Diligence Or Negligence? 02/17/00

Analysis by Ted S. McGregor Jr.


"I think the council really has exercised honest and forthright due diligence. " That's how, in January, 1997, then-Mayor Jack Geraghty described the events that led up to the city's decision to participate as a partner in the River Park Square project. Now, three years after that controversial decision and just seven months after the new mall opened, the degree and quality of that due diligence is being reexamined as a way to understand why the parking garage - the city's portion of the deal - is failing to meet expectations.


As the specter of having to tap the city's parking meter fund to help the garage stay afloat has emerged as a real possibility, the scramble for solutions has begun. A few want to refinance the entire deal; others flirt with the idea of somehow reneging on the pledge of the parking meter money; and some want to stay the course, waiting for the second phase of the mall to open and the additional parkers it could bring. But even after just seven months, the garage's performance is so far below expectations that some are saying holding course isn't really an option.


How could so many people be so surprised by the garage's performance? Weren't the best consultants in the country hired to test the feasibility of the entire project, specifically the garage? That Walker Parking Study, most agree, is where the garage's problems begin. How a document that appears to be so deeply flawed came to be relied on so heavily for this project raises new questions about that study and the city's self-described due diligence.





BEYOND DUE DILIGENCE


To understand the importance of the saga of the Walker Study, you need to go back to Oct. 17, 1996. That's when the city council was holding a public hearing on whether to join the project. The council chamber was split between angry "naysayers " who decried the use of public money for a private purpose and downtown boosters with "I & szlig; Downtown " buttons on their lapels. Suddenly, Councilwoman Roberta Greene surprised everyone by calling for a brand new study to verify the findings of the Walker Study and its companion, the Real Estate Economics Study (which estimated the economic impacts of the mall). Greene's idea was embraced by the council, and the accounting and consulting firm of Coopers and Lybrand (now PriceWaterhouseCoopers) was hired to quickly put together a report.


When the time came a few months later in January to revisit the issue, Coopers and Lybrand's report was delivered to the city on the Friday before the Monday council meeting. However, the developer, Spokane's Cowles family, found certain passages to contain proprietary information, so the document was sent back to Coopers and Lybrand's offices in San Francisco. Rather than put the council meeting off, however, copies of the revised report were circulated only hours before the Monday night meeting. At that meeting, a representative of Coopers and Lybrand made a short presentation, but was asked no questions by council members. The council voted and endorsed the plan as an emergency ordinance, effectively accepting the findings of the Walker Study.


The day after the Jan. 27, 1997, vote, Geraghty said that nothing in the Coopers and Lybrand Report changed anybody's mind about the project. He also added that, "We had to make a decision at this time. "


Geraghty's statement reflects the relentless lobbying that the council was experiencing at the time, not only from the developer, but also from the general public, a good chunk of which felt the project would help revitalize downtown Spokane. The developer's argument - that if the council didn't decide right then and there Nordstrom might dump the project - was later somewhat undermined as the project dragged along for almost another two years without Nordstrom bailing out. Nonetheless, the risk of Nordstrom losing interest could have had the effect, as the developer often put it, of leading to the boarding up of two square blocks of downtown retail property.


Whether the council members read the Coopers and Lybrand Report prior to the vote as part of their due diligence is at least in question today, as the report is filled with questions about the Walker Study. For one thing, the Walker Study suggested that the average stay of every car to visit the garage would be three hours; Coopers and Lybrand pointed out that the national average for such models is 1.2 hours. Coopers and Lybrand questioned the wisdom of raising the hourly rate from $1 to $1.50 and also pointed out that there was no parking validation program included in the documents they reviewed. Even the Walker Study states that a validation program could have significant impact on the garage's performance, but Coopers and Lybrand finds that missing element crucial, stating that in the Walker Study, "the revenue and cash flow projections [of the garage] could be materially overstated. "


When asked at the time about a parking validation program and why one wasn't included for analysis by Walker, Geraghty said the details of a parking validation program could be worked out in the coming years. In fact, the garage's validation system wasn't finalized until one week before the mall opened in August.





STUDYING THE STUDY


After that vote on the emergency ordinance (meaning the decision couldn't be overturned by a voter referendum), the city had officially joined the project. But there were many loose ends to tie up, and in the process of negotiations with the developer and in securing the federal Housing and Urban Development (HUD) loan, the Walker Study came under scrutiny again.


One of the key elements of the city's participation was the price of the parking garage, which the city would agree to buy from the developers (by law, municipalities are restricted to helping to fund parking enterprises when participating in such projects). This transaction would help fund the construction of the garage and parts of the mall. When you buy a parking garage, there's not only the value of the bricks and mortar to be considered when setting a price; the revenue such a facility can generate must also be gauged. In setting the value based on future revenues, the Walker Study would again be the primary source document, as it projected the garage's income-generating capability. As part of the pricing process, the city hired appraisers to make sure the figure settled on in negotiations and supported by the Walker Study was reasonable.


In his report, Spokane-based real estate appraiser Scot Auble seemed to pick up the train of thought started by Coopers and Lybrand regarding the Walker Study: "It is important to understand what the Walker Report is not, " he wrote. "This report professes to be a financial feasibility study for the expanded River Park Square parking garage. However, this report does not address the issue of competition as it pertains to regional malls in the Spokane area and does not develop any estimates of success of River Park Square in capturing a share of the Spokane retail market.


"Additionally, " Auble wrote, again mimicking Coopers and Lybrand, "the assumption regarding the average length of stay per car does not appear to be reasonable. "


Still, if such assumptions were acceptable to the city, then the appraisers found the purchase price reasonable. The city agreed to pay $26 million for the garage. Then and now, many say the city grossly overpaid for the expanded parking structure - perhaps by as much as $15 million.


Such charges of overpayment are just the kind of trouble the city of Seattle got into in 1997, when critics of their similar public-private partnership related to the Pacific Place Mall charged that the city overpaid the developer by nearly $23 million. The difference in Seattle, however, was that the money in question was being used not on parking but to build a new flagship store for Nordstrom. In Spokane, the construction of the parking garage and the Nordstrom structure were physically intermingled, so it could be argued that money being spent on Nordstrom was really being used to build the garage, and vice versa.


The other important impact the purchase price had was that it was used as the basis for setting the ground rent, the amount of money paid to Cowles-owned companies (owners of the land under the parking garage) by the Public Parking Development Authority (PPDA), the entity that would oversee the garage's management. That $63,750 per month cost is one of the reasons the parking garage is struggling so mightily today.


The Walker Study was revisited again, in late-1997, when the city engaged three Gonzaga University business professors to determine whether the proposed funding mechanisms fit with HUD standards (the federal agency allows communities to choose between homegrown experts and national consultants in fulfilling this requirement).


While the professors - Bud Barnes, Kent Hickman and Carl Bozman - found the funding mechanism to be satisfactory based on the HUD standards they were provided with, they took the opportunity to rule out the Walker Study as a legitimate feasibility study, as Auble did before them. They wrote that the project's lack of an overarching feasibility study was a weakness that HUD might call into question (which it never did). The professors also delved into the garage's lack of a validation program, as Coopers and Lybrand did, wondering whether that might impact Walker's projections for success. With little information to go on, the professors instead included a statement from the developer's agent, Bob Robideaux of Robideaux and Associates. They quoted him as saying any validation program would be "revenue-neutral to the garage, " and that if there were shortfalls, they would be "made up through other sources. " One clear lesson of the first seven months of the garage's operation is that validation has proven to be anything but revenue-neutral to the garage.


Since the council failed to heed these warnings from disinterested parties, it's no surprise that its members ignored similar pleas from representatives of the Sabey Corporation, then owners of NorthTown Mall. Although viewed by many as motivated by sour grapes over watching the city assist their future competitor, Sabey executives appear to have been right on about the Walker Study, which they were known to call a "fairy tale. "


As for the local media, a critique of the parking plan, including the Walker Study, appeared here in The Inlander on Oct. 16, 1996, four months before the vote on the emergency ordinance. The article quoted one of the appraisers of the garage, Daniel Barrett, as saying that, "several questions are raised regarding the validity of the Walker Study. "


Not surprisingly, no such articles were published in the Spokesman-Review, the city's only daily newspaper, which is owned by the family that is developing the mall.





INAUSPICIOUS ASSUMPTIONS


Whether the Walker Study is a true feasibility study or just a projection of revenue, it is based on a specific set of assumptions. This is the line of reasoning used by John Dorsett, a principal with Walker Parking Consultants of Indianapolis, in defending the study he helped put together.


"The only comment that we would have is that the development is not fully developed, " says Dorsett. "There are some assumptions in the report that have not come to fruition. And there are things that have changed programmatically with the project. "


Essentially, Dorsett says the numbers in his report are only valid if the assumptions they are based on exist, from the size of the movie theater to the amount of retail space leased out. He also says there are outside forces that can impact the success of a garage, including the way on-street parking is managed. And he says that the $1.50 figure the study uses as the amount the garage would recoup for every hour parked was later changed as the validation program evolved. Dorsett also says his firm was never asked to update its findings as new information, like validation, came into focus.


Walker was hired by the Spokane Downtown Foundation, the owner of the garage. But the foundation was later reimbursed the cost of the study by the developers. Dorsett says his firm develops its work independently and does not accept figures from developers or clients. So where did Walker come up with the three-hour average length of stay (versus the national average of 1.2 hours)? He only says his firm uses national data to arrive at its figures. Beyond that, he says he has "no comment " on how that key statistic made its way into his study.


And where those assumptions came from is a question that remains as officials try to sort out what happened. And there are other questionable passages in the Walker Study. For example, when setting a baseline of parking demand for the area the garage would serve, Walker's own methodology betrays a weakness. Walker's model suggested that 3,848 cars would be parked within the 15-block zone they saw as the garage's capture zone during a given time. But on their visit to Spokane, the consultants only found 1,734 cars parked in that zone. Despite this discrepancy, the Walker Study makes a leap of faith, sticking with its original number, writing that, "despite the discrepancy between parked cars in the 15-block study area and peak parking demand modeled using shared parking analysis for a typical weekday, we are confident that the parking demand ratios accurately reflect demand for the area. "


The Walker Study offers no foundation for its confidence that parking demand would somehow double over what was observed on the street. And Walker concludes that revenue in the garage, in the first year of its existence (this year), would reach $4.37 million, up from the about $725,000 the garage brought in before the redevelopment. That's about a 500 percent increase.


Since the garage is on pace to bring in more like $1.5 million this year, it's obvious that, for whatever reason, the Walker projections were just plain wrong. Two questions are emerging out of this realization: What can be done to turn the garage into at least a break-even operation until the bonds are retired? And who is to blame for allowing such a flawed study to serve as the linchpin for such an economically and politically important project?


As for the latter, the easy answer is that the responsibility lies with the city council that ignored repeated red flags - some waved by consultants that were paid thousands of dollars by the city to look for exactly these kinds of flaws.


Phyllis Holmes, who was on the council in January, 1997, and voted for the project along with Greene, says the council relied on Walker's strong national reputation in judging the report: "It appeared to be a good, solid study, " she says, "but it simply hasn't worked out. I do feel like there was due diligence; they're a firm that is widely known and highly reputable. "


So does Walker bear some responsibility for misleading the council with what appears to be a flawed report? (Walker is mentioned in the official statement that went out with the bond issue, suggesting a higher level of reliance - and responsibility - than if it hadn't been named in those documents.) Or does blame fall to the developer for not providing a clear enough picture of the project to the city and the consultant, or for not delivering the project in the manner expected by Walker?


As for the more pressing question of what can be done to turn the garage around, thereby saving the city's investment and the downtown revitalization that it is designed to spur, it seems more and more likely that there are two ways out; one characterized by poisonous recriminations and a conflagration of lawsuits, the other by political courage and shared pain.





MALL GOOD, GARAGE BAD


Those who are now charged with following through on the city's policy to make the garage pencil out agree that it is the victim of unrealistic expectations.


"Revenues are significantly below the levels in the studies, " says Roy` Koegen, the city's bond counsel, who helped craft the funding mechanism. "And, " he continues, choosing his words carefully, "we relied on those studies in making financial decisions. "


"We all wish the parking facility was performing better than it is, " says Mike Ormsby, attorney for the Spokane Downtown Foundation, the owner of the garage and issuer of the bonds. "There's just no way to sugarcoat that. "


"Mistakes were made, " is all that Terry Novak can offer by way of explanation. The former Spokane City Manager now serves as the volunteer chairman of the Public Parking Development Authority (PPDA), the independent entity that has been given the responsibility of overseeing the operation of the garage.


Even the developer's attorney, Duane Swinton, admits that Walker appears to have been wrong on some key assumptions (although, he says, the garage is approaching that controversial three-hour average stay figure; current users average 2.2 hours per visit).


While the garage has struggled, the developer's reports show that the mall itself is thriving. Although only half built, the retailers - some in Spokane for the first time - are reported to be pleasantly surprised by their level of success. Robideaux and Associates, the mall's manager, estimates that, through the end of this year, the city will benefit to the tune of $4.2 million in tax revenues and fees that weren't there before the redevelopment. As for the jobs that were promised as a condition of the HUD loan, Swinton says the project has already created 600 full-time equivalent jobs, just 76 fewer than HUD required, with many more stores still to be added. And anecdotally, the traffic being generated by the AMC Theaters is bringing more diners into downtown restaurants than ever. (Anecdotal evidence suggests the success of the mall isn't yet manifesting itself in increased retail spending outside its walls, but such impacts may not be felt for three to five years, Swinton says.)


The one nagging problem seems to be that many of the visitors to the mall are finding somewhere else to park. After all, as has been widely publicized in recent years as downtown has struggled with its parking image, there are more than 6,000 parking spaces in the downtown district. Ironically enough, the garage's loss has brought a 14 percent increase to the downtown parking meter revenues (based on the change between November, 1999, and November, 1998), perhaps leading to an overall increase of as much as $50,000 to the fund. And with The Phantom of the Opera starting its month-long run here this week (and a potential $10 million total economic impact), the benefit of out-of-towners attending the show and shopping in a downtown with River Park Square versus one without it is expected to come into even sharper focus.


But parking on the street isn't necessarily cheaper than parking in the garage, so there must be other reasons people are avoiding the garage. Novak says research shows the pricing was frightening some people away. He points to a sign that used to greet visitors as they entered the garage that said the maximum one-day price was $16, a shocking figure by Spokane standards (they changed the number to $8). Then there was the new system, in which you paid for your parking in the mall, not from your car at the exit. Despite being the standard in most new malls, the system was confusing and user unfriendly in the early days of the mall, when people were forming their opinions and parking habits. And the changes to the validation system (which went from two hours of free parking prior to the redevelopment to a $1 discount now) were the source of many user complaints. Finally, the marketing of the mall and its garage has been minimal considering its $100-million pricetag. Although the Downtown Spokane Partnership (DSP) has continued to market the downtown as a whole to the region, Nordstrom, the mall's anchor, has long been known to do very little local advertising. Shoppers who long ago fled downtown for outlying malls have not been coaxed back to River Park Square (and its garage) to the degree many had expected.


Currently, the PPDA is taking over the operation of the garage from River Park Square, and Novak says users can expect changes in the garage. The authority is now reviewing the results of a request for proposals that was issued to national parking management firms. Such a firm could be hired to run the facility for the PPDA by the beginning of April. And River Park Square plans to install new automated ticketing kiosks that will allow for the handling of greater traffic, as when a movie lets out. Over some concerns from retailers, the garage will start offering monthly parking soon, and the developer will also install a fourth elevator this summer to improve access to the garage. Finally, a plan is in the works to create a $260,000 regional marketing campaign (funded by River Park Square, the DSP and, backers of the plan are hoping, the city) aimed at increasing use of the garage.


As all parties are trying to come together to solve these problems, it's not helping that a dispute has erupted between the city and the developer - the partners in the project. The River Park Square developer is asking the city to release the final 5 percent of the HUD loan for use in constructing the second phase of the mall. The city contends that the $1.5 million isn't to be released until after the project is completed. While it appears the city is holding the money as its final bit of leverage in the deal, the developer is holding $163,000 it owes the city for repayment of the HUD loan as its own leverage in prying loose the cash in question.


Complicating the dispute is the fact that many of the people who worked on the deal are no longer with the city. Then-City Manager Bill Pupo has left, as will acting City Manager Pete Fortin this week. And in a switch akin to Steve Eugster's move from critic to councilman, Stan Schwartz, the assistant city attorney who worked on the HUD loan, has joined the private firm of Witherspoon Kelly, the same firm that represents the developers he once negotiated against. The three remaining officials who worked closely on the project are City Attorney James Sloane, Assistant City Manager Dave Mandyke and Director of Community Development Mike Adolfae. And Sloane's future is uncertain, as many believe the new majority on the city council intends to somehow instruct their surprise city manager appointee Henry Miggins to remove Sloane from the post he has held for 27 years.


"With all the changes in personnel over there, it's a little difficult to know who, precisely, we're supposed to deal with, " says Swinton.





DIGGING OUT


The uncertainty surrounding what that new council majority will do about the underperforming garage is what has people so nervous. Talk of lawsuits erupting over the deal and worries over defaulting on the bonds stem from the suspicion that the council will seek a way out of the three-year-old deal. The only way default could be triggered at this moment is if the council chose to revoke its participation in the project, specifically in the pledge of parking meter revenues to cover any operating shortfalls in the garage. Then again, if nothing is done, it appears default could come on its own as soon as July.


One longshot legal remedy that is starting to be at least floated is to somehow renegotiate the purchase price (which appears to have been inflated by the Walker Study) and/or the ground rent (which has made it difficult for the garage to succeed). The problem is that both figures are so wrapped up in the financing plan that to change either or both would cut out the heart of the deal - a deal so ironclad, officials say it would be extremely difficult to renegotiate. Proving that the city was misled on the value of the property is also made more difficult because of the council's failure to act on repeated warnings about the Walker Study.


Meanwhile, there's a legal argument being offered by Eugster that says that since the garage is losing money, any funding granted it would be a gift, and cities can't pledge money without guarantee of repayment. While it's a clever argument, it's essentially the same one he made before the state Supreme Court in 1998 - and lost on. The court held that since the city will be given ownership of the garage after the bonds are paid off, any payments along the way are legitimate. In its ruling, the court did add, however, that, "the wisdom of the plan is not for this court to consider. "


As for somehow abandoning the parking meter fund pledge, it's almost impossible for a council to rescind contracts signed by previous councils, but there are ways to get the same result through the back door. Some have suggested the parking meter fund should be emptied out and not refilled. But the repercussions of precipitating a default on the bond payments would likely create a mess for the city much bigger than the mess that is perceived to exist at the garage. Koegen says the city's future ability to issue bonds would be crippled, calling into question such potential projects as the Davenport Hotel improvement district, a street improvement bond and an expanded convention center. Additionally, he says bond markets often lump regions in with municipalities, meaning a default by the city of Spokane could hurt economic development efforts in the county and North Idaho as well.


At least one council member is concerned about the possibility of somehow triggering a default: "My priority is I don't want to see the city's bond rating threatened, " says Cherie Rodgers, who joined the council just a week after the pivotal January, 1997, decision.


But how to stay out of default may be a moot point, as the PPDA expects the garage to be in technical default all this year. In the world of bonds, technical default is when you are losing money but you can still, somehow, make your payments; true default is when you can no longer make your payments. Despite the relatively soft blow of losing $16,000 between September and December of 1999 (not the $150,000 that made its way into some media reports), Novak says the PPDA expects the garage to lose a much as $150,000 per month for the foreseeable future.


The bond payments are made twice a year, in February and August, and the one made just this week was the last that relied on money that was built into the bond issue to cover the first few payments. Now the garage is on its own, and the August payment looms as the day of reckoning.


Some don't see things so darkly and say the best thing for the council and the city to do is stay the course and hope that enough cars materialize to grow the garage's revenues out of their current shortfall. But Novak and Koegen seem to think that it's time to admit that the original plan isn't working and consider refinancing the bonds, thereby making the payments a little easier to swallow. Beyond the obvious financial concerns, one of the key reasons Novak cites for considering such a move is to possibly remove the parking meter guarantee from the deal altogether. His motivation, he says, has as much to do with politics as it does with money.


"If we don't solve this thing before the next election, every budding young politician will see downtown projects as toxic, " predicts Novak.


Indeed, the parking garage issue has already played a part in consuming a handful of local political careers, including Geraghty's.


Whatever the motivation, conventional wisdom says refinancing, if it's even possible, will cost the city a bundle (albeit over time) from higher interest rates and additional fees and commissions (costs that might be avoided if the right kind of buyer could be found for the new bonds).


Koegen says right now he doesn't know how expensive refinancing could be, but he wants to have the PPDA (with money the city loaned it on Monday night) study the issue. To do that, Novak and Koegen are expected to hire some of the nation's top consultants - Lehman Brothers and Keyser Marston, so far - to give any financing plan that may emerge a sterling pedigree (ostensibly to counteract any bad publicity the overall project has generated). They seem to be operating with a great deal of urgency, suggesting they see no future for the garage if the wait-and-see approach prevails.


While any decision to refinance the bonds that may come in the next few months could offer salvation to the garage - and all it represents, most importantly the city's commitment to keeping downtown Spokane vital - it would also, by definition, be an admission that the original plan was a failure. Deciding to redo the entire deal would provide the final proof that, for whatever reason (a flawed Walker Study, overzealous boosterism), the city failed, proclamations of due diligence notwithstanding, to deliver on promises it made to its citizens when it went into the parking business. F





Sidebar one





The River Park Square parking garage's failure to thrive is better understood by looking at its monthly expenses. Public Parking Development Authority (PPDA) officials estimate that the garage will bring in about $120,000 per month at least until the second phase of the mall is open and more shoppers start using the garage:





Facility lease payments:


$143,500/month


This is the amount paid to the Spokane Downtown Foundation by the PPDA to lease the garage. This figure reflects the cost of the bond payments, which will ultimately offset the purchase price of the garage. This number will increase to $185,470 in August.





Ground rent: $63,750/month


This is paid to the developer by the PPDA for use of the land under the garage.





Operating expenses: $63,000/month


This is the amount it costs to run the facility. The number is provided by River Park Square, which has operated the garage since it opened. Now, however, the PPDA is assuming that responsibility and will hire a professional parking management firm to operate the garage. Proposals are now being reviewed, and the proposals could promise a level of expense below the current figure.





Grand total: $270,250/month





- estimated income: $120,000/month





= estimated monthly loss:


$150,000/month





Since the garage's revenues are expected to be used to pay off the bonds that were issued to buy the expanded garage from the developer, the operating deficit suggests the current financing structure simply won't work and that falling into true default is only a matter of time. This is why PPDA officials are considering refinancing the deal. As for the parking meter fund, it was pledged to cover any shortfall in ground rent or operating expenses, not facility lease payments. Since projected income even falls short of the facility lease payments, the question becomes how that difference will be made up. PPDA officials say they hope to remove the parking meter pledge altogether if the bonds are refinanced. At the end of the life of the bonds, the city will be given possession of the garage structure, but not the property beneath it. - T.M.





Sidebar two





One confusing aspect of the River Park Square deal is understanding the difference between the bonds and the loan that were used to fund it. The $31.4 million in municipal, tax-exempt bonds that were issued by the Spokane Downtown Foundation (on behalf of the city) were used to fund the purchase of the parking garage from the developer (the total purchase price is $26 million).


The bonds, which have barely managed investment-grade ratings, had to be strengthened by the addition of the parking meter fund pledge (which can't fund payments but can fund operating shortfalls in the garage). Prudential Securities ultimately placed the bonds with institutions, like fund managers. This is seen as a strength since institutions are not as easily spooked by the threat of default as individual investors can be.


And that threat appears vey real; in fact, the bonds are already in technical default and may reach true default status by July. The initial bond issue included funds to cover payments through this month, but starting in March, the garage is on its own. Payments are made by the Spokane Downtown Foundation twice a year, in February and August, but the garage funds those payments monthly, so true default may wait until July or August - when the next real payment hits.


The $23 million loan, which was granted by the federal Housing and Urban Development agency, was secured by the developer to help fund the construction of the entire project. The developer was able to access the low-interest loan since it was partnering with the city on a project that was expected to have a positive impact on the city through job creation. The developer repays the HUD loan, which doesn't appear to be in long-term jeopardy (although there is a squabble currently which has led to the developer to withhold its payments on the loan).


The remainder of the project was funded through the developer's cash and loans from U.S. Bank.