Letter to APS Board re sale of AIS property

To:      Atlanta Board of Education

Cc:      Errol Davis

Ladies and gentlemen,

It is a huge mistake to sell the AIS property instead of using reserve funds to bridge the FY14 deficit. It makes no sense to get rid of a unique, income-producing asset in order to keep a fungible asset (cash) that will barely keep up with inflation. 

The reserve fund balance at the end of FY 2014 is currently projected to be $49.5 million. According to Chuck Burbridge, the target fund balance is 7.5% of revenue or $42.5 million. If APS uses cash from the reserve fund rather than selling the AIS property, the fund balance will still be at or near its target balance, and APS will hold onto an asset that will produce income and appreciate in value. To quote a radio commercial, “this is the biggest no-brainer in the history of man.”

During one budget meeting, Mr. Davis said something along the lines of "I know I need $6 million today, I have no idea whether I'll need this property in 25 years." The premise of this statement is that the only way APS can get $6 million is to sell the AIS property. This is a false choice.

The decision boils down to which one of two assets will APS get rid of. One asset is cash in the fund reserve that will actually lose buying power for at least the next 2 years (Fed has announced ZIRP will remain in effect through 2015). The other asset is real estate that will begin returning at least 8% of its value beginning in 2019 and, at the same time, will appreciate in value. The only difference between these two assets is their respective liquidity. Since APS is nowhere near running out of reserve funds, liquidity is not an issue.

Beginning in 2019, the AIS rent will increase to 8% of the re-appraised value of the property. This will be at least $640,000 a year and could be as high as $2 million annually (some think the property is worth $25 million). No later than 2026, APS will have recouped today’s “sale price” in the form of rent payments from AIS.

The AIS property is positioned geographically right where the demographers predict APS will need capacity, and APS has the right to terminate the lease in 2036 (although its impossible to know if and where APS will need capacity in 2036). If APS gets rid of the AIS property and needs similar property in 2036, it will cost 3 to 4 times the current sale price - at least $17 million and perhaps as high as $50 million. If APS doesn’t need the property in 2036, it will continue to receive annual rent which will have increased in line with inflation.

APS has a choice to keep the property, receive annual rent and have the property if it needs it, or APS can sell the property, lose the annual rent and then face the possibility of having to purchase land in the future at a much higher price.

Selling the AIS property would be a bad financial decision and it would also be a short-sighted strategic decision. There is no glut of available land in North Atlanta, as you learned while searching for a new site for North Atlanta H.S. Think about the financial consequences to APS if it had sold the Brandon Primary Center site years ago. Lack of vision has been a problem for APS for as long as I can remember. Now is a good time to change that.

I do not advocate in any way even considering the sale of the AIS property. I cannot imagine a single person with expertise in finance recommending such a sale. However if, I repeat IF, APS is going to sell this property, it must at a minimum get fair market value, which is at least $10-11 million and probably much higher. I have reviewed both of the appraisals, one by APS and one by AIS, and they are both fundamentally flawed. APS’ appraisal states current annual rent is $208,152. AIS’ appraisal states current annual rent is $211,451. They cannot both be right, but more importantly, how can the appraisers differ on such a simple, basic fact that is so easy to confirm? The more significant problem, however, is that neither appraisal takes into account the increase in rent that will occur in 2019. This creates a HUGE difference in estimating value based on the discounted cash flow (DCF) method and causes both appraisals to grossly underestimate the value of the property.

The APS appraisal does not properly apply the annual CPI rent escalator. Instead of adjusting rent based on annual increases in the CPI-U index, it increases rent a flat 5% every 5 years. This underestimates appropriate rent increase by approximately 10% every 5 years.

The AIS appraisal does just the opposite, increasing rent by approximately 4.15% each year which is slightly higher than the historical norm. AIS then discounts this value by 9%, which is at the upper end of a reasonable discount rate, which range from 7-9% (APS appraisal used 7%, but the average suggested by the literature is 8.13%). The 9% discount factor has the affect of significantly reducing the value of the property.

The appraisals discount the value of the land by 7% (APS) and 9% (AIS). Both of these rates are far too high for real estate in the heart of Buckhead. In its simplest form, the discount rate is a measure of the rate of return that an investor would want on its money, and the riskier the investment, the greater the discount rate. Investment in real estate in Buckhead is relatively risk free. We cannot predict the future with certainty but we know that in 25 years this property will be worth far more than it is today. The discount rate set forth by statute for use in litigation is 5%, and I would suggest the same is appropriate for estimating the present value of land.

The AIS rate of 9% results in a 50% lower residual value for the property that the APS rate of 7%, and about 1/5 the value of a 5% discount rate. While there can be a good faith debate between 5% and 7%, the 9% rate used by AIS is simply indefensible and has the affect of virtually eliminating any residual value in the land. The premise of AIS’ appraisal is that you can pay $770,000 now and in 2051 you will own the land that they conservatively estimate will be worth $20 million free and clear. This is how family fortunes are made.

If you apply reasonable CPI escalation and discount rates, the value of the property, subject to the leasehold, is easily between $10 and $11 million. At a minimum, APS should not accept anything less than that.

Finally, one very important factor to take into account is that once APS sells the property to AIS, the lease goes away and the fair market value increases instantly. Comparable sales data suggest a price per acre of undeveloped land in excess of $3 million. That would put the unencumbered value of the 9.2 acre site in excess of $27 million. I guarantee you that AIS has done this analysis. AIS would love to buy the property for $6 million and immediately pocket $15 million or more in paper profits. Then, when the time is right, which could be the day after the sale closes, they could sell the unencumbered property for fair market value and use the profits to build a state of the art school in north Fulton County, which it would then own free and clear. APS is not and should not be in the business of doling out windfall profits.

AIS has a sweetheart deal right now. APS has 100% of the leverage. Unless AIS goes bankrupt, APS has a guaranteed stream or inflation-adjusted revenue on top of an appreciating asset. Please do NOT APPROVE THIS SALE.

As always, thank you for your consideration.

Tom