Saturday, April 02, 2011

News from Forest City conference call: AY office space forgotten; project will get built at company's pace; no mention of EB-5 or modular construction

During a conference call with investment analysts yesterday held by Forest City Enterprises, there were no questions about Atlantic Yards, so apparently issues of modular construction or EB-5 fundraising have not reached the radar screens of those analysts.

But there were some clues in both remarks by FCE officials and documents released by the company.

For one thing, the Atlantic Yards office tower--a key component of expected tax revenues--seems to be off the table, suggesting it's not expected in the near term. Another involves the repeated claim that Atlantic Yards will develop at Forest City's pace.

Where's the office space?

An end-of-year Supplemental Package to the Securities and Exchange Commission, described Atlantic Yards as the first among "Projects Under Development""
Below is a summary of our active large scale development projects, which have yet to commence construction, often referred to as our "shadow pipeline" which are crucial to our long-term growth. While we cannot make any assurances on the timing or delivery of these projects, our track record speaks to our ability to bring large, complex, projects to fruition when there is demand and available construction financing.

1) Atlantic Yards - Brooklyn, NY
Atlantic Yards is adjacent to the state-of-the art arena, the Barclays Center, which is designed by the award-winning firms Ellerbe Becket and SHoP Architects and is currently under construction. In addition, Atlantic Yards will feature more than 6,400 units of housing, including over 2,200 affordable units, approximately 250,000 square feet of retail space, and more than 8 acres of landscaped open space.
Missing was any mention of the office tower.

At Forest City's pace

In remarks recalling the November 2008 presentation in which Forest City included Atlantic Yards among projects where "we control the pace," CEO Chuck Ratner indicated that the developer still feels the same way.

Noting that FCE is often asked by the investment community "where will the growth come from and when," he said it starts with the company's existing portolio.

"The second part of the growth story is new projects. There, we have an ample pipeline of entitled opportunities, at the Yards and at Waterfront in DC, at Atlantic Yards in Brooklyn, at Johns Hopkins in Baltimore, at Stapleton in Denver, and elsewhere," he said. "In all of these places, we can initiate development at a pace that is appropriate to the market while maintaining a balanced risk profile for our company."

That indicates that the penalties set up by the city and state for delays are not considered onerous.

"When is a more challenging part of the question, to be sure. But when has always been the demand in the market coming together with financing that allows for the spread between the cost of capital and the cash on cost return. This is how we create value for the shareholders in the real estate investment business."

"As [Chief Financial Officer] Bob [O'Brien] mentioned in his comments, that is already happening for apartment projects is in good markets. We started Foundry Lofts at the Yards in DC, because it's a great market with strong demand, and our finance team was able to secure attractive financing through HUD. We're ready for more projects of that type, and we anticipate starting additional apartment projects in the near to mid-term."

"In office and retail, there are still some issues of both demand and ability to finance, but there are signs of improvement there also. When that trend continues, we have the flexibility to act in those segments, as well."

"The broader point is that we are seeing more opportunities as the economy improves, as credit markets strengthen, and as sponsors, land owners, and others look for opportunities to take advantage of improving conditions."

"In summary, even as we continue to exercise appropriate caution, we continue to look to our portfolio for strong performance, the signs we are seeing and the opportunities that are surfacing give us confidence in our business and optimism about the future."

A dramatic two years

"It is amazing to look back where we were less than 24 months ago, when the entire economy was in the initial free fall of the recession," Ratner said in his prepared remarks. "That was a very dark time, for our country and for the real estate industry, as I'm sure you'll all remember. We certainly remember it vividly.

"Ironically, it was two years ago that our stock closed at a low of $3.41 a share. [FCE.A is now over $19, but hit $69.75 in 2007.] By that time, we had already set up a strategy and were taking the difficult but necessary steps to strengthen the company and put us in the position to take advantage of improving conditions."

"Over the next several quarters of '09 and through 2010, our rental properties portfolio showed remarkable resilience and strength, both in terms of overall growth and as a reservoir of value that we were to selectively tap to generate liquidity," he added. "We scaled back long-term development but continued to deliver high-quality new properties from our under-construction pipeline. in 2010, we delivered more than $500 million of new properties, at our pro rata share, which collectively are generating more than 175 basis points of spread over the anticipated cost of permanent debt."

"We've also successfully managed our debt maturities in the operating portfolio, and we've accessed the capital markets to generate liquidity and continue the process of improving our balance sheet."

Minieri's departure

At the beginning of the call Ratner made reference to the recently departed Forest City Ratner president and Chief Operating Officer.

"As many of you know, Joanne Minieri has often joined our calls in the past. Joanne is leaving Forest City after a great 17-year career. She has helped build a great franchise in New York for our company. Joanne is a great talent, a wonderful person, and a dear friend. She will continue to serve in a consulting role to ensure a smooth transition."

Given that no replacement has been announced, that's further evidence that she was nudged out in an effort to save on salary.

Savings on the Nets

According to the Form 10-K to the SEC, the sale of the Nets has been crucial to the bottom line:
The Nets

On August 16, 2004, the Company purchased an ownership interest in The Nets, a member of the National Basketball Association (NBA). The Company’s ownership of The Nets is through its subsidiary Nets Sports and Entertainment LLC (NS&E). NS&E also owns Brooklyn Arena, LLC (Arena, an entity that through its subsidiaries is overseeing the construction of and has a long-term lease in the Barclays Center arena, the future home of The Nets. Upon adoption of new accounting guidance for the consolidation of variable interest entities (VIEs on February 1, 2010, NS&E was converted from an equity method entity to a consolidated entity. As of January 31, 2011, NS&E consolidates Arena and accounts for its investment in The Nets on the equity method of accounting. As a result of the Company consolidating NS&E, it records the entire net loss of The Nets allocated to NS&E in equity in loss of unconsolidated entities and allocates the other NS&E minority partners’ share of its loss through noncontrolling interests in the Statements of Operations for the year ended January 31, 2011. Prior to the adoption of the new consolidation accounting guidance, the Company recorded only its share of the loss for The Nets through equity in loss of unconsolidated entities.

On May 12, 2010, the Company closed on a purchase agreement with entities controlled by Mikhail Prokhorov (MP Entities). Pursuant to the terms of the purchase agreement, the MP Entities invested $223,000,000 and made certain funding commitments (Funding Commitments to acquire 80% of The Nets, 45% of Arena and the right to purchase up to 20% of Atlantic Yards Development Company, LLC, which will develop non-arena real estate. In accordance with the Funding Commitments, the MP Entities agreed to fund The Nets operating needs up to $60,000,000 including reimbursements to the Company for loans made to cover The Nets operating needs from March 1, 2010 to May 12, 2010 totaling $15,000,000.
Once the $60,000,000 is expended, which is anticipated to occur prior to the start of the 2011-2012 NBA basketball season, NS&E is required to fund 100% of the operating needs, as defined, until the Barclays Center arena is complete and open. Thereafter, members’ capital contributions will be made in accordance with the operating agreements. Since May 12, 2010, The Nets’ losses have been allocated to the MP Entities, the majority owner since the losses are allocated based on an analysis of the respective members’ claim on the net book equity assuming a liquidation at book value.

For the years ended January 31, 2011, 2010 and 2009, the Company recognized approximately 25%, 68% and 54% of the net loss of The Nets, respectively, because profits and losses are allocated to each member based on an analysis of the respective member’s claim on the net book equity assuming a liquidation at book value at the end of the accounting period without regard to unrealized appreciation (if any) in the fair value of The Nets. Our percentage of the allocated losses for the year ended January 31, 2011 was lower than the prior year primarily due to the allocation of losses to the MP Entities, as discussed above.
Note how the decreased loss helped Forest City hit record earnings. (Click on all graphics to enlarge.)



Risks

The 10-K also offers a boilerplate description of the risks faced, indicating a potential loss of nearly half a billion dollars on Atlantic Yards. Notably, there was no mention of modular construction.

The document states:
Examples of projects that face these and other development risks include the following:

Brooklyn Atlantic Yards. We are in the process of developing Brooklyn Atlantic Yards, which will cost approximately $4.9 billion over the anticipated construction and development period. This long-term mixed-use project in downtown Brooklyn is expected to feature a state-of-the-art sports and entertainment arena, the Barclays Center arena, for The Nets basketball team, a member of the NBA. The acquisition and development of Brooklyn Atlantic Yards has been formally approved by the required state governmental authorities and final documentation of the transactions was executed on December 23, 2009. Tax exempt financing for the arena also closed on December 23, 2009, the proceeds of which became available on May 12, 2010. We have commenced construction of the arena and related infrastructure as well as infrastructure related to other elements of the greater Atlantic Yards development project. As a result of prior litigation, this project has experienced delays and may continue to experience further delays.

There is also the potential for increased costs and further delays to the project as a result of (i) increasing construction costs, (ii) scarcity of labor and supplies, (iii) the unavailability of additional needed financing, (iv) our or our partners’ inability or failure to meet required equity contributions, (v) increasing rates for financing, (vi) loss of arena sponsorships and related revenues, (vii) our inability to meet certain agreed upon deadlines for the development of the project and (viii) other potential litigation seeking to enjoin or prevent the project or litigation for which there may not be insurance coverage. The development of Brooklyn Atlantic Yards is being done in connection with the proposed move of The Nets to the planned arena, the timing of which is subject to delays. The arena itself (and its plans) along with any movement of the team is subject to approval by the NBA, which we may not receive. In addition, as applicable contractual and other deadlines and decision points approach, we could have less time and flexibility to plan and implement our responses to these or other risks to the extent that any of them may actually arise.

If any of the foregoing risks were to occur we may: (i) not be able to develop Brooklyn Atlantic Yards to the extent intended or at all resulting in a potential write-off of our investment, (ii) be required to pay the City and/or State of New York liquidated damages for failure to meet certain agreed upon project deadlines, and (iii) be in default of our non-recourse mortgages on the project. The exposure to loss on this investment is approximately $525 million, excluding any potential write-offs for the arena or any liquidated damages described in (ii) of this paragraph, and could have a significant, material adverse effect on our business, cash flows and results of operations. Even if we were able to continue with the development, or a portion thereof, we would likely not be able to do so as quickly as originally planned, would be likely to incur additional costs and may need to write-off a portion of the development.
New York as key market

As the graph below indicates, properties in New York represent 33.7% of Net Operating Income, the single largest segment of the company's portfolio.

The sale of 49% of 15 retail properties in New York will detract from income but the opening of the Beekman Tower and, eventually, the Barclays Center arena, will add income.


Office space, retail trump apartments

You wouldn't know it from looking at Atlantic Yards, but Forest City Enterprises relies much more on office and retail space than housing in its portfolio.

As the graphic below indicates, retail properties represent 38.2% of Net Operating Income, Office 34.8%, and apartments 19.9%.

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