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Cash-flow drama at TCBY Tower.

Cash-flow Drama At TCBY Tower

Projections Fall Apart In Soft Office Space Market, Causing Flake And Co. To Scramble For Tenants And Financing

There's a great real estate drama unfolding in Little Rock. It's a tale about the financing of the state's largest building, in fact, the tallest office tower between Dallas and St. Louis. It's a story the building's owners, -- a limited partnership led by John Flake -- and its chief financial backer -- the Teachers Retirement System of Texas, -- prefer not be told in much detail.

Running well below projections, the TCBY Tower is losing an estimated $2.2 million a year, according to an analysis by Arkansas Business. The losses -- based on occupancy as of Jan. 30, estimated income and expenses, both of which are stabilized in the study -- coupled with the shutoff of a line of credit at First Savings of Arkansas pose a mighty hurdle to overcome in current economic times.

Located in the heart of the Arkansas capital's central business district, the 40-story TCBY Tower stands as a monument to initiative, but also to the same kind of financing that led to the downfall of the state's largest thrifts and major financial institutions across the nation.

Estimates derived from cost-of-construction reports and appraisals indicate the project was 100 percent financed, a frequent practice in the mid-1980 boom years and the savings and loan lending explosion.

Unlike the heralded collapse of many financial institutions, the tower story, following its own particular course, continues to be written. While the conflict is heightening, the outcome is not clear.

The spotlight is on John Flake, chairman of Flake & Co. which is managing general partner of the Capitol Avenue Development Co., a limited partnership and the building owner.

Given the project's non-recourse financing, he could technically walk away without any personal liability for himself, his company or the limited partners. But with the size of the project and the attention it is receiving, he might be hard-pressed to find agreeable lenders for other projects, if he let this one go down.

The lender, the Teachers Retirement System of Texas is solid and may be able to sustain a hit the size of the TCBY Tower, but its strength may also allow it flexibility in assisting Flake & Co. with its problems.

Among the factors that led the retirement system in December 1986 to provide permanent financing in the form of a $65 million loan was an overwhelming ebullience about prospects for economic growth at Little Rock and confidence in the successful business executives involved as limited partners in the deal. The start-up leasing included major tenants such as Arkansas Power & Light Co., the Wallace, Dover & Dixon law firm, Merrill Lynch Pierce Fenner & Smith and Frost & Co. accounting for 50 percent of leasable space in the tower. (Of the four tenants, all are limited partners in the project except Merill Lynch.)

Consequently, the retirement system provided financing at a low risk to the owner/developer. In exchange, the lender would reap what it saw as an attractive reward -- 10 percent interest and a 45 percent participation in building profits.

A document obtained from Teachers Retirement System of Texas lists project costs of:

Parking Deck

$4,200,000 -- construction cost

75,000 -- arch. & eng. fees

78,000 -- devel. management

400,000 -- construct. interest

200,000 -- closing costs

100,000 -- contingency

$5.1 mil. -- Total Est. Cost


$36,416,000 -- construction cost

1,424,640 -- arch. & eng. fees

425,000 -- tenant inducements

9,250,000 -- construct. interest

425,000 -- letter of credit fees

675,000 -- lease fees

75,000 -- advertising

1,300,000 -- const. contingency

2,000,000 -- closing, points, etc.

625,000 -- develop. adminis.

7,101,882 -- tenant finish

$59.7 mil. -- Total Est. Cost

TCBY Tower Project

$64.8 mil. -- Tot. Est. Cost

Besides the costs of the project, building owners incurred another expense of $3.3 million to move AP&L from its quarters in the First Commercial Building and sublease the utility's space there. LOOKING BACK ON the permanent financing decision made by the Texas teachers retirement system, the loan was within a range generally followed by conservative lenders for projected net operating income. But the loan did not pass muster on two other conservative lending criteria.

Net operating income for the first year was 76 percent of debt service, listed as cash flow on a projection by Lomas & Nettleton Advisory Group Inc. dated Dec. 16, 1986.

Despite the first-year loss, optimistic projections saw a three-year average to be 120 percent. Net operating income was expected to climb to 154 percent by the fourth anniversary, 182 percent by the 10th year and 211 percent by the 15th year.

Lomas & Nettleton forecast a total project deficit of only $1.7 million, contained within the first year. However, as the project has fallen below expectations, $5.2 million already has been drawn from a First Savings line of credit, obtained to shore up any shortfalls.

As of Jan. 30, at the start of the fourth year of operation, the annual cash flow before debt service is estimated to be a deficit of $2.2 million or a coverage of 70 percent, according to a review by Arkansas Business. (See accompanying tenant list and chart of cash-flow summary.)

While initially meeting a criterion for net operating income, the teachers' pension fund apparently dismissed two other conservative lending criteria.

* The $65 million loan was for approximately 100 percent of the project cost, when more cautious lenders would require equity participation by the developer and lend no more than 85 percent of project cost.

* The pension fund loan was for 82 percent of the $79 million appraisal by George Fox Jr. of Appraisal Consultants Inc. at Little Rock. Conservative lenders would not have made the loan for more than 75 percent of the appraisal, which is $59.3 million.

Joe W. Perrone, chief investments officer for the retirement system, says the loan follows a format used by the pension fund and is closely monitored.

Brad Ritter, communications director for the Texas State Teachers Association, says Perrone's agency "is one of the soundest retirement systems in the country." The pension fund is in top fiscal shape, and Ritter says he cannot imagine it making a bad loan.

John Flake declined to be interviewed, but in response to written questions, says with a participating mortgage, it is very typical to see a loan-to-value ratio higher than with a straight mortgage.

"The environment in Little Rock for Class A office space has changed dramatically since the inception of the TCBY Tower project," Flake writes. "Although not performing exactly as projected, we remain pleased with the operating performance of the building. The permanent financing remains securely in place and is performing as planned." COMPARING THE TCBY Tower with recent deals at the Stephens Building, formerly the Rogers Building, and the First Commercial Building indicate that the $65 million loan is far more than the building's market value.

The Stephens Building (completed in 1985) sold for $24 million or $55.56/Gross SF, which when applied to the TCBY Tower brings its value to $41.1 million.

Connecticut Mutual Life Insurance Co. is trying to sell its 44 percent share of the First Commercial tower (completed in 1975) at $46.67/Gross SF. Applying this valuation to the TCBY Tower, its value would be $34.5 million.

A cash-flow appraisal based on optimistic leasing of the building yields a rosier picture.

Known income minus expenses brings a net operating income of $4.5 million. Capitalized at a 10 percent rate, that yields an appraised value of $45 million for the leased space.

Then add the unleased space of 175,000 SF, which if occupied would bring an average projected rent of $12.50/SF. This would yield nearly $2.2 million.

Next, subtracting a 20 percent vacancy rate gives about $1.8 million, which when capitalized at 11 percent yields a $19.3 million appraised value on prospective leases.

Using this method, the total appraised value on the building would then be $64.3 million, which is close to the amount of the note from the retirement system. SOME MEMBERS OF the Arkansas real estate community, a few of whom are jealous of the project's favorable financing arrangement, forecast an imminent failure for the project.

Perrone says the project already has technically defaulted with action by the Resolution Trust Corporation to rescind the project's $7.2 million line of credit at First Savings. The pension fund set the maintenance of a line of credit as a condition for issuance of its loan.

Rather than singling out the project on its merits, the federal regulators are seen as tightening all exposure for the insolvent thrift.

Perrone says his major concern about problems with the building's financing comes from journalists' questions rather than from any reports he sees from the limited partnership, which has kept its payments current.

He says the tower owners may ask to modify the loan agreement so that a line of credit is not required, and the pension fund may grant the request. GIVEN THE SLOW-MOVING local economy and cash-flow problems at the TCBY Tower, it may be difficult for Flake & Co. to find a replacement line of credit.

The building managers and the pension fund officers decline to release current rent rolls or recent profit and loss statements. But through other documents obtained from the retirement system and other sources, Arkansas Business is able to structure what informed observers say is a close approximation of the tower's financial picture.


$8,970,000 -- rents

300,000 -- parking income

70,000 -- antenna rental

$9.3 mil. -- Total Income


$6,700,000 -- debt service (TRS)

500,000 -- debt serv. (1st Sav.)

3,300,000 -- operating expenses

150,000 -- leasing expenses

25,000 -- tenant inducement

825,000 -- tenant finish out

$11.5 mil. -- Total Expenses

Income - Expenses

($2.2 mil.) -- Net Operating Loss

Notes: Financial summary covers period ending Jan. 30. Interest on the loan from First Savings of Arkansas assumes an average rate of approximately 10 percent on $5.2 million borrowed. This second mortgage provides for an adjustable rate, based on the day an advance from the line of credit was made.

Other Arkansas Business survey findings indicate:

* Through January, the tower had 26 tenants, occupying a total of 456,000 SF.

* Average rent was computed to be $19.67/SF.

* Total occupancy was 73 percent.

Flake & Co. and the teachers retirement system were provided copies of the financial summary drawn up by Arkansas Business, but they declined to correct any figures or comment on its accuracy.

Flake & Co. is aggressively pursuing new tenants and has met with a measure of success.

Tenants who moved in earlier this month or are set to move in later this year are:

* KKYK-FM, which will occupy 6,000 SF and pay an undisclosed rent.

* The Bureau of Alcohol, Tobacco & Firearms, 3,500 SF, $12.50/SF

* Kremer & Associates, 3,000 SF, $10.25/SF

* Worldwide Travel, which will add 2,500 SF to its current office, rent undisclosed

* Social Security Administration, 1,250 SF, $12.50/SF

But transitions endured by major tenants have become problems for TCBY Tower owners.

AP&L is transferring its nuclear engineers and their support staff to Russellville, where they will be located at the Arkansas Nuclear One plant. The transfer, expected to be completed this fall, will leave three floors vacant. Even if no new tenants are found, the utility is expected to continue to pay rent on the office space.

If AP&L decides to sublease the space, it will become direct competition for Flake & Co. as it tries to fill up other space.

A second major problem involves the dissolution of the Wallace, Dover & Dixon law firm, which had occupied three upper floors. With the departure of Larry Wallace, the firm's managing partner, the firm has broken up into two firms -- Dover & Dixon and Cross & Gunter.

Reportedly, the high rent charged to the Wallace firm at $23.43/SF or $814,340 per year was one factor that led to disagreement among the partners, who split away.

With the demise of Wallace, Dover & Dixon, the entity, which signed the original lease, speculation is that the two law firms will try to negotiate new leases, which are more favorable, or move out.

As options for boosting the project's financial strength are explored, going back to the limited partners appears unlikely. The $2.2 million in annual losses break down to $1,833 a month from each limited partner for each 1 percent of the partnership they own. The amount would be easy for some to pony up, but impossible for others to sustain.

AP&L owns nearly 50 percent, and utility observers wonder if ratepayers will be tapped to help make up the towers' net operating losses.

One possible solution for the partnership involves finding an equity angel with from $10 million to $15 million, which would be used to pay off the First Savings loan and to cover any future losses until the building occupancy reaches profitability.

To save their participation in the project and eliminate their losses, majority partners already in the project probably would approve a new player.

The teachers pension fund also would probably go along. Even though not a formal partner, the retirement system will gain 45 percent of any profits before distribution is made to the partners, according to the loan agreement.

Another likely scenario would be for the pension fund to take full ownership of the building, if a default occurs. With its deep pockets, shortterm losses would be easy to carry until the building reaches the breakeven point.

It looks grim for the TCBY Tower owners and their lenders right now. But the story has a long way to go. No doubt it will probably take a few turns, both predictable and unpredictable. Given the shrewdness and determination of John Flake, however, he, his partners, and pension fund officers may be smiling at the final curtain.

"We are committed for the long term project and the enjoyment of its use by our tenants," Flake says. "We remain optimistic about the 1990s and the occupancy and profitability of TCBY Tower."
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Title Annotation:Little Rock office building
Author:Kern, David F.
Publication:Arkansas Business
Date:Feb 12, 1990
Previous Article:Trading up.
Next Article:Pack Journalism?

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