Cash on cash

Arkansas Business, July 8, 2002 by Gwen Moritz

THE COOPER REALTY INvestment folks -- president Dewitt Smith, two other executives and two lawyers -- came to see me. It is fair to say that CRI is not happy with the way its joint ventures with Arkansas Teacher Retirement System have been characterized in Arkansas Business.

I'm now persuaded that I was mistaken in the way I described the CRI/ATRS purchase of the Two Financial Centre in this column on June 17. That office building was purchased in May 2000 by Cooper Financial LLC, which -- despite its name -- is 80 percent owned by ATRS. CRI owns a 20 percent interest and is the managing partner of the limited liability company. CRI also manages the building for a fee equal to 4 percent of the rent paid by tenants.

Based on my own misunderstanding, I reported in my column that CRI had purchased the building, then sold an 80 percent stake in it to ATRS, receiving more cash than CRI had put into the project in the first place. That was incorrect: The building was purchased by the joint venture, and CRI has maintained its investment.

I am happy to be set straight on that matter and happy to clear up my error I'll let CRI's own figures, which Smith et at provided to me, describe the deal:

The base purchase price of the building was $9.75 million. ATRS put $3.06 million into the joint venture, while CRI put in $765,000. The joint venture borrowed, first from Regions Bank and then from ATRS, $8.6 million against the building, and CRI is the sole guarantor of that note.

If we define the initial equity as the portion of the purchase price that was nor leveraged, the joint venture's equity as of May 2000 was $1.15 million. ATRS' 80 percent share of that, then, was $920,000. So what happened to the other $2.14 million that Teachers put into the pot?

Some $840,000 went into immediate renovations. But even more -- almost $890,000 -- went into "remedial reserves." The total amount reserved, more than $1.1 million, represented better than 11 percent of the purchase price, but that is in line with Smith's favorite word for the CRI approach to real estate: conservative.

It is that very conservatism that has led to the other part of AB coverage that has rankled the Cooper folks: the question of how the return on their ATRS deals stacks up against the retirement fund's other real estate investments.

Ever since a chart ranking 22 ATRS real estate deals by return on investment appeared in our May 27 issue, CRI has disputed the notion that its three joint ventures with Teachers have scored below average. In fact, even more CRI representatives appeared before the ATRS board of trustees on June 27 than came to visit me the day before, and they argued strongly that their deals have returned more than the 8 percent goal to ATRS -- if you count money that is going into reserves as well as into the ATRS bank account.

It boils down to a debate over definitions: Does cash-on-cash return mean money actually mailed to ATRS, or can it include reserves held by the joint venture against future contingencies? If the former, which is what ATRS real estate manager Tom Ferstl (and the table that appeared in AB) set out to compare, then the investments with CRI are returning below par. If the latter, which Smith says is the only right way to define cash-on-cash return, then the three Cooper/ATRS joint ventures are returning an average of 8.54 percent.

State Bank Commissioner Frank White, an ATRS trustee, told me the visit from CRI's A-Team was instructive. The main thing he learned, White said, was that the trustees need to be clear about the returns being projected before making any more real estate investments. After all, he said, actuaries have determined that the fund needs to have a cash return of 8 percent a year in order to meet its obligations to the state's retired teachers.

"The way Cooper portrayed cash-on-cash is probably correct," White said. "It made me think we should have asked for 10 percent."

The ATRS staff is working up new procedures for reviewing real estate investments, he said.

While White didn't say this, I got the impression that the CRI investments -- and undoubtedly some of the fund's other real estate investments wouldn't pass muster under the new procedure. But at least the debate over how to define the ROI may have been settled.