This was a 1000+acre combination of fee simple (freehold) and leasehold interests in land around a scenic bay in Puerto Rico, and the lease agreement also had an option to purchase. A developer was acquiring these interests for an already approved project to build hotels, villas, and a cruise ship port. This mixture of interests meant that I had three tasks to do:
1. Determine the market value of the fee simple parcel, whose purchase price had been set in year 2000,
2. Determine the market rental rate for the remaining parcels and compare to the contractual rental rate to determine if there is a positive leasehold value, and
3. Determine if the option price was above or below market value in order to determine if the option had any value.
In my background check on the borrower, I found that he had pled guilty a year ago to a criminal charge of mortgage fraud and was also being sued by the FDIC. This became troubling to me as he required a quick closing on the loan and was using an unknown escrow company, yet had no signed, valid contracts as of my visit or several days afterward. What was also suspicious was that the price kept on changing with each new contract version he sent, all of which were in MSWord and easily alterable.
The ground lease was to another unaffiliated LLC who was supposedly going to assign its interest to the borrower after the lease was signed, but despite my requests, I never received a document of this assignment of leasehold interest. Moreover, the lease had a clause which rendered it null and void if anyone in the tenant’s company had had a criminal conviction.
The fee simple parcel had an abandoned sugar mill, and there was no environmental report to inform me about possible contaminants. Common sugar mill contaminants include bagasse (from boiler fuel), pesticides from the sugar liquid and residue, and metal oxides from the rotting of the structures. This site had an estimated 50,000 tons of scrap metal, much of it rusting, placing iron and zinc oxides into the soil.
The bay’s water was as turbid as New York Harbor and unlike the clear blue water one would normally expect in the Caribbean. The problem was agricultural runoff from the farms upstream, making the bay very silty, compounded by incoming wave action from the Caribbean Sea. The waterfront of the fee simple site, moreover, consisted mainly of bulkhead and mangroves, making it unsuitable for a beach. Beaches are one of the principal attractions of Caribbean resorts.
Moreover, the bay’s maximum depth was only 29 feet, whereas most cruise ships have drafts (distance from waterline to bottom of keel) of more than 25 feet and need another 6 feet of depth for clearance. The bay would have to be dredged first and periodically thereafter until the continuing river silt deposits were under control.
Sales of large parcels of entitled land had not occurred in several years in this part of Puerto Rico, but a look at listings of property for sale indicated asking prices below the sales prices of several years ago. An adjacent, waterview parcel entitled for 100 hotel rooms and 50 villas is listed for sale at just $35,000 per acre or $10,000 per UBV (“unidad basica de vivienda” or “unidad de vivienda basica”, meaning “basic housing unit”, a unit of measure uniquely created by the Reglamento de Zonificacion de Puerto Rico, the zoning regulation for Puerto Rico). One UBV is equivalent to a 3-bedroom dwelling. A 2-bedroom dwelling counts for .8 UBV. A one-bedroom dwelling counts for .6 UBV, and a hotel room counts for .4 UBV.)
The purchase option was based on a price close to $100,000 per UBV, ten times as high as the neighboring property, so the purchase option was considered to have no value.
Because the ground rent was in steps leading up to a stabilized rent equivalent to 8% of the purchase option price, and no ground leases were found as high as 8% of value, the leasehold interest itself was also considered to have no value.
The only parcel that was considered to have value was the fee simple brownfield parcel, so there was insufficient collateral to support the large development loan requested by the borrower. Furthermore, he never showed the ratified, valid contracts that would show that he was really closing these transactions (with my client's funds) on the day he specified, with his chosen escrow company. (I always advise my clients to use nationally known escrow companies.) I suspected a scam.