Like I've been saying, just watch as Hansen and Ballmer start hinting that there's a contingency deal to buy a team, with the contingency being based on arena progress. Within 48 hours of such an announcement, the rubber-stamping will commence.

You'll see.

From the deals I've seen over the last 10 years, though, Seattle's doing way better than average. I don't know if that is, or should be, good enough, considering how lousy some of the deals have been. Sure is better than the deal KC got, though.

Neil would you consider the value of the land in 30+ years in determining the I-91 compliance, even at a reduced appreciation or flat valuation?

I watched a majority of the hearing yesterday and wanted to understand a lot of the assumptions the city was making on their numbers (Avg Attendance & Ticket Prices). Do you think that would be easy to obtain from the city? most data presented was very high level.

I know there is an indirect economic impact to the city in hotels and money coming in from out of town. I wish there was a way to estimate it. Even if it wasn't used for I-91 compliance since you could never get Van Dyk to agree to including it.

Sure, land value counts. I'd want a more conservative appreciation rate than 5%, and not getting access to the land for 30 years will reduce its value, but it's worth something.

I have some of the ticket price/attendance numbers: Looks like they're assuming 530,872 per year for NBA, 485,684 per year for NHL, 164,156 for concerts. Average sports ticket price would be $55, with 1.7% ticket price growth per year. Concert ticket price would be $60, growing 2% per year. That help?

And I'd really like to see a serious study of indirect economic impact as well. I noted that in Hansen's Powerpoint, he said that there's no substitution effect from anyone who comes from outside the city - which is blatantly wrong, unless people from the suburbs are currently barred by statute from ever going inside Seattle city limits unless it's for a basketball game.

JB, once again, I'd like to contrast this with a recent deal that failed: Sacramento.

Think Big claimed a $391M arena would generate $7B in new activity over 30 years, a claim that the vast majority of people found absurd. Everyone but the Council and Mayor, that is. I think that would have given them an annual ROI of around 60%. The Sacramento Bee never questioned that figure.

The point being, at 5%, at least you guys are getting numbers that are debatable. 5% seems high to me, but then we've seen what property values do in some cities. Even now, look at Orange County; I bet they've averaged way over 5% over the last 20 years -- and that's with declining values over the last 7 years.

If they say 5%, I'd say that's too high -- but it's not preposterous. It could come close.

I would call it a not-so-sophisticated attempt to circumvent I-91...

No big surprise that someone has challenged this deal under I-91, though. I've been expecting it and I assume that both the council and Hansen have too.

Agree w Mike M, it's still a pretty good deal for Seattle as it stands (if it stands as is...), but they passed this legislation for a reason (albeit, "shockingly", just a little too late to cover the Mariners & Seahawks new homes... I wonder if anyone considered the protectionist aspect of the legislation when it was being written?) and it either needs to be enforced or eliminated, as decided by the people of Seattle.

I would hope an exemption would not happen. There is no value in imposing regulation on "the little guy" and exempting the big fish. It makes municipalities look like fools (which, come to think of it, they often are...)

Thanks for the figures Neil. That helps. Seems like the attendance numbers are super conservative which would figure some of the lowest in both leagues, at least over the last 4 or 5 years). Probably the right approach to evaluate risk in a relatively worst case scenario. Although in a worst case scenario, the city should worry about bankruptcy of ArenaCo.

I live in Seattle and have traveled to Vancouver for an NHL game maybe 10 times over the last 6 years and have made trips to NYC, BOS, MINN, DC and Montreal to see hockey games in that same time-frame. I also have several friends that have season tickets to the Canucks and live in Seattle. It's also interesting to see all the Canadians come down when the BlueJays play the Mariners. I know there is a benefit but objectively laying it out there seems so challenging.

I am interested in seeing this work without getting creative. This is still one of the best Arena deals that any city will see but it doesn't mean it should be automatically approved.

This could set a very interesting precedent for other cities to follow that should make leagues and team owners nervous.

I am not the most financially savy person but hope someone can answer this. If the Council staff thinks so little of the future value of the land and if the council does not want to include the value of the land in its final analysis, then why don't they just promise to give the land back to Hansen for free after 30 years? On the ledger they would not be losing anything as they already do not think enough of it to count the value. It wouldn't change their equation one bit.

www.databasebasketball.com/teams/teamatt.htm?tm=sea&lg=n

One could argue that if you're being conservative on your attendance figures, going by the last year the Sonics were in town would be appropriate. If you want to estimate with 650,000 I guess that's fine too.

Eric, are you suggesting that the city find a way to keep the arena and transfer the land ownership and tax obligations to ArenaCo after 30 years ? Or are you saying the city should give both land and arena back to ArenaCo at the end of the lease-purchase?

I don't expect Hansen would want the land back - he'd just have to pay property taxes on it, and it'd have a 30-year-old arena sitting in the middle of it.

My sense is the land transfer was mostly concocted for exactly this reason: It gives Hansen something else to stick on his side of the ledger, and it doesn't really cost him anything, since all he wants is a place to stick an arena for the next 30 years, and he gets that with the current deal.

I found it interesting when there was discussion of using the negotiated rent payments for the arena at the end of the 30 year bonds as a way to evaluate the future value of the arena. I guess you could do that, but at any realistic inflation rate $4M/yr for an arena 30 years from now is quite a bargain. Seems that would be far below fair market value.

@ChefJoe

What is your definition of a "realistic inflation rate"? Several European nations (Switzerland, Greece, Portugal) have recently tipped into deflationary cycles. Swiss CPI (Consumer Price Index) is -1.0%+ this year. That means there isn't any inflation, prices are going down. In Switzerland's case it's partly due to the strength of their currency but there are also broad macro trends across Europe (declining wages, declining employment rates, overvalued financial sector equities, massive debt deleveraging at both the household and sovereign level) that are pushing their economies towards deflation or at least tempering inflation. Those same forces are at work in the U.S. (and Japan, where this already played out over the last two decades and resulted in massive real asset price depreciation) and will probably be a factor through 2020 at least.

In fact, if it wasn't for the Federal Reserve's two Quantitative Easing initiatives plus their Operation Twist measures, I am almost positive much of the U.S. economy would already be in a deflationary cycle. The question you have to ask yourself is how long the Federal Reserve can keep measures like that up?

So just keep in mind that if the two "lost decades" in Japan's economic history and the deflationary pressures in Europe are any lesson, even assuming a 0.5% inflationary rate for that arena land over the next 30 years maybe a wild-eyed unrealistically optimistic estimate.

Of course, if we do enter a sever deflationary cycle, pension liabilities alone will bankrupt thousands of American municipalities so the value of a few acres in downtown Seattle may be a complete afterthought at that point.

@ChrisInLA

It seems to me that we're a nation with a lot of debts. If inflation stays low then that hurts the ability to pay those debts off vs what high inflation rates do. Some theories are proffered that the country should actually try to have a several year burst of high inflation to help pay those off.

When dealing with a 30-50 year contract, however, I'd try to keep things macro and go with a long-term historic norm like the 3.2% we've had for a 100 year average. At that rate the buying power from $4M is down to 39% by year 30.

Yes, the decade following the 1929 great depression had several years with negative inflation rates but the decade after that also had massive inflation (and wartime spending) so I would go with long term averages.

But I really don't see the US having a lost decade or two or three. Too much ruthless capitalism, businesses and banks are examined and allowed to fail rather than keep digging holes, and we're far more consumer-spending/low savings than the Japan of the lost decades. The more open and quicker we mark things to market the sooner the US can recover from the "irrational exuberance" of easy credit and living off housing price increases.

@Niel,
FYI, I think that budget worksheet you linked to must have been a fairly early draft. It's nice that it's all broken down more than most of the budget documents I've seen, but it's obviously not fitting the current MOU because the base rent stays at 2M for 37 years rather than the 4M bump at yr 30 that's in the current MOU.

Neil deMause I have made some attempts at taking the way back machine and calculate the substitution rate as how it applies to the Sonics leaving town and frankly to get an accurate appraisal of the substitution factor is probably impossible.

The reason I believe this is impossible is because the Sonics played in Seattle during the 2007-2008 season and played in OK city for the 2008-2009 season.

Why this is particularly difficult is that was pretty much the year that the housing bubble burst and tax revenues were down everywhere. In addition, I believe attendance the last year in Seattle was probably less than normal because of the lack of enthusiasm because of the announcement that the team was leaving was public.

It could have provided a great test study for an economist if there weren't so many other unusual factors that dramatically skews the data.

@acbytesla it's funny because you hit on something that drove me out of economics in college. The theories always seemed to assume all things being equal "this was the impact" but how in the world can all things be equal. As a college student I had a hard time buying into a drop in interest rate had downstream impacts to job growth. #I can accept it now but at the time I changed my major to accounting because I didn't feel like economists lived in the real world :-##

I've always thought scientific surveys would be the best way to assess the impact. I am not a survey expert but maybe interviewing people going to other sports or entertainment events to see if they reveal behavior change or shifts in spending.

I imagine most sports teams can pull zip codes of ticket purchases to determine how many people come in from outside the city limits or county or state. I also assume that the leagues pour over this data as well. That doesn't cover the substitution impact but it can show the external impact. But the devils advocate says that visitors might have spent that money at Seattle Center instead of the Mariners game.

The biggest impact on ticket sales has to winning..#but don't tell the Maple Leaf Fans that#. So if there is a team losing #Let's call them the Mariners# and attendence is down. Where are consumers spending that money now?

acbytesla: What about looking at how economic activity/tax receipts changed in Seattle the year the Sonics left, and comparing it to how those factors changed in other U.S. cities the same year? That should help control for the effects of the recession.

To all here,

It is just really amazing to watch the whole debate here. So little substantive financial anlysis going on it is truly amusing.

I-91 requires that the return to the project exceed the 30 year T-bill rate - which is currently at 2.66%.

Forget the value of the real estate. Forget any incremental taxes. The guranteed rent and tax payments here are $14 million per year. That is a 7% return on a $200 million investment. This is so far in excess of the I-91 requirement its comical that its being brought up by the "skeptics" (just haters# and for the political theater going on here.

You should all read hansens reponse today. The city actually made an error in trying to come up with a "fair value" approach alternative. They added the "risk premium" to the debt service cost instead of the City's cost of capital. Hillarious! Neil, even you have to get a good laugh out of this one.

For those of you who don't understand the difference, debt service includes principal repayment and thus is a premium #and also arbitrary - the amortization schedule of principal repayment varies considerably from loan to loan#

The city's cost of capital is currently 4.2% and a 1% risk premium would make it 5.2%. The city simply added 1% to the debt service and concluded that the return hurdle was 8%.

And substitution. Please. Anyone who thinks that the incremental taxes generated will not be greater than the modest substitution effect is just not being intellectually honest or has not attempted to undestand the tax streams that flow to the city.

Given that there is no substitution effect on property tax, B&O tax, and leasehold excise tax, and the substitution of admissions tax is really limited as the admissions tax rate does not apply to most forms of spending and is 6x as high as the city's portion of sales tax and in excess of 50% of the people are coming from outside of Seattle - the substitution here is minimal. Again its not the substitution of "entertainment dollars", its the substitution of taxes that matter.

And as far as incremental taxes - lets see you have: All the people coming from outside the city and spending money outside the arena on ber and food, the hotel taxes, the rental car taxes the taxes from the taxes on the spending from the new jobs created #player payroll alone!#.

Dave,
when I-91 is quoted they often leave out that the return was to be after financing costs (bond interest) was to be taken away. As the city/county are using bond interest rates of 5.5% for their estimates I-91 requires the return to be 5.5%+2.7% US treasury rate.

It's understandable, that part of the "fair value" statement seems to be left out of all the Mayor and ArenaCo slides about I-91.

www2.seattle.gov/ethics/vg/20061107/sportsct.htm

Sec. 2. Fair value is defined herein as no less than the rate of return on a U.S. Treasury Bond of thirty years duration at the time of inception of any such provision of goods or services, real property or lease; and further, such return shall be computed as the net cash on cash return, after interest and any financing costs, on the depreciated value of the cash investment of the City of Seattle in such goods, services, real property or facility, and shall exclude all intangible, indirect, non-cash items such as goodwill, cultural or general economic benefit to the City, and shall also exclude unsecured future cash revenues.

ChefJoe

First, since the city is not providing cash I91 actually doesn't technically apply. But if we ignore that, I agree that it requires a rate of return of financing plus treasury. But even still, the number you come up with is 8.2% You are telling me that the value of the land plus the incremental taxes wouldn't add up to the additional 1.2% required? That's 2.4 million a year.

I91 should not sink this. If it does, it will be because politicians wanted cover for what would in essence be a policy (or political) decision.

I am interested in the question Andrew has posed above. Hopefully Neil or Dave will have an answer. I am also curious about the 5.5 percent borrowing cost of the city that chefjoe has brought up. How can we verify this number. Hansen mentions in his post that this number should be around 4 percent. If he is right then 4 + 2.7 is 6.7 percent, which is under the 7 percent that will be covered by Hansen's annual payments. And we are not even counting the value of land or any incremental taxes. If it is indeed 5.5 percent then he has a problem if we leave out value of land and taxes. Any way to verify the 5.5 percent number.

Chefjoe, I am also curious if you are associated with or run nosonicsarena.com. Whoever is writing those posts makes some good points but I am wondering why they are staying anonymous. Everyone else involved in this debate publicly is putting their name out there.

Chefjoe,

You honestly don't have any idea what in the heck you are talking about. I have a graduate degree in finance and practice it for a living. I am very well versed in calculating project returns, NPV, and IRR.

Let me break this down in a way you can all understand.

The very first principal of modern finance is that you calculate the return on an asset INDEPENDANT of how it is financed. This is critical becuase for any project there are typically endless financing options that will all distort the underlying returns - i.e. if you put 50% down on a house and use a 15 year fixed rate mortgage, or put 10% down and take out a 10 year interest only loan.

Thus to do this correctly we need to assume the City makes the entire investment in Cash and then calculate the return stream from rent and taxes.

The correct way to do this is to layout the investment amounts by year (positive and negative# and then use excell to calculate the internal rate of return #IRR#. The simpler option/shortcut in this case is just to divide the annual payment amount - $14 million - by the total investment - $200 million - which gives you a return of 7%.

You then compare that return to your return hurdle - which can be calculated from a finance perspective by a using WAAC #or weighted average cost of capital#. This caclulation can get complicated but essentially requires that a premium to the risk free rate of return is earned to compensate for the risk of the project - the more risky the project, the higher the return requirement, the less risky the less of a risk premium required.

However, in this case we have a legal requirement that the return hurdle is "Fair value is defined herein as no less than the rate of return on a U.S. Treasury Bond of thirty years duration at the time of inception of any such provision of goods or services, real property or lease; and further, such return shall be computed as the net cash on cash return, after interest and any financing costs"

Please people, note that in this assumption there is no interest of financing costs as we are assuming the city is investing CASH#

Thus the return hurdle is just 2#6% - the current rate on 30 year treasuries - plus hard costs the city had to do the deal#

The City has proposed that this rate is to low and it deserves a higher rate of return - which is a reasonable point as the 30 year treasury rate is below its own cost of debt #4#2%)# It is also reasonable to assume that the city should get a premium to its cost of borrowing for taking on some risk here# Given the security protections in the MOU - I'd agree that about 1#0% premium is reasonable# But again, this is not part of the law as it is written#

But ChefJoe you ABSOLUTELY DO NOT ADD the treasury rate to the city's borrowing cost# You are just flat out wrong here# They cost of the City's debt already reflects the risk free rate# Any bond investor considering the City's debt and demand a premium to "risk free" short term US debt - thats why it is at 4#2% now instead of at a risk free rate that is close to zero or a 30 year treasury rate of 2#6%! You are mixing this up Chefjoe#

Thus we would get to a fair value return hurdle for the city of 4#2 + 1#0 = 5.2%

And lastly people. PLEASE NOTE THIS FACT FOR THE DISCUSSION. If you would like to assume the city is using $200 million in bonds, there net investment is zero and if they even earn $1 more than their hard expenses, there return is infinate. This is why you have to look at this as a cash investment.

The comical part of this is that people keep assuming the upfront investment is $200 million, and then the city has to earn a return after deducting the interest on the $200 million. People - that is double counting. That would make this a $400 million investment, funded with $200 million up front and then $200 million in debt. Hopefully you all can realize that.

I would also just like to clarify one point. If you were to truly calculate the "fair" required rate of return, you would actually not add a premium to the City's cost of borrowing.

You would add it to the risk free rate to determine the approriate hurdle rate for the project. The caveat is that it would be higher than 1%. The historic Stock Market risk premium is 1.5-2.5% oveer treasuries, so that is probably as decent as any - which would still get you back to a required return of around 4.5-5.0%.

And for any of you who doubt this is an appropriate level of risk, I would simply ask of how many investments do you know that offer you a guranteed payment stream of over 5% for 30 years with the level of gurantees this transaction has.

Wow, I don't know where to begin. I don't want to take over Niel's discussion.

1st) I have been visiting that nosonicsarena site as it has a lot of helpful sources but really I have no idea how one would even code a website like that. I guess I'm flattered.

2nd) I tend to view this as two transactions, one where the city issues bonds to be paid from the general fund. The second where it gets paid back from loaning that bond money to Hansen and counting the taxes, etc as return. It seems like applying complex (even if accurate) financial terms and models to what was a really simple initiative may be going to far. I-91 defined fair value as return at least TBill rate after financing costs. I presume they're issuing bonds that are good for $200M now and the holders are given a guaranteed 5.5% return annually on the bonds (city/county's estimate on the rate). That's the cost of capital/financing costs. To earn a Treasury return above that you'd need additional interest (sometimes called risk premium)? You don't think I-91 is saying that the Treasury rate is the rate to use for the risk premium?

campus.murraystate.edu/academic/faculty/lguin/FIN330/HurdleRate.htm



I understand there's a lot of ways to model and calculaste returns on investments but I-91 seemed to say "if we give you $200M (even if we finance it), cover our costs to borrow and give us a TBill yield above it.



It's very confusing. The mayor said I-91 compliance was the model for this deal so shouldn't his staff have presented figures supporting that, not "it can't really apply" ?

ChefJoe,

Let me try to make a point crystal clear so that everyone here can understand this again.

1. You either make the investment with cash and there is no financing costs - the money just comes straight from the general fund

Or

2. You make the investment with bonds/debt, on which there is debt service and financing costs and the equity investment by the city is ZERO NOT $200 million - which is the reason they came up with the "this should not apply. In actuality there would be some modest costs that would need to be repaid in the form of fees and such not covered in debt service - but that would probably be less than $1 million.

By definition it can't be both and you and others keep twisting these two together and effectively double counting the investment amount in trying to calculate the return hurdle. You can't have a $200 million investment by the city and debt service on $200 million in borrowed money. Again that is a $400 million investment.

From a finance standpoint, again the correct way to value the project is always WITHOUT the financing costs to determine the return - which in this case is 7% Chefjoe.

You then factor in the financing cost in developing your return hurdle to see if the projects meets it.

And no Chefjoe, you would not add the 30 year treasry rate to the City's borrowing rate. From an I-91 perspective, and I will grant you that it is poorly written, it requires a treasury rate of return plus financing costs. In this case we have no financing costs because it is a cash investment. So the return hurdle is treasuries plus any other expenses incurred.

Again, the second you start to argue about adding back in the City's debt service costs as an expense you are now assuming the project is funded with debt, and the city's investment is now zero again.

If we were to disregard I-91 and try to come up with a better return hurdle, we would ABSOLUTELY NOT add the 30 year treasury rate to the city's cost of funds. Again, this reisk free rate is alreadey embedded in the City's cost of funds and it is the reasons Seattle's bonds trade at a premium yield to treasuries.

Chefjoe, this would equate to a 7.5% plus hurdle rate - or 5% above the risk free rate. The historical stock market premium is 2% above the risk free rate.

If you used this approach, virtually no projects in the US would be funded by the private sector as they would not meet any corporate hurdle rate.

David, I just don't know why you keep trying to model it as a single investment.

It's two investments, with an intermediate party handling the "cash" but obligated to pay. The city/county issues bonds paid that they intend to pay for with some fraction of rent and some fraction of taxes the arena generates that are removed from the general fund. The city/county loan that bond money to the arena to buy an arena and then agrees to be paid back from those sources.

Bondholders-City transaction, City-Arena transaction

The models for a single investment don't work out so well when you apply them to two transactions.

If you loan $200 and that gets paid back over 30 years at 5.5% interest that would equate to somewhere around $408 in borrowing costs. If you wanted to earn more than the borrowing costs it would require more payments, right ?

So ArenaCo gets $200 million in bonds upfront and only pays the city/county $406 million . How is that a profit over borrowing costs ?

www.seattle.gov/arena/docs/120330-ArenaModelOutput.pdf

Oops, wrong term "borrowing costs".

If you loan $200 and that gets paid back over 30 years at 5.5% interest that would equate to somewhere around $408 in required payments. If you wanted to earn more than the borrowing costs it would require more payments, right ?

So ArenaCo gets $200 million in bonds upfront and only pays the city/county $406 million . How is that a profit over borrowing costs ?

www.seattle.gov/arena/docs/120330-ArenaModelOutput.pdf

I am not sure why you are having such a hard time wrapping your head around this Chefjoe.

If the City borrows the entire amount, it HAS NO INVESTMENT IN THE PROJECT. It has by DEFINITION financed its entire contribution.

If you would like to use this approach, then if the city earns $1, so $406,000,001, ITS RETURN IS INFINATE ChefJoe. This is an fact and why you are having such a hard time understanding it is not clear.

Let me give you a real world example to make a comparison. If you buy a apartment building $10 million that yields $700K in rent, your yield is 7%.

If you pay cash for the property, the yield on your investment is 7%.

If you put down 10%, or $1 million, and borrow the remaining $9 million at 5%, your return would be calculated as follows:

Rent of $700K less debt service of $450K = profit of $250K.

You then divide the $250K by the $1 million investment, and the "cash on cash" return becomes 25%!

This where you are going way, way, way off in your analysis Chefjoe. You are effectively trying to divide the $250K return by the purchase price of $10 million, instead of $1 million - which in this case would result in you miscaclulating the yield at 2.5% instead of 25%.

Thus by extending this logic to an investment that is financed 100% with debt, you have by definition ZERO "cash"/equity invested in the project and any $1 of return you generate above the debt service is an infinante return.

You need to reconcile these facts in your head Chefjoe if you want to get a grip on the returns here.

So you're going to analyze using the "cash on cash" definition, which isn't a great evaluation for a 100% financed investment. I see what you're saying now.

I guess that's why the council is trying to evaluate it based on the "fair return" term that appeared on the simple ballot.

ChefJoe,

I get what you are saying, except that "fair return" is defined in I-91 (Seattle Ordinance #122357). Fair Return is defined in I-91 as it "shall be computed as the net _cash_on_cash_ return, after interest and any financing costs"

If I-91 left "Fair Return" undefined, I could see trying to figure out the intent of the ordinance's fair return definition; however, by defining the term, Chris Van Dyk pigeon-holed I-91 into a specific use-case.

This is why the council keeps saying that the letter of I-91 is moot, because you get divide-by-zero errors. So we're left looking at intent, which is much murkier.

Yeah. I-91 was definitely not written by a financial guru, more of a "Eyman" character.

Although you got to imagine the council's position if 74% of the votes thought they required a fair return on their money and then you try to say "this bond is 38% projected rent payments and 62% expected entertainment business tax payments."

The electorate is going to remember their ballots which said:

CITY OF SEATTLE

INITIATIVE 91

For-profit Professional Sports Organizations

Seattle Initiative Measure Number 91 concerns property, goods, and services Seattle provides to for-profit professional sports.

If enacted the measure would require that for-profit professional sports organizations pay the City at least “fair value” for goods, services, real property, or facilities the City provides or leases to them, either directly or through another public entity or a non-profit organization. The measure defines “fair value,” based in part on the rate of return for 30-year U.S. Treasury Bonds. Any Seattle resident would have standing to file a lawsuit challenging City acts that allegedly violated the measure.

Should this measure be enacted into law?

Yes…

No…

I don't disagree with your opinion of the intent Chefjoe. Just your calculations of returns.

But I would just say that a 7% annual return with these saftey measures is a very good return in this interest rate environment and would easily meet any "fair value" return hurdle - for the city of Seattle, any corporation in america, or any private investor.

Do you know anywhere you can get a 7% return today ChefJoe

Did you see where Neil broke down the finance costs in his most recent post and found maybe a 3.3% return over the cost to borrow?
I believe his analysis is based on his older spreadsheet (no 1% debt service escalation or increased rent after 30 years indicated, so it predates the May 16th MOU).

It also doesn't seem to reflect how the county believes the public financing with mostly be taxable (and at the higher 5.5% interest rate).

I've seen several junk bond funds that boast 7%+ returns, but I wouldn't borrow money to buy them.