This article was originally posted for Red94.net on June 18th, 2019.
With the NBA Finals now having passed, I found myself reflecting on the successes of the Golden State Warriors these past five years, and how the team became the greatest NBA dynasty of its time. As a Rockets fan, it sometimes pains me to discuss the Warriors, a team that has been responsible for Houston’s four out of its last five exits from the NBA playoffs. However, the Rockets can learn a great deal not only from the organization’s careful roster construction but also its business operations.
They say ownership is the greatest competitive advantage in sports, but owning one’s real estate is certainly a close second.
Much has been discussed how the Golden State Warriors successfully managed to build arguably the greatest roster of NBA talent ever assembled. First, the team drafted extremely well, choosing Stephen Curry in 2009, Klay Thompson in 2011 and Draymond Green in 2012, setting up its core championship foundation. Next, the team pivoted away from head coach Mark Jackson in 2014, hiring Steve Kerr as his replacement. In Kerr, the franchise developed a stronger identity and its now famous “assist-first” culture – the team went from being sixth in assists during 2013-2014 to leading the league in all seasons subsequently thereafter. Finally, as a result of a collective bargaining agreement between the league and players’ association, the salary cap jumped from $70 million in 2014-2015 to $94 million in 2015-2016, allowing the team to add arguably the greatest player of this era’s current NBA generation in Kevin Durant to an already 73-win championship team. These were perhaps the three most important developments on the basketball side that allowed the Warriors to dominate the league over the last five years. Credit to General Manager Bob Myers is well-deserved.
The Luxury Tax Conundrum
But, now, we turn our focus to the business and operations side of the team, which, much like the basketball side, has been ahead of the league as well. Much of NBA media this past season has made it seem as though the Warriors would not be able to retain its core four stars due to the seemingly onerous luxury tax burden the team would have to pay to keep them together.
In fact, it has been calculated that it could take $1.6 billion in payroll over the next four years to keep Curry, Durant, Green, and Thompson together while also filling out the team’s remaining roster spots. This is due to the luxury tax assessed on NBA franchises that go over a certain salary threshold ($124mm) and a repeater tax levied on teams that do so three out of four years. The next season alone could cost the team $380mm in payroll, nearly twice the amount of what it was in 2018-2019 ($197mm). This is unprecedented territory for any NBA team, and no franchise has ever paid the repeater tax. However, the Warriors have most likely found the greatest loophole to solve this steep financial price, much like the salary cap loophole they discovered to sign Durant in 2016.
The Chase Center
What is the loophole, one may ask? Around the same time the Warriors embarked on their first championship run, the organization announced plans to build a new arena, the Chase Center, in the Mission Bay district of San Francisco. Construction broke ground in 2017, with the arena’s expected completion planned to line up perfectly with Durant’s and Thompson’s contracts expiring. The Chase Center is not just a basketball arena, but a 900,000 square foot mixed-use real estate development, complete with 580,000 square feet of office space (of which Uber Technologies has leased 100%) and 100,000 square feet of retail space. It will be owned and managed by the Warriors organization as well, presenting several new, ancillary means of real estate income, for which the franchise does not share with the NBA.
The Financing of the Chase Center
Unlike most arenas and stadiums over the past 20 years, the Chase Center was entirely privately financed, making the Warriors the owner of the real estate. Most sports teams work with local municipalities to issue bond financing, making local taxpayers, many of whom may not even be fans of the team or sports in general, pay for the stadium. Following the financing, the local municipality typically owns the stadium and the sports team leases it. The Warriors, however, went a different route in order to retain ownership of the project, primarily financing the Chase Center through the sale of joint venture stakes, ticket and suite pre-sales, corporate sponsorships and personal seat licenses (PSLs). PSLs give their holders the right to buy season tickets and can be traded in the secondary market. In the case of the Warriors, PSL holders will be paid back in 30 years, making the financing technique a form of no-interest debt. Below is an estimated breakdown of how the Chase Center was financed, though given that there are no public records officially indicating the breakdown, some sources are unaccounted for:
Beyond the PSLs, The Golden State Warriors sold a 45% stake in the project’s office development to Uber Technologies, as well as a 10% stake to Alexandria Real Estate Equities, a publicly-traded REIT. Along with these joint venture stake sales, the Warriors were able to secure a 20-year lease from Uber, which is occupying 100% of the 580,000 square feet of office. The annual lease payments from Uber to the Golden State Warriors alone constitute $50mm, which brings us to the Warriors’ real estate income.
The Critical Difference of GSW’s Real Estate Income
With the Warriors standing to receive a sizeable $1bn in lease payments from Uber over the next 20 years, the team has set itself up to have a stable source of cash flow to support its basketball operations long after Durant, Curry, Thompson, and Green retire. Further, this income is not shareable amongst NBA teams and, thus, is 100% applicable to GSW’s bottom line. I am sure this will be one of the more contentious points in the next CBA negotiations.
Beyond the lease with Uber, the Warriors will receive income from 100,000 square feet of retail space, which could result in $10mm in annual lease payments once fully leased, based on going rates in the Mission Bay submarket. In addition, since Oracle Arena was owned by the Oakland-Alameda County Coliseum Authority, the team no longer has to make lease payments to an outside entity. This also enhances the team’s bottom line.
All in all, the team stands to potentially make $63mm in rent revenues annually, and that does not include a planned hotel and apartment development that could open in 2023.
How the Property Company Can Support the Operating Company
This now brings us back to the original luxury tax conundrum of the Warriors. No team in the history of the NBA has come remotely close to the type of staggering payroll the Warriors would have to shell out over the next four years, yet no team has set themselves up better to take on such a steep financial cost than the Warriors. The Warriors estimate that the move to the Chase Center is expected to generate an additional $175-200mm in annual revenues on top of those generated at Oracle. To be conservative, let us assume it would take the team three years to reach that goal. Further, using 2019 as a base ($196.8mm), the marginal increases to the payroll each year going forward would average $200mm annually. That would make the team, currently sporting a ~26% profit margin, immediately in the red.
However, the Uber lease, along with the expected revenues from the 100,000 square feet of retail real estate, would make the team EBITDA positive. Further, 10 of the 29 available spaces in the retail portion have already been leased, with famed restauranteur Michael Mina anchoring the project. Below is a projected profit & loss statement on how the scenario could potentially play out:
As the team’s majority owner, Joe Lacob, knows from being a partner at Kleiner Perkins, several start-ups and technology companies are negative cash-flowing, so this new, less-profitable reality is not so uncommon in his mind.
While the above model does not factor in any debt service payments, it also doesn’t consider several other revenue opportunities the team could extract, including, but not limited to:
- Acquiring additional corporate sponsorships
- Generating advertising revenues from streaming services
- Setting up a new television licensing deal
- Growing revenues from the Warriors’ eSports franchise (Golden Guardians)
- Executing on the planned hotel and apartment development
- Extracting fees from managing the Chase Center’s real estate through a related property management company
- Renting out the Chase Center’s outdoor park space for events
The Warriors are ultimately executing on what is known as an “opco-propco” strategy, whereby companies are divided into an operating company and a property company. The property company owns all of the real estate that is associated with the generation of revenues, while the operating company uses the assets to generate sales. The Warriors are not the first to do this in professional sports – the Chicago Cubs under owner Thomas Ricketts executed the 1060 Project, a dramatic expansion of Wrigley Field and creation of ancillary real estate assets, while Detroit Red Wings / Tigers owner Illitch Holdings did the same with District Detroit, anchored by Little Caesars Arena.
An Astonishing Return on Investment Is a Confluence of Several Factors
All in all, the acquisition of the Golden State Warriors, led by majority owner Joe Lacob, has proven to be one of the most lucrative deals in all of professional sports. The team was purchased for $450 million in 2010, four years before Stephen Curry, Draymond Green and Klay Thompson reached their prime. Second, during the same timeline, the technology sector has grown at a meteoric pace – 26% of the S&P 500 is now comprised of technology companies. This reality has enhanced the value of the Warriors’ San Francisco / Bay Area market and allowed the team to drive up ticket prices, thereby increasing its gate receipts. Third, the Warrior’s first championship of this dynasty was a revenue multiplier, with sales growing 52% from $201mm in 2015 to $305mm the following year. The team continued to grow revenues thereafter by an average of 15% for the following two years. Finally, the team is now set up to extract even greater value from its real estate holdings through its move to the Chase Center, taking advantage of being in one of the most highly valued real estate markets in the world. These four factors have helped the team achieve a $3.8bn valuation, representing an exemplary 8.6x return on investment and 26.9% compounded rate of return, and this is before considering any cash flow distributions that have occurred along the way and leverage used, both of which would make the return even greater to investors.
Lessons for the Houston Rockets
So why is the Golden State Warriors’ successful business planning so important to the Houston Rockets and its owner, Tilman Fertitta? First, Mr. Fertitta should truly do everything in his financial power to get the Houston Rockets a championship. With the Western Conference wide open for the 2019-2020 season following devastating injuries to Durant and Thompson, this may be the best window of opportunity the team gets. The benefits of winning a championship have been clearly outlined by the Warriors’ success and significantly outweigh any marginal expenses incurred during such a pursuit.
Second, the team needs to begin focusing on how to integrate its assets to make it become more like a media and entertainment company with real estate holdings. Mr. Fertitta already has the foundation to execute on this strategy – Landry’s, Inc. is one of the most successful dining, hospitality and entertainment companies in the world, and one can see the vision that he’ll seek to accomplish in merging his legacy assets with the Houston Rockets. Yet the next step would be to own the team’s real estate.
Toyota Center, much like Oracle Arena, is owned by a local municipality (Harris County Houston Sports Authority), so the Houston Rockets organization, unfortunately, is a tenant that is paying $8.5mm annually to Harris County through 2033. The team and its business operations could look to the Warriors and Chase Center as a blueprint, financing either a new arena or purchasing Toyota Center from Harris County and begin to, bit by bit, assemble nearby real estate to create a synergistic experience akin to the Chase Center. This would be a tall task to execute on, but as Mr. Fertitta gains more influence in the City of Houston (see his heavy involvement at the University of Houston), this is a potential reality I wouldn’t count out. He is already a landlord for the Post Oak Hotel, Golden Nugget casinos, and several other properties, so he fully comprehends the value of owning one’s real estate and the steady cash flow it can provide. Further, he could populate the project’s retail real estate spaces with several of his many restaurant brands. A key drawback the team suffers is being in the Houston market, whose economic success often ebbs and flows with that of the energy industry. While the real estate market has recovered since the oil and gas business bottomed out in 2014, its values are certainly not on par with those of San Francisco. However, the team does enjoy the advantages of being in Texas, which does not levy state income taxes and is more business-friendly than California. Further, Houston is one of the fastest growing major cities in the country and will soon overtake Chicago as the third largest city in the United States.
The other unknown factor, as I’ve posited before in the past, is how sports gambling will evolve in the league. Mr. Fertitta’s Golden Nugget operations could enhance the team’s revenue in ways we can’t quite imagine yet, though I’m sure Mr. Fertitta has his vision in place here as well.
The question is whether Mr. Fertitta can generate the funds to execute on a vision this grand, but the Warriors’ creative financing of the Chase Center proves there is a path that can be followed. They say ownership is the greatest competitive advantage in sports, but owning one’s real estate is certainly a close second.
Sources Used: Alexandria Real Estate Equities, Uber Technologies, San Francisco Business Times, Business Insider, ESPN, Forbes, USA Today, Statista, Spotrac, Washington Post, San Francisco Chronicle, CBS San Francisco.