Can?t-Miss Real Estate Investment Snares Even Experienced Developers

The real estate meltdown in Northwest Arkansas bloodied novice and experienced investors alike. Two central Arkansas development veterans were among the collateral damage in a $10.1 million can’t-miss deal gone bust: John Flake and Andy Collins.

Collins acknowledges he should have done more due diligence, while Flake insists he was just a passive investor in the package of three apartment projects marketed toward Hispanics.

Flake and Brandon Rogers, then an up-and-comer, put together the investment in more than 250 units near the Springdale Airport four years ago. They brought in a group of partners and joined them to collectively pony up $2 million.

That money, combined with $8.1 million in non-recourse financing, got the deal rolling with expectations the apartments would generate an annual pre-tax cash flow of $400,000.

“We all thought this was something our kids were going to be fighting over,” Rogers said. “The market was hot and everything was working up there.”

Instead of creating an investment legacy for their heirs, the partners struggled to keep the project at break-even. That led to the dismissal of the property manager, a lawsuit, counterclaims of mismanagement and a general bout of hurt feelings.

Today, the $8.1 million non-recourse loan package backing Strawberry Meadows (103 units), Crutcher Street (97 units) and Powell Street (53 units) is in default. Ownership of the apartments is in the process of shifting to a receiver, CW Capital Asset Management LLC of Needham, Mass.

“I’m embarrassed that I invested in the project,” said Collins, the largest investor in the deal. “It was pitched as one thing, but the bottom fell out very quickly. It became apparent the deal was never going to work out. I should’ve done more due diligence on my own, and instead I relied on others.”

Bad Timing

The project loans went into technical default on March 4, when Brandon Rogers filed for personal bankruptcy. Rogers listed estimated assets of nearly $5.6 million and liabilities of more than $21.3 million.

His Chapter 7 petition triggered the technical default because of his position as a managing member of the limited liability companies overseeing the apartments.

But the financial honeymoon was waning only a year after the properties were purchased from James Mathias. The timing of the transaction couldn’t have been better for Mathias and worse for buyers.

Problems were outlined in a lawsuit filed by Bobby Stephens, an investor whose B&B Management Co. was ousted as property manager on March 1, 2008.

“In August 2006, federal authorities raided two of the three complexes and caused the residents of 30 of the 250 units to be deported. Most of these residents had rented these units when they were owned by previous management. The raid caused the properties to lose favor in the market.

“In addition, beginning in mid-to-late 2006, the local Springdale economy nosedived and its total population has since declined.

“The development has severely affected the market for apartment unit rentals especially since the previous economic boom had caused apartments to be built in excess of demand.

“By the end of December 2007 capital needs of the projects were even more dire, as occupancies had declined below a point where debt could be serviced and expenses like payroll timely met. Owners had been supplied with financial reports expressing the distressed state of the finances of the complexes. Owners declined to support a capital call, though the same was requested.”

“It was presented as a home-run deal, that we were lucky to be getting in on it,” said one investor, who discussed the investment on condition of anonymity. “I knew it was a class C property [in terms of quality], but I didn’t know it was full of illegal aliens.”

Stephens claimed he was owed $156,000 in his August 2008 complaint against the ownership group. The partners countered that Stephens mismanaged the properties and asked for an audit.

The lawsuit was settled with Stephens accepting a $120,000 claim against partnership assets. According to some investors, that claim translates into zero since the lender holds first priority on the financially challenged projects.

Bridger Commercial Funding of Mill Valley, Calif., originated the loan package on the deal and sold it to Bank of America. On March 23, 2006, the debt became part of a mortgage-backed securities offering when it was sold to COMM 2006-C7 Commercial Mortgage Pass-Through Certificates, with Wells Fargo Bank as trustee.

 

‘A Tremendous Challenge’

Shortly before his dismissal as property manager, Stephens gave a status report on the project in advance of a conference call meeting with the partners scheduled for Feb. 21, 2008.

“The past five months have been a tremendous challenge to our partnership,” Stephens wrote in a letter dated Feb. 13, 2008. “There has been a loss of jobs (especially construction) in this job market that has softened our market. The Mexican population started migrating back to Mexico in October of 2007, which was about 45 days earlier than normal.

“Our competition started target marketing to the Mexican market last summer. These are the two new complexes, with 700 units within one mile of our locations that were opened about the same time we acquired these properties.

“Our major competition reduced their rates and created the one month move-in specials or one-month free rent for a six-month lease (with no deposit).

“In order to get any traffic, we have had to match these move-in specials, therefore, this has created a cash drainage to our balance sheet. We really started feeling the softness in August, then in November when the migration started early our occupancy dropped down below 70 percent …”

“We have all been hopeful this market would rebound much sooner. Therefore, we are going to make a capital call in the next two weeks. This money will pay off the credit line, all reimbursable expenses and management fees and inject cash needed to operate on through June 2008 based on our projections for tenant revenue.

“Summary including the above explanation is a total of $242,755.33 for the current capital call. This represents about 12 percent of our original capitalization.

“Two of our partners have expressed a desire to put these facilities on the market for sale. We would like to have your opinion. Please let us know your thoughts at the meeting.”

Flake has portrayed himself as a passive investor in the deal, although he and his Orion Capital Partners collected up-front fees and marketed it to investors.

“None of us would’ve invested with Brandon,” one investor said. “We were investing with an experienced guy, John Flake. The people were relying on John and his management company to have done due diligence and manage the deal.”

Flake insists otherwise. “No, I was a passive investor in it,” he said. “It obviously was not successful.”