Michael Brydon: View from the West Bench

Friday, July 07, 2006

Vision only as strong as its underlying economic model

Op-ed column in the Penticton Herald: 20 Jan, 2006

I submitted a letter to the editor in mid-2004 that was critical of the South Okanagan Events Centre (SOEC) for being out of step with Penticton’s future demographic reality. I was subsequently chided (albeit gently) by a number of people for failing to get behind a fantastic opportunity for the community. This is fair enough: many people have invested significant time and talent into developing a vision for the SOECC and the last thing they need is negativity from people without a vision. But a few days ago, I drove past the former Ford Theatre for the Performing Arts in Yaletown (built for $27M, sold three years later for $7.75M) and was reminded that a vision is only as strong as its underlying economic model.

According to the numbers being circulated, the SOEC will cost roughly $30M to build. The provincial government has agreed to contribute almost $10M so, if we take the land as free, pretend that a contribution from federal government will offset the $10M or so in site preparation and relocation costs, and assume no cost overruns, the outstanding capital cost is $20M. The cost of financing $20M over 50 years at 5% is roughly $1.1M per year. In their initial feasibility study, International Coliseums Company (ICC) estimates that the facility will generate roughly $2.6M per year in revenue and cost roughly $1.7M per year to operate. This leaves about $0.9M per year to apply to financing costs. The ongoing annual shortfall of $200K is modest (the parks and recreation budget for the city is $6.3M), but we should recognize that the ICC numbers are based on some conspicuously rosy assumptions.

As others have already pointed out, ICC makes money by building and operating facilities, not by preparing feasibility analyses. Given that operating fees (roughly $130K/year in this case) typically come off the top line, the city, not its operating partner, bears the risk of overly optimistic revenue projections. There are at least three problems with the initial feasibility analysis that suggest that the revenue projections are indeed optimistic. First, the revenue from the major tenant, the Penticton Vees, is double-counted. Specifically, the city’s cut of revenue from 30 games x 1800 spectators plus rent and “ticket surcharge” is included in the SOECC’s feasibility analysis even though the bulk of this revenue is not new to the city. In reality, the money appearing in the revenue model for the SOECC is offset by a gapping hole in the revenue model for Memorial Arena. Second, the projected operating surplus for the SOEC includes a significant contribution (approximately $350K annually) from pay parking. The problem is that the parking space for the SOECC is contiguous with that of other community facilities. As a consequence, anyone who is unlucky enough to have a swimming lesson, minor hockey practice, or concert that happens to overlap with the 143 events scheduled for the SOECC each year will either be stuffing $2.25 into a meter or buying an annual pass. This seems to me more like a tax on people with kids than a legitimate revenue source for a premium facility. Finally, there are the attendance estimates themselves. The largest non-hockey sources of gate revenue for the facility are projected to be concerts and “thrill shows”. ICC, based on its experience operating other facilities, predicts 22 events per year with an average attendance of 3,500 per show. Unfortunately, our limited experience with this type of event in Penticton suggests that these estimates are high. For example, the rodeo held Memorial Arena last fall attracted crowds in the hundreds, not thousands.

Even if we ignore double counting and attendance estimates that are off by an order of magnitude, it is clear that the SOECC will never spin enough cash to cover its costs. This is true whether the facility is financed by the city alone or with a private-sector partner (which invariably has a higher cost of capital and a shorter investment horizon). Unfortunately, no one seems willing to face up to the inevitable consequence of building such a facility: it will cost taxpayers money. Instead, we are being treated to some suspicious economic reasoning. For example, we are told that casino revenue can be used to cover the shortfall and that this is somehow preferable to using tax revenue. As others have already pointed out, this is nonsense. We are also told that the indirect economic benefits of the project more than compensate for its costs. But a short-term economic stimulus only makes sense when the target of the stimulus has idle capacity. The construction industry here and elsewhere is having difficulty satisfying existing demand. Rather than stimulating the construction industry in a positive way, the SOEC will lead to increased costs and delays for other projects in our region. The result is a costly distortion in which public spending crowds-out private investment.

The single most important factor that makes the SOEC worth considering despite its challenges is the $10M contribution by the province. As much as many of us despise the notion of spending $30M on an events center while those needing emergency care in our crumbling hospital are made to wait for hours in a linen closet, it is pretty clear that if we decide to pass on the SOECC, the money will not end up not in our hospital, but in some other community. Plus, there are other considerations: the prospect of more ice, bigger ice, comfortable seats with room for legs, and the cachet of having some Finns or Belarusians living among us for few weeks before heading to the Olympics. These may be modest benefits. But spread over the Penticton and surrounding RDOS tax base, the annual cost per household of subsidizing the SOEC may also be modest. The problem is that it is impossible to know whether we are talking about $10 or $100 without a realistic, informed, and objective economic reckoning. And, despite a looming deadline, we still have not seen one.

0 Comments:

Post a Comment

<< Home