Wayne Dernetz | 9th Street
faironomics by Wayne Dernetz | fair gov by Dwight Worden
Many Del Mar residents are asking, “Can Del Mar afford to purchase the Fairgrounds?” and, “Is $120 million a fair price?”Although the details remain confidential or uncertain (pending legislative authorization for the sale), the answers to those questions can at least be framed. Keep in mind, once the Legislature authorizes the sale and the City’s negotiators and the State reach a preliminary agreement, the details will become known and the public can weigh in before any final decision is made.
Del Mar’s financing plan relies on three elements: first, a purchase money contribution of $55 million from a horse breeders’ group for prepaid rents on the race track; second, a City revenue bond issue, amount not yet specified,for additional purchase money; third, any remainder as a promissory note from Del Mar to the State, terms of which are not yet agreed or disclosed.
The breeders’ group portion would reduce the City’s purchase obligation to $65 million. Whether this amount can be raised entirely through revenue bonds or an additional promissory note will be needed, is not yet determined. The revenue bond issue cannot be properly “sized” until more is known about the foreseeable revenues from Fairgrounds operations. That is still to come.
Why Revenue Bonds?
Revenue bonds are preferred by local governments to finance the acquisition, construction or improvement of utilities or other facilities (like the Fairgrounds) that generate dependable revenues. Revenue bonds have been used to finance water and sewer systems, toll roads, airports, stadiums, and even convention centers.
Revenue bonds are not general obligation bonds. Only designated revenues are pledged to pay annual bond interest and principal. In case of default, bond holders cannot tap other assets of the issuer. Their only recourse is to appoint a trustee to operate the revenue-generating facility on their behalf.
To guard against default risks, at issuance a cash reserve account is established, held by a third-party trustee, sufficient to meet two to three years’ of debt service requirements. If revenues fall short, the reserve can be used to avoid default. The reserve also earns interest and ultimately is used to pay the last remaining bond interest and principal obligations. Revenue bond issuers often purchase default insurance to secure the highest possible bond rating and reduce the interest cost ofthe bonds.
The final sizing and redemption of the Fairgrounds bond issue will depend upon foreseeable revenues from the Fairgrounds, bond market interest rates and other current market conditions. Working with professional financial advisors and prospective bond purchasers, the City will determine the best sizing according to those conditions.
Using revenue bonds to raise most, or all, of the City’s purchase price makes sense. The City will operate the Fairgrounds as a business “enterprise.” That means the Fairgroundswill become a self-financing activity using best business practices, including re-investment of earnings. Cities operate many such enterprises, from airports to golf courses. The Del Mar water and sewer systems currently operate as enterprises.
Is the Purchase Price Fair?
Some have suggested the $120 million price for the Fairgrounds is ridiculously low. Others say it is too high. But determining the value of a property is not a simple thing. Property owners would like to value their property at its “highest and best use.” But that isn’t what determines the market value of property̶that is, what the property would sell for.
Market value means the amount a knowledgeable, willing, and unpressured buyer would likely pay to a knowledgeable, willing, and unpressured seller. Several factors enter into determining market value including the type and condition of the property, its intended use, applicable regulations, and general market conditions at the time of sale. Highest and best use value is not used in determining market value.
Market valuation methods vary according to the type of property. Market value for residential property relies on “comparable sales” of similarly situated properties, making adjustments for the condition and special circumstances of the property (an ocean view, for example). An investor interested in developing or redeveloping property would utilize the “direct capitalization” method; that is, the amount of gain that can be realized from the development. But buyers and sellers of business or industrial property typically use the “income potential” method. The market value is determined by discounting future cash flow resulting from the intended use of the property, allowing for existing regulations and the property’s condition.
The State and City are committed to continuing the fairgrounds and race track uses, perhaps with minor adjustments. The “income potential” method, therefore, is the best method for determining its market value. Anticipated revenues from future operations of the Fairgrounds, discounted by the State’s current investment earnings rate, with adjustments for restrictive regulations, current zoning,and condition of improvements on the property, will provide a “fair” market value.
Until the books are examined and reasonable projections made of future revenues, no one can say if $120 million represents a fair market value. But that information will be forthcoming in due course.
Wayne Dernetz is a former City manager, City attorney and bond counsel.