The city of San Diego doesn’t have any sort of strategy for all the property it owns.
Last week, the City Council rejected a potential 55-year lease extension for a company that runs Mission Beach’s historic Belmont Park, asking city staff to come back after negotiating better terms.
The Council meeting underscored a strange truth when it comes to how the city leases its property to private entities: There isn’t any common understanding of what constitutes a good deal, nor are deals negotiated with any overarching long-term vision in mind.
It’s been that way for a long time.
The city owns lots of property. City employees occupy some of it, but other properties are leased to private entities, both nonprofits, like the museums in Balboa Park, and for-profits like SeaWorld and Belmont Park. At one point the city wasn’t even sure what all it owned, let alone what it was trying to accomplish with it all.
A 2007 consultant’s report said the city’s real estate assets department needed to create standard performance measures to grade individual properties and the city’s portfolio as a whole, and develop a broad plan to generate a return on the portfolio.
Four years later, a city auditor’s report beat the same drum: The city needs to create a central plan for all its real estate, and to measure how well it’s doing.
It’s not doing either.
“The city should have an overarching strategic plan that guides what it’s doing, that says, ‘This is our mission, this is what we believe in,’ that sets guidance and expectation on how things will be handled,” city auditor Eduardo Luna said. “You set a policy, and that guides how you administer something.”
Luna’s audit didn’t specifically look at the city’s long-term leasing practices, but said it would like to in the future.
Council policy calls for decisions to be made with a comprehensive “portfolio management plan” in mind, but that plan’s fallen by the wayside, said Cybele Thompson, who was hired earlier this month as the city’s new real estate director.
“We’ve had a portfolio management plan in the past,” she said. “(Last Monday) was my first day. In the next couple months we’ll work with the mayor and Council staff to make any strategic decisions.”
Otherwise, Council policy says the city shouldn’t lease its property for below market value, except in unusual circumstances. It has some other general guidelines, like examining “the capability, expertise, and experience of the potential lessee,” and whether there are “special public benefits to be derived (if any).”
But measuring public benefit is slippery. That’s how a lease like Belmont Park could be described by Councilman Ed Harris as “a public giveaway to a big corporation” and by Councilman Scott Sherman as a solid deal.
All Real Estate Is Unique
“One of the issues the city has is you have such different (conditions) at each property, so there’s never an apples-to-apples deal,” Thompson said. “In general, we’re trying to balance profitability and the greatest public benefit.”
The Belmont Park deal would have cemented the city’s partnership with Pacifica Enterprises, the company that’s been running the oceanfront amusement park since 2012, while getting the company to take care of a $5 million renovation of the Plunge Building, a large historic building in disrepair.
That’s the public benefit to this deal.
Pacifica’s lease currently runs until 2038, and would be extended to at least 2064, with the minimum annual rent increased from about $900,000 to $1.1 million, which would be revisited every 10 years. Pacifica is also trying to take over the lease for the Big Dipper roller coast; if that happens, the rent would tick up to $1.3 million, and it’d be required to make another $2.5 million in repairs to that historic structure.
But those required repairs aren’t just acts of charity. The city cuts the expenses out of the company’s minimum rent by including subsidies, or “rent credits,” in the deal.
So the lease includes $5.2 million in rent subsidies to offset the repairs. And the current lease still has $2.9 million in remaining subsidies that’ll carry over, so Pacifica would have a total of $8.1 million in discounts during its lease term.
Those subsidies are expected to expire within seven to 10 years, “after which rental payments in full would be due to the city,” according to a report on the deal by the independent budget analyst. If that happened, the city would bring in at least $104 million from Belmont Park over the life of the deal.
Maurice Robinson, an expert on municipal leases who consulted with San Diego for its lease with SeaWorld, said getting the private company to make investments up front is key.
“Typically any city’s goal is to get the private sector to pay for repairs that you need as early as you can get them to do it, even if it means they don’t pay rent for a few years,” he said. “The idea is the city is not harmed, because they’re getting the investment on the property, so even if the next guy walks, the property is in better shape.”
“It’s called OPM — other people’s money,” Thompson said. “If you can get that from the tenant up front, it’s a better deal for the city.”
Harris wasn’t impressed. If the city’s giving subsidies for the repairs, that means the city’s effectively paying for them, he said. Instead, it could borrow money to make the repairs, and use the rent to pay it back.
“We are paying to repair the Plunge, whether we pay (Pacifica) to do it, or if we get the full rent, bond against it and hire a contractor,” he said. “It’s the same thing.”
But even Cory Briggs, a prolific environmental attorney who sued the city over an atypical lease extension it gave a Mission Bay hotel, said it’s perfectly appropriate to give a tenant a discount early on so you improve the city asset sooner, and then the city can make its money on the back end once the subsidies expire.
“But then you have to give an incentive so they don’t screw you on the back end,” he said. “You can’t make it free in the early years, because then they just walk away when it’s up.”
For example, the city could mandate the repairs happen early, but give only 75 percent of the subsidy in the first 10 years, spreading the remainder out so the tenant must stick around to get the benefit.
There isn’t any such incentive in the Belmont Park deal.
And the history of the park suggests Briggs’ concern is well established. The city gives early subsidies, counting on making its money on the back end. But the back end never comes.
Since the city struck the current lease in 1988. Even though the annual minimum rent is currently set at $900,000, the city has actually collected only $1.6 million total in those 26 years. In 2011, it collected only $29,166.
The last operator said he couldn’t make the annual payments once the rent subsidies ran out. He had requested a lease extension — one very similar to the one being offered to Pacifica — to keep him in the property. When the city balked, he went into default and eventually declared bankruptcy. (The previous operator also sued the city, and Pacifica inherited the lawsuit when it took over the lease; it agreed to dismiss the suit in exchange for getting extension negotiations started.)
Pacifica could also move on when payments escalate. But that’s where evaluating the company itself as a potential partner becomes important, the city says.
It points to the Pacifica’s dismissal of the lawsuit, and investments the company’s already made as evidence that it’s trustworthy.
In total, Pacifica’s invested $22 million renovating the Wavehouse, building two new restaurants, improving common areas and building a rooftop event space. Those repairs have also benefited the company financially, as they increased the occupancy from 77 percent to 100 percent.
In all, the IBA said the lease was a little longer than similar leases in the state, and the rent was a little lower (it oddly didn’t mention that 50-year leases are extremely common in San Diego).
Whether it’s a good deal is up to the Council, the report says.
‘Shouldn’t Be Doing This Willy-Nilly’
While the Council split on the lease, it unanimously approved a much different 50-year lease in late 2012 for the Bahia Resort Hotel.
That deal extended the lease term for Evans Hotels by 50 years, and specifically stipulated that no improvements of any kind were required on the property. It was odd, because revenue is just one of the benefits of leasing land to private entities; the other is that the city gets improvements on its assets.
Briggs sued over it, because in addition to requiring no improvements, the deal also didn’t come with an up-to-date appraisal of the property’s value. Weeks later, when the Council re-voted to avoid Briggs’ lawsuit, an appraisal was conducted by Evans’ own appraiser. The issue is going to trial Oct. 28.
In one way, the unanimous approval of a long-term lease requiring no improvements and the rejection of a long-term lease requiring many improvements shows the city’s inconsistency with its leaseholds. Or, as the city says, it shows no two deals are alike.
But the Belmont Park deal and the Bahia deal were similar in another way.
Both came to Council after skipping any committee discussion, and in both cases the lessee told Council the deals had to be approved immediately or they’d fall apart. For the Bahia, the thinking was to quickly take advantage of favorable interest rates. For Belmont, Pacifica said it was negotiating with the company that holds the roller coaster lease, and was facing a hard deadline.
“I’ve seen (San Diego) do some last minute, 11th hour proposals where the lessee says they need to do the deal now, which probably wasn’t true, and (the city) certainly should be criticized for not taking their time,” he said. “It appears they’ve lost their way on process. There’s just no cause to do this willy-nilly. It’s a big cost for the city, a big asset.”
Likewise, Harris said he didn’t buy that there was a “hard deadline” looming for Pacifica.
“This is the third hard deadline I’ve heard about,” he said. “They’re not walking off of this deal.”
But Sherman spokesman Diana Palacios reiterated that rejecting the deal last week would be a loss for the city.
“Instead of delivering a win for Mission Beach in Harris’ final weeks as a Council member, this could end up being the biggest lost opportunity for that community in decades.”
Clearly, there’s little agreement from the two most outspoken sides of the dispute.
“It’s certainly true that there’s very little guidance on the books for this stuff,” Briggs said. “But this isn’t the first long-term lease they’ve done, and neither was Bahia. It’s not like there’s ever any clamor to have a black-and-white standard from Council.”