The Nets and NBA Economics
David Stern would
have you believe the Brooklyn-bound franchise embodies everything wrong with
the league's finances. It's not true.
By Malcolm Gladwell POSTED SEPTEMBER 26, 2011
http://www.grantland.com/story/_/id/7021031/the-nets-nba-economics
Ten years ago, a New York real estate developer named Bruce Ratner fell in love with a building site at the corner of
Atlantic and Flatbush Avenues in Brooklyn. It
was 22 acres, big by New York standards, and within walking distance of four of
the most charming, recently gentrified neighborhoods in Brooklyn Park Slope, Boerum Hill, Clinton Hill, and Fort Greene. A third of the
site was above a railway yard, where the commuter trains from Long Island empty
into Brooklyn, and that corner also happened to be where the 2, 3, 4, 5, D, N,
R, B, Q, A, and C subway lines all magically converge. From Atlantic Yards as
it came to be known almost all of midtown and downtown Manhattan, not to
mention a huge swath of Long Island, was no more than a 20-minute train ride
away. Ratner had found one of the choicest pieces of
undeveloped real estate in the Northeast.
But there was a
problem. Only the portion of the site above the rail yard was vacant. The rest
was occupied by an assortment of tenements, warehouses, and brownstones. To buy
out each of those landlords and evict every one of their tenants would take
years and millions of dollars, if it were possible at all. Ratner
needed New York State to use its powers of "eminent
domain" to condemn the existing buildings for him. But how could he do
that? The most generous reading of what is possible under eminent domain came
from the Supreme Court's ruling in the Kelo
v. New London case. There the court held that it was permissible to seize
private property in the name of economic development. But Kelo
involved a chronically depressed city clearing out a few houses so that
Pfizer could expand a research and development facility. Brooklyn wasn't New London. And Ratner wasn't Pfizer: All he wanted was to build luxury
apartment buildings. In any case, the Court's opinion in Kelo
was treacherous ground. Think about it: What the Court said was that the
government can take your property from you and give it to someone else simply
if it believes that someone else will make better use of it. The backlash to Kelo was such that many state legislatures passed
laws making their condemnation procedures tougher, not easier. Ratner wanted no part of that controversy. He wanted an
airtight condemnation, and for that it was far safer to rely on the traditional
definition of eminent domain, which said that the state could only seize
private property for a "public use." And what does that mean? The
best definition is from a famous opinion written by former Justice Sandra Day
O'Connor:
Our cases have
generally identified three categories of takings that comply with the public
use requirement.
Two are relatively straightforward and uncontroversial.
First, the sovereign may transfer private property to public ownership such
as for a road, a hospital, or a military base. See, e.g., Old Dominion Land Co. v. United
States, 269 U. S. 55 (1925); Rindge Co. v. County
of Los Angeles, 262 U. S. 700 (1923). Second,
the sovereign may transfer private property to private parties, often common
carriers, who make the property available for the public's use such as with a
railroad, a public utility, or a stadium.
A stadium. The italics are mine or
rather, they are Ratner's. At a certain point, as he
gazed longingly at the corner of Atlantic and
Flatbush, a light bulb went off inside his head. And he bought the New Jersey Nets.
Earlier this year, NBA commissioner
David Stern was interviewed by Bloomberg News. Stern was expounding on his
favorite theme that the business of basketball was in economic peril and that
the players needed to take a pay cut when he was asked about the New Jersey Nets. Ratner had just sold the franchise to a wealthy Russian
businessman after arranging to move the team to Brooklyn.
"Is it a contradiction to say that the current model does not work,"
Stern was asked, "and yet franchises are being bought for huge sums by
billionaires like Mikhail Prokhorov?"
"Stop
there," Stern replied. "
the previous
ownership lost several hundred million dollars on that transaction."
This is the
argument that Stern has made again and again since the labor negotiations
began. On Halloween, he and the owners will dress up like Oliver Twist and
parade up and down Park Avenue, caps in hand,
while their limousines idle discreetly on a side street. And at this point,
even players seem like they believe him. If and when the lockout ends, they
will almost certainly agree to take a smaller share of league revenues.
But Stern's
success does not change how strange the NBA position is. There is first
of all the hilarious assumption that owning a basketball franchise is a
business at least as that word is used outside of, say, the president's
mansion in Pyongyang.1 But beyond that is a second, equally ridiculous assumption, which is that the
economics of basketball teams are principally about basketball. As it
turns out, they are not.
Bruce Ratner's
original plan for the Atlantic Yards site called for 16 separate commercial and
residential towers and a basketball arena, all designed by the superstar
architect Frank Gehry. The development would be home
to roughly 15,000 people, cost in excess of $4 billion, total more than eight
million square feet, and make his company by some calculations as much as
$1 billion in profit. To put that in perspective, the original Rockefeller Center one of the grandest urban
developments in American history was seven million square feet. Ratner wanted to out-Rockefeller the Rockefellers.
Ratner knew this would not be easy.
The 14 acres he wanted to raze was a perfectly functional neighborhood,
inhabited by taxpaying businesses and homeowners. He needed a political halo,
and Ratner's genius was in understanding how
beautifully the Nets could serve that purpose. The minute basketball was
involved, Brooklyn's favorite son Jay-Z
signed up as a part-owner and full-time booster. Brooklyn's
borough president began publicly fantasizing about what a professional sports
team would mean for his community. The Mayor's office, then actively pursuing
an Olympic bid, loved the idea of a new arena in Brooklyn.
Early on, another New York
developer, Gary Barnett, made a competing play for the railway yard. Barnett's offer was, in many ways, superior to Ratner's.
He didn't want the extra 14 acres, so no land would have to be expropriated
from private owners. He wasn't going to plunk a small city down in the middle
of an already crowded neighborhood. And he tripled the value of Ratner's offer. Barnett lost. He never had a chance. He
wanted to build apartments. Ratner was restoring the
sporting glory lost when the Dodgers fled for Los Angeles. As Michael Rikon,
one of the attorneys who sued to stop the project, ruefully concluded when Ratner's victory was complete: "It is an aphorism in
criminal law that a good prosecutor could get a grand jury to indict a ham
sandwich. With regards to condemnations in New York,
it can fairly be said that in New
York a condemnor can
condemn a Kasha Knish."2 Especially if the kasha knish
is being eaten to make way for a professional basketball arena.
Ratner has been vilified both
fairly and unfairly by opponents of the Atlantic Yards project. But let's be
clear: What he did has nothing whatsoever to do with basketball. Ratner didn't buy the Nets as a stand-alone commercial
enterprise in the hopes that ticket sales and television revenue would exceed
players' salaries and administration costs. Ratner
was buying eminent domain insurance. Basketball also had very little to do with
Ratner's sale of the Nets. Ratner
got hit by the recession. Fighting the court challenges to his project took
longer than he thought. He became dangerously overextended. His shareholders
got restless. He realized had to dump the fancy Frank Gehry
design for something more along the lines of a Kleenex box. Prokhorov
helped Ratner out by buying a controlling interest in
the Nets. But he also paid off some of Ratner's
debts, lent him $75 million, picked up some of his debt service, acquired a
small stake in the arena, and bought an option on 20 percent of the entire
Atlantic Yards project. This wasn't a fire sale of a distressed basketball
franchise. It was a general-purpose real estate bailout.
Did Ratner even care that he lost the Nets? Once he won his
eminent domain case, the team had served its purpose. He's not a basketball
fan. He's a real estate developer. The asset he wanted to hang on to was the
arena, and with good reason. According to Ratner, the
Barclays Center (the naming right of which, by
the way, earned him a cool $400 million) is going to bring in somewhere around
$120 million in revenue a year. Operating costs will be $30 million. The
mortgage comes to $50 million. That leaves $35 million in profit on Ratner's $350 million up-front investment, for an annual return
of 10 percent.3 "That is pretty good out
of the box," Ratner said in a recent interview.
"It will increase as time goes on." Not to mention that the rental
market in Brooklyn is heating up, the first of Ratner's
residential towers is about to break ground, and his company also happens to
own two large retail properties directly adjacent to Atlantic Yards, which can
only appreciate now that there's a small city going up next door. When David
Stern says that the "previous ownership" of the Nets lost
"several million dollars" on the sale of the team, he is apparently
not counting the profits on the arena, the eminent domain victory, the
long-term value of that extra 14 acres, or the appreciation of Ratner's adjoining properties. That is not a lie, exactly.
It is an artful misrepresentation. It is like looking at a perfectly
respectable kasha knish and pretending it is a ham sandwich.
And let's not forget
Mikhail Prokhorov. How does he feel about buying into
the financial sinkhole that is professional basketball? The blog
NetsDaily4 recently dug up the following
quotation from a 2010 interview Prokhorov did with
the Russian business newspaper Vedomosti:
"We have a
team, we're building the arena, we've hired professional management, we have the option to buy into another large project, the
building of an office center. For me, this is a project with explosive profit
potential. The capitalization of the team will be $700 million after we move to
Brooklyn. It will earn approximately 30
[million]. And the arena will be worth around $1 billion."
Let us recap. At
the very moment the commissioner of the NBA is holding up the New Jersey Nets as a case study of
basketball's impoverishment, the former owner of the team is crowing about 10
percent returns and the new owner is boasting of "explosive" profits.
After the end of last season, one imagines that David Stern gathered together
the league's membership for a crash course on lockout etiquette: stash the
yacht in St. Bart's until things blow over, dress off the rack, insist on the
'93 and '94 Chαteau Lafite Rothschilds, not the earlier, flashier, vintages. For rich
white men to plead poverty, a certain self-discipline
is necessary. Good idea, except next time he should remember to invite the
Nets.
One of the great forgotten facts about
the United States
is that not very long ago the wealthy weren't all that wealthy. Up until the
1960s, the gap between rich and poor in the United States was relatively
narrow. In fact, in that era marginal tax rates in the highest income bracket
were in excess of 90 percent. For every dollar you made above $250,000, you
gave the government 90 cents. Today with good reason we regard tax rates
that high as punitive and economically self-defeating. It is worth noting,
though, that in the social and political commentary of the 1950s and 1960s
there is scant evidence of wealthy people complaining about their situation.
They paid their taxes and went about their business. Perhaps they saw the logic
of the government's policy: There was a huge debt from World War II to be paid
off, and interstates, public universities, and other public infrastructure
projects to be built for the children of the baby boom. Or perhaps they were
simply bashful. Wealth, after all, is as often the gift of good fortune as it
is of design. For whatever reason, the wealthy of that era could have pushed
for a world that more closely conformed to their self-interest and they chose
not to. Today the wealthy have no such qualms. We have moved from a country of
relative economic equality to a place where the gap between rich and poor is
exceeded by only Singapore
and Hong Kong. The rich have gone from being
grateful for what they have to pushing for everything they can get. They have
mastered the arts of whining and predation, without regard to logic or shame.
In the end, this is the lesson of the NBA lockout. A man buys a basketball team
as insurance on a real estate project, flips the franchise to a Russian
billionaire when he wins the deal, and then as both parties happily count
their winnings what lesson are we asked to draw? The players are greedy.
Malcolm Gladwell is a staff writer at the New Yorker and the author of The Tipping Point, Blink, Outliers and most recently,
What the Dog Saw. He is a
consulting editor for Grantland.
http://www.grantland.com/story/_/id/7021031/the-nets-nba-economics