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Goldman Sachs lowers rating on Forest City Enterprises, predicts arena construction within a year

Three months after RBC Capital Markets analyst Rich Moore nudged Forest City Enterprises (FCE) down from "outperform"--meaning better than its peers in the real estate sector--to the middle ranking of "sector perform," so yesterday did Goldman Sachs lower its ranking from "Buy" to "Neutral," though the analysts did not predict any further delays in the Atlantic Yards project nor consider AY a factor.

When I wrote October 25 about RBC's move, I noted that RBC rather dramatically cut its price estimate for Forest City (parent of Forest City Ratner) from $80 to $54, and that the current price was about $56. Yesterday, Forest City shares closed at $45.53. Then again, as the Yahoo chart above shows, the stock has done very well over five years.

Goldman Sachs advice
According to excerpts from the Goldman Sachs report:
We are downgrading developer, Forest City Enterprises, to Neutral from Buy given the lack of catalysts for the shares. Since adding FCE.A to the America’s Buy list on 01/26/06, the shares total return was +26.5% vs. the RMS at +34.4% and the S&P 500 at +16.8%.Over the last 12-months, the shares total return was a -17.5% vs. -14.0% for the RMS and +5.3% for the S&P 500. FCE.A’s performance since our Buy rating is attributed to solid internal growth and NAV creation from the company’s development pipeline. We continue to view FCE.A’s long-term growth story favorably, but now see several near-term headwinds given the slowing economy.

Capital an issue

While the analysts don't consider the credit market will hamper development starts, capital has become scarce:
Forest City’s shares should continue to face pressure for several reasons, some of which we believe is warranted (i.e., slower land sales, moderating retail and residential portfolio fundamentals), while others we think may be overstated (i.e., credit market impact on development starts, potential for major land impairments)... Additionally, we expect capital to remain scarce, given wider risk premiums.

Still bullish longer-term

The analysts predict a bit of a short-term slowdown:
While Forest City delivered ~$1.0bn in new developments in 2007, the company only plans to deliver ~$650mn in 2008. Previously, we had anticipated development starts of ~$2.0-$2.5bn over the next 6-12 months from the company’s shadow pipeline. We now believe some of these starts could be pushed into 2009 given compressing development yields resulting from an increase in capital and construction costs. Also of concern is the company’s relatively high leverage level of 63% (Debt/EV), which could limit the company’s expansion plans in the current credit environment.

Arena to start within a year

Atlantic Yards, or at least a part of it, gets a mention:
While the company has been successful accessing capital in the debt markets over the last six months (totaling $1.8bn), we believe lenders could begin to require larger risk premiums and more restrictive covenants increasing Forest City’s cost of financing future projects. We now expect Forest City to start ~$1.5-$2.0bn over the next 6-12 months including: the Beekman residential project in Manhattan, NY ($650mn); the Waterfront development in Washington DC ($500mn); the Barclays Arena in Brooklyn, NY ($800mn -$180mn pro-rata); and The Yards project in Washington DC ($400mn-$500mn).

What exactly does that mean? One, that the arena would cost $800 million, including financing, and that only $180 million would be spent within the next six to twelve months. Two, it suggests--but does not prove--that only the arena would be under construction.

Then again, the analysts may be using "Barclays Arena" as a proxy for parts of the arena block. And, of course it assumes that, as Forest City executives have said, pending lawsuits will be cleared by the first half of FY 2008.

Times building a hit

The report also says that the developer's New York Times building was a huge hit, costing $700/square foot "as compared to current average market replacement cost of $1,000-$1,200/SF," and leading to $120 million in new proceeds via refinancing.


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