How the City Came to Lease a Lemon - Voice of San Diego

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How the City Came to Lease a Lemon

It’s likely the city never would have purchased 101 Ash St. if a developer hadn’t come along to act as middleman. But that structure also laid the groundwork for a situation that is stunningly messy even in the canon of San Diego real estate history.

101 Ash St. / Photo by Scott Lewis

The city of San Diego has long struggled with leases for buildings to house its workers. A lot of employees work out of City Hall downtown but many do not, and so the city’s rental arrangements are spread out.

A decade ago, city leaders floated a brand new City Hall complex but the idea floundered and the city, instead, began renegotiating its leases. Then came an opportunity. Sempra Energy, long headquartered in a high rise across the street from the Civic Center, was moving to East Village and abandoning its space at 101 Ash St.

Sandy Shapery, who owned the building, approached city officials in late 2014 and over the next year would make rental offers ranging anywhere from $86 million to $110 million. City leaders were intrigued but the back and forth was stilted.

One offer, for instance, came with a 10-year lease and annual rent increases of 3.5 percent. It would have forced the city to pick up property taxes.

Another sticking point: Shapery wasn’t keen on giving the city the option to own the building at the end of the lease. By spreading out the payments over many years, he could keep his tax obligations low. Shapery also wanted to keep the furniture in his name.

The city declined.

Then Shapery took on a new partner in the building. Developer Doug Manchester, the litigious and intensely political developer who had just sold the Union-Tribune, purchased a 49 percent stake in 101 Ash St.

That presented a political problem. Manchester was a supporter of Mayor Kevin Faulconer, but his connection made the deal harder, not easier, because from the outside it looked like Manchester would be getting a major payday so soon after Faulconer was elected.

“I think it made it difficult for the city to do a deal with Doug Manchester,” Shapery said. “It kind of looked like nepotism or just a little too close. And I think that was a detriment, even though I first saw it as possibly a benefit — we have the mayor’s ear.”

Then something changed. Another developer entered the picture: Cisterra Partners. The company had  recently cut a deal with the city to help it lease and eventually own another high rise, the Civic Center Plaza tower that has long housed the office of the San Diego city attorney and others. Now it was proposing that Shapery sell the property to Cisterra. Cisterra would in turn flip the property to San Diego as part of a 20-year lease-to-own agreement.

After paying rent for 20 years, the city would become the new owner. It worked on paper. The city agreed to the deal.

But when a major renovation of the property spiraled out of control last year, taxpayers were left holding the bag for what could cost hundreds of millions of dollars to either abandon or rebuild into usable workspace.

The structure of the deal all but ensured that outcome because, as independent budget analysts concluded Wednesday, the deal was “horribly one-sided in favor of the landlord.” An outside law firm also recently concluded that while securing new space for its workforce, officials effectively shielded the owners from legal liability should something go wrong.

And it did — at literally every step of the way. The burden that the building presents to future city finances has become an all-consuming scandal in City Hall. Now, almost six years after the city first explored purchasing the property, we’re learning more about how discussions began and why.

It’s likely the city never would have purchased 101 Ash St. if Cisterra hadn’t come along to act as middleman. But that structure also laid the groundwork for a situation that is stunningly messy even in the canon of San Diego real estate history. And its cleanup will fall on taxpayers for years to come.

Where it All Went Wrong

Before Cisterra got involved, the city was still hoping to land favorable leases elsewhere. But officials changed their minds after the Executive Complex, another building near City Hall, went through major renovations and its owners made clear that they intended to triple the rent.

The Real Estate Assets Department turns its attention back on 101 Ash St.

City spokesman Craig Gustafson said officials wound up striking a deal with Cisterra in 2016 because the developer proposed financial terms that were “far superior than anything Shapery ever offered.”

Critically, Cisterra was offering to sell it for $72.5 million, which was less than what Shapery had offered the year before. After adjusting for inflation over two decades, the deal with Cisterra would end up costing about $127 million, according to the city’s independent budget analyst.

Excerpts of a preliminary legal review of the purchase, leaked to NBC 7, contend that by acting as a middleman in a major real estate transaction, Cisterra didn’t have an incentive to look closely at the building’s true condition.

At the same time, officials never sought an independent assessment of 101 Ash St. and instead took claims by Cisterra and the owners that the building was in excellent condition at face value. Some of the disclosure documents the sellers turned over were based on mere visual inspections of the site.

Had officials dug deeper, they would have discovered that the building’s fire safety and other critical systems needed repair. A consultant hired by the city now estimates the building will need about $115 million in repairs that could take up to four years to complete.

The property was built in the 1960s, purchased in the 1990s by Shapery, and for many years housed Sempra Energy. In 2014, James Seifert, the company’s real estate chief, testified to the California Public Utilities Commission that part of the reason the employees were leaving the building was because it needed significant capital improvements.

That should have been a red flag to anyone wanting to buy the property.

NBC 7 found the testimony online. Yet both Shapery and city officials have said they were unaware of it until this spring. Seifert’s statements were at odds with what Shapery had previously told the city — that 101 Ash St. wouldn’t need capital improvements for a decade.

None of the reporters and lawyers looking closely at the deal have presented evidence to show Shapery, and by extension Manchester, intentionally misled the city. Shapery has long maintained that he provided all the documentation in his possession about the building’s true condition.

By early 2017, Manchester no longer had any connection to the property. He bought into 101 Ash St. for $20 million in 2015 and could hardly wait to sell his portion. On the same day the sale closed with Cisterra, Shapery cut Manchester a check for $25 million.

That would suggest Manchester made around $5 million in an 18-month span, but he told the Union-Tribune earlier this year that most of his profit was eaten up by consultants and other unspecified costs.

Emails obtained by VOSD attest to Manchester’s unhappiness over the deal and suggest he tried to spite the city in whatever measly way he could.

‘We All Made a Profit’

On Jan. 4, 2017, one day after the money changed hands, a contractor reached out to say she wanted to schedule a walk-through of the property but Manchester had instructed one of her engineers — a man who used to work with Manchester — not to go back into the building.

Shapery was roped into the conversation later in the day.

“I can only assume Papa Doug is angry with the city and Mayor Faulconer because we weren’t able to put the deal together with the city when Cisterra was,” Shapery wrote. “I am happy someone was able to do it as it just makes so much sense. Besides, we all made a profit.”

Manchester didn’t respond to an interview request.

When asked about the email exchange, Shapery said he didn’t remember it. And when asked whether he’d be willing to go back through his files, he declined. He said he was tired of talking about 101 Ash St. — tired of beating a dead horse.

“We did what we were supposed to do,” he said. “I don’t hide stuff.”

Though Manchester didn’t get airtime during the 2016 City Council discussions, his financial involvement wasn’t a secret. The side of the building shouted “Manchester Financial Group” to the public. There were also press reports in the Union-Tribune, Business Journal and Reader citing the Shapery-Manchester connection.

At a City Council land use committee meeting in September 2016, elected officials, including then-City Councilman Todd Gloria, pressed Real Estate Assets Director Cybele Thompson and her supervisor, Ron Villa, on why San Diego shouldn’t just buy the property outright.

Gloria got vague and convoluted answers.

Thompson, for instance, said “a direct purchase was deemed not the best option for the city.” Villa cited “a timing overlap” and said a bond consultant had advised against it.

In any case, Shapery and Manchester weren’t offering a straight-up purchase. Not to Cisterra. Not to the city.

At one point, Gloria asked how soon the city could take control of the building and remove the signage. There were knowing smirks in the chamber.

Last week, when asked about Manchester’s donations over the years to Faulconer, Gustafson pushed back on any suggestion that the mayor in 2016 had tried to pull a fast one on the City Council.

“Political connections had nothing to do with this transaction,” he said. “The dumbest way ever to secretly benefit a campaign contributor is to buy a building with that contributor’s name on it.”

‘People Ought to Be Thanking Me’

The entire discussion might have faded into the public’s short memory if the construction side of the project hadn’t gone totally haywire.

After realizing that the building needed significantly more work, officials went back to the City Council and got an additional $30 million for a full-scale remodel in 2018 that they said would help house more employees. Two years prior, they’d said the building could use a power wash and little else. It was move-in ready.

But over a roughly six-month period in 2019, the county documented 16 asbestos-related violations. Engineers and other employees who worked on the construction site, and who’ve since filed dozens of legal claims, allege the city tried to hurry the project along and got sloppy. A law firm preparing the city’s defense has put the blame on environmental contractors.

Seemingly everyone is preparing or hinting at litigation, including the city.

Despite the ongoing embarrassment and the new costs to emerge, a Cisterra principal who cut the deal with the city and Shapery defended it. Jason Wood argued that having a single building that could house hundreds of employees, rather than paying multiple leases for facilities scattered around downtown with costs that could escalate in the future, was still a good thing and would pay off in the long term.

“People ought to be thanking me for saving the city millions of dollars over decades,” he said.

Wood remembered calling both Shapery and Thompson in late 2015 with the hope of replicating a lease-to-own deal that Cisterra had previously facilitated at Civic Center Plaza. He described 101 Ash St. as a “win-win-win.”

But neither Shapery nor Thompson thought a deal was possible then — there was a feeling of impasse, Wood said.

Cisterra eventually managed to persuade both parties to come to the table and to agree to a new arrangement. This fact, Wood said, demonstrates that the developer was not a straw entity, as some have suggested. He also, like Shapery, pushed back on the accusation that his company somehow committed fraud in the course of the transaction.

During the negotiating process and at the request of the city in 2016, Cisterra agreed to a $5 million allowance for renovations. But emails obtained by NBC 7 show that the figure was a best guess because the city hadn’t yet drawn up plans with its architects.

“The $5 million was simply an assumption based upon new paint and carpet throughout the building and minimal (tenant improvements) otherwise,” Thompson wrote in a February 2018 email.

Looking back, Wood said, Cisterra might have considered offering the city more than $5 million — if Thompson or others had asked. But they didn’t.

Even so, James Parker, one of the attorneys investigating the debacle, revealed at a Thursday City Council meeting that what had sounded like a $5 million benefit wasn’t exactly that. It was more like a loan factored into the city’s lease payments.

“Built into the lease was an obligation to repay the tenant improvement allowance,” Parker said.

With that baked into the building cost plus another $14.5 million in other fees and charges, Parker suggested the original building sticker price of $72.5 million may have been closer to $92 million.

All Bad Options

The 101 Ash St. sale and lease agreements are now under intense scrutiny by outside lawyers, the city auditor, members of the City Council and reporters. At least two officials have lost their jobs.

After hearing presentations Thursday by officials and consultants on a variety of expensive options going forward, the City Council unloaded.

Councilwoman Vivian Moreno accused officials of trying to hide the property’s true ownership at the start and minimize the threat of asbestos. She also called Cisterra a “straw seller” and cited a gross lack of due diligence when buying the building.

“Taken together, this could not have been the result of mere incompetence or bad luck,” Moreno said. “This was a deliberate fraud.”

Moving forward, the options on the table range from essentially “do nothing” to “sell the property at a loss” to “walk away and let attorneys go to war.” Multiple City Council members have also asked if the city could demolish the high rise and build another in its place.

Moreno’s use of the word “fraud” in the same meeting was an important one because the lawyers who’ve looked at the lease have echoed what City Councilwoman Barbara Bry has been saying for months — that it’s completely one-sided and indemnifies the sellers for basically anything that happens on site.

As one commercial real estate expert suggested to VOSD back in February, the city might be able to break the lease if it can demonstrate that the sellers didn’t properly disclose everything they knew about the building’s true condition upfront. In other words, if there was fraud involved in the transaction.

Parker warned against pursuing that train of thought in public, though.

“This is a one-sided contract,” he said. “It protects Cisterra in full and a decision to claim that Cisterra committed fraud or that there’s some legal method to stop the payments because of dissatisfaction, which is very understandable with this deal, poses great legal risks for the city.”

Wood told VOSD that Cisterra may be willing to return to the bargaining table if the city is willing to truly negotiate rather than simply expect Cisterra to take all the losses. He noted, though, that bond holders will ultimately want to be paid.

“I don’t have anything to give,” he said. “We don’t have any control over the bond financing. We don’t even get the rent checks. The rent checks go directly to the trustee of the bond holders.”

Councilman Chris Cate may have put it best when at the Thursday meeting he told his colleagues: “This whole thing freaking sucks.”

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