There has been a lot of debate recently about the City’s responsibility is to ensure a successful Market House for the public. (I laid out my overall views in Sunday’s guest column in the Capital). What has been noticeably absent from the debate so far, however, has been the financial numbers. The numbers are the foundation for the proposed lease with Gone to Market, and the lease can only be understood within the context of the numbers.
For those who have the time and interest, this blog entry goes into detail about the numbers. The bottom line is the Market House is not economically viable as a market-rate business proposition. A standard commercial lease would ensure that the Market House would fail.
Any way you slice it, the Market House’s profit margin is very small. Even if it is very successful, there will only be so much profit to go around. For instance, if the Market House merchants do $3 Million in gross sales, there will only be $65,000 in rental revenue remaining after paying the operating expenses. If we hit a home run and the merchants do $4 Million in gross sales, there will still only be $145,000 in rental revenue after expenses. Either way, it’s not a lot of money to split between the City and GTM.
Structuring the lease to minimize City expenses rather than maximize profits
If this lease were a true 50/50 partnership in which the City and GTM both shared equally in the operating expenses, then it would make sense for the City and GTM to share equally in the rental revenues. But this lease protects the City by placing the full responsibility for operating costs on GTM’s shoulders. GTM will be paying $175,000 per year in annual operating costs, on top of their up-front investment of more than $100,000 in interior improvements. As a result, they need the opportunity to receive a fair return in order to justify their financial risk and their investment of time and money. The lease addresses this by assigning GTM a nominal asset management fee of 2% of gross sales during years in which rental revenues exceed operating expenses. The remaining revenues are shared between the City and GTM 50/50.
It’s true that the lease is complicated. It would have been simpler for the City to simply charge Gone to Market $1 per year in rent, make GTM responsible for all operating expenses and let them keep all profits. After all, government is in business is to provide a public service, not to make a profit. Still, even though it would have been simpler to just charge GTM $1 per year, we structured the lease so that the City will still earn some profits once the Market House gets up and running.
(A brief note about the operating expenses, to address the concern that GTM can pad its operating expenses in order to avoid sharing any profits with the City: The lease requires the City to approve GTM’s operating expenses every year. In addition, GTM must submit quarterly financials to the City every three months, and an outside CPA will provide independent oversight by reviewing GTM’s books and submitting a financial statement to the City annually. Since the City’s profit sharing depends on GTM’s successful management of the Market House, the City will be monitoring revenue and expenses very closely. This is very different from the typical landlord-tenant relationship.)
The main financials and tenant and landlord responsibilities are as follows:
- The City will be responsible for delivering the Market House structure to GTM with adequate HVAC, sprinklering under the eaves (because the outside tables have been in violation of fire code for years), reconfiguring the utilities to allow for the improved layout that opens up the perimeter for customers, and installing operable windows and/or bi-fold doors to provide a more vibrant and open experience.
- GTM and its merchants will be responsible for interior tenant fit-out.
- The merchants will pay rent to GTM projected to be 8 percent of gross sales.
- GTM will be responsible for paying all operating expenses, projected to be $175,000 per year.
- If the merchants’ rent to GTM covers annual operating expenses, then GTM takes an asset management fee of 2 percent of the gross, (if there is enough rental revenue remaining). If the merchants’ rent is not enough to cover operating expenses, then GTM takes the loss and receives no profits.
- If there is rental revenue left after covering operating expenses and after GTM’s 2 percent, then GTM and the City split any remaining profits 50/50.
Here is what this means in dollars. GTM anticipates that once the Market House is fully occupied and going strong, the merchants will do $4 Million in gross sales per year.
Scenario A: Gross sales of $4 Million
- Rental revenue of $320,000 (8% of gross sales)
- Less operating expenses of $175,000
- Of the $145,000 rental revenue remaining, GTM receives asset management fee of $80,000 (2% of gross sales)
- GTM and the City split the $65,000 profits remaining 50/50 ($32,500 to each).
- So overall, GTM takes home $112,500 (their 2% of gross plus their 50% share of net profits).
To put this in perspective, in order to achieve $4 Million in gross sales, the merchants need to do more than $1,000 per square foot. That’s higher than many successful restaurants. GTM is optimistic that they can achieve this, but what if they don’t hit a home run? Let’s say they just hit a double, and the merchants do $3 Million in gross sales.
Scenario B: Gross sales of $3 Million
- Rental revenue of $240,000 (8% of gross sales)
- Less operating expenses of $175,000
- Of the $65,000 rental revenue remaining, GTM receives asset management fee of $60,000 (2% of gross sales)
- GTM and the City split the $5,000 profits remaining 50/50 ($2,500 to each).
- So overall, GTM takes home only $62,500.
As you can see, the return for the operator is minimal, and there are further “what ifs” that could negatively impact these projections. For instance, utility costs could increase and drive up operating expenses, or the operator may only be able to charge rent of 5 percent of gross sales rather than 8 percent. If the City further burdened the lease by requiring a fixed rental payment of $40,000 or $50,000, which is what the City used to make before the Site Realty debacle, the economics just wouldn’t work.
In other words, if we as a City want to bring in an experienced, outside operator to invest in the Market House rather than run it ourselves, we need to be willing to forego some of the limited revenues that we would have seen in order to allow the operator a return on their investment.
In a similar vein, some argue that the City should not pay the costs to fix up the structure. I believe as a matter of policy it is the City’s responsibility to maintain the structure, just as it is the City’s responsibility to maintain its parks, roads and other physical assets. But simply as a matter of finances, if the operator had to pay the $600,000 to fix the structure on top of the other expenses that the City is making them pay, the numbers would not work. We could not get an operator in there to do it. The margins are just too small and the profits just aren’t there.
The City cannot have it both ways. A vibrant public market cannot survive if charged top rent. The City needs to choose which priority is more important. To me, the choice is clear. There is no better investment in downtown that the City can make than to make the Market House successful.
City needs to act despite the controversial nature of the Market House
So why all the debate? Unlike a police station, where there is a clear consensus about its purpose and the government’s responsibility, there never has and never will be a consensus about the Market House. Should it continue to be a public market or should it be used as something else? Should the City keep it or sell it? If we want it to remain a public market, should the City operate it, should we hire someone else to do it, should we create a development corporation to run it, or should we lease it? Should the City invest in the structure or not? Should we seek to maximize the City’s revenues from it or seek to renew its historic character as an authentic public market?
We can debate these questions for another six months and still not achieve a consensus. It is time now to act.
Despite the City’s financial challenges, we still need to invest in our top priorities
Some alderpersons understandably hesitate at the $600,000 estimate for improvements. As mayor, I appreciate more than anyone the need for the City to live within its means. In order to balance the budget without raising the property tax rate, I had to lay off employees and cut spending by $11 Million – 13 percent of our total budget, the largest cut of any of Maryland’s 157 municipalities. But fiscal responsibility is not just about reducing spending, it is also about prioritizing. Some things need to be done right, and the Market House is at the top of that list.
Any decision the City Council makes will be criticized, but the worst decision of all is to make no decision. Downtown’s economy is on life support and it needs bold, decisive action. Incremental steps won’t cut it. We need to do more than get the Market House reopened – we need it to succeed. We want it to become a true destination again, serving as the catalyst for a renaissance of our downtown. We need to show some resolve, do it now, and do it right.
It is important that community members make their voices heard on this issue. Contact information for the City Council is online here. I also invite people to call me directly at 410-263-7997 to discuss the lease.