Will Sacramento take the gamble? Arena deal poses both risk and reward

The risk is there, and so is the potential reward.

Sacramento is poised to make one of the most expensive wagers in its history Tuesday, when the City Council votes on a binding agreement with the Kings to build a $477 million arena at Downtown Plaza.

The public’s end of the bargain: a $255 million subsidy, financed mainly by a bond issue that amounts to a giant mortgage on the city’s parking operations. The city will be responsible for an estimated $21.9 million in annual debt service, to be supported by lease payments from the Kings and a projected rising tide of parking revenue.

In return, the Kings will convert the dying downtown shopping center into a silvery-white arena that city officials say will revive the urban core and inspire a gusher of development. The Kings’ future in Sacramento, on shaky ground for most of the past decade, will be cemented for the next 35 years.

“We think that, together with the city, we can do really important things for Sacramento,” said Kings President Chris Granger. The team plans to spend $222 million on its share of the project, and is making plans to redevelop much of the rest of Downtown Plaza with a hotel, office tower, shopping and other amenities.

Project critics, who have tried unsuccessfully to put legal roadblocks in front of the $255 million subsidy, say the plan is deeply flawed. Councilman Kevin McCarty, who has consistently opposed the project, said the city is being overly generous at the expense of other pressing civic needs. He also said the predictions of economic ripple effects are overblown, and the city is taking a big financial risk.

City officials counter that the danger is minimal. They say they have crafted a plan that shields the city’s general fund from harm, including the $9 million culled each year in profits from parking operations. Still, they acknowledge the plan isn’t foolproof.

“There’s no such thing as no risk,” said City Manager John Shirey. “We have done everything possible to protect the general fund from any liability. But at the end of the day, if for some reason the Kings aren’t able to perform or the revenues aren’t up to expectation ... you can’t say there’s no risk.”

The plan appears likely to win council approval. Fourteen months ago, the council voted 7-2 to approve a nonbinding arena “term sheet” that was roughly similar to the plan that is on the table now. One big difference now: The definitive agreement, which was finalized May 9, gives the city greater certainty about the revenue it will receive from the arena – one of the major sources of funds to repay the city’s debt.

Instead of relying on a share of the arena’s profits and fees based on ticket sales, the basis of the old agreement, the city will get guaranteed lease payments from the Kings. The rent checks will start at $6.5 million a year and eventually grow to more than $18 million.

“This plan is less risky in the sense that you know what you’ll be receiving from the lease,” said Jeff Michael, a University of the Pacific economist who reviewed the financing plan at The Sacramento Bee’s request.

Municipal bond expert Marilyn Cohen agreed that the guaranteed payments are a plus for the city. “This is a big improvement over the first iteration,” said Cohen, founder of Envision Capital Management Inc. in Los Angeles and a self-described skeptic on big expenditures for sports facilities. “This looks like a well thought-out plan.”

Thin margin for error

The agreement has certain safeguards built in. If the Kings leave town shortly after the arena opens, they would have to pay the city $580 million. By Year 30, the penalty is reduced to $203 million.

Nonetheless, there are uncertainties. Notably, the city is counting on its network of parking garages and meters to expand in the coming years, generating more cash for debt repayment. Growth in parking revenue, along with the Kings’ lease payments, constitute the two main pillars of the city’s plan to pay off the bonds.

The parking system currently generates around $30 million a year in revenue. The city’s financing plan hinges on its projections that parking operations will contribute an additional $7.5 million a year to city coffers by 2020.

Municipal finance consultant Tim Gage, former director of the state Department of Finance, said the city needs to explain the revenue growth in greater detail. “Is this parking revenue realistic?” said Gage, co-founder of Blue Sky Consulting Group in Sacramento.

City officials say it is. The forecasts are based in part on a month-old study by Walker Parking Consultants of Elgin, Ill., and reflect a plan the city is formulating to overhaul its parking operation and grow revenue.

Over the next few years, Sacramento plans to install several hundred more meters around town. In some areas, the hours during which motorists must pay to park will be extended. New technology will allow the city to usher in “dynamic pricing,” which is taking hold in other cities, in which motorists pay higher fees during arena events and other high-traffic times.

Rates will go up, too, although not dramatically. For example, John Dangberg, assistant city manager, said meter rates could increase 25 cents an hour next year, to $1.50. The rate hikes “are inflation-based and they’re market-based,” he said, adding that they would occur regardless of whether the city spent money on an arena.

Even if parking revenue grows as expected, the first few years of the 36-year financing arrangement will be tight. The city expects to tap into a kind of reserve fund, seeded with unused hotel occupancy tax revenue, to help make debt payments for several years.

Despite the cushion from the hotel tax, there’s little margin for error in the early years, said Dennis Howard, a University of Oregon business professor who studies stadium financing.

“It’s very thin,” he said after examining the city’s plan.

Dangberg, however, said there will be enough cash to cover the debt. “We are very confident that we are going to be able to generate the revenues necessary,” he said.

The situation will ease considerably in 2021, when old debt on the city’s garages is paid off. That will free up millions of dollars for servicing the arena bond, and the city will no longer have to dip into the reserve fund.

Borrowing cost unknown

Some elements of the financing plan won’t be worked out for months. The city still doesn’t know exactly how much it will borrow via the bond sale, when it will borrow, or how much the money will cost. Shirey’s staff is asking the council to authorize borrowing as much as $325 million, including dollars to help pay debt service while the arena is still under construction. (The city isn’t allowed to use general fund dollars to make debt payments during construction, Dangberg said). But officials say the actual amount will probably be considerably less.

The timing of the big bond sale is also unclear. It could take place early next year or sometime later, depending in part on which way interest rates are trending. The city expects to pay 6.7 percent interest, although that won’t be known, either, until the bonds are sold.

To subsidize the arena, Sacramento will transfer to the Kings $32 million in publicly owned land around the city and $223 million in cash. The Kings are also getting the city-owned Downtown Plaza parking garages and the right to build six digital billboards on city property.

As for the Kings’ owners, they are contributing $222 million to the arena, in addition to the $36 million they already spent buying Downtown Plaza and going through the development approval process. The Kings also will pay for the final piece of Downtown Plaza, the former Macy’s men’s store, whose price won’t be known until eminent domain proceedings are complete.

The arena plan that goes to the City Council on Tuesday caps more than a decade of failed attempts to craft a blueprint for keeping the Kings in town and building a new facility. This quest took on greater urgency last year when the Kings’ former owners, the Maloofs, agreed to sell the team to investors from Seattle.

The NBA vetoed the Maloofs’ plan, prompting the family to sell the Kings to a group led by Silicon Valley technology executive Vivek Ranadive. But the NBA retained the right to buy and relocate the franchise if a replacement for decaying Sleep Train Arena isn’t open by 2017. The Kings hope to break ground this summer at Downtown Plaza and open the building in 2016, a year ahead of the NBA deadline.

While the arena’s construction appears all but inevitable at this point, the plan still has critics. Two taxpayer groups lost a court fight to place the subsidy question before voters on the June ballot. McCarty, who is expected to cast a “no” vote when the council makes its decision Tuesday, said the arena is too risky and doesn’t generate nearly enough financial return for the city.

McCarty said the city has other, better uses for its money, including basic municipal services, a much-needed renovation of the Community Center Theater and construction of the Powerhouse science center proposed for north of downtown.

“There are a lot of economic development projects you could spend money on, and the arena could possibly be a good one,” McCarty said. “But to put all of these resources in, and looking at what we’re getting in return, it doesn’t pencil out as a fair return on our investment.”

Shirey said the arena subsidy doesn’t mean the city won’t support other projects, including the theater and the science museum, and he defended the plan as an effective use of city resources.

“Obviously, any time you make an investment, there’s an opportunity cost,” the city manager said. “We’re saying the best way we can invest in our city is this arena. We’re going to get the most return; we’re going to get the biggest bang for the buck.”

‘A reasonable investment’

How much of a bang? A report released in January by a political action committee controlled by the Kings and Mayor Kevin Johnson said the new arena will generate $11.5 billion in economic impact over 35 years.

Project opponents, and many academic economists, reject studies like these. They say sports facilities generally divert dollars from other entertainment activities and create little new wealth.

“It’s pretty hard as a serious economist to endorse a sports arena purely for their economic development purposes,” Michael said. “They’re generally oversold.”

But the UOP professor also said building a sports arena and retaining the Kings are legitimate city pursuits. “That’s a civic amenity that a lot of people care about,” Michael said. “That has value.”

Overall, he said, the arena deal represents “a reasonable investment” that is certain to have a positive impact on Sacramento’s downtown. The Kings say they will build 1.5 million square feet of retail space and other amenities immediately north of the new arena. No timetable has been set, but Kings executives say they will move as quickly as possible.

“It’s in our best economic interest to have a complete plaza when we open in October of 2016,” Granger said.

Beyond the confines of Downtown Plaza, the real estate market is starting to percolate in anticipation of the arena’s arrival. Developers plan to convert the adjacent Marshall Hotel, now a low-income single-room occupancy hotel, into a boutique property. The 10-story Fruit Building office tower is getting a $4 million makeover.

A block east of the arena site, the Renaissance Tower, a 28-story skyscraper, has been put up for sale by USAA Real Estate. The broker’s sales brochure makes multiple references to the arena, includes a list of the Kings’ new owners and tells potential buyers about the jump in office-building lease rates after NBA arenas opened in Brooklyn and Charlotte, N.C.

“The new Kings Arena will have a profound impact on downtown Sacramento’s commercial real estate market,” the brochure says.

Michael Ault, head of the Downtown Sacramento Partnership, an alliance of businesses in the central city, said he is getting a steady drumbeat of calls from retailers and brokers, seeking information about available space and lease rates.

The arena “has created this sense of momentum among the development and retail community, which has been sitting on the sidelines for a few years,” Ault said.

Related information:

•  Marcos Breton: Kings arena is a solid investment for Sacramento

•  Kings will spend $90 million in early months of arena construction, document shows

Related stories from Sacramento Bee