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Once again, KPMG report on IRR doesn't mean profit

Two published articles this week have inaccurately suggested that the KPMG audit the Empire State Development Corporation (ESDC) commissioned actually estimated Forest City Ratner's profit on the Atlantic Yards project.

First, the New York Sun reported, in an article noting that the state never saw a full business plan for the project:
Cash flow projections and interviews with executives were the basis for the report's conclusion that the developer would stand to make a total return on its investment of about 9.8% on the mixed-use portion of the project.

Then the Brooklyn Paper followed up:
The KPMG report projects that Ratner will walk away with a $400-million profit from his state-backed $4-billion Prospect Heights Xanadu.

So how do we square this with New York magazine's estimate of $1 billion profit? We don't.

IRR vs. profit

As I reported in December, quoting affordable housing expert David A. Smith, internal rate of return (IRR) doesn't mean profit:
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 includes overhead. As I wrote:
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?


Note that the KPMG report was delivered to the ESDC in late December. Forest City Ratner in early October provided its own sketchy three pages of cash-flow estimates, released on February 28. They left the same questions unanswered.

I interviewed Smith again, who said:
“The schedules omit nearly all of the financing and operating assumptions. They omit any sketch as to how the equity will be raised from five different legal and financial entities (team/arena, condo, rental, hotel, and office), without which one cannot tell what is the cost of external capital versus developer capital. They omit a sources and uses of funds, without which it is impossible to tell what fees (however proper they might be!) the developer and its affiliates may be charging the venture ('off the top', as it were). They do not tell us where the $230 million (and counting) of equity that has already been contributed came from, nor at what current or future cost."

So we're still in the dark, but the profit figure is likely well over ten percent.

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