A plan to sell and lease back 11 state-owned office properties to help bridge California’s $19 billion budget gap has taken a twist, with one of two final proposals more akin to pawning the buildings than selling them.
A unique proposal from the California Municipal Finance Authority and a Boston private investment firm amounts to a second mortgage that would keep the buildings in public hands, according to real estate analysts who have reviewed what’s known of the proposal at the Business Journal’s request.
Some critics said it amounts to a convoluted way to issue more debt, and the state would be better off simply unloading the buildings.
“We are in debt up to our eyeballs and now need to find fancier ways to borrow money?” asked Adrian Moore, vice president of research at libertarian think tank Reason Foundation, who supports the idea of a straight-ahead sale and lease-back.
Under a typical sale-and-lease-back arrangement, an owner agrees to sell a property and then lease space in it from the buyer. That way, the seller gets a big, up-front payment from the deal, although it commits to paying rent as a tenant.
The plan by the authority – which is an independent state agency that finances economic development projects – would involve selling tax-exempt bonds and using the proceeds not to buy the properties but to pay for a long-term lease of them.
The partnership would then lease the office space back to the state for an undisclosed period. Ultimately, the state would take back ownership.
One person familiar with the arrangement called it a “lease lease-back” instead of a “sale lease-back.”
The other final bidder is an investment group managed by Hines Interests LP, a Houston commercial real estate developer and manager, according to industry trade publication Commercial Mortgage Alert. Its proposal is said to involve a traditional sale and lease-back.
The sale of the properties has been trumpeted by Gov. Arnold Schwarzenegger as a way to generate cash to help close the largest state budget deficit in the nation. The plan was approved by the Legislature in June 2009.
The state’s Legislative Analyst’s Office said in a report issued April 27 that the sale could produce proceeds topping $600 million after outstanding debt on the buildings and transaction expenses were paid. A decision on the matter is expected in the coming weeks.
Some Democratic leaders oppose the sale of state offices, so the finance authority proposal would appear to split the difference: it would generate up-front revenue for the state while keeping the buildings in state hands.
However, a key downtown L.A. Democrat who is opposed to the sale said he disliked what he heard about the finance authority plan after it was described to him by the Business Journal.
“(It’s) a more complicated way of doing what we shouldn’t be doing,” said state Sen. Gilbert Cedillo.
The governor’s January budget proposal had assumed a sale price of about $1.7 billion, but the offers by finalists are believed to be higher. According to published reports, the state has received more than 300 bids, including multiple offers that value the properties at more than $2 billion.
The 11 properties include 24 buildings, some of which the state already owns outright and others that would have been paid off over the next decade. Two of the buildings are in downtown Los Angeles, and house many key government agencies and bodies.
The Ronald Reagan State Building at 300 S. Spring St. is the larger and more prominent of the two downtown L.A. properties. Built in 1989, it totals 739,000 square feet, and tenants include the Department of Justice and Department of Financial Institutions.
The second local property, the Junipero Serra State Building at 320 W. 4th St., is an older, 519,000-square-foot building. Constructed in 1914, the 10-story building houses the Department of Corporations, among other agencies.
Among other prime properties in the 7.3 million-square-foot portfolio are the San Francisco Civic Center, the Elihu Harris Building in Oakland and the Capitol Area East End Complex in Sacramento.
The state’s Department of General Services, which is handling the auction, has declined all comment pending the selection of a winning bidder. The Governor’s Office and the Boston firm partnering with the finance agency, named AEW Capital Management, did not return calls. Hines also declined comment.
The plans
The proposal from AEW and the finance authority also is being seen by some as a way for the state to circumvent a change in the law put into effect by Proposition 58, a successful 2004 ballot measure backed by Schwarzenegger. It banned long-term borrowing to cover budget deficits.
By creating a joint proposal including a private company and the finance authority, which has the ability to issue bonds to finance state and municipal projects, Moore said the state would be circumventing the law.
“It is just a way to utilize a loophole in the law and borrow some more money – as if the state hasn’t borrowed enough money in the last 10 years,” said Moore, who said he had never heard of such a plan but characterized it as “basically taking out a mortgage.”
Out of 17 prospective buyers who made it to the second round of bidding, the AEW and finance authority proposal was the only one that did not include the traditional sale-and-lease-back structure proposed by other buyers, according to trade magazine Real Estate Finance & Investment.
AEW, a subsidiary of New York-based asset manager Natixis Global Asset Management LP, buys and owns properties on behalf of institutional and private clients.
The authority plan specifically calls for the issuance of $2.75 billion in tax-exempt revenue bonds to generate cash to lease the properties for an undisclosed period, believed to be in the range of 20 to 50 years. The bonds would pay about 5 percent, and a trustee would be appointed by the partnership to collect lease payments from the state on behalf of bondholders, according to the trade magazine.
It is unclear whether all that money generated by the bond sale would be given to the state as an up-front payment or whether there would be payments or some other arrangement. It is also unclear what the partnership has offered to pay for the properties and if it is less than the Hines-managed offer. The trade magazine reported AEW would not put capital into the deal but would still draw fees as the asset manager. Also, a brokerage would be hired to manage the properties.
However, for all the work put into developing the proposal, it is possible it will not come out a winner. The traditional sale-and-lease-back proposal involving Hines was said to have the “inside track” in a June 18 story in Commercial Mortgage Alert.
The Hines proposal includes financing from investment bank JPMorgan, according to a source with knowledge of the deal. Hines has extensive real estate holdings in California, including downtown L.A. office towers Union Bank Plaza, Citigroup Center and Figueroa at Wilshire.
JPMorgan did not return calls.
The situation
The details of the proposal are not only being kept from the public but apparently from key officials.
The State and Consumer Services Agency, which oversees the Department of General Services, denied a request by the Assembly’s Accountability and Administrative Review Committee for details on the bidders, according to an Associated Press story.
However, committee Chairman Hector De La Torre, D-South Gate, has introduced a bill that would require a 50-year cost-benefit analysis of the potential deal and legislative approval of the transaction. The bill, approved earlier this month on the Assembly floor by a unanimous vote, could be ready for Schwarzenegger’s signature as soon as the first week of August. It’s unclear whether the governor intends to sign or veto it.
De La Torre declined comment on any of the proposals but said he generally considers lease-backs to be financial gimmickry. He cited findings in the report by the Legislative Analyst’s Office that found leasing back the properties would cost the state $200 million more each year than maintaining ownership.
“It just doesn’t pencil out in the long term,” said De La Torre. “Again, this policy of owning being preferable to leasing is a policy that has been supported by Democratic and Republican governors for years. I am not supporting some crazy, wild-eyed idea.”
