Wednesday, April 30, 2008

City agreement allows FCR to build 44% smaller Phase 1; what about NYC's extra $105M?

Despite assertions by Forest City Ratner officials that “all of Atlantic Yards... will be built," the State Funding Agreement, which the Empire State Development Corporation (ESDC) quietly released last month, gives the developer 6+ years to build the arena, 12+ years to build the five towers in Phase 1, and an unspecified amount of time to build the 11 towers in Phase 2.

A look at the previously-unreleased City Funding Agreement signed last September shows the developer has an even gentler deal: modest penalties for delay, plus allowance for a much smaller Phase 1 than that outlined in the General Project Plan passed by the ESDC in December 2006.

(I obtained the City Funding Agreement from the New York City Economic Development Corporation, or NYCEDC, via a Freedom of Information Law request. Warning: 13+ MB.)

The City Funding Agreement involves NYCEDC and ESDC, while the state agreement involves ESDC and the developer. There's considerable overlap between them. (Click on all graphics to enlarge.)
  • The city agreement casts further doubt on the schedule for affordable housing units, perhaps the main generator of political support for the project.

  • It includes no penalties as long as the developer builds, within 12+ years, 1.5 million square feet in Phase 1--some 44% smaller than promised less than a year earlier.

  • It permits a scenario of only 300 affordable housing units by 2020

  • With such a smaller Phase 1, it further reduces expected tax revenues.

  • It does not address the city's $105 million contribution for infrastructure, raising the possibility that, upon the project's demise, the city could recover only its initial $100 million outlay.

  • It confirms that the initial $100 million--once intended at least in part for infrastructure--will be used to reimburse Forest City Ratner for the seemingly generous checks the developer wrote to owners of properties destined for the arena footprint.

  • It requires larger penalties for a delayed arena than a delayed Phase 1, suggesting that the arena is more of a priority.

  • It sets a schedule for relatively modest penalties; an arena three years late (given the grace period), delayed to 2018, likely would cost the developer little more than $10 million in damages to the city.

  • Such relatively modest penalties also apply to Phase 1 delays; should the Phase 1 site lie fallow until 2027--nearly two decades from now--the six-year delay (given the grace period) likely would cost the developer only $17 million in damages to the city.

  • It also poses relatively small penalties if FCR abandons the project within three years; that suggests that a decision to pull the plug, should it be made, would come sooner rather than later.
City amplification?

Given the issues raised by the document, I posed several queries to NYCEDC. Agency spokeswoman Janel Patterson provided some limited factual answers, but cautioned, "Questions involving hypotheticals or processes are not topics we can address."

Those topics, however, are important, because they shape the incentives and pressures on the developer. Perhaps they’ll come up if the City Council addresses Atlantic Yards in an oversight hearing. For now, increases in construction costs and losses by the Nets basketball team may be more significant costs calculated by the developer.

(Note that, while Phase 1 has in the past been used to define the Arena, the four towers around it, plus the tower at Site 5, in this case, Phase 1 is defined as those first five towers.)

Oversight coming?

Indeed, when I summarized my findings for City Council Member Letitia James, the project's leading political opponent, she said she had no knowledge of the agreement. She said that both the Council's Contracts Committee, which she chairs, and the Economic Development Committee should look into the deal.

"I’m shocked that liquidated damages are higher" for an arena delay than for a Phase 1 delay, James said. "And why is the penalty so minimal?"

Also, given that the State Funding Agreement, in certain circumstances, would require repayment of state funds advanced for infrastructure, so should the City Funding Agreement, she concluded.

Is there a separate agreement between NYCEDC and Forest City Ratner regarding that $105 million contribution for infrastructure? There's no reference to it in either the city or state funding agreements, which raises the question of whether the city could ever get some of that money back.

"There is no such agreement at this time," Patterson replied, which could mean 1) they're working on it or 2) they forgot about it.

City oversight might fulfill some language in the document, a contract between NYCEDC and ESDC, which states somewhat conclusorily, “Whereas, the City and NYCEDC have determined that it is in the best interest of the people of the City that ESDC undertake the Project and desire to fund ESDC for the Land Acquisition Costs.”

While the City Council did authorize the $205 million in the budget, there was no vote or debate in City Council over the project as a whole.

A smaller Phase 1

Though the entire project was "anticipated" in the ESDC's General Project Plan to take ten years, the State Funding Agreement revealed that Forest City Ratner has six years after the close of litigation and the delivery of property via eminent domain to build the arena, and 12 years to build Phase 1 of the project before penalties--repayment of yet-unspecified portions of the state's $100 million in funding, plus liquidated damages to the city--kick in.

The City Funding Agreement grants even more slack, since it defines “Substantial Completion” of Phase 1 as the construction of at least 1.5 million square feet within those 12 years.
That’s 44% less space than that the 2.69 million square feet “expected” in the General Project Plan (right) approved by the ESDC in December 2006.

(How many buildings is 1.5 million square feet? According to a document in the General Project Plan delineating maximum building heights and square footages, the two largest towers, including Building 4, at the southwest corner of Sixth and Atlantic avenues, and the flagship Miss Brooklyn, conceivably could meet the 1.5 million sf minimum. However, that’s now unlikely, since Miss Brooklyn already seems to have been reduced. The city and state agreements incorporate a document that defines Phase 1 as five towers. Thus, the required 1.5 million square feet could mean five smaller towers. Or it could mean three towers completed within 12 years, with the other two completed at some later date.)

While a smaller Phase 1, once completed, should have less of an impact on traffic and transit, a longer buildout might cause other complications, such as from continued construction.

I asked NYCEDC’s Patterson to “explain the rationale for agreeing that building no more than 1.5M sf generates no penalty,” but was told that was among the topics they can’t address.

Less affordable housing


A smaller Phase 1 likely would bring less affordable housing, given the requirement that 30% of housing built in Phase 1 be affordable.

Given the timetable allowed in the State Funding Agreement, Forest City Ratner could, without penalty, build fewer than 300 affordable units--and only 120 low-income units--over 12 years. (That 12-year endpoint, in a best-case scenario, could be 2020 if litigation clears later this year and properties are delivered via eminent domain, but more likely would come a year or two later.)

How do I calculate 300 units over 12 years? For simplicity’s sake, I assume 500,000 square feet devoted to office space and 1 million square feet of housing. (Actually there’d be some space for retail and possibly a hotel; right now, the developer describes Miss Brooklyn as an office tower with 528,000 sf of zoning rights, though no anchor tenant has emerged.)

If 1 million square feet of housing means 1000 units (at 1000 square feet per unit), 30% of that would result in 300 affordable units. Of the 300 affordable units, 40% would be low-income.

Lower revenues

A smaller Phase 1 would mean lower revenues than the figures predicted in state documents. The state estimates presumed a project built within ten years. The slow buildout permitted in the state document--6+ years for the arena, 12+ years for Phase 1--was the first step in lowering the revenues.

The agreement that "Substantial Completion" of Phase 1 requires only 1.5 million square feet further diminishes such expected revenues.

The missing $105 million

Should the arena or Phase 1 be delayed, the developer would have to pay a schedule of liquidated damages, which I’ll discuss below. Should the project be abandoned, the City Funding Agreement, oddly enough, apparently requires repayment of only the initial $100 million promised by the city.

The document makes reference to “City Funding” of $100 million, defining it narrowly as funds used to help the ESDC buy the arena site--essentially, to reimburse Forest City Ratner for purchases already made. It does not offer a more commonsense definition of “city funding,” which presumably includes the $105 million added in 2007, leading the city to summarize (right) contributions as $205 million.

While the State Funding Agreement requires the developer, should the project be delayed or abandoned, to repay portions of the $100 million in state money advanced for infrastructure, the City Funding Agreement requires the repayment of only the initial $100 million, which the agreement defines as “Disbursements.”

So it may be that the additional $105 million, which like the ESDC’s payments, is directed at infrastructure, would not have to be repaid. Or, as Patterson's cryptic statement left open, another agreement may be under discussion.

Money for infrastructure, not benefit FCR?

Does that additional $105 million benefit just this project, or the neighborhood in general? City officials have suggested the latter. In January 2007, Deputy Press Secretary John Gallagher explained, "The additional funding is for infrastructure improvements, several of which would have been required with or without the construction of the Atlantic Yards Development and others that are necessary regardless of what is built on the site."

Mayor Mike Bloomberg, according to the Brooklyn Paper, attributed the higher allocation to the “rising cost of cement and steel,” adding “We have a commitment to pay for infrastructure costs and we will meet that commitment."

Doug Turetsky of the Independent Budget Office suggested to Neil deMause of the Village Voice that the city's additional expenditures were not generic: "some of which might have been on the books prior to Atlantic Yards, but some substantial amount of which is likely related to the scale of the project—such as the need for expanding sewer and water capacity."

In other words, maybe some of the money does benefit the developer. After all, Forest City Ratner officials apparently agree. Executive Joanne Minieri told investment analysts earlier this month:
We have executed the funding agreement with the city and state for the $200 million of subsidy and received an additional $105 million allocation from the city.

And executive Chuck Ratner of parent Forest City Enterprises followed up:
[J]ust in these past six or eight months, we got the various governmental agencies, state, city, borough, in New York, to increase their commitments to Atlantic Yards by 105 million dollars on top of the 200 [million] they committed. We still need more.


City contribution: infrastructure, property

The use of all $100 million to buy property was not explicitly contemplated in the nonbinding Memorandum of Understanding (MOU) signed in 2005. It stated (p. 5), The City’s capital contribution shall be used for the same purposes as the ESDC’s capital contribution [site preparation and public infrastructure improvements], except that the City's capital contribution may also be used to fund a portion of the costs of acquisition of the Arena Site (other than the MTA Properties).
(Emphasis added)

That suggests that city funds would be used for both infrastructure and property acquisition. The word “except” allows the city to use its capital contribution for property acquisition, but the phrase "may also" suggests that the $100 million would not be used exclusively to buy property. But the MOU was not binding.

(Last year, an NYCEDC spokeswoman said the MOU “had always included the possibility of buying land, as well as improving the infrastructure,” according to the Daily News. True, but it didn’t suggest that it would be used only to buy land.)

The “portion” of the costs for acquisition of the arena site comprises a large majority of those costs. While the city has advanced $100 million, plus a token $10 (above and right), another page included in the funding agreement (below) cites $103.5 million as the aggregate cost so far for properties on the planned arena block: Dean and Pacific streets, and Sixth and Atlantic avenues.

A few buildings and one condo are still not owned by Forest City Ratner, and some buildings owned by the developer have tenants with rent-stabilized leases who are suing the state. The cost of purchasing the extant buildings, either through negotiation or via eminent domain, as well as potentially settling with the tenants, would presumably be added to the aggregate cost.

"Stop Payment"

Some Brooklyn City Council members, at a hearing in March 2007, expressed dismay that city money would go to property acquisition, not infrastructure. And citizen groups at a protest last June made the same point, calling for “Stop Payment.”

The potential for a subsidy request greater than $200 million initially pledged by the city and state should’ve been evident to city officials well before the MOU was signed 2/18/05. Seven months earlier, as I reported, a 6/28/04 business plan submitted by FCR indicated that infrastructure and condemnation costs had already reached $221.2 million, and that costs were rising.

So government officials should have known that the developer might request a greater subsidy. However, when the project was approved in December 2006 by the ESDC, the official documents cited only a $200 million subsidy pledge.

The $105 million increase was announced only in January 2007, after the project had been approved. Had the expected increase in subsidy been made public earlier, would the project have faced more protest?

City money for *new* acquisition of land?

Did the city make clear that the public funding would go to reimburse Ratner for properties already purchased? Not quite. A hearing last year of the City Council Committee on Finance/Economic Development included this exchange between Council Member James and NYCEDC's Seth Pinsky:

JAMES: The other $100 million, which is unspecified and is basically one big pot; what is that $100 million for? Does anyone have any idea?

PINSKY: The $100 million will be exclusively for acquisition of land, to reimburse or pay for new acquisition of land for the project. None of it will go towards condemnation.

Pinsky’s language was not inaccurate, but a little disingenuous, since the $100 million will not be used for new acquisitions, and he was in a position to know that, though he may not have known yet. A look at the list of properties purchased as part of the Arena Land shows that all are on the map of properties owned or controlled by the developer as of 11/1/06.

Generous developer?

Given that it’s now clear that the money would be used for reimbursement rather than new purchases, now we know that the seemingly generous payments made by the developer depended on taxpayer support. (The property owners had another reason to deal, of course: the threat of eminent domain.) So when project supporters like Errol Louis claim that some property owners were “newcomers who made out like bandits,” they should consider the additional context. (More here.)

Even if it had been Forest City Ratner’s own money, the developer’s willingness to pay an apparent premium was also an opportunity to acquire land that would increase enormously in value thanks to the state override of zoning.

Liquidated damages for delays

The City Funding Agreement posits a convoluted schedule of liquidated damages should either the Arena or Phase 1 be delayed. (See Exhibit I, p. 265-70 of the PDF.) Essentially, it assesses penalties that are keyed to both the extent of delay and whether the delay begins sooner rather than later.

I asked Brooklyn Law School Professor David Reiss, who specializes in real estate law, to take a look at that section. He suggested that, while the schedule may seem generous, he couldn’t ascertain how fair the deal was, given that he hadn’t seen the whole document nor was he familiar with the overall finances of the deal.

Liquidated damages, he explained, are a common solution in real estate deals, offering advantages to both sides--guaranteed calculation of damages vs. predictable costs, plus the opportunity to avoid litigation.

“The developer seems, as far as I can tell, to have a very long period (as reflected in the various Outside Dates provided for in Exhibit I) in which it has to do its work before the liquidated damages provisions kick in,” he commented. “The liquidated damages seem to come in two phases. A relatively modest phase (the first five years) and a more punitive phase (year six on) where the liquidated damages is at least twice as high as at the end of the first phase.”

“I would also note that the liquidated damages for the Arena being late are significantly higher than for Phase I being late (the latter being roughly five times higher),” he added.

(Note that the schedule at right does not apply directly to the damages the developer would have to pay; rather a "multiplier," beginning at 2%, would be applied, thus resulting in significantly lower payouts.)

“These liquidated damages provisions seem to provide significant redress to the City if the Developer deviates from the plans of, delays, or terminates the Project," he concluded. "Determining whether the amount of redress is proportionate to the overall size of the Project is beyond the scope of my analysis.”

Indeed, my suggestion is that the redress seems rather modest.

A delayed arena

The document gives an example of a late arena. It assumes that Year 0--the date of first funding --begins on August 15, 2007 and the Effective Date--the date by which “all litigation... shall have been sufficiently concluded so as to permit such financing and construction to proceed.... [and] ESDC has acquired and delivered vacant possession of the Project Site”--does not occur until November 10, 2014. (That assumes a much longer litigation process than most people expect.)

That means the Arena Outside Date--six years later--would be November 20, 2020, Year 13 after the initial funding. Upon that Arena Outside Date, the developer would have to deliver an Arena LOC (Letter of Credit) equal to three years of Liquidated Damages. That Arena LOC is calculated by applying a multiplier (2% for the first year, 3% for the second, etc.) to Column B of Schedule A. Thus the LOC would be the sum of the first three years, or 2%+3%+4% of the Column B amount, or $14,850,000. That would be the total due if the arena were three years late.

(If you click on the graphic to enlarge, the sum of $14,850,000 should be visible under the first shaded section. The bottom shaded section has two lines. The Total Due Upon Substantial Completion is $103,950,000, while the Total Less Arena LOC Amount is $89,100,000. Note that the Total Due assumes an arena eight years late, rather than three, and that the sum due increases steadily for the first six years, then doubles.)

The dates in the above example are not necessarily realistic. First, the date of the first city Disbursement was 2/22/08, NYCEDC's Patterson confirmed, so we're in Year Zero. Also, the Effective Date more likely would occur in 2009 or 2010.

Assuming the delivery of property via eminent domain by 2009, the Arena Outside Date would be six years later, in 2015, Year 7. That means the multiplier would be applied to $115,000,000, according to Schedule A, not $165,000,000. Thus an arena delayed until 2018--three years late--could cost the developer a total of $10,350,000.

The State Funding Agreement also would require repayment of a portion, not yet established, of the $100 million from ESDC.

A delayed Phase 1

The document gives an example of a delayed and partly complete Phase 1. It assumes that Year 0--the date of first funding--begins on September 25, 2007 and the Effective Date occurs on December 1, 2009.

That means that the Phase 1 Outside Date--12 years later--would be December 1, 2021, which is Year 14. For the purposes of the example, the developer has completed 1.1 million square feet, less than the 1.5 million square feet required.

The developer would have to deliver a Phase 1 LOC (Letter of Credit) equal to three years of Liquidated Damages. That adds up to a little more than $2.6 million. As the example shows, if the additional 400,000 square feet is not finished within ten years, the total damages would be $29.3 million.

(If you click on the graphic to enlarge, the sum of $2,638,350, the Phase 1 LOC, should be visible under the first shaded section. The bottom shaded section has two lines. The Total Due Upon Substantial Completion is $29,315,000, while the Total Less Phase 1 LOC Amount is 26,676,650. Note that the full chart assumes Phase 1 to be ten years late, rather than three. Note that the sum due increases steadily for the first six years, then doubles.)

Note that a “completion multiplier” diminishes the amount owed by 53.3% or nearly half. Thus, if Forest City Ratner were to build none of Phase 1, the completion multiplier would be 1 and the damages roughly double each year: about $5 million over the first three years, plus another $12 million over the next three years.

So an 18-year delay after the Effective Date--the 12-year grace period, plus six years of delays that would generate penalties--means the developer could sit on the project until 2027 and pay only $17 million to the city.

That's not necessarily realistic, given the developer's promises and the inevitable pressure from city officials, but it is, according to the city document, possible. So it may give the developer leverage in either gaining additional subsidies or access to scarce affordable housing bonds.

The State Funding Agreement also would require repayment of a portion, not yet established, of State Funding Payments.

Liquidated damages for abandonment

And what if Forest City Ratner abandons the project? Well, the City Funding Agreement states that, if the project is abandoned or terminated before the Arena Outside date (6 years after the close of litigation and the delivery of property), the ESDC--not the developer--would repay the Disbursements, up to the $100 million total, to NYCEDC, plus Liquidated Damages. Again, the additional $105 million is not mentioned.

Depending on the date of abandonment, the Liquidated Damages could be modest. It’s not clear to me where those Liquidated Damages come from, but possibly from refunds to ESDC of state monies advanced to the developer.

For example, if the final disbursement of city funding occurs in 2010, two years after the first disbursement, and the project is abandoned by 2011, the Liquidated Damages would be calculated according to Year 3 in Schedule D, and would total only $8 million.

If the delay is one year longer, the damage total would leap to $29 million. (Note that Schedule B applies to a scenario in which the final disbursement occurs during the same year as the first disbursement; Schedule C applies to a scenario in which the final disbursement occurs one year after the first disbursement.)

The more than threefold jump between the penalties if the project is abandoned in the first three years and the penalties if it's abandoned in the following three years suggests that, should Forest City Ratner decide to ditch the project and sell the team to New Jersey investors--a scenario which, the Real Deal reported, is somewhat more plausible, despite the developer’s denials--the decision should be made in three years, by 2011.

It’s unclear to me what happens if the developer abandons the project after the arena is built. I queried NYCEDC’s Patterson: "What if the project is abandoned *after* the Arena Outside Date? Is there any provision for that, or does some other clause of the agreement apply?”

I got no answer, but the explanation may lie elsewhere in the documents. Still, it would be worthwhile to have NYCEDC officials answer some questions.

Questions unanswered

Several important issues raised in both city and state funding agreements have yet to be resolved, and the ESDC has so far been reluctant to provide details.

Neither set any deadline for the completion of the 11 towers of Phase 2; indeed, both documents, as in the excerpt from the City Funding Agreement at right, allow for the distinct possibility of the General Project Plan being amended.

A yet-unannounced completion date, the “Final Deadline,” according to the State Funding Agreement, will “take into account the need for satisfaction of Government Authorities’ obligations to the Project.”

What does “satisfaction of... obligations” mean? Given that the next paragraph in the state agreement cites “Governmental Authorities making available to the Project affordable housing subsidies then customarily available,” it seems that the Final Deadline depends significantly on such subsidies.

Right now, there are many projects competing for a limited supply of such subsidies. Forest City Ratner could successfully compete for such subsidies. Or the supply could be increased. For now, however, the issue is murky, which may be why no Final Deadline has been announced.

No comments:

Post a Comment