Banks warn of impacts for breaking Anchorage LIO lease
Editor's note: This story has been modified from the first version posted online to reflect the owner of the Anchorage office as 716 West Fourth Avenue LLC, of which developer Mark Pfeffer is a member, and to include the correct number of appraisals on the building which was four and not three as originally written.
The Alaska Legislature’s 10-year lease on its 64,000-square-foot office building in Anchorage has become a political football, possibly a preview of fireworks to come in the 2016 legislative session.
Some legislators are pushing for the state to break its lease on the new building, which was signed with 716 West Fourth Avenue LLC, an Anchorage-based company whose members include developer Mark Pfeffer and longtime building owner Bob Acree.
The Legislative Information Office, or LIO, is on 4th Avenue in downtown Anchorage, and includes adjacent parking for the building.
“We’re leasing a Cadillac at a time when all we can afford is a Chevrolet,” said Sen. Gary Stevens, R-Kodiak, the current chair of the Legislative Council.
The Legislative Council, a House-Senate committee that manages the Legislature’s affairs when not in regular session, will meet and possibly decide the issue Dec. 19.
One option being considered is purchasing the building outright from 716 West Fourth Avenue LLC. Pfeffer said he is willing to sell the building for less than $38 million, which includes financing costs for issuing bonds to pay off the existing debt, and making the building owners whole on their investment.
Pfeffer briefed the Journal on the project Dec. 14.
One concern that has surfaced is the effect of a cancellation on the state’s reputation in the financial community, particularly at a time when national credit rating agencies are watching Alaska closely.
Pfeffer also said Dec. 14 that he would pursue legal recourse against the state should the Legislature break the lease.
The cost of the project was $44.5 million, including $2.89 million spent to purchase an older building formerly home to Anchor Pub adjacent to the legislative building. The cash equity held by Pfeffer in the building is $9 million.
The final tab also included the cost of improvements needed by the Legislature. The lease was signed in September 2013.
Critics now argue the $3.3 million annual rental cost is too high, given the state’s current financial condition, and that cheaper space is available.
The alternative space the critics, including Stevens, point to is the state-owned Atwood Building on 7th Avenue, which is used by state agencies and the governor.
Stevens said there is space in the Atwood Building for legislative offices and that state agencies would not be displaced.
However, the state’s financial community is worried over the effect a lease cancellation would have on the state’s overall financial credibility, which is already under stress because of the sharp decline in oil revenues.
“We alert you that this action will likely impact the state’s credit worthiness and the cost of borrowing in the future,” wrote Steve Lundgren, president of the Alaska Bankers Association, in a sharply worded letter sent April 8 to budget conference co-chairs Sen. Pete Kelly, R-Fairbanks, and Rep. Mark Neuman, R-Big Lake, when the breaking of the lease was first raised.
“Doubts about the state’s willingness to service its obligations will reverberate, and cause lenders and investors to begin a focused reassessment of notes and securities where the source of payment is the state.”
The state Senate had voted to not make the payment on the lease, in effect breaking it, in its version of the operating budget. The House budget included the rent payment.
The bankers association was strongly opposed, enough a meeting was held on Easter Sunday to vote and draft the letter.
The payment was ultimately approved in the final state budget.
Lundgren expanded on his comments in an interview with the Journal on Dec. 15.
“Our association’s comments do not speak to the issue of the building or the lease but mainly to the statewide impact that could occur on all state leases,” or building space, he said.
If an Alaska bank helps finance a building that will be occupied or partly occupied by a state agency, “the institution would look to the strength of that lease. If there is an annual ‘out’ clause in the contract it is like not having a long-term lease at all,” he said.
Northrim Bank and Wells Fargo NA participated in the construction loan on the Anchorage LIO; EverBank issued the long-term loan on the building in December 2014.
Banks may decide not to lend for the building or, more likely, to raise fees for a risk premium, he said. That would trickle through to the lessee in the form of higher rent.
The consequence, if the Legislature were to renege on the 4th Avenue building lease and move to the Atwood Building, the cost of rentals for any agencies would climb because building owners will build in a risk factor for a similar lease cancellation by the state.
There may also be broader ripple effects, for example if the state moves to borrow money for state capital projects and to finance future state retirement pensions through bonds as Gov. Bill Walker is proposing.
All state obligations and contracts have a “contingent on appropriations” clause, but that authority has rarely been used.
Stevens said he recalls it having been used with a lease on an office building in Juneau, although the circumstances of the matter were not described, and also was told the state administration has used it two or three times on other state leases.
None of those are as high profile as the new Anchorage building, however.
Meanwhile there is also a lawsuit filed by Anchorage attorney Jim Gottstein, owner of an older building adjacent to the new LIO that Gottstein claims was damaged during construction, and that the new lease is illegal.
Gottstein claims the rental contract violates a state requirement that rates on lease extensions, which is the way the Legislature chose to structure the deal, must be at least 10 percent under prevailing rates in the market for comparable space.
The lease rate is above the prevailing rates, Gottstein said.
Pfeffer disputes that and cited several appraisals by Northrim, Wells Fargo — who both appraised the building at $44 million in value — and an independent appraiser, Waronzof and Associates, that was hired to do the analysis under the direction of the Alaska Housing Finance Corp., a state agency with experience in commercial building development.
Waronzof estimated the cost of the project at $48.5 million with and estimated rental rate, on comparable space at $3.9 million annually. That is to be compared with $3.38 million to be paid annually under the Legislature’s lease with Pfeffer.
Pam Varni, executive director of the Legislative Affairs Agency, which provides administrative and legal services to the Legislature, signed off on the appraisal in a Sept. 19, 2013, letter to the Budget and Audit Committee.
“The annual rental payment (to Pfeffer) will be $281,638 per month or $3,379,658 per year, exceeding the 10 percent reduction in market rental value,” required by law, Varni wrote.
“Our annual savings will be $528,341,” in contrast with the comparable lease rate determined by the independent appraiser, she wrote.
There is a tangled history to the new legislative office building. The old building, constructed in 1972 was first leased by the Legislature in 1992 from longtime owner Bob Acree. Pfeffer became a partner in the building later.
There were multiple extensions of the original lease, including five one-year extensions from 2009-13.
The building was aging and one-year lease extensions did not allow for major investments in upgrades. Its one elevator was among the slowest in the state. It was not compliant with Americans with Disabilities Act, lacked secure parking, proper meeting spaces and on-site IT equipment.
(Note: This writer was once stuck in the elevator with nine people for three hours, with the emergency phone connected to an answering service in Nebraska.)
The Legislature began looking at new options in 2007, one being a rebuilding of the old Anchorage Times building also on 4th Avenue that is owned and used by the Alaska Court system and other a rebuilding and conversion of the state parking garage on 7th Avenue, which is across from the state’s Atwood Building.
The state Department of Administration said no to the conversion of the 7th Avenue parking garage, however, and the conversion of the Anchorage Times building also did not proceed, although it is not known why.
The former Unocal (then Chevron) building on 9th Avenue was also looked at, but the building was purchased and occupied by NANA, the Kotzebue-based Native development corporation.
The Legislative Council then began a long process of Requests for Information, or RFIs, and Requests for Proposals, or RFPs, to solicit information on available space or request actual proposals from building owners.
There were 12 of these over the years, Pfeffer said, including “government-to-government” solicitations for space from other state agencies.
The requirement was for 35,000 square feet of usable space and dedicating parking. There were 28 responses to the various solicitations with proposed locations on Klatt Road, in south Anchorage, and in east Anchorage.
“At that time the Legislative Council also took a vote to indicate a preference for staying downtown,” Pfeffer recalled.
By 2013 the building “was getting into rough shape,” he said, but one-year lease extensions did not allow for major investments in upgrades by a building owner.
Through all of this no one suggested moving the Legislature into the Atwood Building, Pfeffer said.
Council makes call
In early 2013 the Legislative Council decided a major decision needed to be made. Rep. Mike Hawker, R-Anchorage, then the council’s chair, was authorized to request proposals for major renovation or even reconstruction from Pfeffer, the building owner.
Pfeffer said he responded with three options:
“One was essentially new carpeting and paint, which wouldn’t have changed the lease rate; a second was a more extensive renovation and included work on the elevator, which would have added to the rent,” he said.
A third option was a full modernization, essentially a new building.
In May 2013, the Legislative Council agreed the last option, full modernization and reconstruction, was best, but also put out one more RFI to see if any other space was available.
Former Rep. Bill Stoltze, R-Chugiak (now a state senator) was a member of the council and asked that the entire Municipality of Anchorage, from Girdwood to Eklutna and included Stoltze’s Chugiak district, be surveyed.
There were two responses, one in a building at 64th and A Street, the Carr-Gottstein building in a South Anchorage industrial area, and a second between Northern Lights Boulevard and Fireweed Lane, on streets where there are large buildings occupied by engineering firms.
Both options were rejected by the Legislative Council.
In June 2013, the council authorized Hawker to ask Pfeffer to develop a proposal for “full modernization.”
This required a scoping out of space needs and uses. Two new elevators were needed as well as meeting rooms on the first floor, so members of the public could have easier access. Security was also to be provided for parking because of safety concerns in the old, unprotected underground parking.
There was also to be a facility for emergency power. That was not in the old building.
Off-street access by trucks was also needed for the twice-yearly loading and unloading of equipment and files to be moved to the state capitol building in Juneau for annual the legislative session.
In the old building the trucks blocked off part of 4th Avenue for loading and unloading. Also, in the old building all of the Legislature’s information technology services were in other locations. All of the “IT” was brought into the new building.
Pfeffer developed a proposal for the building incorporating all of these needs including a rough estimate of the annual lease rate, about $3 million a year.
A period of cost validation followed, conducted by Alaska Housing Finance Corp.
The scoping of needs for the new building was done over an 11-week period from June through August 2013, and involved legislative staff, the Legislative Affairs Agency and others, about 60 being engaged at different times.
Hawker was authorized to proceed to execute a contract with Pfeffer in August 2014, but the council also asked if the state could purchase instead of lease the building.
Pfeffer said he would be agreeable but the legislators decided to stick with the lease option. The contract was signed in August of 2014, but did not include a sale option clause.
Four appraisals were completed on the building. Two were done in 2013 by the banks providing construction financing, Northrim Bank and Wells Fargo, and both came in at $44 million, close to the actual cost.
A third appraisal was done by EverBank, which took out the long-term debt on the building, in December 2014. That also came in at about $44 million. The fourth was done for Alaska Housing Finance Corp., which came in at $48.5 million.
The reconstruction began in late 2013. It was finished on time and legislators moved into their new offices in December 2014.
Stevens, who is chair of the Legislative Council, said he hopes the council will make a decision Dec. 19 that will end the political wrangling.
He would like to see the committee vote, with finality, to either buy the building from Pfeffer, to stick with the existing lease or to terminate it and move to the Atwood Building.
“One concern I have is that with state money getting tighter the very expensive lease in Anchorage will drain funds for the Legislative Information Offices in other parts of the state,” Stevens said.