Most ATRS Real Estate Returning Less Than 8%

Fewer than half of the real estate holdings of Arkansas Teacher Retirement System are meeting or exceeding the pension fund’s annual return on investment goal of 8 percent.

Performance details of 23 properties were presented last week to the pension fund’s investment committee by Tom Ferstl, real estate manager for ATRS.

The four-page handout provides a one-year snapshot of most of the real estate owned by the largest pension fund in Arkansas. It examines about $250 million worth of real estate investing ATRS has made through outright acquisition or through partnerships and joint ventures.

According to financial information provided by property managers and compiled by Ferstl, 10 out of 23 are making at least an 8 percent return on investment.

Three apartment/golf course projects in Oklahoma are producing a combined 7 percent return for ATRS. The pension fund owns a 49 percent stake in these limited partnerships with Lindsey & Associates of Fayetteville.

The apartment components of the developments in Broken Arrow, Owasso and Moore appear to be doing well. But the golf course operations are lagging behind.

Jim Lindsey, president of Lindsey & Associates, reported that ATRS was paid its minimum guarantee of 7 percent. But the underperforming golf clubs prevented additional profits.

“Golf courses haven’t performed according to pro formas,” Lindsey told the pension fund’s real estate investment committee. “Apartments have overperformed.”

Lindsey discussed operations at the three projects as part of a proposal to proceed with phase two apartment construction at the Broken Arrow and Owasso projects. The proposal was tabled until Lindsey & Associates could submit an appraisal and provide more detailed financial data on the performance of phase one.

As part of his handout to the investment committee, Ferstl included financial information on ATRS loans totaling almost $46.3 million associated with 12 Lindsey apartment projects.

About $43.3 million worth of the funds, loaned in September 1999, is drawing 7 percent interest. About $3 million dates to October 1999 and yields almost 7.5 percent.

Lindsey & Associates is the only firm that has a borrower’s relationship with the pension fund as well as partnership deals.

Ferstl’s handout only covered properties managed by real estate firms on behalf of the pension fund. Three undeveloped pieces of land in Fayetteville ($4.26 million), west Little Rock (purchased for $4.3 million) and Jonesboro ($2.8 million) were not included. These three properties were envisioned to become retirement projects.

But the developments, proposed by former ATRS executive director Bill Shirron, were shelved when concerns of profitability grew.

The raw 10-out-of-23 statistic isn’t as underwhelming as it might appear.

Several of the properties were never expected to meet the benchmark. Among those are the $45.6 million Victory Building development in Little Rock, which was completed this year.

The 260,187-SF office building and adjoining parking deck weren’t forecast to hit the 8 percent mark in the first year of operations. However, unless leasing activity picks up, the project still will fall short of the expected financial performance.

Two other properties, 1,364 acres in Benton County and a 56,000-SF former Harvest Foods store in southwest Little Rock, are speculative investments with near-zero return.

The Benton County acreage was assembled for about $11.8 million during 2000-2001 with an eye toward cashing in on development opportunities afforded by the nearby Northwest Arkansas Regional Airport.

The Riley Building in Little Rock was an unintended acquisition by the pension fund. Pat Riley Sr. turned over the office project to ATRS as part of a financial settlement after he defaulted on an $11.5 million loan with the pension fund.

If the sale of three other Riley properties is finalized as proposed, ATRS will recover all of the outstanding principal owed on the loan. Over time, profit from the Riley Building may allow the pension fund to make good on lost interest and out-of-pocket expenses associated with the Riley default.

“They have an asset there that will help them recoup their losses,” Ferstl said. “That was my goal — to make this as close to a wash as possible.”

Ferstl sees the project stabilizing at about a 5-6 percent return on investment after it generated a woeful 1.75 percent in 2001. ATRS paid off a $1.125 million Riley loan to the Arkansas Public Employees Retirement System and spent more money to upgrade the neglected property.

The three apparently underperforming joint ventures with Cooper Realty Investments of Bella Vista are more enigmatic. Despite repeated requests to Cooper, Ferstl was unable to gather full financial data on the Two Financial Centre office building in Little Rock, 1 and 2 American Center office buildings in Nashville, Tenn., and the Crescent Center retail project in Memphis.

“Maybe they were embarrassed by their performance,” Ferstl said. “I don’t know, but I was able to extrapolate some numbers to help give us a picture of where we stood.”

ATRS owns 80 percent of the projects in separate joint ventures with Cooper.

After two years of ownership, the Bank of America Plaza in Fayetteville is generating a 7 percent return on its $3.55 million investment.

The real estate committee also endorsed two new real estate-related investments subject to appraisals and other exceptions.

The first was providing up to $22 million to fund the redevelopment of the North Little Rock Memorial Hospital into a state office building. As proposed, the state would lease the 40-acre property and buy it after completion.

Ferstl mentioned the item while reporting to the investment committee that afternoon. The need for the newly created real estate committee was underscored when Ferstl was berated for looking at a deal that didn’t meet investment guidelines. It was clear that some of the members of the investment committee didn’t know the difference between the amortization of a loan and the term of a loan.

The proposed term of the funding package was six years with monthly payments based on a 24-year amortization schedule. Some members thought it was a 24-year agreement instead of a six-year deal.

The other item brought before the real estate committee was a proposal to invest $5 million in a 50-50 joint venture to develop and own an 80-unit upscale apartment development in west Little Rock.

As proposed, ATRS would receive a minimum return of 7 percent the first five years of the project that would increase to 8 percent after that. Consolidated Residential LLC of Wichita, Kan., would receive up to a 5 percent management fee after the pension fund was paid. Any profits left after these two items would be split 50-50.

With projected rents of $1,400-$1,600 a month, the project would be establishing a new high point in the Little Rock market. The Kansas company owns similar high-end projects that are successful in other cities, according to Consolidated Residential representatives.

ATRS Loans

Lindsey & Associates Apartment Loans from Arkansas Teacher Retirement System

Project — Amount* — Net Operating Income

Greens at Marion II — $8.50 — $790,803

Station — $6.20 — $576,822

Centennial Valley — $5.40 — $502,393

West Wood II — $4.80 — $447,979

West Wood — $4.65 — $432,616

Eagle Hill Golf Development — $4.00 — $372,143

Moberly Place — $2.92 — $271,850

Markham Hill — $2.87 — $267,637

Moberly Manor II — $2.00 — $186,071

Crossover Terrace — $1.95 — $181,419

Meadow Lake II** — $1.50 — $165,839

Meadow Lake** — $1.49 — $165,839

Total — $46.29 — $4.36 million

All figures are for 2001. *In millions. **Interest rate on loan is 7.47 percent. All other projects are at 7 percent.

Source: Lindsey & Associates as compiled by Tom Ferstl, ATRS real estate investment manager.