Wednesday, December 27, 2006

Ratner's profit likely would exceed IRR, but the public's still in the dark

So how much profit would Forest City Ratner make? Remember, a real estate expert consulted by New York Magazine estimated 25 percent, though he didn't have enough figures to be certain.

Two things are clear, however. First, the "internal rate of return" (or IRR) figures in the KPMG audit commissioned by the Empire State Development Corporation don't tell us anything about Ratner's profit.

Second, the public still doesn't know whether this is a good deal or not.

Overall rate of return?

In covering the approval last week of the Atlantic Yards plan, the Times reported:
The developer has yet to divulge precisely how much money it will make on the project. But Mr. Silver yesterday played down concerns that the developers were using public subsidies to generate excessive private profits, noting that the board’s official review powers were limited to vetting the state’s contribution to the infrastructure costs.
“Our role is not to measure the profits that the private investors will make,” Mr. Silver said yesterday. “Our role is to make sure that state liability on the project will be limited to what they say it will be. And we were satisfied about that, plain and simple.”
According to a KPMG audit commissioned by the Empire State Development Corporation, a copy of which was provided to The New York Times, Forest City estimated that the overall rate of return on the $4 billion project, excluding the arena, at about 10 percent over 30 years. The accounting firm estimated the return at about 7 percent.

That confused a technical term, IRR, with a more colloquial "overall rate of return." And Silver's quote dismissed the requirement, in a 2/18/05 Memorandum of Understanding, that the developer was required to provide a 30-year pro forma income and cash flow statement regarding the Atlantic Yards project. (Was that just for internal consumption?)

As I noted, somewhat more cautiously:
So what really would be the developer's profit? How do the tax breaks and grants factor in? A sentence in an earlier version of the Times article raised a question:
But because Forest City is using grants and tax-exempt bonds to finance the bulk of the project, critics cautioned, the project’s investors will likely earn a much higher rate of return on their direct investments.

(Why was that sentence eliminated? Possibly because the financing is still unclear.)

The missing context

Indeed, crucial context was absent. I ran the report past David A. Smith, founder of Recapitalization Advisors, Inc., a Boston-based affordable housing consulting firm.

IRR, Smith explained, is typically used as a way of harmonizing an estimated return from various kinds of investments, including equity (cash) and debt. But the transaction includes both outside investors and the developer, or sponsor. Sponsors like Forest City Ratner, Smith said, "use other people's money as much as you can. They are entitled to a development profit for their services in assembling the resources. So the sponsor is trying to minimize cash outflow and maximize development fee."

That development fee would cover overhead, supervision of construction, supervision of architects, and a profit allowance. And some of that is buried beneath the numbers of the document.

Unanswered questions

Simply assessing an IRR on the equity sources, not the debt, doesn’t answer two important questions, Smith noted:
1) What fees to the sponsor are included in uses of funds?
2) Among the equity sources, what percentage is coming from the sponsors and what percentage is coming from outside investors?

"I find it very surprising that a full 'sources and uses' on the transaction is not publicly available, given the significant amount of public resources going in," said Smith, who noted that affordable housing transactions typically offer a transparent document explaining where the money is coming from and where it will go.

"The goal is for the allocating agency to see that their contribution gets the absolute highest bang for buck," Smith said, because different projects compete for scarce subsidies. "In Atlantic Yards, it’s within the realm of possibility that the problem is they have a moving target, with sources and uses in flux even as the individual phases are also in flux."

"I don’t fundamentally have a problem with the idea that some aspects they might not choose to publish in the paper, but you’d like to have confidence that a review was being done of the public contribution, and whether the public contribution is getting an adequate return on its public investment," he said.

Does report give guidance?

What should legislators think about the KPMG document? "As far as I can tell, KPMG thinks it can work, but raises the related question of whether the state is getting the best value for the resources it is providing," he said.

How could one do that? "You could bid it," he said. "But if it’s not bid, you first obtain from the sponsor a complete 'sources and uses'. Secondly, you drill through it to understand the projected and anticipate profits to the sponsor. You quiz them on it."

Smith said that, with "a massive and highly complex undertaking" like Atlantic Yards, "your complications and volatility and risk go up, and then likewise the compensation for that risk goes up. I wouldn’t have problem defending a large development fee, because there’s a lot of exposure."

Still, he noted, the questions remain. "One, have public resources been adequately protected in the sense of public officials or administration officials getting good value for money going in? Two, even assuming they have relative to this transaction, is this a good use of money relative to other things those public resources could be used for?"

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