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The unexplained factor in Atlantic Yards sale to Greenland: Forest City knew modular plan was troubled (but land value has since risen, leaving bottom line murky)

When it emerged in August 2013 that Forest City Enterprises would put 50 to 80 percent of Atlantic Yards on the block, the Times quoted “real estate analysts” as suggesting Forest City could “reap as much as $800 million.”

That suggested significant profit. But CEO David LaRue soon said Forest City was not aiming to get more than book value for the property, a proportionate share of the $545 million it had spent.

Those questions didn’t faze analysts. “This is consistent with what they do,” commented Paul Adornato, an analyst at BMO Capital Markets. “They’ll take all the risk at the early stage of a project. Once they create value, they look to monetize that by bringing in investors. The layup will be to build the rest of the Yards as the market allows.”

Actually, one document filed with the SEC disclosed that the joint venture could mean Forest City would lose control of the asset and could result in “future impairments, some of which would likely be significant." That's real-estate speak for losses, at least on paper.

Today, Forest City's deal --with a stated loss of $148.4 million after taxes--seems perhaps hasty, as the value of buildable land has continued to shoot up, raising the value of the market-rate housing, including condos and rentals. Also, the city has agreed to fund subsidized housing at a higher price point than the developer originally promised, thus pointing to higher returns.

The unexplained factor

Still, Forest City's desire to deal was surely driven by the recognition--as has only recently become clear--that its ambitious and costly modular construction gambit was not working as anticipated.

Though there was no public announcement, the plan was troubled even as the prototype was assembled and the factory fit-out delayed in 2012, we now know.

So Forest City knew that it would not save money on the first tower, and--with the factory still devoted to modules for the first building--might not promptly produce modules for the subsequent towers.

So the corporation may have decided it didn't want to extend its exposure, even if property values were rising.

To make that deal, Forest City found a partner less driven by the immediate bottom line but eager to make a splash in the world's media capital, and to move its money from China to a more stable investing environment.

Deal initially murky

Indeed, by early October 2013, the deal had emerged: Forest City would sell 70% of the remaining project, including towers and infrastructure, to the Shanghai government-owned Greenland Holdings Group.

It was appropriate that the largest commercial real estate deal ever for a Chinese company in the United States would involve Greenland, a huge company with $58 billion in assets, known for putting up huge towers in China and eager to spread its footprint around the world,

That lowered the risk and ensured development fees for Forest City, which is slated to consistently take 5% from all projects.

Since the price was not initially disclosed, we couldn't tell if Forest City was cashing out or taking a hit. Still, it was clear that, as with the entrance of Russian oligarch Mikhail Prokhorov as majority buyer of the Nets and minority buyer of the arena, global capital would flow into Brooklyn after the locally nimble Forest City did the heavy lifting.

"This investment would allow us to move forward with one of the most ambitious affordable housing programs in our City's history,” Mayor Mike Bloomberg piously declared, regarding the Greenland deal.

Or, to be more clear, to help Forest City offload the risk and reward. Forest City stock jumped 5.45% at the news, on a day the general real estate sector rose about 1%.

Readjusting the value

Maybe the Greenland deal wasn’t so great for Forest City, after all. In its third-quarter investment results, Forest City on Dec. 9, 2013 revealed a potential hefty impairment, or lowering their Atlantic Yards investment value by $250-$350 million.

The factors included "construction timing and costs, expected future rents and operating expenses from the vertical development, holding periods, cash proceeds at the end of the estimated holding period," according to Forest City's Form 10-Q.

CFO Bob O’Brien cited the "ten years of carry on our existing costs”—the long wait—and rising infrastructure costs.

The announcement prompted calls from investors and analysts "expressing surprise and disappointment," CEO LaRue acknowledged.

"Clearly we are disappointed with this possible impairment as well," he told investment analysts. "It spotlights two of the hard lessons we've learned coming out of the recession. We need to control land rather than own it, prior to being ready to go vertical, and we need a strong capital partner up front for a project of this magnitude.”

In other words, they overshot. Investors frowned: Forest City's Class A shares on the NYSE dipped 2.9%, even as the market overall rose slightly.

Forest City and its partners had invested some $545 million, with total costs of approximately $770 million, including debt. "Basically, you take an impairment when the probability of future cash flows dictate it," O'Brien elaborated. "It’s clear that the costs incurred to date, plus the future costs, as we evaluate them with Greenland, result in the range of impairment that we’ve indicated in our filing. It is accounting driven, but it reflects market values..."

Forest City on December 16, 2013 revealed an unspecified capital contribution from Greenland, then four days later provided the number: Greenland would pay $200 million--which suggested the value of the total current investment was only about $286 million.

That meant the impairment, at Forest City's pro rata share of Atlantic Yards, would be $242.4 million, or $148.4 million after taxes.

That's not a small number, but it's also far less than the fees Forest City expects to earn. And, though Forest City's proportionate share of profit goes down, it also stands to earn its share from the condo buildings and the subsidized housing.

The cost of land, and the returns now

“Based on the 6.4 million square feet of remaining entitlements in both phases," Forest City said in December 2013, "the total anticipated costs yield an expected average cost per square foot of approximately $180-$220 per square foot, prior to vertical development.”

As of 2013, that was a relatively high number. One broker reported $173 as the record price per buildable square foot in Downtown Brooklyn.

A year later, however, the numbers were much higher. Forest City Ratner was looking to sell its development site at 625 Fulton Street for $300 to $350 per buildable square foot or more, Crain's reported last October.

That leaves some questions. Was it unwise, in retrospect, not to wait?

Or was Greenland the only investor available?

And was Forest City's board, running a public company that has quarterly earnings reports, simply unable to look at a longer time horizon?

After all, Greenland Forest City is now marketing condos at 550 Vanderbilt, the first condo building, starting at $550,000, and going up to $5.5 million, surely above the prices projected just a few years ago.

And the first two all-affordable towers, however below market, will have rents that ensure more return than the original promises for the subsidized housing.
2015 rent levels for B3; rent should be higher when building opens in 2016

Going forward, Forest City CEO MaryAnne Gilmartin has said, "every building will be a conversation with the city around exactly how we put that building together."

That implies shifts in affordability based on available subsidies and the developer's push to profit.

The murky bottom line

So, despite the nearly $150 million hit that Forest City appears to have taken in the sale to Greenland, I'd say it's premature to assess what Atlantic Yards/Pacific Park Brooklyn ultimately means to the bottom line.

After all, they sold 80% of the Nets for an apparent loss, but now should get a good chunk of that back when selling the remaining portion. And the Barclays Center is well behind its revenue goals, but they're aiming to sell their share of the arena at a profit.

Then again, in February they announced a $146 million impairment regarding B2, presumably to be reduced somewhat after taxes, and with some portion potentially recoverable through litigation. 

Then there's the question of returns over the long term from the condos and rentals. And, of course, the prospect of new subsidies or grants, or tweaks in the income formulas for the subsidized housing. 

Heck, even though they claim this is the third and final round of fundraising via the EB-5 program, they may go back to China for more cheap capital from millionaires seeking green cards.

Atlantic Yards/Pacific Park, when analyzed in the soaring real-estate market of 2006, was said to offer a billion-dollar profit. Conditions have changed.  

But even the impairments can't be seen as definitive. Atlantic Yards, as I've said, is a "never say never" project. After all, it's not even Atlantic Yards any more.

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