Seattle Mayor Mike McGinn and County Executive Dow Constantine are working behind closed doors to draft a memorandum of understanding (MOU) with San Francisco hedge-fund manager Christopher Hansen, who wants to bring NBA basketball back to Seattle. Under the MOU, the city and county would provide up to $200 million of public financing for a new professional basketball and hockey arena in Seattle's SoDo district.
City sources suggest that the MOU will be released soon. Then will come intense scrutiny by the City Council and others. The vetting had better be intense, because in these negotiations the private side is thick with lawyers, clever deals, and arcane, hidden factors.
A good place for initial skepticism is the repeated claim that this project will be "self-financing." That is absurd on the face of it. There are real choices to make in using $200 million of public financing. That much money is never free. There are up-front costs, opportunity costs, and major mitigation costs that will require more public money to be spent. Pretending otherwise is pure spin.
Another reason for alarm is the absence of a truly independent entity to do the due diligence, such as an Arena Due Diligence Commission. Such an independent entity should not be packed with politicians who stand to benefit politically, nor with private parties who stand to benefit economically (landowners, team owners, bondholders, hedge-funders, investors, construction unions, boosters, nearby real estate developers, etc.).
The Arena Review Panel that early on concluded the idea to be worth exploring sketched a roadmap, detailing 17 rock-solid due diligence items (Section 4) still to be tackled. That panel's work was more "preview" than "review." A new panel should do the heavy lifting that is real due diligence.
But even where the reviewing entity is independent, in these stadia deals there is often a mismatch around the negotiating table, with the public playing defense. The true benefits to backers are greater than most people realize. The opportunity costs and the risks to governments are frequently clouded by fan-fueled boosterism. Vital questions that merit attention can be lost in the din: What is the best use of public financing? Is subsidizing private businesses really the most important thing we can do with these resources right now? Are we maximizing benefit to the public?
The strongest card that the city and county hold is their approval of the deal. The danger is that officials, pressured by the sports interests and their own political interests, will play that card way too early in the game, yielding negotiating strength before full public consideration of every deal detail. That may have already happened, with McGinn and Constantine rooting hard for the idea way before the full costs are known.
Critical in this arena proposal is the fact that Hansen, the backer, is in the hedge fund business, managing the money of high-net-worth individuals with a sharp eye on tax laws, offsetting losses, and hedging. Hedge funds find ways to make money while also paying far less tax on that money. This is a fairly rare skill that clients pay handsomely for. Combining ownership of a professional sports team (whether or not it makes money) with a publicly financed stadium deal offers a field of dreams for hedging opportunities.
On the face of it, investing in an NBA franchise seems risky and an almost sure way to lose money. But not really. These deals provide arena and team investors all kinds of ways actually to make money and capture value on some smart hedges that are unavailable to public financiers and almost invisible to the public eye.
Here are at least six ways for such a "foolish" investment to pay off for investors.
First, the owner group stands to make money on the dirt they already purchased. The MOU will likely specify that the City/County will purchase the land at an appraised price. But who specifies the appraisal? Will it be an arbitrative process (average of multiple appraisals from appraisers chosen by all the parties) or an arbitrary one (the seller's appraiser)? Even so, the purchased land, thanks to the speculative real estate interest it will have generated, is sure to make money, all the more so as years go by.
Second, the owners stand to make money on the acquisition and sale of the teams. Regardless of team performance or operating results, team prices go up, often by a lot, when they are sold over time. That's because team ownership offers powerful tax advantages, and also because there is a shortage of teams to be purchased, thanks to an artificially constrained supply.
Third, the Roster Depreciation Allowance (PowerPoint) allows team owners to claim a significant financial benefit by pass-through depreciation of player salaries (as an asset, just like a herd of cattle), while also claiming their salaries as expenses. It's tricky, obscure, and it requires sophisticated accountants and lawyers who can easily be a few chess moves ahead of the team on the other side of the table. These allowances are worth millions if someone has a lot of other income to offset.
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