaRS Phase 2. For the last 15 months as construction of the building neared completion, MaRS has been frustrated by ARE in signing major institutional, investment-grade tenants at net rental rates below $30. This second standoff between ARE and the Province/MaRS has led the Government to appoint the External Panel (the Panel) to review the situation and make recommendations, given the Government’s underlying public policy objective of fostering innovation at the MaRS Centre and its de facto role as sponsor of the project.

Mandate

The Panel was asked to assess the continued participation and additional financial support by the Province in unlocking the value proposition of the MaRS Phase 2 real estate complex. In making the assessment, the Panel was asked to take into account the underlying public policy objective of the MaRS mission which is the development of a world-class innovation and convergence hub in Toronto dedicated to improving Canada’s social and economic prosperity from innovation and collaborative initiatives in life sciences.

Specifically, the Panel was asked to consider and recommend:

  1. whether the 99-year leasehold interest in the MaRS Phase 2 lands held by ARE should be acquired and, if so, whether MaRS Phase 2’s land and building should (i) be immediately sold to a third party in the private sector, (ii) purchased by the Province or a broader public sector entity or (iii) continue to be owned by MaRS;
  2. if applicable, the funding mechanism for the acquisition of the leasehold interest and the additional real estate and related costs to secure substantial lease-up of MaRS Phase 2; and
  3. any safeguards and related initiatives that should be taken by the Ministers in connection with additional financial support from the Province for MaRS Phase 2.

Recommendations

The reasons for the Panel’s recommendations are detailed in individual sections below but, in summary, the Panel’s two key recommendations are as follows:

  1. MaRS should acquire the leasehold interest from ARE to unlock the fiscal sustainability of MaRS Phase 2. This will significantly reduce the time and cost to achieve substantial (96%) lease-up of MaRS Phase 2, ensure that MaRS Phase 2 reaches its potential value in the order of $400 million and, in the long term, enhance the economic value of the MaRS Centre. Substantial lease-up with tenants already sourced by MaRS pending the resolution of issues with ARE will ensure that all loans provided for MaRS Phase 2 will be commercially refinanced and repaid with interest to the Province (with 60% of such funds repaid with interest by 2019 and the balance fully repaid with interest by 2035); and
  2. MaRS Phase 2 should not be used to house Ontario Public Service employees (on either a temporary or permanent basis), but with tenants critical to the execution of the MaRS innovation mission in life sciences. This mission is not inconsistent with MaRS Phase 2 being a fiscally sustainable real estate project. The funding mechanism for the acquisition of the leasehold interest and the additional real estate and related costs to achieve substantial lease-up should be made available to MaRS through a repayable, interest-bearing line of credit (the LOC) provided by the Province with appropriate covenants and security against MaRS Phases 1 and 2. Further, the IO Loan should also be transferred to the account of MRI in order to efficiently monitor the Government’s funding to MaRS and the covenants and the real estate security granted by MaRS to the Province. Debt owed for principal and interest payments on the existing IO Loan should be restructured to form part of the LOC. Cash advances from the LOC for MaRS Phase 2 real estate and related costs should be approved by an independent third-party monitor selected by the Government, with final approval for payment by MRI and the Ontario Financing Authority (OFA).

The Panel has also made recommendations related to MaRS’s approach to its mission and operations that will support the successful completion of the MaRS Phase 2 project and the development of MaRS Phase 2 as a leading life sciences hub. These recommendations can be found in Subsection 5.3(B).

The Panel’s Resources

The Panel was given unfettered authority to source information from any party inside or outside government. The Panel accessed the following:

  • Ministry of Economic Development, Employment and Infrastructure (MEDEI) - Realty Division – responsible for policy, planning and oversight with respect to the Government’s real estate portfolio and accommodations
  • MEDEI and Ministry of Research and Innovation (MRI) - Research, Commercialization and Entrepreneurship Division – responsible for the Government’s innovation agenda and entrepreneurship support programs.
  • Infrastructure Ontario (IO) - Transaction Structuring, Risk and Commercial Projects Group – responsible for structuring IO transactions to optimize market participation and value.
  • MaRS Board and Executive Team

A complete list of Panel resources can be found in Appendix B.

Panel’s Work and Recommendations

5.1 Recommendation 1 – Acquisition of ARE Leasehold Interest

The Panel was asked to consider and recommend whether the 99-year leasehold interest in the MaRS Phase 2 lands should be acquired and, if so, whether MaRS Phase 2’s land and building should (i) be immediately sold to a third party in the private sector, (ii) purchased by the Province or a broader public sector entity or (iii) continue to be owned by MaRS.

A. Acquisition of ARE Leasehold Interest

The Panel was provided with background and documents related to the leasehold interest acquired by ARE in MaRS Phase 2. The Panel was also briefed on the origins of ARE’s involvement with MaRS.

ARE was competitively selected in June 2007 from an international competition to select a development (equity) partner that would be responsible for financing, constructing and tenanting MaRS Phase 2. ARE is well-known as a leader in developing life sciences realty projects in San Diego, Boston and other American clusters, and agreed to develop MaRS Phase 2 in exchange for a 99-year ground lease arrangement whereby MaRS would in time receive annual ground rent payments and a modest share of annual revenues. ARE began construction in 2007 with two key tenants committed to MaRS Phase 2 – the Ontario Institute for Cancer Research (OICR) and Public Health Ontario (PHO) – and confident that other life sciences companies would also commit to be tenants in the project at net rental rates of at least $30 per square foot.

The 2008 global credit crisis and subsequent stock market meltdown had a significant impact on both the real estate market in general and the life sciences sector in particular. Companies and sectors that would have provided ideal tenants to MaRS Phase 2 were no longer growing. Moreover, the market for laboratory space softened due to a shift by large life sciences companies away from large, centralized research facilities, particularly in urban areas. ARE stopped construction of MaRS Phase 2 in early 2009, which by then had reached ground level.

MaRS efforts from 2009 to 2011 to force ARE to restart construction met with little success. In addition, the incomplete structure was at risk of deteriorating with ongoing delays. MaRS engaged the Province, over a two-year period, in discussions to restart the project. Construction financing was provided through the IO Loan. Leveraging MaRS ownership of the land and investments made by ARE in the building’s foundation infrastructure, MaRS stepped into ARE’s position as the developer. ARE’s construction and related costs remained in the project as equity and ARE retained the right to approve net rental rates for MaRS Phase 2.

It is clear to the Panel that the Government’s decision to move forward with the construction of MaRS Phase 2 was made with an understanding of challenging macroeconomic conditions, and that construction financing was not commercially attainable by MaRS Discovery District, a charity without a credit-worthy balance sheet. IO approved a construction loan (the IO Loan), facilitated by the former Ministry of Energy and Infrastructure through a regulatory change to the Ontario Infrastructure Projects Corporation Act, which allowed construction to move forward. The Ministry of Research and Innovation was engaged through a request to Treasury Board/Management Board of Cabinet (TB/MBC) for permission to provide the DSG for principal and interest payments under the IO Loan if MaRS was unable to do so. The Ministry of Health and Long-Term Care was a signatory to the MRI TB/MBC submission as it related to lease rates for the Central Public Health Laboratory (CPHL), which was to be housed in MaRS Phase 2. The Government publicly announced its financial support for resuming construction in July 2011 and, in effect, becoming the de facto financial sponsor of MaRS Phase 2.

It is reasonable to question the decision taken by the Government to allow MaRS to resume construction with ARE retaining the right to approve net rental rates for MaRS Phase 2. The Panel, however, found three compelling reasons for resumption of construction:

  1. the Government’s decision to relocate the CPHL, now part of the Public Health Ontario (PHO) agency, had been identified as a priority dating back to the work of the SARS Commission. The Commission reported that it was “essential that the provincial laboratory be revitalized with the necessary physical and human resources.” Relocation of the laboratory within proximity of major research hospitals provides an opportunity to improve responsiveness and increase collaboration amongst health care system agencies, both benefits that were highlighted to TB/MBC as part of the original approval for the CPHL’s relocation following the SARS Report;
  2. the pause in construction had resulted in prolonged exposure of the building’s foundation infrastructure to the elements. The Panel heard that the building’s foundation infrastructure would have required significant redevelopment if it had been left exposed through another winter. By recommencing construction, the Government protected the significant investment in place and averted the need for a repeated investment in the building’s foundation; and
  3. net rental rates for similar facilities in New York, Boston and other American cities were at least $45 per square foot, which were used as a benchmark for MaRS Phase 2; this strengthened ARE’s resolve to retain the approval right over lease rates that did not align with its targeted financial returns on the equity it was required to retain in the project to facilitate the IO Loan.

The Panel has concluded that the veto right over net rental rates held by ARE is the major impediment to the lease-up of MaRS Phase 2. The Panel recommends that the buyout of ARE’s leasehold interest in the project is essential to arriving at a fiscally responsible solution to MaRS Phase 2’s vacancy challenge.

A buyout price of $65 million has been negotiated with ARE. The agreed upon price followed lengthy negotiations and reflects a discount from the $93.3 million which ARE recorded in its 2013 US federal tax filing as its project costs when construction was halted by ARE in 2009. The Panel is of the view that the negotiated amount is in line with the appraised values provided by independent third party appraisers when the discount rates used in their analyses to determine final appraised values are adjusted for the shorter time to achieve substantial lease-up and for the investment grade quality of and length of leases with the prospective institutional tenants already sourced by MaRS.

The Panel, therefore, recommends that the buyout of ARE’s leasehold interest for $65 million should be accepted and the transaction completed as soon as possible to clear the way for MaRS to sign tenants to leases for MaRS Phase 2.

B. Ownership of Leasehold Interests

From the outset, our examination of MaRS Phase 2 revealed two challenges: the Government is faced with the need to maintain its vision for an innovation-based economy on the one hand, and recognize fiscal realities on the other. Ontario’s support for MaRS is part of a broader vision for an economy driven by the interactions and collaborations of researchers and entrepreneurs, guided by expert advisors and mentors and enabled by funding from governments, corporate sponsorships, donations and foundation grants.

MaRS plays a unique role in this vision as the coordinator of business acceleration programming across the province, the Regional Innovation Centre (RIC) for Toronto and one of the physical anchors of the Toronto innovation ecosystem. MaRS Phase 2 is viewed as an opportunity to build on the flagship role of MaRS, leveraging its location in the Toronto Discovery District and its expansive floor plates of customizable Grade A laboratory space to attract unique, specialized life sciences tenants which will further the innovation mission of MaRS.

Information provided to the Panel from all parties was consistent as it related to the ideal use of MaRS Phase 2. Laboratory or lab-mixed use is the most appropriate and efficient use of MaRS Phase 2. It was purposely designed and built for laboratory-based use. MaRS Phase 2 was intentionally built out to a “core and shell” standard instead of a typical Toronto base building standard, to ensure walls, floors, lighting, heating, ventilation and other elements could be tailored to the specifications of sophisticated laboratory operations. The building was built to accommodate a range of possible tenant activities, including the Biosafety Level 3 laboratory of Public Health Ontario, with energy systems that drive operating costs above those costs in typical office buildings.

Critical to the Panel’s understanding of the MaRS Phase 2 situation is the progress of growth in Ontario’s innovative life sciences sector. MaRS Phase 2 serves as a logical focal point for these commercial activities. Its location, scale and laboratory profile make it an ideal destination for research and commercialization organizations, as well as the companies they spin off. Specialized areas of commercial strength are emerging in Toronto. In oncology, the Ontario Institute for Cancer Research (OICR), already a MaRS Phase 2 tenant, has become a model for translational research. The Centre for the Commercialization of Regenerative Medicine (CCRM), an initiative of six research institutions in partnership with an industry consortium, is accelerating the commercialization of stem cell technologies through seed projects and is providing support for scaling of stem cell-based products and stem cell manufacturing platforms. Organizations like OICR and CCRM have the potential to unlock the commercial potential of Ontario’s world-class scientific research. Moreover, MaRS Phase 2 is a better value proposition for all interested parties once it is leased up with paying tenants who can reinforce its innovation mission and attract researchers and entrepreneurs who wish to leverage the benefits of colocation in the building.

The Government’s actions to realize success from MaRS Phase 2 must also be viewed in the context of a commitment to fiscal restraint. The Government has made a commitment to eliminate its budget deficit by the 2017-18 fiscal year. Unplanned expenditures with no reasonable chance of recovery are impediments to delivering on this important objective. MaRS Phase 2 does not fall into this category as any support by the Government is projected to be repaid (with interest) with a very high degree of certainty. However, steps must be taken to remove ARE’s veto over net rental rates and to convert current letters of intent into leases for MaRS Phase 2 as quickly as possible. The monthly cost of delay in achieving substantial lease-up is at least $1 million.

The Panel assessed the Government’s fiscal and budgetary commitments within the context of the direction received in the Terms of Reference to ensure that our recommendation is balanced and protects the taxpayer interests. It is the Panel’s opinion that the taxpayer interest is best protected by MaRS ownership of MaRS Phase 2 with financial support from the Province to (i) secure ARE’s leasehold interest and (ii) to fund the remaining real estate and related costs to achieve substantial lease-up of the building. The reasons for the Panel’s ownership recommendation are outlined immediately below under the three options presented to the Panel by MEDEI, being a sale to a third party in the private sector, Government ownership or MaRS ownership.

  1. Sale to a Third Party

    A sale to a private sector third party in its current state of 30% lease-up would not be in the best interests of the taxpayer.

    First, the construction risk of MaRS Phase 2 has been eliminated as the building was completed and commissioned in early 2014. Hence, future real estate and related costs to substantial lease-up can be forecasted with a high degree of certainty.

    Second, the financial business case supports the commercial viability of the project with the Province as the initial sponsor, with major investment-grade institutions in late-stage negotiations with MaRS to enter into long-term leases once the purchase of ARE’s leasehold interest is completed.

    Third, the financial business case confirms that the IO Loan and the additional financial support from the Province recommended below by the Panel will be commercially refinanced and repaid, with interest, to the Province by 2035, with at least 60% commercially refinanced within 5 years (See Section 5.2).

    Fourth, a sale to a private sector third party will result in a lengthy tender process that will delay the lease-up of MaRS Phase 2. Further delays may cause prospective institutional investment-grade tenants currently in active and sensitive negotiations with MaRS to reconsider their tenancies or revise the terms of their potential leases because of the uncertainty over the sale process and a new owner. This uncertainty will likely result in a less-than-attractive market value for MaRS Phase 2.

    Fifth, it is most likely that sale to a third party will lead to several logistical issues related to the sharing of costs, free movement of tenants between MaRS Phases 1 and 2 and the integration of the MaRS Centre as a life sciences innovation hub.

    Sixth, given the specialized nature of the building and the expertise required to operate it, there is no assurance that many private-sector third party bidders for the project will have an active interest in pursuing the acquisition of MaRS Phase 2. This will impact the competitive pricing of MaRS Phase 2 and may result in an unnecessary financial loss to the Province.

    For the above reasons, the Panel is of the opinion that a sale of MaRS Phase 2 in its current state of 30% lease-up represents the highest risk option in protecting the taxpayers’ financial interest in the building. The Panel, however, believes that a sale of the building to a private-sector third party after substantial lease-up remains an attractive alternative, but should only be exercised by the Government if MaRS defaults on its financial obligations to the Province.

  2. Government Ownership

    The ownership of MaRS Phase 2 by the Province or a broader public sector (BPS) entity is also not recommended by the Panel.

    First, MaRS Phase 2, at a projected average net rental rate of $25.35 per square foot, has attracted considerable demand by major investment grade institutions interested in long-term leases which will result in substantial (96%) lease- up of the project within 12 months of completion of the ARE transaction. A lease-up of this scale, the quality of tenants, the average net rate, the ability of prospective tenants to pay for significant fit-out costs and the long terms of the leases will eliminate any risk premium that would, in many situations, be rightly ascribed to MaRS ownership (versus Government ownership) through an increase in the discount rate applied to future cash flows from MaRS Phase 2. There will, however, be a risk premium applicable to MaRS ownership which will be the difference in borrowing rates between the two forms of ownership. The higher cost of financing, as a result of MaRS ownership, is factored into the repayment schedule of all Provincial funding for MaRS Phase 2.

    Second, there is no discernible increased value that Government ownership (because of its large realty portfolio and hence considerable scale to manage vacancies in the project) will bring to the project over a MaRS ownership scenario. The current vacancies in MaRS Phase 2 will be quickly filled (as mentioned above) once the ARE transaction is completed, with major tenancies already sourced by the MaRS team at current market lease rates.

    Third, ownership by the Province will remove any opportunity for MaRS to seek and secure donor contributions for MaRS Phase 2 from naming rights, from charitable contributions, from citizen founders of MaRS and other Canadians, from corporate sponsorships and from other stakeholders (such as the federal government) that have a large stake in the success of MaRS. Ownership by a BPS entity will provide opportunities for fundraising but will result in competing interests for donor contributions. This will likely limit the ability of MaRS to maximize donor contributions for naming rights, from citizen contributions and corporate sponsorships and likely impede its ability to seek grants from other stakeholders, including other levels of government.

    Fourth, ownership by a BPS entity will result in a lengthy process which will start with the Province acquiring ownership of MaRS Phase 2 and then entering into negotiations with the BPS entity’s governing body for the sale or gifting of MaRS Phase 2 to the entity. Such a delay will be costly to the project and may result in significant risks to occupancy by prospective tenants for MaRS Phase 2 which may decide to seek less desirable space in other locations.

    Much of the public’s interest in MaRS Phase 2 relates to the draft proposal, leaked to the public in May 2014, which suggested that Ontario Public Service (OPS) staff would occupy half of MaRS Phase 2. The financial challenges of MaRS Phase 2 prompted the Government to consider whether it would be more appropriate to move OPS staff into an existing, largely vacant building during the rehabilitation and transformation of its downtown Toronto realty portfolio.

    MEDEI has performed extensive analysis on potential options for realty transformation, including the use of MaRS Phase 2 as swing space for staff while renovations are performed on other nearby locations. The analysis confirms that any savings generated by the use of MaRS Phase 2 over other options are offset in the long term by the MaRS Phase 2’s higher operating costs. This option would not, therefore, deliver the long-term savings being sought under the Government’s strategy for realty transformation. MaRS Phase 2 is more suitable to laboratory users rather than office tenants, with most of its floor specifications tailored to sophisticated laboratory operations. Further, moving OPS staff into MaRS Phase 2 would negatively impact the vision for the MaRS Centre as a life sciences innovation hub.

    The Panel has concluded that Government ownership (by the Province or a BPS entity) of MaRS Phase 2, in its current 30-percent lease-up state, is a preferable option to sale to the private sector but not the ideal ownership option for the building.

  3. MaRS Ownership

    MaRS ownership of MaRS Phase 2 affords the Government with three tangible wins and represents the lowest risk option in protecting the taxpayers’ financial interest in the building.

    First, it creates a financially viable MaRS Phase 2 with its sponsorship, with the assurance that the IO Loan and the LOC recommended by the Panel will be commercially refinanced and repaid with interest to the Province, with 60% repaid by 2019.

    Second, MaRS ownership is the best option to fast-track the acquisition of ARE’s Leasehold Interest and secure signed tenancies in the near term, which is the clear path to the fiscal sustainability of MaRS Phase 2.

    Third, the Government would solidify its innovation policy agenda at MaRS by creating a site specific, integrated life sciences ecosystem consisting of MaRS Phases 1 and 2 which, in time, will generate long-term cash returns to advance the Province’s innovation initiatives.

    The Panel, therefore, recommends that ownership of MaRS Phase 2 should remain with MaRS. Moreover, the Panel recommends that the Government take immediate steps to allow MaRS to directly transact with ARE to secure ownership of ARE’s leasehold interest, which will facilitate lease- up of MaRS Phase 2 on an expedited timeline.

5.2 Recommendation 2 – Funding Mechanism

The Panel was asked to consider and recommend the funding mechanism for the acquisition of the Leasehold Interest and the additional real estate and related costs to secure substantial lease-up of MaRS Phase 2.

Financial sponsorship of MaRS Phase 2 brings with it a responsibility to provide the necessary funding for the construction, tenanting and operations of the project until substantial lease-up. The private sector sponsor of the project was ARE, which was selected through a competitive process in which the winning bidder agreed to finance, construct and tenant MaRS Phase 2. After ARE abandoned the project in early 2009, the Province became the de facto financial sponsor in 2011 by providing the IO Loan and DSG.

MaRS Phase 2’s potential is in its ability to meet the unique needs of advanced, research-intensive companies and organizations, particularly those in demand of customized laboratories. This value proposition should not be overlooked because of the vacancy challenge that building has faced over the last sixteen months. Rather, MaRS Phase 2 is best viewed as an opportunity with untapped potential despite a complex sponsorship legacy from ARE to the Province.

  1. Required Funding

    The Government has already made a significant investment to date in MaRS Phase 2 by way of the IO Loan. MEDEI and MaRS have now performed extensive analyses to quantify the funding required to permit MaRS Phase 2 to achieve substantial lease-up, which is required for the fiscal sustainability of the project over the long term. Funding of up to $160 million is the maximum estimate, consisting of the following:

    • the cost of acquiring ARE’s leasehold interest – $65 million;
    • the costs associated with completing the floors for tenants – $55 million; MaRS Phase 2 was built to core-and-shell standards in order to accommodate the specifications of lab- based tenants. Funds are required to bring the floors to base building standards (e.g. with walls, flooring, distributed HVAC systems);
    • Principal and interest payments on the existing loan, currently managed by IO, during the ramp-up of leasing – $25 million; and
    • anticipated operating losses during the ramp-up of leasing – $15 million.

    MaRS lacks the balance sheet capacity to finance the required funding, and commercial financing is not yet a viable option given the lack of lease-up beyond 30% due to ARE’s veto over net rental rates. The Province, as the financial sponsor, has the ability and capacity to respond to the financial requirement and position MaRS Phase 2 (upon substantial lease-up) to generate sustainable net annual cash flows (before debt service payments) starting at $18.3 million and growing over time to $27 million by 2035.

  2. Source of Funding

    MaRS has agreed to contribute its total $5 million reserve of MaRS Discovery District to the required funding of up to $160 million, leaving a remaining gap of $155 million. The most efficient way for the Government to fill this gap is by providing a single line of credit that can be drawn upon to address operating and completion requirements. The LOC will also roll in existing debt owed to MRI for DSG payments to date, and allow MaRS to draw down on funds to make debt service payments on the IO Loan. The Panel recommends that this LOC carry a risk premium of between 1 and 1.5% over the Province’s financing costs. For the purposes of making its recommendation, the Panel has used an absolute rate of 4.0% for MaRS use of the LOC.

    The Panel has reviewed the MaRS lease pipeline, including leases under negotiation and signed letters of intent from prospective tenants. Many of these prospective tenants are institutions with strong balance sheets and access to credit. The Panel has spoken to selected broader public sector prospective tenants which have signed letters of intent so as to confirm the reasons for their interest in securing tenancies in MaRS Phase 2. These prospective tenants have indicated that they are in need of additional space and their interest is part of long term space planning programs to find appropriate accommodation for their particular needs.

    Several of these institutions and research organizations are in desperate need of the kind of high- grade laboratory space offered in MaRS Phase 2, and have few other alternatives in the lease market. The tenant pipeline includes institutional tenants who have signed letters of intent on a minimum of nearly 300,000 square feet, with options for additional floors, as soon as MaRS is in a position to execute leases. These tenants alone will immediately bring the building to nearly 70% lease-up. At this point, the building will not have sufficient remaining space to accommodate all of the companies, research organizations and externally funded incubator initiatives remaining in the pipeline, thereby eliminating the risk to substantial lease-up. There is, therefore, a very high degree of confidence that lease-up targets can be met and an optimal mix of tenants can be realized.

    Completion funding of $55 million represents a worst-case scenario based on leases under negotiation. MaRS anticipates that only $40 million of the LOC will be drawn for completion work, leaving an additional $15 million for contingencies and the opportunity for securing leases with one or two mission-critical life sciences tenants.

    MaRS will seek opportunities to reduce drawdowns from the LOC through donations, corporate sponsorships and funding from other levels of government which would be lost under ownership by the Province. Table 1 below demonstrates the impact on the outstanding balance of the LOC from these prospective funding sources.

    Table 1 – MaRS Phase 2 Line of Credit

    $M Reduction Declining Balance Loan Balance in 20 Years @4%
    LOC allocation   160  
    A. LESS: MaRS contribution 5 155 186
    B. LESS: Additional outside funding – 1st target 10 145 163
    C. LESS: Additional outside funding – 2nd target 10 135 142
    D. LESS: Additional outside funding – 3rd target 10 125 122
    E. LESS: Additional outside funding – 4th target 10 115 102
    F. LESS: Additional outside funding – 5th target 10 105 83
  3. Repayment of Provincial Funding

    At substantial lease-up, MaRS Phase 2 revenues will allow for 120% coverage of its annual IO Loan debt service payments, and the ratio of the IO Loan to the value of the building will fall below 60% in 2017. Experts consulted independently by the Panel, MEDEI, MRI and MaRS agreed that this amount of debt service coverage and loan-to-value ratio would be sufficient to merit commercial refinancing of the IO Loan at 5.5% interest, thereby facilitating a 2019 takeout of the IO Loan and a reduction of at least 60% of Provincial funding to MaRS Phase 2. Table 2 below illustrates the financial metrics for refinancing of the IO Loan.

    Table 2 – MaRS Phase 2 Cash Flow Under Projected Leasing Scenario

      2014 2015 2016 2017 2018
    A. Lease-Up (%) 31 47 96 96 96
    B. Net Operating Income ($M) (9.9) (9.3) 12.6 18.3 18.3
    C. Total Debt Payments ($M) 7.3 14.6 14.6 14.6 15.1
    D. Debt Service Coverage Ratio (B:C) - - 0.9 1.3 1.2
    E. Building Value ($M) 317 363 383 406 411
    F. Initial Loan Principal Remaining ($M) 223 218 212 206 202
    G. Loan-to-Value Ratio (F/E) (%) 70 60 55 51 49
    H. Net Cash Flow ($M) - - - 4.0 3.2

    Real estate market experts consulted by the Panel agreed that a debt service coverage ratio of 1.2 and a loan-to-value ratio of 65% or lower are necessary for commercial refinancing.

    Building value (E) increases based on leasehold improvements and tenancy.

    Assumes commercial refinancing in 2018-19 at 5.5% interest, resulting in modest increase in debt service costs.

    The 20-year time horizon for the LOC is selected based on the additional financial flexibility that MaRS will gain in 2035. At that time, the 30-year lease held by the University Health Network on the Toronto Medical Discovery Tower (TMDT, the east tower of MaRS Phase 2) expires and lease revenues from the building revert back to MaRS. Even under a worst-case scenario where it is unable to secure any donor funding (Line A in Table 1, where the full $155 million LOC is drawn), MaRS will have capacity to re-mortgage the TMDT and refinance the balance of the Phase 2 commercial loan to repay the outstanding balance of the LOC with interest, as illustrated in Table 3 below. If MaRS succeeds in securing outside funding or donor contributions, full repayment may occur sooner.

    Table 3 – Repayment of LOC by 2035

    $M Full Line of Credit $155 Line of Credit with Fundraising Targets $98
    Combined TMDT and Phase 2 Values, 2035 585 585
    Financing available at 65% Loan-to-Value 380 380
    Unamortized Private Debt (5.5%/25 years) (100) (100)
    Unamortized LOC (186) (83)
    Incremental Available Financing 94 197

    Incremental Available Financing refers to the remaining financing the borrower could access under the refinancing proposal; a positive number on this line indicates that refinancing of the unamortized MaRS Phase 2 first mortgage to a commercial lender and outstanding balance of LOC and accrued interest is achievable, plus additional flexibility.

    The Panel is confident that the existing IO Loan can be managed and refinanced in 2019 and that the LOC can be fully repaid with interest at 4.0% no later than 2035. The Panel recommends that security for the LOC should be a second charge on MaRS Phase 2 tower and a lien against the TMDT, along with appropriate warranties, covenants and undertakings from MaRS. Such security and undertakings are necessary to mitigate any risk of capital impairment of the Provincial loans. Further, the Panel recommends the selection of an independent third party to perform due diligence on LOC drawdown requests to ensure that the Government provides funds only as needed and, with respect to completion funding, in accordance with the terms and conditions of signed lease agreements. Moreover, the Panel recommends that the IO Loan be transferred to the account of MRI in order to efficiently monitor the Government’s aggregate funding to MaRS and the covenants and real estate collateral security granted by MaRS to the Province.

5.3 Recommendation 3 – Building a Path to Sustainability

The Panel was asked to recommend any safeguards and related initiatives that should be taken by the Ministers in connection with any additional financial support for MaRS Phase 2 to be provided by the Province.

A. Advice to Government

Government has a critical role to play in setting MaRS on a sustainable path forward. MaRS Phase 2, however, is ultimately the responsibility of MaRS. MaRS must be an active partner in all elements of the stabilization of MaRS Phase 2. It must bring to bear its strategic resources – including its status as a charitable entity to fundraise to ensure that the Government’s funding support for MaRS Phase 2 is minimized and fully repaid with interest. Government, in turn, must hold MaRS accountable for key indicators of progress towards the fiscal sustainability of MaRS Phase 2, including leases executed, rental revenues, completion budgets and expenses, debt service payments, private/donor funds raised and commercial refinancing targets. If MaRS is unable to meet agreed-upon performance measures, comply with covenants in its loan agreements or be unable to commercially refinance MaRS Phase 2, the Government must be prepared to move forward with an alternative strategy of risk mitigation after substantial lease-up, including Provincial ownership or sale of MaRS Phase 2. These oversight measures may result in the consolidation of MaRS financial accounts into the Provincial accounts. The Panel has reviewed the risk of such consolidation and has concluded that consolidation would not adversely impact the Provincial finances.

Continued MaRS ownership of MaRS Phase 2 must come with assurance that appropriate governance and oversight checks and balances are in place with respect to both MaRS and MaRS Phase 2. The Panel heard from all of the key stakeholders involved in MaRS oversight, including the MaRS Board. Existing core funding and program-specific transfer payment agreements provide MEDEI/MRI with access to MaRS performance information. In addition, MRI’s oversight function of MaRS offers significant insights into the status of MaRS. The Panel believes that significant checks and balances are in place, but the Government’s role should be directly acknowledged in the governance structure of MaRS. MRI has long held an observer seat on the MaRS Board. This seat should be maintained, but augmented with the appointment by the Province of an independent voting member of the MaRS Board. This representation will ensure that MaRS remains independently led while providing the Government with full visibility into organizational structure, strategy and decision-making processes.

Public confidence in MaRS’s ability to deliver on its mission also needs to be reaffirmed. The Panel, therefore, recommends that the Government appoint an international panel of experts to advise it on action steps to be taken to enhance the core mission of MaRS and to benchmark MaRS against international standards in order: (i) to advance MaRS business spinoffs and brand reputation in the global life sciences ecosystem; and (ii) to promote greater participation by MaRS in international and domestic innovation partnerships. This panel of experts should also consider additional steps that MaRS should take to simplify its property management operations and align with best practices in research park management. MaRS Phase 1 already shows signs of benefiting from outsourcing and efficiencies, and MaRS should seek out additional opportunities to benefit from similar efficiencies in its operation of MaRS Phase 2. In the long run, these sorts of actions will help MaRS better navigate its demanding dual role of landlord and innovation facilitator. Improvements in this regard will benefit tenants and clients first and foremost, and help cement MaRS as both a trusted partner and a destination for innovators.

B. Advice to MaRS Discovery District

The Panel learned about the range of MaRS responsibilities. MaRS has a regional role in supporting Toronto entrepreneurs; a role in coordinating the Business Acceleration Program (BAP) on behalf of the Province; several special roles in social innovation, early-stage investment and data analysis; and management of the staff and real estate needed for the delivery of these programs. MaRS advisory, mentorship and facilitation services provide significant value to researchers and entrepreneurs in the Toronto area.

It is also clear that real estate is an important element of the MaRS innovation mission. Colocation of researchers, entrepreneurs and ancillary service providers enables positive collaborations amongst players in the innovation ecosystem, while revenues from real estate operations can help MaRS expand innovation programming that furthers Ontario’s innovation agenda. However, due to the conditional nature of most funding received by MaRS and the resulting lack of balance sheet flexibility, the build-out of an advanced real estate asset like MaRS Phase 2 has presented significant challenges.

These challenges provide MaRS with an opportunity to re-examine the manner in which it sets priorities and engages with its partners and stakeholders. First and foremost, MaRS must position itself to be responsive to the needs of its client entrepreneurs. Difficulties on the real estate side of MaRS business have not allowed the organization to maximize its focus on the entrepreneur. One possible means for MaRS to demonstrate its commitment to the entrepreneurial community would be increased representation on the MaRS Board by individuals with experience starting and growing small and medium enterprises. This added perspective may offer a stronger mix of viewpoints that will assist MaRS to focus on its vital mission.

Second, the strengths of the MaRS Board should be leveraged to support a renewed commitment to donor outreach and fundraising. Current challenges have unduly hindered perception of MaRS amongst potential donor groups, yet it is these donors who can ultimately provide the best support to MaRS on its path to fiscal sustainability. The MaRS Board should consider the development of a fundraising strategy that draws on both the success of MaRS programs and the vision of MaRS as a financially sustainable organization. If donations assist in the repayment of the LOC before 2035, then MaRS Phase 2 will transition from a financial constraint to a revenue source ahead of schedule, to the benefit of MaRS and its innovation programs.

Appendix A: Terms of Reference for MaRS Phase 2 Expert Panel

Rationale for Expert Advisors:

The go forward decision for government’s involvement in MaRS Phase 2 requires complex consideration of real estate markets (e.g. tenant prospects), the Government’s fiscal plan, the Government’s accommodation plan, the Government’s innovation strategy and overall value for money.

Currently, many areas of expertise are being brought together within government as well as the consulting sector to help define and support a decision that provides the right balance of provincial interests and is in the long term best interest of Ontario and its citizens, taxpayers and economy.

Accordingly, bringing to bear external strategic expert advice from business leader(s) would provide additional confidence to any forward direction proposed by the lead ministries (i.e. Ministries of Research and Innovation (MRI) and Economic Development, Employment and Infrastructure (MEDEI)).

Proposed Mandate of Expert Advisors:

  1. With due consideration of stated policy and strategic objectives of government (e.g. fiscal constraint, innovation agenda, etc.), review analyses developed by key stakeholders (e.g. MRI, MEDEI, Infrastructure Ontario (IO), Ministry of Finance, etc.), including:
    1. MEDTE, MRI, IO and third party analyses to date (e.g. real estate appraisals, financial advisor analysis, real estate advice, etc.), including consideration following options:
      1. Status Quo;
      2. Partnership model: Government acquire and hold ARE interests and waterfall; shared support for tenant inducement and operating costs;
      3. Government acquisition and sale;
      4. Government acquisition and ongoing ownership in support of government real estate needs;
      5. Government acquisition and ongoing support of innovation agenda; and
      6. Government acquisition and shared use between government and MaRS;
    2. Demand for real estate in the life sciences, research and entrepreneurship sectors; and
    3. MaRS and the MaRS strategy including vision and forecasted tenant prospect list.
  2. As their first priority, provide feedback, guidance, advice and recommendations with respect to the Government’s potential purchase of Alexandria Real Estate’s (ARE) interests in MaRS Phase 2.
  3. Then, provide feedback and guidance regarding the adequacy, accuracy and appropriateness of the other analyses pertaining to MaRS (non-ARE analyses)including, the enterprise-wide priorities for the Government regarding:
    1. As delivered by MEDEI, government’s real estate strategy including the need to have a location to house staff during a major rehabilitation of the Macdonald Block and loan program through IO;
    2. As delivered by MRI, Ontario’s innovation agenda and strategy, MaRS flagship role in that strategy and areas of strategic importance that MaRS Phase 2 real estate can accelerate.
  4. Provide advice and a recommendation to ministers.

Relevant Expertise:

The advisor should bring senior level expertise across the following disciplines: analytical/financial; real estate; health/life sciences; understanding of innovation strategy and complex economic analyses. The advisor should also have a proven track record of having provided valued advice to government.

Process:

  1. Ministries and participants to assemble analyses/ information and provide to the expert advisor(s) for review.
  2. The expert advisor(s) meet with the Ministries and Ministers of MRI and MEDEI to discuss government objectives.
  3. Each ministry and all other relevant participants meet with the expert advisor(s) to present the analyses and information to allow for questions, clarification and discussion. (Timeframe: week one)
  4. The advisor(s) will provide feedback and recommendations on the ARE purchase within two weeks from the date of advisor’s appointment.
  5. The advisor(s) will provide initial feedback with respect to other MaRS related matters including identification of any outstanding analysis. (Timeframe: week four)
  6. The expert advisor(s) develop and present remaining deliverables as set out above. (Timeframe: week four)

Appendix B: Panel Resources

Officials

Ministers of the Crown

Hon. Brad Duguid – Minister of Economic Development, Employment and Infrastructure
Hon. Dr. Reza Moridi – Minister of Training, Colleges and Universities and Minister of Research and Innovation

Ministry of Economic Development, Employment and Infrastructure and Ministry of Research and Innovation

Giles Gherson – Deputy Minister
Bill Mantel – Assistant Deputy Minister, Research, Commercialization and Entrepreneurship
George Cadete – Director, Commercialization
David Meyer – Manager, Capital Programs
Jennifer Flexman – Senior Policy Advisor

Ministry of Economic Development, Employment and Infrastructure

Bruce Singbush – Assistant Deputy Minister, Realty
Maggie Allan – Director, Realty Management

Treasury Board Secretariat

Murray Lindo – Assistant Deputy Minister and Provincial Controller

Ontario Financing Authority

Gadi Mayman – CEO

Infrastructure Ontario

Ehren Cory – Executive Vice President and Group Head, Transaction Structuring, Risk and Commercial Projects
Michael Lindsay – Senior Vice President, Commercial Projects
Craig Lorentz – Vice President, Commercial Projects

Ernst & Young Orenda Corporate Finance Inc. (Under contract to Infrastructure Ontario)

Zachary Pendley – Vice President, Transaction Advisory Services - Real Estate
MaRS Discovery District
Gordon M. Nixon – Chair
Ilse Treurnicht – Chief Executive Officer
Grace Lee Reynolds – Chief Financial Officer
Paul Campbell – Executive Lead, MaRS Real Estate

Documentary Information

ARE Transaction

Letter from ARE to MaRS Denying Consent to Leasing
Appraisal #1 of the MaRS Phase 2 Building (Altus Group)
Appraisal #1 of the MaRS Phase 2 Building (CBRE)
Preliminary Assessment Letter from Ernst & Young Orenda
Draft of Proposed Purchase Agreement for ARE’s Interest

MaRS Discovery District

MaRS Phase 2 Financial Model
MaRS Strategic Plan and Impact Highlights, 2015-17
MaRS Financial Plan, 2015-17
MaRS 2014-15 Operating Plan Summary
MaRS Operating Plan 2014-15, Internal Working Document
MaRS 2014-15 Financial Plan Summary
MaRS Business Unit Operating Plans
MaRS 2013-14 Performance Management Summary
MaRS Discovery District Finance Report, March 2014
MaRS Fundraising Development Strategy
Report of the Fundraising Committee, Board of Directors, Q1 2014-15
MaRS Centre Funding Opportunities
Summary of MaRS Audit Reviews

Toronto Realty Transformation

Letter from CBRE Ltd. to Infrastructure Ontario on Macdonald Block Capital Renewal
Letter from NORR Architects Engineers Planners to Infrastructure Ontario on Queen’s Park Block Renewal Timeline
Ministry of Infrastructure Realty Policy
Management Board of Cabinet Realty Directive