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Idaho's land board expands commercial activity with brewpub lease

Idaho's land board expands commercial activity with brewpub lease

Idaho Freedom Foundation staff
August 8, 2012

The Idaho Department of Lands (IDL) says that it can expect to take in $2.6 million in rent through its investment in a commercial building in downtown Boise, but critics of public involvement in private-sector business operations claim that this expectation is overstated because it doesn't take into account the actuarial uncertainty of potential business failure.

Several months ago, the IDL negotiated a lease agreement for 10 Barrel Brewing, a brewery based in Bend, Ore., to occupy 803 W. Bannock in downtown Boise. The building is held in trust by the IDL as an endowment investment on behalf of State Hospital South in Blackfoot and the normal school fund, which includes Idaho State University and Lewis-Clark State College as beneficiaries.

The Idaho Constitution mandates that the IDL "secure the maximum long term financial return" for its holdings, and officials have in recent years interpreted this provision to include investments in commercial operations that operate in direct competition with private-sector businesses. Controversy surrounding this interpretation led to an effort during this year's legislative session to forbid the IDL from purchasing or operating businesses, which overwhelmingly passed in the House but didn't even see a vote in the Senate.

In a recent address to the Tax Accountability Committee in Nampa, Rep. Grant Burgoyne, D-Boise, said that although the potentially higher returns of successful business operation may seem like an attractive alternative to investing in public bonds or leasing agricultural land, the market is a system of both profit and loss without a guaranteed outcome.

"I think it's dangerous to the endowments," Burgoyne said. "It represents a risk of underperformance or actual financial losses. I think that they have not thought through the corrosive effects of having the government enter into the private sector in that fashion—the effect that it has on private business, the effect that it has on the taxpayer, the effect that it has on the business climate."

Emily Anderson, public information officer for the IDL, pointed out that the investment does not involve the use of tax revenue, only existing endowment funds, and that any building renovations made by the IDL would be necessary for any landlord to make before leasing to a tenant.

"The Endowment contribution to the tenant improvements is based on industry standards," Anderson wrote in an email to IdahoReporter.com. "The Endowment will pay a certain amount for tenant improvements, and beyond that amount the tenant is responsible for any and all additional costs for improvements. The final percentage of the Endowment's share is not yet available because the project is not completed, but the Idaho Department of Lands expects the final percentage of the Endowment’s share of tenant improvements to be far less than half of the overall project costs."

Anderson also maintained that the agency has high expectations for investment success in this leasing arrangement. "Over the term of the lease, the estimated Return on Asset (ROA) will increase from 8.5 percent to 13.5 percent and gross rent will be $2.6 million," she wrote.

Land board watchdog and former state legislator Bob Forrey contends, though, that this expectation doesn't take into account the risks inherent in all business investments.

"There's no guaranteed return in any business. Anybody that has ever run a business, before you even invest your money, you have something in the pit of your stomach. 'Am I going to get a return?' You don't know that," Forrey said. "But they're gambling, and I think it's very dangerous."

The same section the Idaho Constitution mandating a maximum return for IDL holdings specifies that the sale of its lands must be subject to public auction. Although a lease agreement isn't quite the same as a land sale, Burgoyne pointed out that the requirement for public auctions should logically extend to leasing arrangements if and when they are occur, in order to better secure the highest possible return.

"If that lease had been subject to competitive bidding, we could have a much greater assurance that the lease amount—the amount to be paid—would be the appropriate amount, and would be a profitable amount," Burgoyne said. "Competitive bidding is the way that we make sure that this system is honest, and that people in Idaho and from outside of Idaho cannot gain unfair advantage and use the endowments for their ends."

Instead, the brewery negotiated a lease with the IDL absent any direct market competition for the space.

"There was no bidding process," 10 Barrel Brewing partner Garrett Wales said. "We just had a leasing agent. We had looked at several properties in Boise, and that one became publicly available. Literally, just with a sign in it as we were driving downtown."

Forrey argues that the Idaho Constitution's provisions plainly state that the IDL is allowed to control only the land "granted to or acquired by the state by or from the general government," meaning the land given to the Idaho by Congress at statehood and in subsequent years through the Idaho Admissions Act. "They were not granted brewpubs or storage units," Forrey said.

In 1998, though, the Legislature added a general catchall phrase, "other investments," to the constitution's list of acceptable methods for investing endowment funds, which is the language that the IDL has used to justify its entry into commercial real estate.

If the IDL's mandate is to secure a maximum investment return, though, the uncertainty of success in individual commercial operations should serve as a powerful disincentive. The efficient markets hypothesis suggests that because of the widely dispersed nature of market information, investors can't consistently earn returns higher than the market average, an insight that led to the development of index funds. Entrepreneurs can build specific local knowledge into successful business models that may outperform market averages, but public officials have no special insight into which business models might provide disproportionately high returns. That, combined with the real risk of commercial failure, is why Forrey thinks the IDL should restrict its endowment obligations to investments with guaranteed returns like public bonds.

This lease arrangement has been in the works for months, but a new wrinkle has developed that could prevent it from taking effect after all. Although 10 Barrel Brewing is in a position to benefit from the IDL's commercial investment, Boise Weekly reported that the company is having trouble obtaining a license to run an Idaho-based retail brewery while also holding an Alcohol Beverage Control certificate allowing it to import beer from outside the state.

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