Tuesday, May 1, 2012

My take on the Sacramento Kings' Arena Debacle

Yikes, it seems the blog took a month of vacation.  Time to wake it back up.  I wrote this commentary on the Kings' arena for our forecast publication about a week ago.  With the arena deal dying again last Friday, the perspective is still timely, and it's good blog material.

Sacramento Arena Deal Collapses in Spectacular Fashion

It’s been hard to avert our eyes from the train wreck that is the Sacramento Arena deal, especially since the Business Forecasting Center just opened a satellite office in Sacramento and one of our professional colleagues, Chris Thornberg of Beacon Economics, took center stage as a consultant to the owners of the NBA’s Sacramento Kings.  Thornberg questioned the revenue projections underlying the arena financing assumptions, and questioned the City’s financing plan and whether the deal was in the best interest of the City.  The focus on the public benefit from the City’s financing plan was odd for a consultant of the Kings.  Presumably, the Kings would want to persuade the City to increase their Arena subsidy, and it is hard to see how highlighting the City’s financial risk and weak economy helps persuade the City to improve the deal for the Kings.  One plausible explanation for the Sacramento bashing tactic is that the Maloofs are trying to persuade the NBA that Sacramento is an unviable market so the league will approve relocation to another city.  The Maloofs flip-flop and Thornberg’s harsh criticism of Sacramento elected officials led to a heated public war of words, including dueling op-eds in the Sacramento Bee between Thornberg and City Manager John Shirey.
Underlying the drama are objective economic and financial calculations.  Are the revenue and economic projections realistic?  Is it a good business deal for the Sacramento Kings?  Is it a good deal for the City, or a looming financial disaster?  An even more fundamental question is whether a new arena generates enough new economic value to justify a $391 million investment, regardless of who pays for it. 

From the Kings’ financial perspective, the new downtown City-owned arena must be compared to their current team-owned arena in Natomas, and realistic future alternatives including relocation or even renovation of the current arena.  The Kings are reported to be profitable, unlike most of their NBA peers playing in larger, more modern arenas.  The Kings would contribute about $70 million in new arena construction costs, plus agree to a 5% ticket surcharge that would send several million dollars a year back to the City.  Even assuming a conservative $20 million annual revenue boost from a new arena, the Kings could support these direct costs.  However, there are a host of additional provisions that likely make it a poor financial deal for the Kings.  In addition to the direct arena costs, the Kings’ owners would no longer receive revenue from non-basketball events at the current arena like they do currently at the team-owned Power Balance Arena.  The deal also locks them into the Sacramento market for another thirty years in addition to a host of other smaller concerns.  The Kings’ best strategy would seem to be to stay in the existing arena for a while, explore its renovation, while waiting to see if Sacramento or another city makes a more favorable offer as the economy and municipal finances improve.
What about the City?  Is the proposed arena deal a financial disaster?  It is definitely a fiscal risk, but whether it is a potential disaster depends on your perspective and the civic value you place on an arena.  Compared to other publically-financed arena deals over the past twenty years, the deal is more protective for taxpayers than many.  While the City pays about 60% of direct development costs, the City’s real contribution is significantly less than 50% when revenues from a 5% ticket surcharge, profit sharing with arena operator AEG, and other terms are included.  Although the economic development benefits of an arena are badly overstated, it will bring some new net dollars to the region and the Arena is clearly a civic amenity of some value.  Despite these positive aspects to the deal, it is still a significant public subsidy and considerable risk for a City that is in the midst of a serious budget crisis.  The positive cash flow from parking facilities is an asset the City of Sacramento has to get it through the crisis that many similar cities lack.  Financing the arena could involve a 50-year lease on parking facilities to fund an arena whose economic life will likely be less than fifty years.  Some of those parking assets are in key locations, and committing them to a parking lease for fifty years could entail significant opportunity costs.  The same can be said for selling city-owned land such as the 100 acres in Natomas adjacent to the current arena.  The City’s finance plan clearly adds new burdens to the municipal budget, even though some arena costs will be “backfilled” with ticket surcharges and other tax revenue.  Some public expenditure for an arena can be justified - all civic assets have costs - but the Mayor and City Council have clearly pushed the City's side of the deal to its boundary, especially considering the minimal contributions from the surrounding cities and the clear unwillingness of taxpayers to support a dedicated arena tax in the past.
The Mayor has worked hard to retain the Kings and has come up with the best proposal he could, one that pushes the City to its financial limit, and yet still doesn’t appear to be a better deal for the Kings than the alternatives, including the status quo.  The inevitable conclusion is that, like most sports arenas in medium to small markets, a $391 million arena in downtown Sacramento simply doesn’t generate enough new value to equal its cost.  No amount of financial engineering is likely to change that.  The new arena is simply infeasible without an owner and/or a City that is both wealthy and passionate enough about pro basketball in Sacramento to overlook significant financial risks.  Judging from recent events, both sides seem to have an abundance of passion, but a shortage of wealth.

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