Boom turns to bust for state land buyers - East Valley Tribune: News

Boom turns to bust for state land buyers

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Posted: Sunday, May 24, 2009 10:28 pm | Updated: 2:39 am, Sat Oct 8, 2011.

Numerous sales of state land have either defaulted or are teetering on the brink of collapse, propped up by multiple payment extensions granted by the land department to the developers who agreed to pay top dollar at public auctions over the last six years.

The press release touting the largest sale in the history of the Arizona State Land Department made it sound like the boom would go on forever.

The lone bid for the 269 acres in north Phoenix primed for development came in at $149.5 million. That topped the prior record of $135 million for a sale of state trust land set two years before.

"This is a remarkable sales price and a milestone for the State of Arizona, which sends a clear message that the market is strong and very interested in the lands (the) Trust has to offer," state land commissioner Mark Winkleman said in the press release.

But that was 2007, before the cataclysmic collapse of the real estate industry that led the nation into a deep recession.

Scroll down for an interactive graphic on troubled assets

Now both of those record sales, along with roughly 20 others, have either defaulted or are teetering on the brink of collapse, propped up by multiple payment extensions granted by the land department to the developers who agreed to pay top dollar at public auctions over the last six years.

Almost $970 million worth of sales from the land department made since 2003 have been canceled or had at least one extension, according to an analysis of agency records by the Tribune. Some have already failed. Others have had default notices issued. Many remain viable only because the land department has agreed to delay the deadlines on principal and interest payments on sales it financed.

The land department has issued notices of default or canceled the deals on properties that sold for a total of about $554 million, according to an analysis of agency records.

The properties that have either failed or are in jeopardy represent more than half of the land sales made by the state in the last six years when figured on the basis of price.

Winkleman says now he expects more of the deals that he has tried to salvage to go bad.

"If everybody paid us what they said they would when they said they would, that's the best-case scenario for us and everybody else," Winkleman said. "But the market is what it is. And like everybody else that has financed land in the last several years, the world has changed."

The State Land Department manages more than 9 million acres that was granted to a trust when Arizona became a state. The main beneficiary of money raised through land sales and leases is public schools.

The land department went on an aggressive sales binge since 2003, during a time when Arizona ranked among the fastest growing states in the country. In the last six years, almost $1.84 billion in state trust land has been auctioned off to the highest bidder. In the prior 90 years since statehood, about $1 billion of state land had been sold, according to Winkleman.

While the final price is touted in the press releases, the sales are typically financed by the state. The buyers normally put 10 percent down, pay the fees associated with selling the property, and finance the balance through the state.

In the good times, high-dollar sales were the norm. Three state land sales topped $100 million each in the last four years. Two of those have since gone into default and a third has had interest payments delayed for two years.

Of the 13 most lucrative land sales the state has made since 2003, nine have either had default notices issued or payments extended. Four of the top five sales fall into that category.

The most critical sale by the land department in the East Valley is the 1,011 acres auctioned in December 2006 for $58.6 million to Desert Communities Inc., a company owned by Las Vegas developer Jim Rhodes.

Rhodes bought the land and the right to master plan the surrounding 6,700 acres of state trust holdings known as Lost Dutchman Heights. The sale is the first from Superstition Vistas, a 275-square-mile swath of state land that extends from Apache Junction to Florence that has been described as the "crown jewel" of state trust holdings.

Desert Communities has had four extensions since 2007.

In March, Rhodes filed for bankruptcy protection for 32 of his companies in Las Vegas. Desert Communities was not among them.

Company officials insist that the bankruptcy will not affect the planning or development of the Lost Dutchman Heights property in Apache Junction.

No lose

In one sense, the land department is in a no-lose situation.

When a property is auctioned, the successful bidder can pay the money up front or get its own financing. More often, the buyer finances the deal through the land department.

Interest rates charged by the state run at more than 10 percent, Winkleman said. Since the state already owns the property, it does not have to put up any cash to finance the sale.

If a buyer defaults, the state keeps all payments that have been made and takes back the ownership of the land. By then, the buyers have typically paid millions in fees and interest.

One example is the sale of 502 acres of state land in the Desert Ridge area of north Phoenix in August 2005 to a partnership between Toll Brothers Arizona Construction and Pulte Homes Corp. for $135 million.

The partnership paid 10 percent down - $13.5 million. It also paid $2.7 million in fees to close the sale. Over the next three years, the buyer paid another $26.2 million to the state in interest to finance the sale.

The land department granted a single extension in August 2008, and issued a notice of default on the sale two months later. The state took the property back and kept all of the payments that had been made by the partnership - a total of more than $42 million.

Walking away from the property was tough, said Jacque Petroulakis, a spokeswoman for Pulte Homes in Arizona. But given the current real estate market and the additional cost of going ahead with the sale, it made more sense to let the property go back to the state, she said.

"Given the realities of the economy, you have to make those tough business decisions," Petroulakis said. "While a considerable investment was made, we had to look at the numbers, the current market, and make a decision at that time. We definitely discussed possible ways of adjusting the timing of payments but just were not able to come to terms."

Linda Rossi, marketing director for Toll Brothers' southwestern region, declined to comment on the state land sale.

Even among the troubled sales, the state has collected more than $250 million through down payments, fees and interest, according to land department records.

Winkleman, whose last day at the land department was Friday, said the agency is on track to produce about $300 million in revenue this fiscal year. That is down from $382 million last year.

Risky business

But there are downsides for the state in canceling a sale and taking back the property, Winkleman said.

One issue is the condition of the land. If someone buys raw land from the state and does not make any improvements, then there is little risk in taking it back.

However, if the property has been altered by such things as grading or some initial construction, it can become a financial burden on the state to maintain.

But the biggest incentive for the state to grant extensions is to maintain the prospect of getting the full price the land was sold for during the boom times, Winkleman said.

If a developer bought land a few years ago for $100 million, it may be worth only $60 million in today's market.

If granting payment extensions allows the buyer to keep the property, then the state will eventually get full price, Winkleman said.

"It's not like we can turn around and sell that land at the same price," Winkleman said. "We will probably not see these same prices for quite some time. So it's not as if we will be made whole.

"If we say we're not going to do any more extensions, then we're definitely not going to get any more money. I don't see that we're hurt because it's not like we have an opportunity to put it back on the market and get somebody else to start paying us money for it."

Winkleman says he looks at whether the buyer is still adding value to the property when making the decision of whether to grant an extension. That may be by constructing improvements or getting the property zoned for development, he said. It may also be having the buyer secure additional credit to guarantee future payments, he said.

Some buyers have tried to negotiate a lower price, but Winkleman said the law does not allow him to do that and he has rejected those overtures.

Elliott Pollack, a Valley economist and real estate consultant, said Winkleman's approach in granting extensions is the best way to deal with troubled properties. Many of the developers who bought state land in the last several years paid too much for the property, Pollack said. The state has little hope of finding a new buyer for the old price, he said.

Maintaining the land sales through extensions keeps alive the prospect that money will continue flowing to the state, Pollack said. Even if the buyer ultimately defaults, any payments made in the interim will directly benefit the trust, he said.

"This is a very, very reasonable approach," said Pollack, who has been a consultant to developers who have bought state land. "The fact that he's got any (buyers) keeping them going is the smartest thing he can do and quite frankly is nothing short of a miracle. The longer he can keep people in the property, the longer the state is going to end up getting paid off."

Tim Hogan, a lawyer who has represented school districts that benefit from trust payments, said he does not see any immediate downside in granting extensions in an attempt to keep buyers from defaulting. The extensions would probably not make sense in a strong real estate market, Hogan said, but with today's economic conditions, it seems reasonable to give buyers some leeway.

"If there's a prospect for payment, that makes sense," Hogan said.

Legal entanglement

Another risk for the state in cancelling a land sale is a nasty court fight.

Desert Ridge Holdings LLC, the buyer in the $149 million land sale in north Phoenix, sued the state in April, claiming it was misled by agency officials over the availability of water to the site.

The partnership has paid about $18 million to the state, including almost $15 million as a down payment and another $3 million in fees associated with the sale. The notice of default was issued by the land department in December. By then five payment extensions had been approved. The buyers have not made any principal or interest payments beyond the money they put down when they bid on the property, according to land department records.

The three companies that formed Desert Ridge Holdings LLC are also suing each other over disputes regarding payments and loans related to the state land and another development in Glendale.

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