Staff analysis of sale vs. administration of school lands

              L 700.3 S799a 1993 c.1
REPORT PREPARED BY THE
Commissioners
of the
Land OjJice
Staff Analysis
of the
Sale of
School Land
JUNE 1993
STAFF ANALYSIS OF SALE VS. ADMINISTRATION
OF
SCHOOL LANDS
Prepared for:
HONORABLE DAVID WALTERS Governor & Chairman
HONORABLE JACK MILDREN Lt. Governor & Vice Chairman
HONORABLE CLIFTON H. SCOTT State Auditor ~ Inspector & Member
HONORABLE SANDY GARRETT State Superentendent of Public
Instruction & Member
HONORABLE GARY SHERRER President State Board of
Agriculture & Member
being
THE COMMISSIONERS OF THE LAND OFFICE
June 3, 1993
This Staff Analysis Prepared by:
ADVISORY COMMITTEE ON THE SALE VS. ADMINISTRATION OF
SCHOOL LAND
WILLIAM R. HOWARD, JR.
General Counsel
Chairman
J. KEITH KUHLMAN
Director, Real Estate Management Division
Vice Chairman
CAROL J. FORD
Secretary
Member
R. NORVELL CLARKE
Assistant Secretary
Member
PARY G. SHOFNER
Director, Minerals Management Division
Member
HERBERT W. JOHNSON
Director, Financial Division
Member
LAWRENCE N. SWANSON
Commercial Leasing Specialist
Member
TIMOTHY CARTWRIGHT
Administrative Officer II
Member
TABLE OF CONTENTS
I. Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . , 1
II. Historic Overview ... , , . , , , , .. , , , , . , , .. , . , . , , .. , , ,1
III. Trustee Duties and Responsibilities, , , ',' . , , , .. , . , . , . , , . , ,3
IV. Preference Right to Purchase , .. , , , .. , , .. , , , 4
V. Sale vs. Administer Surface Interest. , , , , , , . , .. , , , 8
VI. Sale vs. Administer Mineral Interest . . . . . . . , , , . . , . . . . . ;. 13
VII. Analysis of Investment Alternative to Land . , , , , , , . , . , . , 17
VIII. Financing of School Land Sales .. , , , . , .. , , , , , .. , , , , 22
IX. Conclusions .. , ... , , ... , . , , , . , . . . . . . . . . . . . . . . . . . . 24
TABLE OF EXHIBITS
Exhibit
A
B
8-1
C
C-1
D
E
F
F-1
G
H
Comparison of Treasuries vs. CPt
Lease vs. Sale Values Comparison
Supporting Data to Exhibit 8
Historical Comparison of Lease vs. Sale
Supporting Data to Exhibit C
Revenue Raised if Land Placed on Tax Rolls
Random Sale Analysis of School Lands
Chart of Income from Mineral Interest
Supporting Data to Exhibit F
Chart of Accumulative Income from Mineral Interest
Comparison of Distributable Income
Comparison of Total Return
I. INTRODUCTlON
In response to a request by the Honorable Jack Mildren, Lt Governor and Vice-Chairman
of the Commissioners of the Land Office (CLO), the CLO staff respectfully submit their
analysis of the Sale vs. Administration of School Land. This analysis and report is the
result of a team project that proved to be very interesting and generated a great deal of
enthusiasm among committee members and staff personnel who participated. It also
provided a unique opportunity for CLO staff to express their perception, as trustees, as
to how they can fulfill their Trust duties in the management of the assets of the School
Trust Fund.
II. HISTORICOVERVIEW
There have been numerous legislative studies conducted and independent reports and
surveys written regarding the sale of school land such as the following:
1. Governor Bartlett's Study - 1967
2. E. K. Gaylord's Article - 1971
3. R. R. Williamson's Memo on Sale of Airport Tract - 1980
4. Alexander Holmes Report - 1984
5. The RAM Group Survey of Mineral Interest - 1985
6. The Arthur Andersen and Company Study - 1987
7. The Cimarron and Texas County Assessors Report - 1991
8. LegislativeTask Force on Sale of School Land Report - 1992
The only completely independent study of the issue was the Arthur Andersen and
Company Study of 1987. After an exhaustive study of the entire CLO operations, costing
over $350,000, the Arthur Andersen Study recommended that except for rare exceptions,
surface land should be retained rather than sold.
With few exceptions, the conclusion of the balance of these studies and reports results
in a recommendation to not seJJthe school land because land appreciation is one of the
1
few hedges the School Land Trust has against inflation and the depreciation in the value
of cash dollars. The conclusion of a few of these studies and reports reflect the wishes
of the political and special interest groups that generated the same. Consider for example
the fallowing scenarios:
1. The fee owner farmer/stockmen want all the school land sold for they would
like to buy more land at their price, financed by the CLO aver 25 years at
below market interest rates and be given 50% of the minerals for goad
measure.
2. The County Tax Assessors want all the school land sold for it would put
more land an the county tax rolls which would generate mare revenue for
the county, only a part of which would go to the School Districts.
3. The School District Administrators want all the school land sold if it means
mare immediate funds available to them to meet HB 1017 financial
demands.
4. The tenant farmer/stockmen do not want all school land sold for it would
mean an end to their economical rental of land as compared to the cast to
purchase the same.
5. The legislators want to be responsive to all of the above needs and
requests. and thus must remain flexible in their position and seek some
cammon ground.
6. The Commissioners of the Land Office, as trustees of the School Land
Trust, are duty bound to be responsive only to what is best in the long run
for the beneficiaries and to maintain Trust assets and return full value from
use and disposition of Trust property.
2
The School Trust Fund, as created by Sections 7 through 12 of the Enabling Act and
Sections 1 through 6 at Article 11 of the original Oklahoma Constitution, was created tor
a term in perpetuity: Thus, it is of necessity that this analysis consider primarily the long
term management of Trust assets.
III. TRUSTEEDUTIESAND RESPONSIBILITIES
The primary trust duty at the CLO is to administer the School Land Trust for production
of income for support and maintenance of common schools and state supported
institutions of higher education. (Article 11, Sections 1, 2, 3 and 5 of the Oklahoma
Constitution). Trust duties have been defined by the Oklahoma Supreme Court in the
case of Oklahoma Education Association v. Nigh, 642 P.2d 230 (Okl. 1982). The Court
held the CLO, as trustee of common school lands granted under the Enabling Act, has
an irrevocable duty to maintain the Trust estate for exclusive benefit of the beneficiaries
and to return full value from the use and disposition of Trust property. The Court also
held "the express designation ot the school lands and funds as a 'sacred trust' has the
effect of irrevocably incorporating into the Enabling Act, the Oklahoma Constitution and
conditions of the grant, all of the rules of law and duties governing the administration of
trusts." Id. at 236.
It is well developed case law in Oklahoma that the State of Oklahoma, as trustee of the
School Land Trust, owes the beneficiaries of said Trust its undivided loyalty and good
faith and that all of the acts as trustee must be in the interest of the cestui que 'trust,
(Beneficiary of trust) and no one else. State ex reI. Comr's of the Land Office v. Board
of Comr's of Woods County, 257 P. 778 (Ok!. 1927), Popp et al. v. Munger. 8t aI., 268 P.
3
1100 (Ok!. 1928), State ex reI. Comr's of the Land Office v. Wall, 232 P.2d 940 (Ok!.
1951), Op.Atty.Gen. No. 79-317 (November 15, 1979).
Therefore, CLO staff, as trustees of the School Trust Fund, have attempted to set aside
any political or outside influences upon this analysis and have concentrated their efforts
on how to best manage the assets of the School Trust Fund. Their primary goal is to
maintain the Trust estate for the exclusive benefit of beneficiaries and to return full value
in the long run from use and disposition of the Trust property.
IV. PREFERENCE RIGHT TO PURCHASE
The preference right of the current surface lessee to purchase school land, if it is offered
for sale, is a major stumbling block to the CLO in getting full value from the sale of Trust
property. The mere existence of the preference right to purchase causes a chilling effect
on the bidding process.
The preference right to purchase was created by Sections 9 and 10 of the Enabling Act
and in both Sections reads as follows:
01 ••• it sold, may be appraised and sold at public sale in one hundred and
sixty acre tracts or less, under such rules and regulations as the legiSlature
of the said State may prescribe, preference right to purchase at the highest
bid being given to the lessee at the time of such sale .... "
This preference right pertained only to lands granted by Sections 7 and 8 of the Enabling
Act which were Sections 16, 36, 13 and 33 of each township, and lands that were
selected in lieu of properties already homesteaded. These Olinlieu" properties were known
4
as "indemnity lands" by the CLO. All of the above mentioned lands when leased to a
surface tenant, were known as "preference right leases".
Section 12 of the Enabling Act granted land to certain colleges and universities in lieu of
lands already occupied by internal improvements (such as highways, railroads) and in lieu
of swamp and overflow lands. Lands and grantees are as follows:
Name Acres
Oklahoma University
University Preparatory School (1)
Oklahoma State University
Langston University
Normal Schools (9)
250,000
150,000
250,000
100,000
300,000
Total 1,050,000
The grant of this 1,050,000 acres did not contain the preference right to purchase and
was selected by the CLO from the U. S. Government selection list. These selected
properties were known as "In Ueu Lands" by th. e CLO. All of these lands,. as well as lands
taken into inventory by a mortgage foreclosure, when leased to a surface tenant were '
known as "non-preference right leases".
It has been determined by the Oklahoma Supreme Court and the United States Supreme
Court that preference right to purchase is a contingent right only and manifests itself only
if the CLO offers land for sale upon which a preference right lease exists and contains no
equitable or ownership rights either. to the surface or mineral interest of the land.
Anderson-Prichard Oil Com. v. McBride, 109 P.2d 221 (Ok!. 1941), Magnolia Petroleum
Co. et.d. v. Price, 206 P. 1033 (Ok!. 1922), Price v. Maonolia, 267 U.S. 415, 45 S.Ct. 312,
69 LEd. 689.
5
A former preference right to renew a surface lease existed which needs to be discussed
briefly. Preference right of the surface lessee to renew his lease upon expiration of his
current lease at current appraised value was created by the 35th Legislature, 2nd Session
in 1976 by HB 1163. It was determined by the Attorney General this right did not pertain
to a surface lessee who was in possession of a non-preference right lease. Op. Atty. Gen.
No. 76-311 (January 2, 1977). However, the Oklahoma Supreme Court struck down this
preference right to renew at appraised value as being in violation of the State Constitution
and the Enabling Act. Oklahoma Education Association v. Nigh, 642 P.2d 230 (Ok!.
1982). The rationale of the Court was that appraised value of the leases did not
adequately reflect market value of leases which might be established by open competitive
bidding. This rationale has proven to be true. The market value of surface leases,
established by open competitive bidding since 1982, has averaged 15% higher than the
current appraised value of the leases.
This same rationale carries over into open competitive bidding which should take place
if School Trust Fund properties are to receive full value when offered for sale. Based
upon past experience of the CLO, it has been determined that the mere existence of a
preference right to purchase lessee at a land sale auction has a tendency to chill the
bidding process. In 1980, the CLO offered for sale two adjoining commercial properties,
of 100 acres each, adjacent to the Will Rogers Airport. The notice of sale was published
subject to current surface lessee rights with no specific mention of the preference right
to purchase. Competitive bidding on the first tract resulted in a bid of $18,000 per acre.
At the end of bidding on the first tract, the surface lessee stated he would exercise his
preference right to purchase at the highest bid of 518,000 per acre. This statement
6
caused quite a commotion and resulted in a 30 minute delay in bidding on the second
tract. At the start of bidding for the second tract, the auctioneer could not get an opening
bid. The active bidders 'started bidding, but stopped at $11,750 per acre. This was a
drop of $6,250 per acre. The Commissioners subsequently canceled the sale for it was
later determined that the surface lessee had assigned his preference right to purchase
to a third party. Also, there was a meeting among the active bidders during the break
where an agreement was reached to restrict bidding on the second tract.
It is well established case law in Oklahoma that any agreement made for the purpose of,
or whose necessary effect or tendency is to lessen competition and restrain bidding at
a Judicial Sale, is held to be illegal, because it is opposed to public policy. Citizens
National Bank of Chickasha v. Mitchell, et aI., 103 P. 720 (Ok!. 1909); Nunley v. Loftis, 220
P.841 (Okl. 1924); Dickson v. Taylor, 263 P. 1102 (Ok!. 1928).
There are at least two methods by which this dilemma may be corrected. One involves
federal congressional action and the other involves state legislative action. The
congressional action involves amending the Enabling Act and is not likely to occur. The
state legislative action involves amending the rules and regulations for land sales and may
be likely to occur.
Sections 9 and 10 of the Enabling Act, supra, provide that CLO land may be appraised
and sold at public sale in 160 acre tracts or less, under such rules and regulations as the
Legislature may prescribe. The Legislature has authority to prescribe that bidding at a
School Land auction does not cease when the preference right lessee exercises his right
7
to purchase; but that bidding be allowed to continue until such time as the bidding stops
by its own accord. This process would preserve the rights of the surface lessee to
exercise his right to purchase at the continuing high bid, but still allows open, competitive
bidding, which would more accurately reflect the market value of the school properties
being sold.
v. SALE VS. ADMINISTRATION OF SURFACE INTEREST
The management of school lands as a sacred trust is quite clearly accepted in the State
Constitution. Some other considerations have become apparent over the decades. The
value of this Trust can be diminished not only by investment losses, but also through the
diminution of value caused by inflation. Maximizing income of the Trust is always
tempered with the necessity to preserve its principal value; a goal identifiable as basic to
sound investment practices in general.
When discussing sale of Trust land assets, a very important factor to consider is the
constitutional mandate forbidding the CLO from compounding interest earned on
investments. All interest must be distributed to the school funds annually. (Section 3,
Article 11 of the Oklahoma Constitution). Consequently, any sales proceeds decline in
purchasing power value in direct proportion to the rate of inflation experienced in the
economy.
Statistical studies show the rate of inflation since the "thirties" has been at an annual rate
of 4.11 %, as measured by the Consumers Price Index. (See Exhibit "A".) Conversely,
land held for lease has increased in value (expressed in terms of the number of dollars)
8
over time as the purchasing power of the dollar depreciated, sheltering land from a
diminishing power of exchange.
. The accompanying cash flow analysis depicts a fifty-five year comparison between LEASE
vs. SALE of land valued at $1,000. (See Exhibits "8" and "8-1".) Results at the
conclusion of fifty-five years are as follows:
Lease
Total Funds Distributed
To Schools during the 55 Years:
$ 5,736 $ 4,125
Value of Asset at the End
of 55 Years:
$ 9,164 $ 1,000
A study supporting the preceding analysis shows actual sales of school lands which were
taken back from the purchaser by cancellation of Certificate of Purchase. This study
concludes that retention of land will provide seven times more income than investing in
securities. (See Exhibit "C" and "C-1".)
In further support of these contentions, consideration must be given to the fact that if the
amount of money placed in the permanent Trust by the sale of lands since statehood was
invested at today's rates, the Trust would be making $5,460,000 ($78,000,000 X 7% which
included sale of minerals). With only 25% of the original land grant still held by the Land
Office, these leased lands in F'f92 generated a net income of $6,525,000 to the Trust.
It can be readily shown that if the original land grants had been held, rather than sold, the
Trust would be earning between $24,000,000 and $30,000,000 annually from leasing the
lands.
9
There are certainly other very important factors to consider in any discussion of Trust
asset disposition, but preservation of the Trust's purchasing power (as mandated to
maintain the Trust by the Constitution) is paramount to all others. Without this emphasis,
L the likelihood of the Trust's eventual deterioration is at real risk.
In FY92 administrative costs associated with land management were $1,938,114. This
includes normal lease administration, soil conservation project funding, oil and gas field
wo~.k and field work requested by the legal division in support of foreclosure and
bankruptcy proceedings.
Total income generated from the 795,000 acres of land in FY92 was $8,563,790. With the
current market value of $230,923,845, the gross rate of return to the Trust is 3.71% with
the net rate of return being 2.87%.
Banks which also manage land trusts typically receive one-half (0.5%) to one (1.0%)
percent of the market value of the assets as a management fee. The variables which
account for the percentage difference include the complexity of the account, market value
of the property and goals of the trust.
Using the above stated market value of the land and the management costs, the Trust
is being charged 0.84% of the assets' value. This percentage would actually be lower if
you consider the fact that the Real Estate Management Division also assists other
divisions.
10
Another issue to consider in disposition of surface rights is the currently limited authority
of the Real Estate Management Division (REMD) to exercise prudent land management
practices. Some policy alterations might include:
1. Authority to sell selected land tracts which;
a) have proven historically to be poor performers,
b) carry comparatively high management casts,
c) are mortgage foreclosure tracts which are remote or in poor condition
and/or require extensive repairs and intense land management husbandry.
2. Authority to diversify assets to spread the risk of loss as a sound investment
practice. Recommendations by REMD should consider the long-term impact of a
land sale, because once sold, that source of diversification is not again readily
available as an investment medium.
3. Authority to improve selected lands to accommodate commercial and/or industrial
activities which would generate enhanced returns on the land investment.
The need for expanded authority and responsibility becomes more apparent as economic
development activities intensify with an improving economy, now in progress within the
State.
One issue which advocates for the selling of real estate assets have emphasized is the
amount of ad valorem taxes a sale of school land would generate for the various
counties. A study conducted in 1985 estimated this amount would be $2,370,060 with
only $1,489,752 going to the school districts. (See Exhibit "0".) The CLO staff, using the
11
same ratios but using today's land values, estimates the amount of ad valorem taxes
generated state wide would be $1,658,495,with only $1,042,482 going to the local school
districts.
In the event land is sold, one practical problem arises: How much land can be sold
annually without depressing farm values statewide? A study conducted in October, 1989,
(See Exhibit "E".) based upon a random selection of school lands sold in the early part
of this century in several counties concluded that land appreciated in value at a
compounded rate of 5.25% annually notwithstanding the depressed land values existing
in 1989. Currently, Oklahoma farmland prices are in very slow recovery from their lows
of the past decade. A sale at this particular time seems imprudent in light of the
long-range historical record of value increases. Consideration must also be given to the
sales impact on land values and market rentals in order to avoid undue market distortions
and stress on the surrounding property owners.
There are no examples in recent history to indicate how much land any given market can
bear without hurting prices. It is recommended that if school land is sold, a twenty-five
year period of time be used with a set number of acres being sold each year. At the end
of each year, the local market should be analyzed to insure it can accept more acres to
be sold. If there are indications that the market cannot accept more sales, then there
should be no sales until demand begins to rise again.
12
SUMMARY
1. The rate of return from land, when compared to other investments of similar risk,
currently yields 3 to 4 percentage points lower. However, when the devaluation
of the dollar is factored in, land has an equivalent rate of return.
2. Long-term investment horizons must be utilized when discussing the School Land
Trust and in particular the land asset. Sale of any land must be analyzed in light
of what has occurred historically to rental values and to projected future rental
income.
VI. SALE VS. ADMINISTRATIONOF MINERAL INTEREST
Any discussion regarding sale of CLO minerals should note that data necessary to make
an empirical decision based upon concrete numbers is not available. In past years, the
sale of CLO minerals has not been given serious consideration principally because an
Oklahoma Statute prohibits sale of any mineral interest when selling grazing land. The
most recent objective management audit on the sale of minerals was conducted by Arthur
Andersen and Company in 1987. To quote from that study: "Without cumulative
production information that is easily accessible and without reserve information, we
cannot provide values for producing properties for which royalties are being received.·.
The study also states "[we] risked endangering the credibility of the balance of the study
with value 'guesstimates'''. The study does not deal with the speculative value of
undeveloped minerals.
A supplement to the Alexander Grant external audit in 1984 was prepared by the RAM
Group Ltd in 1985. The RAMGroup is widely acknowledged as being among the leading
13
minerals management firms in the United States. The following is an excerpt from that
study:
In order to niake an intelligent decision whether to retain the oil and gas
mineral interests or to sell the currently producing leases, non-producing
leases and unleased minerals, analyses must be made of their value. A
reserve report should be prepared covering the 240 leases which currently
provide the highest revenue to the trusts. The remaining producing leases
should be aggregated by field and/or county and/or by producing
formation to forecast revenue over their producing life.
In addition, a model should be developed which will allow the forecast of the
future revenues from oil and gas production, leasing activities and lease
bonuses so that the future value of the mineral interest owned by the
Commission can be determined. From this model of historical leasing
activity, a forecast of future income from royalties, rentals and lease
bonuses will be forecast.
It is estimated that cost of the reserve reports mentioned above would approach one
million dollars. The full study suggested above would approach two million dollars. The
Minerals Management Division could operate for almost three years on this amount of
money. Based upon past mineral sales, this report will attempt to provide evidence to
show minerals should never be sold. The belief minerals should not be sold is so widely
held in Oklahoma, no literature can be found to confirm or deny this belief. A Trust officer
at Oklahoma's largest home-based bank is quoted as saying, "I advise all clients to retain
minerals because of value and performance. I feel that if I had advised them to sell their
minerals I would be subject to being sued for failure to perform my fiduciary duties".
STATISTICAL PROJECTION
The Commissioners of the Land Office currently retain approximately 1/3 of the original
mineral grant. It could be accurately assumed that statistically, the per acre revenue from
the minerals sold would equal the per acre revenue of the minerals retained. The total
revenue retained to date from minerals is approximately S600,OOO,000. Attached is a
14
graph and supporting data showing mineral income since 1973. (See Exhibit "F' and "F_
1") The total mineral income from July 1, 1973, through June 30, 1992, is
$469,260,223.07. The cumulative effect of this income is shown in the graph on Exhibit
"G". If all minerals had been retained, the projected cumulative income to the Trust would
be in excess of 1.8 billion dollars. Since minerals are not assessed for property tax
purposes, their retention would not have resulted in a loss of any tax revenue to county
governments.
THE NEW MEXICO EXPERIENCE
New Mexico and Arizona were the two states admitted to the Union after Oklahoma. The
Federal government realized, after its experience with Oklahoma, private interests could
use their influence to pillage the Trusts. Therefore, the government made it more difficult
to dispose of Trust assets. New Mexico currently retains virtually all of its original grant.
Even though New Mexico produces slightly less than one-half of the amount of natural
gas that Oklahoma produces (Arthur Andersen 1993), New Mexico has over three billion
dollars in its permanent fund.
SELECTED PROPERTIES
The following analysis reflects the economic impact of selling two specific CLO properties:
Section 36-12N-26W
Roger Mills County,Oklahoma
This lease is currently producing from the Dodson 36-1 Well and is a direct offset to one
of the largest Morrow discoveries in the history of Oklahoma. The State sold sixty-seven
15
and one-half percent of its mineral interest in this section. The follow examples showing
royalty and bonus payments if the CLO had retained its mineral interests.
Dodson #1-36
Production to Date (12/92):
Value Assigned
Total Value
Royalty Not Received
Bonus Not Received
TOTAL INCOME NOT RECEIVED
4,260,517 MCF
$1.50 per MCF
$6,390,775.00
$748,918.95
$521,776.00
$1,270,694.95
Total Received From Sale of Surface & Minerals
Interest Disbursed Since Sale (assumed 7.5%)
Total Income From Sale
$1,765.00
$10.192.87
$11,957.88
Section 16-5N-18E
Latimer County, Oklahoma
The Commissioners received substantial acreage in the Township Five North Eighteen
East through mortgage foreclosure proceedings. When the Commissioners sold the
surface, they included one-halt minerals. In 1990 what has been described as the largest
on-shore discovery in the last twenty years in the United States was made in what is now
known as the "Wilburton Field". The following example shows what the School Trust Fund
would have realized in royalty payments had the CLO retained its mineral interests.
Kilpatrick Unit
Production to Date
Value Assigned
Total Value
Royalty Not Received
Bonus Not Received
TOTAL INCOME NOT RECEIVED
49,579,438 MCF
$1.50 per MCF
$74,369,157.00
$581,009.03
N/A
$581,009.03
$2,220.00
$7,590.00
$9,790.00
Total Received from Sale of Surface and Minerals
Interest Disbursed since Sale (assumed 7.5%)
Total Income Received
16
OTHER OPPORTUNITIES
The CLO has exp~rimented with marketing of its own gas. In light of recent court rulings,
direct marketing of natural gas has the potential of being a major source of Trust revenue.
If mineral interests were sold, this opportunity would be diminished.
This report has been limited to oil and gas revenue. The CLO currently receives income
from iodine production and have recently received income from helium production. The
CLO has received income from uranium and copper leases. The potential for platinum
and gold production exists on some CLO-owned tracts.
SUMMARY
The potential return to the School Trust Fund from leasing and development of its mineral
interest is too great to justify sale. The proceeds generated from mineral interest are kept
as a part of the permanent fund and are, along with land appreciation, the only current
hedge the Trust fund has against inflation.
VII. ANALYSIS OF INVESTMENT ALTERNATIVE TO LAND
The investments analyzed are. limited to those legally authorized by the Oklahoma
Constitution and Attorney General Opinions. Another consideration is that all interest and
income generated by the School Land Trust, less expenses of operating the Trust, are
distributed monthly to the beneficiaries. These parameters provide a realistic picture of
how the Trust is permitted to function today without engaging in speculation.
17
Section 6 of Article 11of the Oklahoma Constitution mandates permitted investmentsand
reads as follows:
§ 6. Investment of permanent common school and other education funds
The permanent common school and other educational funds shall be
invested in first mortgages upon good and improved farm lands within the
state (and in no case shall more than fifty per centum (50%) of the
reasonable valuation of the lands without improvements be loaned on
counties of Oklahoma, school district bonds of the school districts of
Oklahoma, promissory notes evidencing federal and state insured loans
made to students under any federal or State of Oklahoma insured student
loan program, and United States bonds, preference to be given to the
securities in the order named. The said funds may also be invested in
deposits in federally insured financial institutions or trust companies in
Oklahoma to the extent such deposit is insured by the Federal Deposit
Insurance Corporation, the Federal Savings and Loan Insurance
Corporation, or the National Credit Union Administration.
The Legislature shall provide the manner of selecting the securities
aforesaid, prescribe the rules, regulations, restrictions, and conditions upon
which the funds aforesaid shall be loaned or invested, and do aUthings
necessary for the safety of the funds and permanency of the investment.
Title 64 of the Oklahoma Statutes at Section 51 provides "no bond investment shall be
made until the Attorney Generalof the State of Oklahoma gives his opinion in writing that
such proposed investment is within the legal authority of the Commissioners of the Land
Office, and that such bond as the commission may propose to purchase is valid.U
The current CLO investment portfolio listed at market value as of April 30, 1993, is as
follows:
AMOUNT
U.S. Government Bonds
Farm Loans
Total
$606,376,218
$101.543.569
$707,919,787
18
Section 3, Article 11 of the Oklahoma Constitution mandates the interest and income of
the common school fund be distributed annually to the various school districts
apportioned by ADA and reads as follows:
§ 3. Interest and income - Use and apportionment
The interest and income of the permanent school fund, the net income from
the leasing of public lands which have been or may be granted by the
United States to the Statefor the use and benefit of the common schools,
together with any revenues derived from taxes authorized to be levied for
such purposes, and any other sums which may be added thereto by law,
shall be used and applied each year for the benefit of the common schools
of the State, and shall be, for this purpose, apportioned among and
between all the severalcommon school districts of the State in proportion
to the school population of the several districts, and no part of the fund
shall ever be divertedfrom this purpose, or used for any other purpose than
the support and maintenance of common schools for the equal benefit of
all the people of the State.
The proper distribution of income and interest of the School Trust Fund has been
presented to the Supreme Court on many occasions beginning with Betts v.
Commissioners of the Land Office, 27 Ok!. 64, 110 P. 766 (1910) and ending with
Oklahoma Education Associationv. Niah, 642 P.2d 230 (Ok!. 1982). The result is that the
CLO distributes monthly to the beneficiaries all income and interest generated by the
School Trust Fund, less the expense of operation.
The attached graphs illustratea comparison of potential returns from various types of real
estate compared with the potential returns from investment of sales proceeds in U.S.
bonds in the event that part of the land is sold. (See Exhibits "H" and "1"). One million
dollars ($1,000,000) is used as the beginning value for each case. The annual income
19
distributable to beneficiaries and the total return including appreciation in value are
projected for 30 years with an inflation rate of 4% per annum.
. The following examples illustrate various alternatives:
Case A - Cropland is assumed to yield 5% of market value annually, plus increase in
value at the same rate as inflation. Administrative costs are shown as 0.84% of market
value as indicated by Real Estate Management, leaving a net current return of 4.16% and.
total return of 8.16%.
Case B - Grazing land is assumed to yield 4% of market value annually, plus increase in
value at the same rate as inflation. Administrative costs are shown as 0.84% of market
value as indicated by Real Estate Management, leaving a net current return of 3.16% and
total return of 7.16%.
Case C - Commercial land is assumed to only cover administrative costs for the first five
years, but increase in value at the same rate as inflation. After that it is assumed that
each year 4% of the land will begin earning at the rate of 10% per annum.
Case 0 - The interest on U.S. bonds is assumed to continue at 4% over the inflation rate,
all of which would be distributed currently. It is also assumed 1% would be generated
annually from "yield curve roll-over", which would be retained in the Permanent Fund.
Administrative costs are deducted at the rate of .02% of market value, leaving a net
current return of 7.98% and a net total return of 8.98%.
20
Exhibit "H" shows annual commercial land income exceeds bond investment interest at
an accelerated rate by the year 2012; annual cropland income exceeds bond investment
interest by the year 2017 and annual grazing land income will exceed bond investment
interest at some time beyond 2022.
Exhibit "1" shows the total return on cropland including appreciation exceeds bond
investments by the year 1998, the total return on grazing land including appreciation
exceeds bond investment by the year 2003 and the total return on commercial land
including appreciation exceeds bond investmentsat an accelerated rate by the year 2011.
The CLO, as trustee, has a duty to manage the assets of the Trust with a long range
perspective.
The total School Trust at market value is comprised of the following:
Amount % of Total
Bonds
Farm Loans
Land
Minerals
Total
$ 606,376,218
101,543,569
230,923,840
*200,000,000
$1,138,843,627
53.25
8.92
20.27
17.56
100.00
*Adjusted Arthur Andersen Study
Prudent trust management requires diversification of assets. Twenty percent of total
assets invested in land is reasonable for this Trust. Other pension trusts operating under
the "prudent man" rule generally consider 15% of trust assets invested in real estate to
be appropriate.
21
VIII. FINANCING OF SCHOOL LAND SALES
Historically, mast inquiries into the sale of the school lands include the caveat that CLO
provide for financing of the purchase. Legally, there is only one way in which this may
be accomplished and this is by a Certificate of Purchase, better known as Contract for
Deed.
As was discussed in the Preference Right to Purchase section of this report, Sections 9
and 10 of the Enabling Act provide school land may be sold under rules and regulations
as the legislature may prescribe. The Oklahoma Legislature has prescribed many rules
and regulations pertaining to sale of school land. These are codified in Title 64, Sections
181 through 229.5, including 36 pages.
The Certificate of Purchase is a Contract for Deed which provides a purchaser pay 10%
dawn at time of sale and finance the balance aver 25 years at a competitive interest rate.
The property is placed on county tax roles during the term of the Certificate of Purchase
and the purchaser is to pay all taxes. When all payments are properly made,including
pre-payments, the CLO will issue a Patent to the purchaser.
The Supreme Court inOklahoma Education Association v. Nigh, 642 P.2d 230 (Ok!. 1982)
changed dramatically how farm loans are to be administered. The Court held CLO loans
should be at a competitive market rate of interest and be administered as any other bank
loan. The financing and administration of Certificates of Purchase should be treated in
the same manner.
22
New legislation would be necessary to implement a Certificate of Purchaseprogram which
would comply with the mandate in OEA v. Nigh. A partial listing might include:
1. The rate of interest charged should be at least equal to the current Trust
Funds composite investment rate of return plus at least two (2) percentage
points for administrative expenses. This would place interest rates at prime
rate plus at least two (2) percentage points.
2. A minimum interest rate should be established, to protect the Trust Funds
corpus from a sharp and deep fall in the prime rate.
3. The interest rate should be a fixed rate for a maximum of 20 years. (20
years is the approximate length of any Fund investment.)
4. The maximum dollars funded for anyone purchaser should be $150,000.00.
5. In issuing Certificates of Purchase, the ClO should be allowed to combine
various tracts with common ownership.
6. The basis for granting a Certificate of Purchase should be considered a
commercial transaction, not a personal loan.
7. Each Certificate of Purchase should receive the same credit underwriting as
a "commercial" loan from a financial lending institution. The credit
underwriting to include, but not be limited to: a) a commercial credit
application, b) credit check and verification, c) review of prior years state
and federal income tax returns, and d) use of industry (financial) credit
worthiness guidelines in determining whether or not to accept the Certificate
of Purchase.
8. Rules and regulations would need to be promulgated to implement the
program pursuant to the Administrative Procedures Act.
23
It is recognized that financing land sales from the Trust Fund corpus is inherently riskier,
and for this reason cash sales are preferred.
IX. CONCLUSIONS
1. With few exceptions, the past studies and reports dealing with the sale of school
lands resulted in recommendations to retain the land since land appreciation is one
of the few hedges the School Trust Fund has against inflation and depreciation in
value of cash dollars.
2. The ClO, as trustees of the School Trust Fund, have an irrevocable duty to
maintain the Trust estate for the exclusive benefit of the beneficiaries and to return
full value from the use and disposition of the Trust property.
3. The School Trust Fund has been created in perpetuity and necessitates the
management of Trust assets from a long range point of view.
4. The preference right to purchase has a tendency to chill bidding in an environment
that should be open and competitive. The preference right also lends itself to side
agreements that restrict bidding. This is against public policy. If Trust land is sold,
the preference right to purchase should be amended to allow bidding to continue
beyond the exercise of the preference right, until bidding stops of its own accord.
5. Few tracts of land should be considered for sale because in the long run lease
rental coupled with appreciation in land value will generate more total return to the
Trust than investments in U.S. bonds. This is because land has proven to be a
hedge against inflation.
6. The mineral interest of the School Land Trust should never be sold. It must be
retained due to the potential return it may bring to the Trust. In addition, the
24
proceeds of the mineral interest increases the permanent fund and also acts as a
hedge against inflation.
7. An investment portfolio with 20%invested in land is a prudent investment portfolio.
8. If sale of school land is financed by the CLO, financing procedures of Certificates
of Purchase should reflect current interest rates and commercial credit underwriting
guidelines. Legislative action and rulemaking would be required.
9. The long-range benefit to the beneficiaries should be paramount to the wishes of
any political or special interest group.
25
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or
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AVGS: NOTES:4.75% BONDS:5.19% CPI:4.11%
15 -.------------------------------------------------------------~------__.
14
13 -
12
11 -
10 -
9 -
8 -
7
6
5 -
4 -
3
2 -
1o
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-1 -
-2 -
-3 -
-4 -
-5 -< .
-6 -~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~~".-I
1933
YEARS
n
)7,- ~-1938 1943 1948 1953 1958 1963 1968 1973 1978 1983 1988 [-J
NOTES BONDS c CHAI"IGE IN CPI
t1m---:
>< l1J
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L LA~ l=-- - V'J - ~ALl=-- VALU t=--~ ~ U IVlIJAI\ I~U 1\1
(REFERENCE: ADDENDUM "B")
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500 -
400 -
300 -
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I"
"
200 -
/ ".. ,., .;
/ / I / ' /
" / /
1990 1995 2000 2005 2010 2115 2020 2025 2030 2035 2040
[ZZ] LEASE CASHFLOWS
YEARS
rs:::sJ LAND VALUE INCREASE o SALE CASH FLOWS
1
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12 '50\. 'I II,OlI IU.OI III!. " 12 '''.00 11,000
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II In.oo '2,330 tn. " 1170.'I 21 '''.00 11,000
zz 'R.~ '2,.2' '~.16 1171.01 22 '''.00 11,000
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C7 1100•• 0 12,U7 1\17.12 '217.12 27 1".00 1\,000
C1 110•• 13 1l.089 1\21. " Im •• 7 21 m.oo 1\ ,000
" 110'.03 I3.ZI6 112'.95 1m." " I~.QO 1\ ,000
2020 Z, 1I11.!! n.1" IIll.17 1m." 30 I~.OO 11.000
31 1111.11 13.". 1137•• 0 1m." 31 I~.OO 11,000
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n 1161.11 ".811 1119.'1 1~3.01 3Y '''.00 11,000
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:1 12"'." 11.100 1301." 1512.'2 51 m.oo 11,000
!: Irn.~ 11.121 1l20.~, 15". '5 ~2 I".CO II.COO
:3 12".;7 18.'" 1ll1.77 mo." ~3 m.oo 11.000
:. Im.I' 11.102 13\1." Il.'. ,. 5' 115.00 11.000
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8 -
7 -
3 -
2
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1915 1925 1935 1945 1955 1965 1975 1985
LAtH) LEASE CASH FLOW YEARS - ADDENDUM ;'C" LAND SALE CASI-IFt_OW
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