City Admits It Made Corporate Welfare Deal
City overpaid Pine Street developer
Copyright 1997, Seattle Times Co.
Skirting the state constitution, the city of Seattle intentionally overpaid a developer in order to close the deal that moves Nordstrom into the Frederick & Nelson building.
While critics have assailed a federal loan that paved the way for the retailer's new downtown home, they've missed a second key to the deal: millions of city dollars pouring into a giant hole across the street.
It's a parking garage - underground, out of the limelight and under construction as part of an ambitious three-block commercial complex anchored by Nordstrom's new flagship store.
When the 1,200-space garage is complete sometime next year, the city of Seattle will buy it for $73 million - even though it is expected to cost about $50 million to build.
The difference - as much as $23 million - will go into the redevelopment project, and some of it could wind up with Nordstrom.
A direct cash contribution to the developers or Nordstrom would be illegal under a state constitutional ban on giving public money to private businesses. The city circumvented that law by funneling the money through the garage.
In essence, the developers named a price and the city agreed to pay it, without basing the amount on actual costs or taking competitive bids.
It's not possible to say precisely how large the excess payment is because no one in the city can account for what the $73 million specifically pays for, and the developer won't say.
Pine Street Development is a group of individual and institutional investors headed by Jeff Rhodes and Matt Griffin. They engineered the $400 million project in the heart of downtown Seattle, buying the massive, abandoned Frederick & Nelson building in 1996 and swapping it to Nordstrom for its smaller store across the corner of Fifth Avenue and Pine Street.
Nordstrom is renovating the Frederick's building and will move its headquarters and store there next year. Pine Street Development plans to turn the current Nordstrom into a retail and office complex, and is already erecting Pacific Place, a five-story shopping mall and parking garage one block to the east.
All along, city officials have indicated that the public is paying only for a garage, not subsidizing the redevelopment project.
But they never disclosed the difference between the cost and price of the garage. The Seattle Times recently discovered the gap by examining a construction budget the developer filed with the state.
State auditors, who help enforce the ban against government subsidies, were unaware of that gap. Now that they know, they say they'll review it as a potential violation.
Mayor Norm Rice says he signed off on the high price for the garage because it was an essential step in revitalizing downtown Seattle.
"We wanted to make sure we had a healthy downtown with an investment and attractiveness of a facility that would make people come, feel good and stay," Rice said.
But he said he couldn't explain exactly what the extra money bought.
Tom Weeks, a former City Council member who chaired the Finance Committee when the garage project was approved in 1995, says he knows what the extra money purchased: the redevelopment deal.
"It wasn't that we wanted to build a garage. It was that we wanted a Nordstrom development and a development on the (old) Nordstrom block," said Weeks. "It was presented to us as all or nothing."
Weeks said he knew the city was paying more than the cost of the garage. But he didn't know how much more, and he never asked.
A 1995 memo from the city's Office of Economic Development to City Council members shows officials knew Pine Street Development would come out ahead on the garage deal. The memo contains a brief financial analysis that concludes the "yield" from the sale would help the developer "offset" losses from giving Nordstrom a good deal on the old Frederick & Nelson building.
Parking experts say the only explanation for the large spread between the cost and price of the garage is that the city is subsidizing the developer.
The $23 million spread is "a big difference," said Roamy Valera of the International Parking Institute, the industry trade association.
"It looks like what they're saying is, `We can't give you anything directly. But if you build it, we'll buy it for this price and that's how we'll give to the project.' "
"Someone is making one hell of a profit," said Richard Rich, a Michigan parking consultant. "It's too easy to see through this."
Nordstrom gets $20 million
Dwight Dively, city finance director, defends the price by pointing out that the city gets some extras beyond the bricks and mortar.
The developer assumes all the financial risks of the garage during construction and runs it for six months before turning it over, he said. And the city gets various guarantees, such as control over the historic facade of the Frederick's building and a pledge that a portion of the work on the entire Pacific Place complex would go to women- and minority-owned firms.
But Dively concedes that, like the cost of the garage, no one assessed the dollar value of those extras.
"A parking garage's value is the price you're willing to pay," he said.
The parking experts say the construction deal will cost the city twice the national average per parking stall, even after taking into consideration the higher costs of an underground facility in an urban center.
While city officials are confident they will make a long-term profit, they also expect to lose money the first few years of operation, as parking revenues fall short of payments.
And by taking out a loan to buy the garage at such a high price, Seattle won't be able to borrow as much in the future for other projects.
When the $73 million payment is made to the developer, as early as next November, the city will use up nearly one-third of the $220 million it will have available for long-term, nonvoted debt. That's tantamount to using a third of a credit limit on a personal credit card.
Griffin confirmed that garage construction is costing $50 million but would not provide specifics on how the remaining $23 million would be used.
"Our obligations with the city are basically to provide all the items of value that the city has required. It is not to tell the city how we spent the money," he said. "The costs that it takes for us to provide those items of value are really our problem and our private issue."
Nordstrom could receive as much as $20 million from the garage sale proceeds. That's how much Pine Street Development owes Nordstrom to offset the expense of renovation for its new store. The debt is due soon after the city is scheduled to pay for the garage and could come out of the proceeds, he said.
Nordstrom officials, meanwhile, say they don't know where the $20 million they're owed is coming from. Nor do they care.
"It's not in our interest, nor our concern," said spokeswoman Paula Stanley. "Yes, the developer owes a payment. They need to determine how they make that payment."
What's important, Griffin said, is that the city's purchase of the garage made the project possible. The project is critical to downtown revival, he insisted.
City officials agree. One 1994 report predicted that the Pine Street-Nordstrom development would generate $82 million in new tax revenues between 1997 and 2013.
The genesis of the deal
Four years ago, city officials were sure downtown Seattle was in danger of dying.
Frederick & Nelson, once a jewel in the city's core, had gone out of business after a long decline. I. Magnin and Klopfenstein's and other family-owned businesses were close behind.
Seattle seemed to take the Frederick's closure particularly hard. More than a department store, its regal building and rich traditions - from Frangos to photo sessions with Santa - were part of the city's heritage. But by the early 1990s, shoppers were turning away from downtown amid coad open arms.
Watt had been charged by Rice to come up with a plan to revitalize downtown, and in particular to find a taker for the Frederick & Nelson building.
There were plenty of ideas floating around. But Jeff Rhodes, a developer and founder of Pine Street Development, made a pitch Watt loved: How about nudging Nordstrom to move into the vacant Frederick's building and creating a high-rise retail complex and underground parking on the property across Sixth Avenue? The current Nordstrom site could then be converted into more retail and office space.
Watt was impressed by Rhodes' credentials. New to Seattle's business community, Rhodes had helped build high-profile retail projects in other cities, most notably Copley Place in Boston and Water Tower Place in Chicago.
"The most attractive thing about Jeff was that he wanted to secure Nordstrom in the Frederick & Nelson building, and Norm and I had pretty much agreed that that was the optimal plan," Watt said. "It secured not just Nordstrom's retail operation in downtown, but their office workers downtown."
Indeed, from the mayor's point of view, Nordstrom was central to Seattle's future. Throughout the 1980s and '90s, the company was strengthening its position as the country's most popular upscale retailer. No one, city officials thought, had more stature and economic backbone to succeed in the 700,000 square feet of space in the Frederick's building.
But Nordstrom had grown accustomed to being wooed. Cities across the country had tripped over themselves trying to lure the retailer to their shopping malls, most of them in growing suburban neighborhoods. The enticements had included tax breaks, neighborhood improvements and parking garages.
Seattle, on the other hand, was trying to get Nordstrom to take on a mammoth structure built in 1918 and needing millions of dollars in renovation. It also faced a state law that prohibits cities from giving money or lending credit to any business.
Rhodes insisted the project couldn't work without public financial assistance. And Watt wasn't about to let the vision slip away; moving Nordstrom into the Frederick's building was too important. Watt says he went to the city's Office of Economic Development and "asked what we could do" to support the project.
The answer: a $24.2 million low-interest loan financed through the federal Department of Housing and Urban Development (HUD). With it, Rhodes would be able to save about $6 million in interest when he purchased the Frederick's building. The city wouldn't have to worry about the constitutional prohibition, since it doesn't apply to federal funds.
The federal government had loosened rules for such low-interest HUD loans, and consultants said the city could qualify by declaring the vacant building "spot blight."
They were right. HUD approved the loan, which later came under attack from critics who said the city exaggerated decay in the area in its loan application.
But even that loan wasn't enough for Rhodes and Pine Street Development. They were intent on getting the city's help to build an underground parking garage that would serve the new Nordstrom, Pacific Place, the complex in the current Nordstrom building - and the developers' bottom line.
While many other states allow direct public subsidies, Washington officials have to be creative, Watt and others said.
"We have precious few tools in the state to do economic development," Watt explained. "Here, we have Article 8, Section 7 of the state constitution, saying `Thou shalt not give public funds,' so doing a joint venture with a public garage was a way to help with the project."
City officials also agreed to support a property-tax exemption from the city Landmarks Preservation Board in exchange for Nordstrom's renovation of the building - an exemption that is expected to save the company millions. And they approved construction of a skywalk between the garage and the new Nordstrom, despite a city policy generally discouraging them.
In December 1993, after weeks of informal discussions, the principals came to a meeting of the minds over dinner at the Four Seasons Olympic Hotel. Among those seated around the table: Rice, Watt, Rhodes, one of his partners, Thomas Klutznick, and Jim and Bruce Nordstrom.
Getting bids not an option
Watt, now executive director of the Greater Seattle Chamber of Commerce, said Rhodes first asked for $100 million for the garage. No one took that number seriously, Watt said, and the price came down to around $70 million.
Watt took the numbers to the Engineering Department and asked them to determine if the city could buy and operate a garage in that price range without losing money.
He did not seek advice from any parking consultants or check construction prices on underground garages of similar design and scope.
"I was actually looking at, `What can we do that pencils out for the taxpayers?' " Watt said. "In my mind, the garage was one of the important points to getting the project done."
Watt says he went to the city law department and finance office and asked if the arrangement would be legal, and was told that it would.
In August 1994, Watt asked finance director Dively to seal the deal with Pine Street Development.
In most cases, a city that wants to add parking to downtown would choose a good site and then try to get the lowest construction price for a quality project, parking experts say. But that wasn't what Dively was asked to do. Bidding was not an option by the time the deal reached the finance director's desk. Rhodes had insisted on using only his contractor of choice.
Dively's orders from Watt: Work out an agreement that pays the developers between $68 million and $73 million.
City Council members, meanwhile, were preoccupied with other pieces of the Frederick & Nelson-Nordstrom project - primarily, Nordstrom's insistence that Pine Street between Fourth and Fifth avenues, which had been made into a pedestrian park, be reopened to automobile traffic.
Some council members expressed reservations about the garage deal. Councilmember Jane Noland was the most outspoken, complaining that the $73 million pricetag was too high. In the end she went along with the council's 9-0 vote to approve it but contended the city "has given a gift" to the developers. (Noland declined to be interviewed for this article.)
Garage is a charity project
Making the garage deal even more unusual was the use of a nonprofit middleman.
Pine Street Development recruited John Finke, director of a nonprofit firm called Community Development Properties, to own the land and garage during construction. (The reasons why a nonprofit was brought in are complicated - tied to tax restrictions on Pine Street's main institutional partner, a national pension trust fund.)
Finke arranged to get $47 million in tax-exempt financing for the garage through a program run by the Washington State Housing Finance Commission.
The commission helps charities get low-interest financing for development projects. It doesn't actually loan the money but determines whether a project meets federal and state requirements for getting tax-exempt bond financing through institutional lenders.
The garage qualified as a charity project, commission officials said, by virtue of the fact that it was being built by a federally recognized nonprofit agency formed to promote economic development.
Soon after construction on the garage began, its cost went up by $3 million, due to the unanticipated expense of removing polluted soil and giant concrete blocks unearthed in the excavation.
When the garage is completed, Finke's group will sell it to the city for $73 million, pay off the tax-exempt financing and pass along the rest to Pine Street Development, Finke said.
Rhodes hopes to use a similar tax-exempt financing scheme for a $400 million retail development in Bellevue, which also includes a large parking garage. That city does not intend to buy the 2,200-space garage, which is expected to cost $80 million, but critics contend tax-exempt financing would give Rhodes an unfair advantage over development rivals.
In Seattle, finance director Dively said the city is getting various benefits that don't necessarily cost the developer but hold value for the city. Among them:
-- The city gets an easement on the facade of the old Frederick & Nelson building to ensure it is never removed or substantially altered. Nordstrom is already restricted from making substantial changes to the facade now that the building has been designated a city landmark. That designation will save Nordstrom $10 million over 10 years.
-- The developer agreed to set aside 10 percent of the construction work on the entire Pacific Place project for women and minority firms and to urge retail tenants to hire low-income workers.
-- The city has the right to make the developer buy back the garage after 20 years and can recoup any losses. However, that's balanced by the developer's right to buy the garage at will. In both cases, the sale price would be lower than market value.
-- The city gets the air rights above the five-story Pacific Place building. This allows the city to prohibit making the structure taller.
The city is technically getting the building and land under a lease-option arrangement that is tantamount to a purchase, Dively said.
The $73 million includes $15 million for land and $35 million for the structure.
State auditor gets involved
The Office of the State Auditor, which learned of the garage deal from Times reporters last week, plans to take a hard look at it.
"I think this is something the public wants to know about," said Jan Jutte, assistant director of audits. "They have a right to know if they paid $73 million for a $50 million garage."
The state constitution reads: "No county, city, town, or other municipal corporation shall hereafter give any money, or property, or loan its money, or credit to or in aid of any individual, association, company or corporation, except for the necessary support of the poor and infirm. . . ."
The prohibition, part of Washington's original 1889 constitution, was written largely to stop the giveaways cities and towns once made to entice railroad companies. It does not apply to federal funds.
Over time, and particularly in the past 10 years, Washington's courts have given local officials latitude to determine what constitutes a subsidy. In some cases, they say finance assistance for an economic development project is legal because of "a public benefit" that improves the entire community.
But Jutte said the rules are clear: No city can give money to an individual, specific business or small group of people.
City Attorney Mark Sidran, commenting through a spokeswoman, said his office reviewed the agreement and believes it is legal under the state prohibition.
However, Sidran says he cannot provide a document specifying where the $23 million is going.
"Our office does not have a breakdown of any of these costs or the acquisition package," said Lori Mayfield, Sidran's assistant.
`I'm proud of what we did'
Even if the garage deal is found to be legal, one big question will remain: Was it worth it?
The corner of Sixth and Pine is a far cry from the shuttered windows and boarded-up doors of a few years ago.
Thousands of shoppers spill out of NikeTown, Planet Hollywood and nearby FAO Schwartz. GameWorks, a high-tech super-arcade, draws visitors from across the region. And at night, the streets are jammed with restaurant- and theater-goers.
City officials say Seattle is already reaping the benefits of the boom. Retail sales are up 5.5 percent citywide this year - a rise they credit largely to downtown - and downtown property taxes increased by $3.5 million. From Pioneer Square to lower Queen Anne, dozens of projects are on the drawing boards or under construction.
All this before the new Nordstrom and Pacific Place have opened their doors. Were they really needed for downtown's turnaround?
The mayor and other city officials insist that the show of commitment to the corner of Sixth and Pine by Nordstrom, the city and Pine Street Development provided the psychological boost that turned the tide.
"I think right now you'd be writing a story about how downtown died if we hadn't done the things we did and kicking a mayor out on a rail," said Rice, who completes his term in two weeks. "So now we have a success story and revenues coming in. . . . I'm proud of what we did for downtown."
Others say the seeds for a downtown boom began before the Nordstrom deal was struck, and that it's been fueled not by any psychological boost but by Seattle's popularity and the high-octane national economy.
Developers who brought NikeTown and other newcomers to the area around Sixth Avenue and Pike Street say they already had leases signed and had started construction months before Nordstrom and Pine Street Development made their commitments.
"We knew something was eventually going to happen with I. Magnin's and something was going to happen with the Frederick & Nelson building," said Bob Cunningham, who helped put the NikeTown deal together. "It's still one of the best locations in town."
Meanwhile, the city's money will be tied up in a project that is no sure thing. Even in the midst of these good times, the developers of Pacific Place say they are struggling.
Griffin, co-manager of Pine Street Development, says he has signed up such notable retailers as J. Crew and Williams-Sonoma for the new retail complex, but that he needs more to fill up 300,000 square feet of space.
Some of the sought-after stores have opted for other new retail centers. And Griffin still worries whether he'll have enough tenants to pay the bills. Despite the city's and Nordstrom's large commitment, Pine Street Development has had trouble putting all their financing together.
Without the city's help, the project would not have happened, he said.
"We needed all the money we could get," he said. "And it still wasn't enough. . . . It hasn't gone as smoothly as I'd hoped."