Edmonton Arena Deal Finalized

The Edmonton City Council passed a bill yesterday authorizing a package amounting to $480 million in funding for construction of a new arena in downtown Edmonton.  This appears to end more than 5 years of bickering over the financing of this proposed new arena.  This $480 million dollars in financing is assumed to cover the entire construction costs of the facility, excluding land and other related infrastructure like roads, sewerage, and utilities.   The details of the financing are almost too complicated to cover in a blog post, as the financing mix consists of a mish-mash of local, provincial, and private funds from ticket taxes, property taxes, capital improvements funds, and maybe even loose change from the couches in city hall.

Since at least March 2008, the maintained assumption was that this new arena can be built for $450 million.  That cost estimate was in a document, “City Shaping,” produced by the Leadership Committee for a New Sports/Entertainment Facility for Edmonton in early 2008.  “City Shaping” contained no supporting details for this facility cost estimate.  I have seen a heavily redacted version of a 2007 feasibility report by HOK on the proposed new Edmonton arena, but it also contains no useful details about the expected cost of the facility.  I do not know anyone who has seen the supporting documents for the 2008 $450 million facility construction cost estimate.  Like every other sports facility construction subsidy debate I have observed over the last 15 years, the first cost estimate that appears in the media becomes the focus of the debate.  That first estimate assumes a mythical stature.  In the case of Edmonton, the mythical $450 million cost estimate has been the focus of a five year debate on the financing of the proposed new arena.  A few months ago, the estimate was increased to $480 million, in recognition that things could have gotten more expensive over the last 5 years.

I have a couple of thoughts on this agreement as I prepare for a round of radio and TV spots today and tomorrow here in Edmonton.  First, now that the city has come up with $480 million in funding, what are the chances that the structure can be built for $480 million?  In my opinion, it is extremely unlikely that $480 million will be the final cost of the structure.  The final cost will almost certainly be more. The original $450 million estimate is now more than 5 years old.  Arena construction costs are primarily things like steel and concrete, and lots of labor costs.  Raw materials prices are notoriously volatile, but I looked around the Stat Can web site for some information on construction cost changes. Since 2007/2008, the cost of inputs from steel foundries increased about 17%, concrete has increased about 13%, and union construction labor costs in Edmonton increased 15%.  So it seems reasonable to assume that building a $450 million structure spec’ed out in 2008 would cost about 15% more in 2013; $450×1.15 = $517.5 million.  That means the current financing package is still short $37.5 million, assuming that the original 2008 estimate of the structure cost was accurate.

But the 2008 structure cost estimate came from the team, and previous literature indicates that the initial cost estimates that come to the surface in these situations is a low-ball estimate.  Since the team owner is extracting a subsidy from the government, the standard negotiating tactic is to throw out a low-ball first offer, get the local government to agree to that figure, and let the public officials deal with the inevitable cost over-runs.  Here is a link to a recent Bloomberg article summarizing the results in Judith Grant Long’s excellent book, Public/Private Partnerships for Major League Sports Facilities.  She concludes that the final cost of a new sports facility is about 25% more than the initial cost estimate.  If the final cost of the new Edmonton arena is 25% more than the 2008 cost estimate, then Edmonton is still more than $80 million short in financing for the facility.

I have spoken with a number of public officials in Edmonton over the last 6 years about the proposed new arena.  Every time I raised the issue of cost over-runs, the response was always “we will let a contract for $450 million that explicitly states all cost over-runs beyond the contract price will be paid by the builder, not the city.”  My response was always: good luck getting a general contractor to agree to those terms.  We will soon see how easy it is for the city to strike such a deal with a general contractor.  After that, we will see who pays for the cost over-runs.

I also have some questions about the Community Revitalization Levy (CRL) that represents an important portion of the funds for the new arena.  A CRL is the Canadian equivalent of a TIF District.  It generates revenues from the increased property taxes that can be attributed to the new arena.  Property tax revenues increase because the property values surrounding the new arena increase.  According to the Edmonton Journal article linked to above, part of the final financing deal was that an additional”$15 million will be paid by the city through an increase to the community revitalization levy.”  The CRL has been a part of the arena financing deal for years.  Yesterday the city Council managed to find an additional $15 million in revenues from the CRL. I don’t understand how a CRL can be a variable source of public financing.  CRLs generate incremental tax revenues because of increases in property values.  The government cannot control property price increases.  They can control the property tax rate and the assessed value of the property.  But if they could have raised an additional $15 million from the CRL when it was proposed as part of the financing package years ago, why wasn’t the CRL contribution higher back then?

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Author: Brad Humphreys

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Canada, finance, hockey

5 thoughts on “Edmonton Arena Deal Finalized”

  1. Thanks for doing the actual math on this, Mr. Humphreys. Simply put, this deal stinks. Apart from the concept of welfare for billionaires itself. No doubt most of the councillors who voted for this will be long gone (and probably living elsewhere) when this building opens… assuming they can actually get it built, of course.

    Mr. Katz began this process by suggesting (but never actually committing) he would put $100m into an arena and $100m into ancillary development. We assumed that at least some of that $100m would be for the land he had negotiated options to purchase.

    In fact, he has done nothing of the sort. His $100m arena contribution comes in the form of what amounts to annual rent payments ($100m over 35 years is not the same as $100m up front. Even Mr. Katz understands this, but apparently the council does not). The city chose to buy the land for Katz, when it seemed clear that he had no interest in exercising the options he had negotiated.

    This is a case study in municipal failure. Even Farbrother, who was solidly behind the arena idea initially, has admitted that the CRL probably can’t cover the debt service on the arena development. Over 30 years, this development will cost the city nearly $2bn by my calculations (it’s hard to be completely accurate when forecasting that far into the future – but it will be at least $1.7bn and perhaps as much as $2.2bn).

    That’s ten times what the franchise is worth even under the most favourable analysis.

    Mr. Katz felt the team had such value that he happily offered $40m more than the forbes valuation at the time of purchase. Now he has a case of the shorts? I guess the $20m penthouse he moved to Vancouver to enjoy a couple of years ago is really hitting the bottom line.

  2. The answer is simple – the same way they are doing it in Sacramento – declaring the existence of future tax revenue by fiat to balance an arena funding deal. The (Sacramento) text was “the city’s parking operation shall be structured to provide an additional $9M/yr of revenue to the city” with exactly zero other changes detailed except for the reduction in the total number of parking spaces to make way for the arena.
    Future CRL revenue can also be stated to be whatever is hoped for, as there is no one to be held accountable if the projection is wrong. If 2008 to now seems like too fast for $15M to materialize, consider that the cause is the current Canadian Housing Bubble that cannot be projected into continue 30 years in the future. At some point real estate prices will return to reality, and the tax revenues will stop growing at the fantastic rates needed to meet the funding assumptions.

  3. Excellent points made about the cost over run issue.

    On the CRL, not sure that the city found “extra” CRL revenue. CRL expected to produce approx. $300 to $600 million, with the spending to come over time, based on CRL revenues. Exactly what that money is going to be invested in is still being worked out.

    In the first round, the spending will not be over that $300 million mark, and that includes the extra $15 million for the arena.

    So the city isn’t expecting to find extra CRL money, and will likely switch out some spending on some other infrastructure project and put it into the arena. The $50 million plan to redo Winston Churchill Square, for example, is already in doubt and unlikely to go ahead to that extent of spending.

    The CRL is risky, though it’s worth noting it provides extra provincial infrastructure dollars to the city.

    There is only one taxpayer, but we Edmonton taxapayers have recently had trouble getting a reasonable share of the tax dollars we spend directed towards anything in this city (this is particularly a difficult issue at the federal level, as the feds essentially gouge this province). So any extra funding from province or feds is a huge bonus to taxpayers here, as there’s no assurance those dollars would ever be spend here.

  4. An excellent piece. In particular the CRL. I seem to think that it is just a transfers of funds at best. I am not sure that I agree with David’s math. That $300-$600 million generated by the tax is $300-$600 million those taxpayers won’t have to spend elsewhere in Edmonton. It’s isn’t new money in any sense….

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