Posted by John Vrooman on Wednesday, February 21, 2018 in NCAA Basketball.

Interview with Louisville Courier-Journal.

• I’m trying to get a sense of whether Louisville’s financing plan for its arena is similar to/out of line with what has been done with other arenas. Kentucky’s auditor noted a year or so ago that ¾ of the arena’s revenue comes from taxpayers, through either TIF proceeds or a yearly payment from metro government. Is that about on average for arenas? What else should I consider when I look at the financing?

The Yum Center was originally conceived in a failed attempt to attract the NBA Grizzlies franchise, which was relocating from Vancouver to Memphis in 2001. As I recall the original financial structure of the Yum deal was very similar to the Memphis FedEx Forum lopsided cost split where the public share was over 90 percent. The NBA’s franchise-relocation venue-extortion game usually matches several intermediate markets in a monopoly auction bidding war where the winner is the mid-market that offers the highest public subsidy. In the Grizzlies relocation gambit it was Louisville v. Memphis v. Big Easy. Economists call this the winners curse because the winner of a monopoly auction systematically overpays (over-subsidizes).

As an unfortunate result, the public share of the venue cost varies inversely with respect to market size, and  it has absolutely no relationship to the actual real-world net economic impact estimate, which is usually a grossly overestimated something-for-nothing self-promotion scam.

Most of the NBA arena deals over the decade 1995-2005 were similar 90/10 public-private splits that were asymmetrically upside down in terms of actual social cost-benefit analysis. This includes the 75/25 Kansas City Sprint Center, which is comparable to the Yum Center (both are operated by AEG) because it has no NBA or NHL tenant. The privately funded arena deal exceptions were in the larger metro NBA markets with dual anchor tenant arenas shared by NHL clubs and a full date schedule of events.

Since the (second) Yum Center opened in 2010 however there has been a favorable reversal or at least an improvement to an  even 50/50 split. Louisville comparable markets of Sacramento (2016, Kings) an Milwaukee (2018, Bucks) are both funding about half of their new NBA $500+ million arenas.

What are your thoughts about the use of TIFs for arena financing?

The simple rule of venue finance is that the guys who benefit should symmetrically be the same guys that pay: nothing more, nothing less. A TIF (tax increment financing) is a funding mechanism that tries to assign the arena costs proportionally to those that economically benefit.

TIFs are designed to be used to fund the public infrastructure that connects the venue to the private economic grid. The share of TIF funding should therefore not exceed 10 percent to 15 percent of the total arena costs. Also to reduce the risk to the general fund, the TIF funding mechanism should probably be a property tax on gains in surrounding property values directly associated with the venue. An extensive sales tax TIF is probably too volatile and excessively risky business for the Yum Center and the City of Louisville.

• Some have complained for years that the arena brokered a deal with the University of Louisville athletics that favors the university too much (both in terms of who gets what revenues as well as the number of days that are locked up by the university). Proponents say they had to give a fairly favorable deal because the arena would not have happened without UofL. Can you give some perspective on the position that cities are placed in when negotiating with sports teams on arena terms? Are there differences in college versus professional? Do you get a sense of whether Louisville’s agreement is about on par or worse or better than you’ve seen elsewhere?

Here’s my comment to reuters during the recent UL basketball scandal:

Are you around to tap your expertise? I’m wondering about the potential economic impact to the city and university after what has befallen the university of Louisville’s basketball program. Any thoughts?

Usually a D1 college basketball program has little or no impact on the local economy one way or the other, but in the case of University of Louisville basketball the adverse impact of the most recent scandal on the City of Louisville will be relatively quick and possibly severe. This all depends on the magnitude and severity of the sanctions placed on Coach Pitino and the Cardinals basketball program.

 The unique economic linkages between the basketball Cardinals and the City of Louisville pass directly through the publicly funded, yet-to-be-paid-for KFC Yum Center where the fighting Pitinos have been the anchor tenant. Since Louisville lost the bid for relocation of the NBA Vancouver Grizzlies to the Memphis FedEx Forum in 2001, the economic architecture of the KFC Yum Center has been interwoven with the NCAA D1 basketball Cardinals.

 The Louisville Cardinals are a stone cold semi-professional money machine. With an annual basketball budget in excess of $50 million and a head coach’s salary around $8 million (just ahead of Kentucky’s John Calipari ), the Louisville Cardinals and their head coach are the most expensive basketball program-coach package in the NCAA by a long shot. This basketball budget would place the Cardinals in the top 25 of Power 5 football budgets and Coach Pitino is/was the second highest paid head coach in college sports period (just behind football Michigan’s Jim Harbaugh).

Thanks John.  So the biggest economic impact would be on the university itself in ticket sales, relucatant university donors, out-of-state prospective students, that kind of thing?

Yes but UL basketball also a direct impact on the city’s arena funding for the KFC yum center. Arena bonds were to be paid by tax increment financing based on sales taxes around the arena. In this unique case, the impact of the team (positive or negative) extends beyond the university into the economic grid.

 Understood. So, if the ticket sales or attendance went down, that could impact nearby businesses and in turn the TIF revenues?

Yep.

Does attendance or sales typically dip after a scandal like this where the hall of fame coach is lost?

not always, but the economic connection between Louisville and UL Cardinals basketball is unique. With a $50 mil basketball budget and an $8 mil salary coaching package they may be able to repeal, reload and replace with whomever they want as coach and not miss a beat, depending on penalties and sanctions. After all the speculation however Rick Pitino is still a one-of-a-kind hall-of-fame coach.

Because Louisville basketball is currently on probation the NCAA may hit the program with the death penalty, which would of course magnify the adverse impact on the school and the city of Louisville.

Good point. Are the chances of that slim, though?

Death penalty is rare, but real and possibly imminent.

• A major reason given for the building of the downtown arena was to drive economic development. One of the leaders of the project said the arena has drawn big musical and other acts to Louisville, which in turn has drawn young professionals to the city. He also pointed to a 2014 study by a consultant (CSL International) that showed the arena had had an economic impact of more than half a billion dollars in its first few years of operation. But I’ve seen mention elsewhere that some economists believe that arenas tend to redistribute spending from one part of a city to another. How would I go about getting a sense of the arena’s true economic impact on the city?

Again, a good comp for the Yum Center would be what’s going down at KC’s Sprint Center. Neither venue has a pro sports team and both are operated by AEG (Anschutz Entertainment Group). My basic rule of thumb is to divide the hired consultant’s self-promoting estimate by ten. So just move the decimal point one digit to the left. The reason the impact estimates are so over the top is that they overestimate the positive multiplier effects usually ignore the negative costs.

 This is why real-world regional multipliers are negative-sum or zero-sum at best. The direct effects are overestimated because most economic gains are designed to be captured in the new luxury venues themselves. The indirect economic spinoffs are overestimated because spending in the local economy leaks out like a sieve. Finally economic impact estimates ignore congestion and crowding out of other economic activity in the metro Louisville area. So the spending at the arena just relocates the economic activity from around town to the Yum Center (zero-sum).

• There’s renewed discussion here in Louisville of drawing a professional basketball team here to Louisville. As the city looks at this possibility, what should it keep in mind? Also, have you seen a similar instance where an arena for a college team added a professional team… if so, how did it work?

Louisville would get in line behind NBA empty Seattle and KC markets to start, and remember that the winner in the NBA relocation shell game will systematically overbid with a sweetheart lease. Just ask Memphis, New Orleans, Charlotte and OKC about the 95/5 winner’s curse.

 A crowded profit sharing problem in KC may also replicate itself in Louisville. AEG’s profit sharing deal is a major reason the Sprint Center has always been tenant team-less. The Sprint Center has been caught in a catch-22. The Yum Center may need another anchor tenant to fund the public arena debt, but AEG’s middle-man split of revenues in the Yum Center could effectively block any new tenant from capturing maximum private revenues. The devil is in the details of the sweetheart lease.

• What else do I need to think about as I work through this story?

You will be okay.

V

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Folowup.

You talk about the middle-man nature of AEG as a possible block on an NBA team coming in. I’m not sure I understood… can you explain further the issues with that?

In an arena deal two is company, three is a crowd and four is a multitude. The attractiveness of the Yum Center to a rambling NBA/NHL franchise depends on their ability to control of all of the venue revenue streams even for non-game events. In the AEG-Sprint Center deal in KC the arena manager AEG is guaranteed 16 percent return on top of other rate of return guarantees. KC will probably never see a profit from the Sprint Center because they gave away the ranch to AEG.  There is simply no financial room in KC for a NBA/NHL tenant and their own management company, and the same is probably true for AEG and Louisville.

It is also probable that the sweetheart deal between UL and the City crowds out other anchor tenants. This is for example why Houston has not had a NHL tenant to share the Toyota Center largess with the NBA Rockets. Before the Rockets were recently sold for $2.2 billion they controlled all of the venue revenues from the Toyota Center and blocked the potential revenues for an NHL club. Now that the club has been sold, Houston may get a 32^nd NHL franchise but only if it is also owned by Tillman Fertitta, the new owner of the Rockets.

Also, you talk about the competitive nature of NBA teams causing some cities to over-subsidize. What about with college teams like UofL? We’ve heard from some of the deal’s architects that UofL had good bargaining position because without the university, the arena couldn’t happen, and that the arena was all for the university. Others have said that UofL can’t exactly pick up and go to another city so it shouldn’t have gotten such a favorable deal. The main negotiator on the side of the arena believes the deal with UofL was a good one. Can you provide some perspective on this?

The difference is of course that UL can’t realistically extort the City with the threat of relocation, but why should they. The arena deal is already Cardinal friendly.

(some major points of the UofL deal: UofL keeps 88% of revenue for private suites and premium seating; UofL pays 10% of tickets (or $10K minimum) to arena for men’s basketball and 5% (or $5K minimum) for women’s basketball games and other events; UofL gets 50% of gift shop sales; a recent revision to the lease a few months ago adds a new annual payment from UofL of $2.42M )