Thursday, December 09, 2010

Are Atlantic Yards development rights offered to Chinese overvalued as collateral, or should the MTA have gotten double from FCR for railyard?

Part 5 of a series

The effort by the New York City Regional Center (NYCRC), the private investment pool federally authorized to accept immigrant investor funds, and developer Forest City Ratner (FCR) to raise $249 million from 498 Chinese millionaires under the EB-5 immigration program may be legal, but there is ample reason to question whether it will serve the public interest.

Part 1 of this series concerned the seven-year extension available on Phase 1 of the project should Forest City Ratner not repay the EB-5 loan. Part 2 estimated the developer could save at least $191 million. Part 3 examined the sales effort in China, with the arena front and center, even though it's already funded.

Part 4 reported on claims made in China, on video and in person, by public officials supporting the project. Part 5 concerned the value of the development rights, contrasted with those in last year's deal for the Vanderbilt Yard. Part 6 described reasons to think the development rights are overvalued.

Part 7 explained why China is such a popular target for those seeking EB-5 investors
. Part 8 provided another reason why the Nets played exhibition games in China in October. Part 9 cited the curious avoidance of Mikhail Prokhorov during the pitch in China.

Part 10 noted NYCRC's belated announcement of the project in a newsletter. Part 11
described misleading promotion in the Chinese media and by Chinese firms working with the NYCRC. Part 12 covered the proclamations that are part of the pageantry in China.

Part 13 concerned the role of the NYCRC's preferred law firm. Part 14 linked the land loan to a previous one from Gramercy Capital. Part 15 analyzed the use of weasel words and ambiguous language. Part 16 took another look at a web video pitching the project.

The wrap-up and FAQ is here.


Did the Metropolitan Transportation Authority (MTA) get snookered last year when it agreed to renegotiate the deal with Forest City Ratner (FCR) for Vanderbilt Yard development rights, giving the developer more generous terms than in 2005 because of the weakened real estate market?

Or are prospective Chinese investors seeking green cards in exchange for parking $500,000 each in an Atlantic Yards-related investment pool being misled about the value of the development rights on the site used as collateral?

One or the other seems likely, because a new appraisal of development rights on the site is more than double the 2005 appraisal. That appraisal was never re-done and last year was seen by the MTA as overvaluing the site.

And both may be true--that public transit is losing out on tens of millions of dollars, and the potential investors are being offered a shakier deal than billed--if the real value is somewhere in the middle.

The two parcels do not fully overlap--the Vanderbilt Yard (8.5 acres) occupies the northern portion of the 22-acre site, while the collateral offered to the immigrant investors involves two development parcels on that northern portion and five on the southern segment.

However, the value per square foot of development rights should be fairly constant across the site. (Development costs, such as the cost of a platform for the railyard, would serve as downward adjustments, as described below.)

Value per square foot: $75 vs. $179

The MTA in 2005 appraised railyard development rights at $75 a square foot--and said in 2009 that it would be dangerous to get a new appraisal because land values had undoubtedly declined.

However, the NYCRC and its Chinese agents, promoting Atlantic Yards to immigrant investors under the EB-5 program, tout a new appraisal that calculates the value of the seven parcels at more than $179 a square foot.

The value of the collateral offered to investors is said to be $542,375,000 for 3,025,654 square feet.

The new appraisal, by the real estate firm Massey Knakal (which calls itself "the New York metropolitan area's premier full service sales company, specializing in the sale of investment and user properties"), has not been made public.

However, its conclusions have been outlined in both promotional literature (page from project brochure at right) and public presentations by the NYCRC.

"This security includes a first mortgage on land parcels containing over 3 million square feet of development rights," the narrator of an NYCRC-produced video states, as shown to investors in China. "The State of New York has acknowledged this first mortgage in an official Recognition Agreement."

Official value?

"An official opinion of value report has valued it at over $542 million," the video's narrator states. "The report was conducted by Massey Knakal real estate services, one of New York City's largest real estate services firms. The report has been certified by the Chinese Embassy."

Neither Massey Knakal nor the Chinese Consulate in New York responded to my queries.

Note that "the official opinion of value report" is "official" only according to the NYCRC. It has not been validated by a government agency, as far as I can tell.

Also, "certified by the Chinese Embassy," according to the seal reproduced on the brochure, merely means (according to a translation I commissioned) that the Embassy confirmed the source of the document. It does not endorse the contents.

Such statements seem phrased to offer legitimacy to the report, even if they do not validate its contents, thus potentially helping distract investors from due diligence--a general theme in the pitch in China.

Moreover, no statements in the public presentation I heard (see disclosure at bottom) nor in the brochure acknowledge that the Recognition Agreement, signed by the Empire State Development Corporation (ESDC), FCR, and the NYCRC, allows seven years before the loan must be repaid to the investors.

Determining Fair Market Value

It's unclear whether "the official opinion of value report" from Massey Knakal calculates value in the same manner as the Fair Market Value described in the Recognition Agreement.

The Recognition Agreement designates some adjustments that could add significant costs. It states:
In determining the Fair Market Value of the Mortgaged Leasehold Estate, such determination shall include appropriate and reasonable adjustments for all burdens, costs and expenses borne by the tenant under the Lease, the current tenant's proposed use of the Mortgaged Leasehold Estate, and the anticipated cost of financing the development of the Mortgaged Leasehold Estate in accordance with the requirements of the Lease and other applicable Project Documents.
So the value would constitute not simply a value per square foot calculated via comparable sales, but such variables as tenant costs and financing, which could add costs and delays for a complicated site like Atlantic Yards, reducing the overall value.

One of the unanswered questions I posed to Massey Knakal was whether the potential for delay had been factored into the valuation.

Looking back at the MTA negotiation

The new appraisal suggests that the value of development rights has risen significantly.

In June 2009, with the implicit support of the ESDC, the MTA agreed to FCR's request to renegotiate the 2005 deal for Vanderbilt Yard development rights, or 3,615,790 square feet.

Instead of paying the full $100 million upfront agreed to four years earlier, FCR instead agreed to pay $20 million for the part of the railyard needed for the arena block, then pay the remaining sum over 22 years, at a gentle 6.5 percent interest rate.

Essentially, the MTA turned the public agency into Ratner's bank, giving him relatively low-cost financing--well below non-recourse financing--when there was none to be had. The Real Deal classified the transaction as one of the best deals for a developer during the credit crunch.

The MTA chose not to get a new appraisal for the site, stating in its staff summary that it would be dangerous, given that "the Brooklyn real estate market has markedly deteriorated." Nor did it seek any new bidders.

Therefore the development rights, once assessed at $75 a square foot, were at that amount presumably overvalued in 2009.

"Weakened real estate market"?

A lawsuit--filed by Develop Don't Destroy Brooklyn, elected officials, and others--that challenged the revised FCR-MTA deal was rejected in December 2009.

In an affidavit prepared for the lawsuit, then-MTA CFO Gary Dellaverson asserted, "a second appraisal could not have resulted in a valuation exceeding--or even equaling--that reported in the appraisal of the same property commissioned by MTA in July 2005."

Not only would the appraisal be "adjusted significantly downward to take into account a weakened real estate market, a downward net property value adjustment would also have been anticipated in connection with the calculation of the costs associated with track relocation and platform construction," he stated.

That claim deserves a closer look.

Dellaverson cited hard costs of platform construction of nearly $200 million, more than triple the original appraiser's estimate. He also pegged the cost of a new railyard at $150 million--or, according to the Staff Summary, $147 million.

The cash value of the Vanderbilt Yard: over $200 million?

Even if he was right about the infrastructure costs, Dellaverson's statement about the "weakened real estate market" was questionable, since the Massey Knakal appraisal implies that the real estate market has quickly recovered.

Could the MTA have gotten a new appraisal, which would have raised the value of the property and required more aggressive negotiations with Forest City Ratner, or waited? Quite likely, if you believe the new appraisal.

However, the MTA responds to its political patrons, the governor and the mayor.

Based on the per square foot value of the Massey Knakal appraisal for the immigrant investors' development rights, the value of the Vanderbilt Yard's 3,615,790 square feet of development rights would be $647,226,410.

Subtract $147 million for the railyard, and even another $200 million for the platform, and the total value of the railyard development rights would still exceed $300 million.

Even subtract the questionable $97 million total FCR claimed it would spend in environmental remediation, MTA compensation, and subway improvements, as well as shared sales tax revenue, and FCR still should have bid more than $200 million in cash to win railyard development rights.

However, the deal with the MTA was for $100 million. Now it's likely worth somewhat less, since FCR only had to put down $20 million, and will pay the rest over 22 years at that 6.5% interest rate.

(The MTA claims the deal represents the same present value. That claims is valid only if the interest rate is valid.)

FCR's obligations

Nor would Forest City Ratner even pay some of its pledged costs in full. Keep in mind that some of the EB-5 funding--a no-interest loan--is supposed to pay for the railyard, thus potentially saving the developer the entire cost of the railyard.

(Overall, the $249 million in EB-5 funding could save $191 million, according to a conservative estimate. The railyard should cost $147 million.)

That means the developer would shift its financing costs, part of the burden it promised the MTA it would shoulder, by trading a federal benefit: green cards.

That only passes muster with federal immigration authorities if the EB-5 investment actually creates jobs--a knotty issue, as I've described.

Since the developer has up to 22 years to finish paying for the railyard, it would presumably pay for the platform only when the real estate market recovers. The platform, however, was one of the rationales for the Atlantic Yards project in the first place, as it would remove the "blight" of the open, working railyard.

Is the new valuation too high?

Alternatively, the MTA's decision last year not to seek a new appraisal implies that the collateral now offered to the prospective immigrant investors may not be as safe as advertised.

Given that the 498 investors are being asked for $249 million in total, the $542 million collateral is described to investors as a generous cushion.

However, if the development rights remain valued at $75 a square foot, then the total value of the square footage offered would be less than $227 million, below the $249 million at stake.

Adjusting the value


Moreover, even if the current $542 million value (or something closer to it) is defensible, it likely does not represent Fair Market Value as defined in the Recognition Agreement, given the costs of financing and other costs shouldered by tenants.

Indeed, the Recognition Agreement anticipates a complex process in the case of default, in which a "restructuring advisory professional organization" would be retained, during the two-year period after the loan is due, to help resolve the foreclosure "event."

If after two years--and a total of seven years--the event is not resolved, the NYCRC, as mortgagee, could market the loan to a third party. The ESDC or its designee also could purchase the loan.

In all cases, a Permitted Developer must be found. (It's unclear from the document whether Forest City Ratner could still qualify as a Permitted Developer.)

In any case, it's highly unlikely that the entire stated value of the collateral, $542 million, could be turned into cash in the market.

And that means that any prospective immigrant investors should be asking not only about "immigration risk"--whether they will be getting green cards, thanks to sufficient job creation--but also about "investment risk"--whether their money would be returned, and how soon.

It's hardly clear that they're doing that, or getting full answers.

Note on sourcing

I received the NYCRC brochure via a source in China who got it from a session attendee. I believe it to be an original, complete copy but have not confirmed that; the information comports with other publicly available statements.

I listened to the NYCRC promotional video via an audio recording of a presentation to investors provided to me by Tom Spender, a reporter I engaged to cover an investor session in China. Spender, who approached the session promoters as a stringer for China International Business, covered the session for that publication as well as The National, a newspaper in the United Arab Emirates.

Recognition Agreement between NYCRC, FCR/AYDC, ESDC

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