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ROWLETT RAMBLINGS

A small  diversion

7/20/2014

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A couple of posts ago, I wrote that I discovered that our previous city manager had an earlier relationship with the city's  proposed partner of the development of the Villages of Rowlett.  I wrote that upon discovering this relationship, it sent shivers down my spine.  I have written often that I thought the real estate expertise expressed by our previous city manager  was somewhat less than stellar.  The following is part of the reason why.  The comments below relates to my first exposure to the expertise of our City Manager.   There is some real estate "stuff" in the following story, usually boring to someone  not interested in real estate "stuff."  However, bear with me and I think you will understand my concerns.  Some of the following observations I can not "prove," however I stand ready to give sworn statements regarding all.  Nearly all my commentary on this subject are based on staff reports and exhibits that can be found in the City Council packets of July 21, 2011, Item #3A, and packet dated September 6, 2011, Item #3C.  Both staff reports were prepared by Lynda Humble, then City Manager.  Some of my comments are based on conversations in which there may, or may not be witnesses. 




The land in question was approximately 100 acres lying between the Community Centre and Lake Ray Hubbard.  The net useable amount of land (approx. 50 acres) was to contain mainly apartments. There was a preliminary discussion regarding a lease agreement with LSC Group, LLC, aligned with Stratford Land Corporation on the one side, and City of Rowlett on the other.  I won't bore you with all the nit picking details, but will highlight some major issues.  On September 6, there was a refinement of the proposed lease agreement.  The refinements made the lease more undesirable to the city, however did not change any of the points made below.



It is important to note that no vote was ever taken on this proposal.  This project never got to a vote.  The final disposition seemed to be a breakdown of negotiations.  However, what is important here is what almost made it to council vote.  Its the real estate knowledge at test here.  Not the deal.




Thru some casual conversations and one field trip, all council members had a working knowledge of the project.  Not many of the details of the lease were known, but the City Manager was "working the deal" and was the point guard on the negotiations.  I did not know her well, yet, but I thought she was experienced enough to get the big parts of the deal out the way.  I wondered why she was adamant about leasing the land instead of selling it.  She represented that the city owned the land.  She made an interesting comment once.  She said she wanted to lease the land so that, "The city will continue to have control of the land."  I thought that was an interesting comment because once the lease is signed, the owner usually loses control. If one is expected to bring a bank or other lender into the deal, subject to some extremely rare conditions, most certainly the lessor's control is extinguished until the end of the lease.  I thought she meant "control" from the owner's basis of negotiations, not the life of the lease.  In a later conversation to no one in particular, I heard the city manager make the same statement again.  By this time, I knew that the long term lease was going to require a considerable investment of some lending institution.  I thought it was a bizarre statement to make, since we already knew the term of the lease was now moved from 40 years to 60 years with two 20 year extensions, bringing the potential full term of the lease to 100 years.  For the second time, I did not ask a question about how the city would retain some control.  I assumed there were some facts that I didn't know.  But, when the same statement was made a third time, I had to get some answers.  I told Lynda I didn't understand how we were going to maintain any control when any lender who commits to lend several million dollars on a project IS NOT  going to do so with a third party in control of the land.  They rightfully are not going to risk several million of their depositor's funds on a project in which they are not in a first lien position. 




One of the documents that would be required if the city insisted on retaining ownership of the land would be a Subordination Agreement.  This agreement assigns the city's interest to a subordinate position behind the bank's lien.  Another agreement that would be required is an Assignment Agreement.  This agreement allows that in the case of foreclosure by the bank, that the bank has the right to assign the lease to anyone in which they want to assign it to, presumably a new lessee.  When these two agreements are signed, the city loses all control until the end of the lease.  Our city manager should have known that......and didn't.   When I pointed out these two items, there was a classic "deer in the headlights" look.  I never heard that story again. 




Some other features, but certainly not all,  of the lease were:

1.  The rent rate for the net usable acres (approx. 50 acres) was $200 per acre per year for the first five years, then $400 per acre per year thereafter (possibly 95 years).

2.  In two places of the proposed lease,  it was written that the city could not reject any sublease agreement that our partners entered into. 



Now I've only mentioned a few of the features of the proposed lease.  I have a copy of the lease with notes written all over the 40 page lease.  I already have enough listed above to talk about. 



First, the city manager had no idea what  Subordination and Assignments even were and how they effected her "control."  This did not bode well.  Secondly, she didn't know why the term of the base lease was changed from 40 years to 60 years.  That was because any lender that is asked to lend on leased land wants the lease to run double the term on the loan.  In other words, if the borrower is structuring a loan on a land lease for 30 years, the lease must run 60 years.  Some will structure for 1 1/2 times, but they are rare, but in any event, not for tens of millions of dollars.  the city manager should have known that.



The rent rate above would have produced annual income for the city in the amount of $10,000 for the first and each year of five years (assuming 50 net usable acres), and $20,000 per year for each of the next 95 years.  There is so much wrong with this feature that it is actually painful to write about it. 



 I can take you to real estate appraisal school here.  There is something called a "cap rate."  Its used a lot of ways, but one way is in appraisal work.  Its a simple calculation.  If you know your Net Operating Income (NOI), you can divide that number by the cap rate and it will give you a value.  Current cap rates are now running between 5.5 and 6.5, depending on risk.  So......if Rowlett is making $10,000 per year off the land, and there are no taxes, insurance, operating expenses, the NOI is still $10,000.  Let's use a 6 cap rate.  $10,000 divided by .06 = $166,666.67.  After five years, the income goes to $20,000 divided by .06 = $333,333.33.   I think the land is worth about $2.00 per sq. ft.  or 50 acres X 43,560 ft. per acre X $2.00 = $4,256,000.  We seem to be about $4 million short of our value in the deal. 



We have now have discovered a big  deficiency in knowing basic documents in a real estate deal, and no idea how to determine value in the negotiations.  But that's not all.  Let's look at deal structure.  The rent rate has no escalator.  In every lease deal I have ever seen that went over 5 years, there is an escalator.  Usually on a long term lease like this one, every five years the lease payment is adjusted based on some yardstick.  CPI index is often used, but Treasure Bill rate, and other rates can be used to re-calculate the lease payments.  Of course, this is done to stay up with inflation.  The proposed lease here didn't have any escalator!!  Can you imagine what $10,000 per year would be worth in 100 years?  You may be able to buy a six-pack. 



Now, the above should explain why our proposed partners had the language in two places that the city could not withhold any approvals of  any attempts to sub-lease the property.  They could have signed a lease with Rowlett, walked out the door, and immediately signed another lease with another party at a considerably higher rent rate, reflecting what I think is a $4 million land value.  They could have collected a premium between the two rent rates for the next 100 years, and never lifted a finger to build anything.


We would have given our land away.


So, when I see that our ex-city manager touched the Villages of Rowlett, it sent a shiver down my spine.  I see $6 million becoming $11 million, becoming $12 million.  It's a perfectly logical pattern considering the players.















 















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