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Lease holdover nightmares haunt San Diego city's real estate

Politics, lazy management prove costly to taxpayers, audit finds

In a February 2 memo to Andy Hanau (left), city real estate chief Penny Mausd (right) vowed to complete a series of corrections.
In a February 2 memo to Andy Hanau (left), city real estate chief Penny Mausd (right) vowed to complete a series of corrections.

The condition of the City of San Diego's Department of Real Estate and Airport Management, known as DREAM for short, is more of a nightmare when it comes to handling the city's giant portfolio of leased property, according to a February 9 report by City Auditor Andy Hanau.

"The City allows a much higher share of leases to remain in holdover than other jurisdictions, which may be leading to foregone revenue for the City and potential or perceived favoritism," the findings say.

Rampant city hall politics is part of the mix. "DREAM acknowledged that political will can play a notable role in prioritizing lease renewals, including those in holdover."

But the public remains mostly in the dark. "Though DREAM publishes data about property the City of San Diego owns, including the cost and year of purchase to the City's Open Data Portal, we found no evidence that DREAM has published the recorded value of City lease-outs to enable the comparison between rent and appraised value. "

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Additionally, "DREAM is not exercising or consistently including in contracts rent-based financial disincentives for holdover, reducing the incentive lessees have to renegotiate leases that are expiring."

Deficient record keeping has been chronically hiding the financial hit to taxpayers, an omission raising questions of management misconduct.

"DREAM did not have an estimate of how much revenue the City is foregoing by having so many holdovers. However, with more than 100 properties in holdover and DREAM's property portfolio collecting approximately $80 million in lease revenue annually, even a small percentage of undercharging due to holdover could result in potentially millions of dollars in foregone revenue for the City each year."

According to the document, San Diego is an outlier among American cities in handling its real estate. "Many of the real estate department managers from the cities we benchmarked against believe that in most cases, it is best to avoid leases falling into holdover."

"The cities of Houston and Austin reported 0 percent and 1 percent of their portfolios to be in holdover," the document adds.

"The City of San Jose reported having no commercial leases in holdover and stated that property agents must be able to explain how allowing a lease to enter holdover is aligned with their property management goals. Property managers in San Jose stated that too many holdovers may imply portfolio mismanagement."

"Additionally, the City may potentially be conferring an unfair benefit to the current tenant, creating unnecessary uncertainty for both the City and lessees and limiting the City's ability to enact and enforce updated contract provisions."

Some tenants regard city managers with contempt, using their real estate incumbency to manipulate the staff for better deals. "Lessees believe that they can maintain more favorable lease terms if they stall the process and go into holdover status."

On top of that, "we found that only 7 out of 31—less than one-quarter—of the lease agreements in our sample had up-to-date insurance documented," indicating "that many City lessees may be out of compliance with their lease terms."

Many city properties are loosely monitored, if at all, by city workers. "On-site monitoring of the leaseholds on Mission Bay Boundary Lands had not been completed throughout much of 2020 due to the loss of a full- time position as well as due to COVID-19 restrictions. However, we found that this issue is more widespread than Mission Bay.”

Despite the burgeoning problem, auditors say, "We found the City has made little progress on addressing the prevalence of lease holdovers since a Grand Jury report from 2017."

The 2017 Grand Jury "found that 125 out of more than 500 leases (about 25 percent) of City-owned properties had expired and were continuing on a month-to-month basis in holdover, many in a state of holdover for a decade or more."

In a February 2 memo to Hanau, city real estate chief Penny Maus agreed with the latest report's findings and vowed to complete a series of corrections by next year.

"DREAM will develop a strategy to address and reduce the number of lease holdovers in the City's portfolio," she wrote. "The strategy and implementation will include an update to procedures and consider these recommendations."

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In a February 2 memo to Andy Hanau (left), city real estate chief Penny Mausd (right) vowed to complete a series of corrections.
In a February 2 memo to Andy Hanau (left), city real estate chief Penny Mausd (right) vowed to complete a series of corrections.

The condition of the City of San Diego's Department of Real Estate and Airport Management, known as DREAM for short, is more of a nightmare when it comes to handling the city's giant portfolio of leased property, according to a February 9 report by City Auditor Andy Hanau.

"The City allows a much higher share of leases to remain in holdover than other jurisdictions, which may be leading to foregone revenue for the City and potential or perceived favoritism," the findings say.

Rampant city hall politics is part of the mix. "DREAM acknowledged that political will can play a notable role in prioritizing lease renewals, including those in holdover."

But the public remains mostly in the dark. "Though DREAM publishes data about property the City of San Diego owns, including the cost and year of purchase to the City's Open Data Portal, we found no evidence that DREAM has published the recorded value of City lease-outs to enable the comparison between rent and appraised value. "

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Additionally, "DREAM is not exercising or consistently including in contracts rent-based financial disincentives for holdover, reducing the incentive lessees have to renegotiate leases that are expiring."

Deficient record keeping has been chronically hiding the financial hit to taxpayers, an omission raising questions of management misconduct.

"DREAM did not have an estimate of how much revenue the City is foregoing by having so many holdovers. However, with more than 100 properties in holdover and DREAM's property portfolio collecting approximately $80 million in lease revenue annually, even a small percentage of undercharging due to holdover could result in potentially millions of dollars in foregone revenue for the City each year."

According to the document, San Diego is an outlier among American cities in handling its real estate. "Many of the real estate department managers from the cities we benchmarked against believe that in most cases, it is best to avoid leases falling into holdover."

"The cities of Houston and Austin reported 0 percent and 1 percent of their portfolios to be in holdover," the document adds.

"The City of San Jose reported having no commercial leases in holdover and stated that property agents must be able to explain how allowing a lease to enter holdover is aligned with their property management goals. Property managers in San Jose stated that too many holdovers may imply portfolio mismanagement."

"Additionally, the City may potentially be conferring an unfair benefit to the current tenant, creating unnecessary uncertainty for both the City and lessees and limiting the City's ability to enact and enforce updated contract provisions."

Some tenants regard city managers with contempt, using their real estate incumbency to manipulate the staff for better deals. "Lessees believe that they can maintain more favorable lease terms if they stall the process and go into holdover status."

On top of that, "we found that only 7 out of 31—less than one-quarter—of the lease agreements in our sample had up-to-date insurance documented," indicating "that many City lessees may be out of compliance with their lease terms."

Many city properties are loosely monitored, if at all, by city workers. "On-site monitoring of the leaseholds on Mission Bay Boundary Lands had not been completed throughout much of 2020 due to the loss of a full- time position as well as due to COVID-19 restrictions. However, we found that this issue is more widespread than Mission Bay.”

Despite the burgeoning problem, auditors say, "We found the City has made little progress on addressing the prevalence of lease holdovers since a Grand Jury report from 2017."

The 2017 Grand Jury "found that 125 out of more than 500 leases (about 25 percent) of City-owned properties had expired and were continuing on a month-to-month basis in holdover, many in a state of holdover for a decade or more."

In a February 2 memo to Hanau, city real estate chief Penny Maus agreed with the latest report's findings and vowed to complete a series of corrections by next year.

"DREAM will develop a strategy to address and reduce the number of lease holdovers in the City's portfolio," she wrote. "The strategy and implementation will include an update to procedures and consider these recommendations."

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