Forest City: stalled B2 modular tower represents $146 million write-down

Announcing 2014 fourth-quarter and year-end results, Forest City Enterprises reported a better 2014, but a big hit from the stalled B2 modular tower at Atlantic Yards/Pacific Park, now facing an impairment--a write-down of the asset--of $146 million.

Though the modular factory has been restarted, Forest City acknowledged the possibility it may have to fund the completion of the building from equity if a mortgage loan cannot be extended.

Forest City also pointed to a better potential economic result: it is also trying to recover damages from former partner Skanska; both companies have sued each other.

Net Earnings/Loss

From the press release:

For the three months ended December 31, 2014, the company had net earnings attributable to common shareholders of $69.2 million, or .31 per share, compared with a net loss of $207.7 million, or $1.05 per share, for the fourth quarter of 2013. For the full year of 2014, the company had a net loss attributable to common shareholders of $7.6 million, or .04 per share, compared with net loss of $20.5 million, or .10 per share, for the full year ended December 31, 2013. Per-share amounts are on a fully diluted basis.

The B2 hit

"Fourth-quarter earnings were negatively impacted by a pre-tax, non-cash impairment related to our B2 BKLYN project and the modular factory of $146.0 million, of which $38.7 million represents the write off of the factory," stated CEO David LaRue. "Despite our disappointment at the need for this impairment, we are confident in our ability to complete the building. We expect the factory to be operating at full capacity by late Spring, and to complete the building by the third quarter of 2016. We also continue to pursue legal actions to seek recoveries under our fixed-price contract with the former construction contractor."

More on Atlantic Yards/Pacific Park

"During the fourth quarter, we started four new projects, including 1001 4th Street, SW in Washington, D.C. that is part of our residential development fund with the Arizona State Retirement System (ASRS) and 535 Carlton at Pacific Park Brooklyn that is part of our strategic partnership with Greenland USA," LaRue said. "In addition, we held a ground-breaking event with our partner on 550 Vanderbilt Avenue, the first condominium building at Pacific Park Brooklyn, and expect that building to be added to our under-construction pipeline in the second quarter."

535 Carlton is expected to be completed in the third quarter of 2016.

From the annual report, on B2

The annual report states:

Based on the recent events, including the temporary ceasing of construction and litigation related to the construction of B2 BKLYN, we investigated and evaluated alternatives to restart and complete the construction. During the three months ended December 31, 2014, we completed our evaluation of various scenarios to complete B2 BKLYN and in November 2014, purchased the Construction Manager’s entire 50% ownership interest in the factory used to construct the modular units. In December 2014, we engaged a new construction manager to oversee the construction of B2 BKLYN and began preparations to recommence construction of modular units. Based on current information available, including the Company’s decision to complete B2 BKLYN using modular units and to purchase the modular factory, the Company updated its impairment calculation. As a result, the Company’s estimated undiscounted cash flows no longer exceed the carrying value of the asset, requiring the Company to adjust the carrying value to its estimated fair value as of December 31, 2014. As such, the Company recorded an impairment charge of $146,300,000 during the three months ended December 31, 2014. Based on the latest information available, we estimate the construction will be completed in the third quarter of 2016.

At December 31, 2014, we have $40,538,000 capitalized on the Consolidated Balance Sheet related to B2 BKLYN. Based on the most current information available, total project costs are estimated to approximate $162,100,000, after giving effect to the impairment discussed above. Significant estimates were used to develop the estimated remaining project costs and may change in the future. We continue to vigorously pursue legal action against Skanska USA for damages related to their default of the CM Contract. However, we cannot assure we will be successful in recovering these damages.

Subsequent to the construction stoppage, we received a notice of default on the nonrecourse mortgage secured by B2 BKLYN. We have since entered into a forbearance agreement with our lender which expires on April 8, 2015. In the event we are unable to complete the negotiation of a longer term agreement, or cure the default, we may be required to repay the current outstanding balance of $45,000,000 currently secured by, amongst other things, $37,500,000 of restricted bond proceeds included in restricted cash, $10,000,000 of cash in escrow and an equity letter of credit of $9,300,000. In addition, we may be required to fund the completion of B2 BKLYN with equity until the uncertainties regarding its construction are resolved. 

Additional warnings from the annual report

This is boilerplate, but sometimes such boilerplate poses warnings worth remembering:

We Are Exposed to Additional Development Risk in Connection with Using a New Construction Methodology on B2 BKLYN, Modular Construction, Litigation Risks, and Owning a Factory to Produce the Modular Units

B2 BKLYN is an apartment building under construction in Brooklyn, New York adjacent to the Barclays Center at the Pacific Park Brooklyn project. We decided to use modular construction to build this 32 story, 363 unit apartment building. During 2014, our former partner in the modular factory and the B2 BKLYN construction manager ceased operations at and closed the factory for the fabrication of apartment modular units which were being used in the construction of B2 BKLYN. As a result, in November 2014, we purchased our former partner’s ownership interest in the modular factory and in December 2014, we engaged a new construction manager to oversee the construction of B2 BKLYN and began preparations to recommence construction of modular units.

We are engaged in litigation with our former partner in the modular factory and the former B2 BKLYLN construction manager relating primarily to the project’s delays and associated additional completion costs. We are seeking to recover all costs associated to complete the building, including those incurred by the modular factory. With the re-opening of the modular factory and the re-activation of the B2 BKLYN project site, we do not anticipate further delays resulting directly from the litigation, as the natural conclusion (or settlement) of the pending litigations will be limited to the payment of monetary damages from one party to the other. We may not be able to successfully recover all or any of the costs we are seeking to recover.

In addition to risks inherent in construction projects generally, such as unanticipated site conditions, environmental, and force majeure issues, the following additional risks exist with constructing B2 BKLYN:
• High rise modular construction has not previously been done at the heights of B2 BKLYN. As a result, the project has encountered, and may continue to encounter, delays and increased costs in the fabrication and assembly of the modular units. Based on the latest information available, we estimate the construction will be completed in the third quarter of 2016. If the project continues to experience such delays, we may fail to satisfy completion deadlines set forth under the lending arrangements for the project and the lenders may not be willing to extend such deadlines. Failure to meet the completion deadlines could result in a default under such lending arrangements with a resulting acceleration of the debt and foreclosure of the project, as well as reputational damage;
• Third party claims that any element of the design or construction methodology infringes on protected intellectual rights could delay the project and increase construction costs; and
•In 2013, two trade organizations representing New York City-licensed plumbers and mechanical contractors sued the City of New York, challenging a determination by its Department of Buildings (“DOB”) that certain piping work performed in a modular factory need not be performed by licensed plumbers or mechanical contractors if such work was monitored by a licensed professional engineer and otherwise complied with the technical requirements of the New York City Building and Construction Codes. Piping work at our modular factory is being performed by non-licensees monitored by a licensed professional engineer in accordance with DOB’s determination. We intervened in the proceeding, and in December 2013 the Court dismissed the suit. However, these trade organizations appealed the Court’s determination. It is possible that the lower Court could be reversed on appeal. It also remains a possibility that other construction industry organizations could bring similar suits challenging the DOB-authorized fabrication methodology used in our factory. If the DOB’s determination were overturned and licensees were required in the modular factory, it would likely increase the cost of construction and potentially delay the completion of B2 BKLYN.