Update to Lake City Property Issue
Via Director Peaslee, new info from Ron English, legal counsel for the district about the Lake City property (and thank you to Mr. English for this detailed explanation).
It's quite long and detailed and I am printing it in its entirety. I still have my three main issues with this idea:
- should the district be in the property management business at all? It is not a core purpose of the district.
- Mr. English's statement says that the district's real estate adviser says:"annual returns over a 20 year period of at least $400,000 can be expected and that the negotiated agreement represents a fair result to the District."
However, there is no guarantee for the amount the district could earn and we have all seen what effect downturns in the economy can have on deflation of real estate. My advice would be that if the district goes down this road to make NO plans around this money. Meaning,"oh, we have $400k from this so we can pay for Program X from it."
Also, keep in mind that money borrowed from the Community Schools fund would need to be paid back into the fund BEFORE the district uses any profit for other uses. This is a bit confusing because using the money from this fund in this manner doesn't seem to NEED to be paid back to the fund but that's what English told the Board at the Board meeting.
- Is this the best use of scarce capital dollars right now given all the building condition/capacity management needs? It may be a pressing issue but surely not more urgent than others. I question using almost $3M for this. It will not be paid back to the Community Schools fund for nearly a decade. And, there will be no useful profit to the district until beyond that time. The needs are now.
There is also this (which I had reported before):
Questions have also been asked about what other uses may be made of the Community Schools account. Assistant Superintendent for Business and Finance, Duggan Harman, advises that the action recently approved by the Board on April 4 to establish this account keeps control of the account with the Board. The account is within the Capital Eligible Projects Fund of the Capital Fund and the Board acted “to set aside and restrict the use of $18,700,000 within such fund, and the investment returns on such amount after September 1, 2011, to such uses asare expressly approved by the School Board.”
The Board Action report goes on to state, “It is anticipated these funds may be used for the World School, for temporary loans to other capital eligible activities and for unexpected needs of the District.”
I don't want to be unkind but the wording above sounds a lot like a slush fund for whatever "unexpected needs" are. The Community Schools fund money should have a real and verifiable use. And again, this switching of money around from fund to fund makes it extremely hard to track. We got off course with the money for the JSCEE and we can't go that route again.
Mr. English's statement:
The property was leased to Lorig in the early 1980’s. Under the terms of the ground lease, the District remains the owner of the land, and the lessee controls the building, collects rent from subtenants, pays expenses and pays the District rent. While the District technically remains the “owner” of all the property, including the building, the lessee has all the benefits of ownership during the lease period. At the end of the lease, the District will resume control over the entire property.
The rent is set every five years, and is currently $74,000 annually, plus a percentage calculation, based on net revenue after costs and debt service is paid. For the past several years the percentage calculation has not resulted in any additional payments to the District. This is primarily due to the significant debt service costs incurred by the lessee to service its loans and also because during the period when the redevelopment proposal was being pursued (see discussion below), the lessee did not aggressively seek to fill vacancies, which resulted in reduced occupancy and reduced revenue. The tenant has since started to refill the building, with higher occupancy rates being achieved.
The rent was due to be reset last fall, and the parties engaged in discussions as to the correct amount, based on the formula provided in the lease. The lessee argued the formula would result in little if any increase in the base rent, and the District argued for a substantial increase. Under the lease, if the parties cannot agree the matter will go to arbitration. I have been assisted throughout the negotiations by our real estate advisor, Jim Reinhardsen of Heartland.
The lessee proposed an alternative to arbitration, to renegotiate the terms of the lease, keeping the base rent low, but modifying the percentage rent calculation. We rejected that proposal.
The lease allows the lessee to encumber (“mortgage”) the property for loans to improve the building. The lessee currently has approximately $3 million in outstanding debt on the project and indicated that if the lease terms are not modified, it may not be able to refinance the major mortgage loan, which comes due in October 2013. This could result in a default on the mortgage. Under the terms of the lease, if a default occurs on the mortgage, the District rent will be zero, likely for several years, until the lender sells the leasehold interest to a third party. This provision was included in the original lease and has not been changed since.
Questions have also been raised about the likelihood the anticipated revenues will be realized. The projections are based on actual returns in recent years, even with the reduced occupancy noted above. Heartland has performed an analysis of various assumptions about revenues, costs, occupancy rates and other variables, and advises that annual returns over a 20 year period of at least $400,000 can be expected and that the negotiated agreement represents a fair result to the District.
Wednesday night I was unable to tell you how much the management fee is to operate the building. This fee has now been proposed by the tenant at four percent (4%) of gross revenues. On Thursday I will provide the A&F Committee a listing of anticipated revenues and expenses (including maintenance and operating costs).
If the transaction is approved, the lessee will manage the property for the first three months. Property Management expects to issue a request for proposals for management of the property by early June, to select a longer term management firm. Our Property Leasing Coordinator, Diane Taguba, was herself a manger of commercial properties prior to joining the District, and would administer any resulting contract.
Questions have been raised about whether a default would be likely, given the substantial net operating income generated by the building. We are unable to assess the likelihood of a default by the lessee on its loans, given that it turns on the lessee’s internal finances and their ability to find a lender. However, given that no percentage payments have been due in several years, default must be considered a real possibility should the District reject this proposal, pursue arbitration of the rent pursuant to the lease and obtain an award for increased rent. This would further increase the lessee’s costs, and could preclude a refinancing of the mortgage by the lessee.
Questions have also been raised as to whether the building is needed for capacity management purposes. This question will be directed to Pegi McEvoy, and I will ask her or Lucy Morello to discuss it at the A&F meeting on Thursday. The property is located less than a mile from Olympic Hills, Rogers and Cedar Park. Lake City is a small site (the playground portion was sold to the City Parks Department many years ago) and the structure has been designated as an historic building. This designation limits redevelopment possibilities. For example, several years ago the tenant and the District agreed to a redevelopment to add a multi-story residential building on the parking lot portion of the site, but we were unable to secure approval from the City Landmarks Board to build an economically viable structure, and that proposal was abandoned. Nonetheless, I believe that the existing building could be reconverted to school use while maintaining its historic character, with substantial renovations. No analysis has been made as to how this might be done or how much it might cost.
Questions have been asked about what options the District has. As indicated in the Board Action Report, if the proposal is not approved, the District will proceed under the lease to set the rent pursuant to an arbitration process. The resulting rent will not be less than the current $75,000 annually. If the tenant is unable to refinance its loans and defaults, the lease provides that District’s annual rent will be zero until the leasehold interest is sold to a new tenant, which could be several years. After that period, the rent will be reinstated, probably at a higher rate than before. We believe that over time the District will recover the unpaid rent. The proposal to terminate the lease, as well as both alternatives, has been evaluated by Heartland to determine the likely Net Present Value of each possible result. As requested by Director Carr last Wednesday, I will provide the A&F Committee with comparisons of the value of each option.
Questions have also been asked about what other uses may be made of the Community Schools account. Assistant Superintendent for Business and Finance, Duggan Harman, advises that the action recently approved by the Board on April 4 to establish this account keeps control of the account with the Board. The account is within the Capital Eligible Projects Fund of the Capital Fund and the Board acted “to set aside and restrict the use of $18,700,000 within such fund, and the investment returns on such amount after September 1, 2011, to such uses as are expressly approved by the School Board.”
The Board Action report goes on to state, “It is anticipated these funds may be used for the World School, for temporary loans to other capital eligible activities and for unexpected needs of the District.”
Based on this language, Mr. Harman and I believe with board approval, these funds can be used for any capital eligible purpose. The Lake City proposal, as a loan which would be repaid, would be consistent with this action.
If you have additional questions, please let me know and I will be happy to discuss them at the A& F meeting on Thursday.
It's quite long and detailed and I am printing it in its entirety. I still have my three main issues with this idea:
- should the district be in the property management business at all? It is not a core purpose of the district.
- Mr. English's statement says that the district's real estate adviser says:"annual returns over a 20 year period of at least $400,000 can be expected and that the negotiated agreement represents a fair result to the District."
However, there is no guarantee for the amount the district could earn and we have all seen what effect downturns in the economy can have on deflation of real estate. My advice would be that if the district goes down this road to make NO plans around this money. Meaning,"oh, we have $400k from this so we can pay for Program X from it."
Also, keep in mind that money borrowed from the Community Schools fund would need to be paid back into the fund BEFORE the district uses any profit for other uses. This is a bit confusing because using the money from this fund in this manner doesn't seem to NEED to be paid back to the fund but that's what English told the Board at the Board meeting.
- Is this the best use of scarce capital dollars right now given all the building condition/capacity management needs? It may be a pressing issue but surely not more urgent than others. I question using almost $3M for this. It will not be paid back to the Community Schools fund for nearly a decade. And, there will be no useful profit to the district until beyond that time. The needs are now.
There is also this (which I had reported before):
Questions have also been asked about what other uses may be made of the Community Schools account. Assistant Superintendent for Business and Finance, Duggan Harman, advises that the action recently approved by the Board on April 4 to establish this account keeps control of the account with the Board. The account is within the Capital Eligible Projects Fund of the Capital Fund and the Board acted “to set aside and restrict the use of $18,700,000 within such fund, and the investment returns on such amount after September 1, 2011, to such uses asare expressly approved by the School Board.”
The Board Action report goes on to state, “It is anticipated these funds may be used for the World School, for temporary loans to other capital eligible activities and for unexpected needs of the District.”
I don't want to be unkind but the wording above sounds a lot like a slush fund for whatever "unexpected needs" are. The Community Schools fund money should have a real and verifiable use. And again, this switching of money around from fund to fund makes it extremely hard to track. We got off course with the money for the JSCEE and we can't go that route again.
Mr. English's statement:
The property was leased to Lorig in the early 1980’s. Under the terms of the ground lease, the District remains the owner of the land, and the lessee controls the building, collects rent from subtenants, pays expenses and pays the District rent. While the District technically remains the “owner” of all the property, including the building, the lessee has all the benefits of ownership during the lease period. At the end of the lease, the District will resume control over the entire property.
The rent is set every five years, and is currently $74,000 annually, plus a percentage calculation, based on net revenue after costs and debt service is paid. For the past several years the percentage calculation has not resulted in any additional payments to the District. This is primarily due to the significant debt service costs incurred by the lessee to service its loans and also because during the period when the redevelopment proposal was being pursued (see discussion below), the lessee did not aggressively seek to fill vacancies, which resulted in reduced occupancy and reduced revenue. The tenant has since started to refill the building, with higher occupancy rates being achieved.
The rent was due to be reset last fall, and the parties engaged in discussions as to the correct amount, based on the formula provided in the lease. The lessee argued the formula would result in little if any increase in the base rent, and the District argued for a substantial increase. Under the lease, if the parties cannot agree the matter will go to arbitration. I have been assisted throughout the negotiations by our real estate advisor, Jim Reinhardsen of Heartland.
The lessee proposed an alternative to arbitration, to renegotiate the terms of the lease, keeping the base rent low, but modifying the percentage rent calculation. We rejected that proposal.
The lease allows the lessee to encumber (“mortgage”) the property for loans to improve the building. The lessee currently has approximately $3 million in outstanding debt on the project and indicated that if the lease terms are not modified, it may not be able to refinance the major mortgage loan, which comes due in October 2013. This could result in a default on the mortgage. Under the terms of the lease, if a default occurs on the mortgage, the District rent will be zero, likely for several years, until the lender sells the leasehold interest to a third party. This provision was included in the original lease and has not been changed since.
Questions have also been raised about the likelihood the anticipated revenues will be realized. The projections are based on actual returns in recent years, even with the reduced occupancy noted above. Heartland has performed an analysis of various assumptions about revenues, costs, occupancy rates and other variables, and advises that annual returns over a 20 year period of at least $400,000 can be expected and that the negotiated agreement represents a fair result to the District.
Wednesday night I was unable to tell you how much the management fee is to operate the building. This fee has now been proposed by the tenant at four percent (4%) of gross revenues. On Thursday I will provide the A&F Committee a listing of anticipated revenues and expenses (including maintenance and operating costs).
If the transaction is approved, the lessee will manage the property for the first three months. Property Management expects to issue a request for proposals for management of the property by early June, to select a longer term management firm. Our Property Leasing Coordinator, Diane Taguba, was herself a manger of commercial properties prior to joining the District, and would administer any resulting contract.
Questions have been raised about whether a default would be likely, given the substantial net operating income generated by the building. We are unable to assess the likelihood of a default by the lessee on its loans, given that it turns on the lessee’s internal finances and their ability to find a lender. However, given that no percentage payments have been due in several years, default must be considered a real possibility should the District reject this proposal, pursue arbitration of the rent pursuant to the lease and obtain an award for increased rent. This would further increase the lessee’s costs, and could preclude a refinancing of the mortgage by the lessee.
Questions have also been raised as to whether the building is needed for capacity management purposes. This question will be directed to Pegi McEvoy, and I will ask her or Lucy Morello to discuss it at the A&F meeting on Thursday. The property is located less than a mile from Olympic Hills, Rogers and Cedar Park. Lake City is a small site (the playground portion was sold to the City Parks Department many years ago) and the structure has been designated as an historic building. This designation limits redevelopment possibilities. For example, several years ago the tenant and the District agreed to a redevelopment to add a multi-story residential building on the parking lot portion of the site, but we were unable to secure approval from the City Landmarks Board to build an economically viable structure, and that proposal was abandoned. Nonetheless, I believe that the existing building could be reconverted to school use while maintaining its historic character, with substantial renovations. No analysis has been made as to how this might be done or how much it might cost.
Questions have been asked about what options the District has. As indicated in the Board Action Report, if the proposal is not approved, the District will proceed under the lease to set the rent pursuant to an arbitration process. The resulting rent will not be less than the current $75,000 annually. If the tenant is unable to refinance its loans and defaults, the lease provides that District’s annual rent will be zero until the leasehold interest is sold to a new tenant, which could be several years. After that period, the rent will be reinstated, probably at a higher rate than before. We believe that over time the District will recover the unpaid rent. The proposal to terminate the lease, as well as both alternatives, has been evaluated by Heartland to determine the likely Net Present Value of each possible result. As requested by Director Carr last Wednesday, I will provide the A&F Committee with comparisons of the value of each option.
Questions have also been asked about what other uses may be made of the Community Schools account. Assistant Superintendent for Business and Finance, Duggan Harman, advises that the action recently approved by the Board on April 4 to establish this account keeps control of the account with the Board. The account is within the Capital Eligible Projects Fund of the Capital Fund and the Board acted “to set aside and restrict the use of $18,700,000 within such fund, and the investment returns on such amount after September 1, 2011, to such uses as are expressly approved by the School Board.”
The Board Action report goes on to state, “It is anticipated these funds may be used for the World School, for temporary loans to other capital eligible activities and for unexpected needs of the District.”
Based on this language, Mr. Harman and I believe with board approval, these funds can be used for any capital eligible purpose. The Lake City proposal, as a loan which would be repaid, would be consistent with this action.
If you have additional questions, please let me know and I will be happy to discuss them at the A& F meeting on Thursday.
Comments
Helen Schinske
If we furlough even more, we can do even bigger deals.
Can those really be the terms? Are these standard terms in commercial real estate or is this a special deal for SPS?
FishySmellDetector
It is too bad the site is so small -- but when I think of things that the District could use (that do NOT require playgrounds -- like a home for NOVA, space for the Homeschool Resource Center, places for CTE activities, etc. -- I think I concur, at least in concept, with the idea that you could, at some point, remodel the space for District use (after, of course, you have recouped the purchase price over time).
Given that the City is pressed for park maintenance funds -- maybe we could even get our playground back, and do something for the lower grades?
As for the lease - I'm not a commercial real estate professional, but I would think the smart thing for the district to do would play hardball. Let them default in 2013, then offer the bank 60 cents on the dollar for the leasehold interest. If a private party comes in and offers more, all the better, as then SPS won't have the headache and risk of managing a commercial space in sketchy economic times.
It's actually a cool old building, with some interesting history, but I wouldn't want to be on the hook to maintain it.
Couldn't we get a better deal from Lorig as the default day nears?
Still, if this is a good deal, then what is to keep the District from finding other buildings that we could acquire for $1m - $3m with similar cap rates and buying them?
I also have to wonder, do we need the income more than we need the large amount of cash in hand, or do we need the cash in hand more than we need the income?
We need the cash in hand now.
young punk
Two and a quarter years to go
This idea of playing chicken in negotiations with a lessee who cries poor mouth...I have a feeling that taxpayers are going to be walking home in a barrel.
- RollerCoasterFabio