Sunk Costs and the Taj Mahawker

Anchorage Legislative Information Office (Photo Erik Hill/ADN)

Anchorage Legislative Information Office (Photo Erik Hill/ADN)

It’s been a long time since WC got  geeky and wallowed in some economics. Sure, only geology is less popular as a topic around Wickersham’s Conscience, but this example is too classic to let pass by.

A “sunk cost” is an expense that has already been made. It cannot be recovered. In economic terms, those spent funds are no longer a factor in future decisions. If someone says, “We’ve already spent $1 million and we can’t walk away from that” they are indulging in the sunk cost fallacy. If you’ve invested millions in a new office building and say, “We can’t walk away from that,” you are indulging in the sunk cost fallacy.

The “Taj Mahawker,” of course, is the new Anchorage Legislative Information Office, where the rent negotiated by the Legislative Council and Rep. Mike Hawker (R, Anchorage) is between two and three times the fair rental value of comparable properties. The all-glass exterior walls, glass elevators and posh quarters cost the state of Alaska $333,000 a month, $4 million a year. That’s about $5.56 per square foot. No sensible businessperson in Anchorage would sign themselves up for a 10 or 20 year lease at $5.56/sf. You’d hardly know there was a a terrible fiscal crisis, eh?

The Anchorage legislators’ tenancy in the new building is a classic sunk cost.

It’s a completely foreseeable consequence of a no-bid process, but that’s not the point of this blog post.

The Legislative Council, the 16-member group in charge of issues like office space, just decided to stay another year, to pay rent, while they decide whether to purchase the building. Any real estate appraiser – the folks who determine the fair market value – will tell you the way to appraise a commercial property is the income it generates. Because that’s based on rent, it’s a near-certainty that the appraised value of the property – the amount the sellers will want from the Legislature – will be 2 – 3 times a comparable building.

The point is the Legislature has already boxed itself in; the purchase price is going to be as outrageous as the current rent. Instead of canceling the lease and moving out, they are staying on, spending more precious money on above-market rent. The Legislative Council has made a bad decision – continuing to pay high rent – because it made an earlier bad decision – entering into the lease in the first place. A sensible tenant would recognize money spent cannot be recovered, and that there is no point in adding to it.

But it’s embarrassing to have to admit to a bad decision. And the Republican caucus doesn’t exactly encourage independent thinking.

Fairbanks is used to Anchorage’s outlandishly expensive projects. The Anchorage Performing Arts Center, the Anchorage Port Expansion; it’s more or less the accepted standard. But what we’re not used to up here is mistakes that should be recognized and avoided by anyone who has had an economics class.

WC’s abysmally low expectations for the Majority Caucus continue to be disappointed.