Affordable Housing Institute : US

“If we do not hang together, assuredly we shall all hang separately.”

– Benjamin Franklin, who was born and raised in Massachusetts

 

An investment in knowledge always pays the best interest.

 

In late December, at the request of the Massachusetts Housing Partnership (MHP, www.mhp.net), my for-profit Recap Advisors released a white paper (available in .pdf here as Recap Update 72) that focused on the crisis in US affordable housing rental production arising out of the logjam in LIHTC pricing that we first described last March. 

 

Even a simple listing of the largest 2006 investors in LIHTC equity reveals the critical point the LIHTC equity market has crossed.  What had been an $8 billion investment industry may be as little as $4-5 billion in 2008, even though the total amount of LIHTC available will increase, indexed to population.  (Section 2C)

 

We at Recap think the report is important, as in this hiatus before President-Elect Obama is inaugurated, stakeholders are buzzing with possible stimulus packages, and if we are going to spend billions, we ought to spend them smartly.

 

The white paper’s published! The white paper’s published!

 

The crisis in affordable housing production.  As we put it in the report’s opening:

 

As the nation and the Commonwealth come to grips with the most tumultuous financial environment in at least thirty years, the LIHTC industry is facing:

 

·         A sudden and pervasive withdrawal of credit and global repricing of risk.

·         The largest downward correction in LIHTC pricing in the program’s history.

·         Massive and ongoing consolidation in the banking sector, which until recently was the all-but-exclusive consumer of LIHTC equity investments.

 

Put these factors together and it is clear that the LIHTC and affordable housing world in 2009 will be vastly different than the equilibrium which prevailed through the end of 2007.  Further, no one can say with any certainty when equilibrium will return and at what price levels.

 

For affordable housing production, this is a crisis for the pipeline:

 

It’s cold for developers if equity isn’t flowing through the pipeline

 

As I’ve described elsewhere, housing tax credits work because:

 

Investment tax credits — including the historic tax credit and the LIHTC — by their very nature create a market mechanism, because the amount of credit is so large that a typical real estate sponsor cannot consume it personally.  Hence the sponsor is sent to the capital markets to find soft equity, which means there is (a) a market dynamic between buyer and seller, and (b) the manifestation of an investment banker who makes a business structuring buyer and seller investments.

 

This worked fine until very recently, because (as the report puts it):

 

Until the end of 2007, LIHTC funding was supply constrained—that is, demand for LIHTC equity vastly exceeded supply of awards, and demand for LIHTC allocations vastly exceeded supply of allocations.  During 2008, that polarity completely reversed.  Now, supply of awarded LIHTC equity greatly exceeds demand.

 

This is a gigantic challenge, because sellers have to sell, whereas buyers do not have to buy. 

 

I don’t feel like buying

 

·         A ’seller’ of LIHTC equity—that is, a sponsor with an award—must convert the LIHTC into cash through equity syndication in a limited time window or lose the LIHTC entirely.

·         A ‘buyer’ of LIHTC equity—that is, a corporation with pre-tax earnings seeking to manage after-tax earnings and cash flow—can either buy something or do nothing.

 

This imbalance was tolerable only when demand vastly exceeded supply.  Now that it is not, something akin to desperation is setting in among some categories of developers.  (Section 3C.)

 

Still moving toward a closing!

 

Nine months ago, I wrote:

 

As of March, 2008, nobody knows what $1 of 2008 LIHTC will be worth, because by far the majority of investors who will eventually buy it are deferring their purchase decisions, and may do so for the next several months. Right now the effect on our industry is about the same as if the air-traveling public had elected to stay home for six months.

 

What if nobody wants to fly?

 

When demand falls, prices also fall until there emerges a new body of consumers who support a new lower price. Where will they come from, and at what level will prices stabilize? While prices are falling, what does that mean for current participants, especially lenders and investors?

 

Remarkably, the situation is no better today; as the report notes:

 

Best expert estimates suggest that, whereas in every year from 1988 through 2007 all allocated LIHTC was sold and closed, the nation as a whole will end 2008 with a substantial inventory of unsold LIHTC—perhaps $3-4 billion worth, or 40% of the 2008 allocations—where allocating agencies have awarded LIHTC to developers, but developers have been unable to secure a firm equity commitment much less close.

 

This situation is without precedent, and its consequences are likely to prove troublesome to the stabilization of 2009 LIHTC equity prices. Trouble will intensify as the sponsors (and their allocating agencies) of properties with overhanging unsold LIHTC realize that if they do not sell the commodity, at any price, then they will simply lose it back to the national pool.  (Section 2F)

 

Beyond the immediate challenge for the development pipeline – roughly two vintages’ worth of allocations, the ‘07 and ‘08 years – we also face the prospect of vanishing value for the nation’s most important rental housing production resource:

 

Today, the Low Income Housing Tax Credit (LIHTC) is the nation’s most important affordable housing financial resource.  Historically, Massachusetts has been among the nation’s leaders in innovative use of the Low Income Housing Tax Credit; the state has always consumed its full allocation and its allocating agencies have garnered numerous NCHSA awards of excellence.

 

This leads into our recommendations:

 

1.  Participate with stakeholders in a collective response to the crisis.  Shared interests should trump parochial or competitive interests.  As we put this recommendation:

 

Sponsors, syndicators, and lenders know as well as anyone the specific barriers to quick deployment of LIHTC.  Since we no longer have the luxury of a rising market that allows all deals to eventually get funded, we need to collectively reevaluate the allocation process. 

 

More than one of our sources told us, in the plainest possible terms, that it would not review LIHTC properties in one or more states because the state had a reputation for being procedurally difficult. 

 

Who  has the upper hand now?

 

We started with this recommendation because of our target audience – namely, state allocating bodies.  Unlike developers, syndicators, and investors, all of whom have been coping with the credit crisis for a year now, the allocators are insulated both by their secure employment in the government sector and because as salaried executives, they are used to process, whereas program participants are used to outcomes.  Deals close or they do not.  That downside risk has been alien to allocating agencies, because for over two decades, states have had the upper hand in LIHTC allocations: they offered, and the market eagerly accepted.

 

Sponsors would queue up, equity would always be ready to invest, and allocators could pick and choose while stretching credits dollars ever thinner.  In a rising market, that is a rational and efficient use of subsidy dollars.  (Section 4B)

 

Things are different now:

 

Now the market is contracting.  Many deals will not close.  Unless we change the process to concentrate subsidy resource effectively, we will allocate LIHTC that will go unused, thereby wasting federal resources designated for Massachusetts.

 

States need friends:

 

Procedures and approaches that worked when LIHTC equity investors could be found for virtually any award of credits have led to an imbalance that fails miserably when LIHTC equity is undersubscribed.  (Section 1B)

 

There comes a time when states need friends

 

Those readers who have not dealt with long-incumbent bureaucracies might think such statements obvious.  Yet, for those who for decades have simply had to raise an eyebrow for the world to come running, it is incredibly difficult now to shift to having to negotiate and sell.

 

Using new mental muscles: learning how to negotiate and sell

 

2.  Avoid incentives that align against equity markets.  Rather than lose credits to a national pool, every state should spend its resources within that state.  As the report puts it:

 

State allocation criteria will not be able to overcome the pressure from investors, at least in the short term.  So, making allocations to deals that are unattractive to investors will simply mean allocations go unused for lack of an investor. 

 

A marketplace where you easily sell everything you produce is qualitatively different from one where some goods rot because they are totally unsold.

 

As Recap documented two years ago, by the mid 2000’s LIHTC pricing had reached its apex and its ultimate buyer: the profitable financial institution which also placed meaningful monetary value on maintaining an Outstanding CRA rating and hence consumed substantial LIHTC equity to assure itself of that Outstanding.

 

Once you get past the gag reflex, these credits are Outstanding!

 

LIHTC not used by one state reverts, after a roughly two-year interval, back to a national pool and is reallocated to states with excess demand. 

 

The national pool in 2006

 

Until recently, this was a minuscule pool: now it is likely to be enormous, with huge consequences for the program nationally.

 

The national pool in 2010

 

A program whose investment products had become almost nationally standardized is about to separate into layers of desirability:

 

The market’s centrifugal force will separate LIHTC by desirability

 

Given new investor sensitivity to deal attributes and an investor-centric pricing market, we can expect greater price differentials to emerge.  A likely spectrum appears to be from $0.60 to $0.80.  Pipeline properties at the high end of the pricing range will have four or five of the features in Section 3E –strong markets, uncomplicated financing, well-capitalized developers, agency support, and CRA area.  Pipeline properties at the lower end, to the extent they are feasible, are likely to have only one or two features.  Pipeline properties with just one or none of those features will not close.

 

Will not close is syndicator-speak for die. 

 

It used to be that winning the allocation won you a successful deal.  Now, winning the allocation means only the chance to spend more money with no certainty of surviving to an equity closing.  The winnowing, we think, is going to be severe:

 

Some of your deals are going to  be blown away in the wind

 

We thus foresee roughly a four-tier pricing structure conceptually as follows:

 

 

If this tiering shakes out, not only will better tiers command more favorable prices, their prices will stabilize first. 

 

Several of my professional friends who are equity syndicators have told me that sponsors who spurned them years ago have been sending large packages of interesting properties to syndicate, only to find that the syndicators too are stymied, because the investor appetite is lacking:

 

With some exceptions, properties in lower-tier markets will be disfavored by national investors, who can tacitly redline entire states and regions because they are interested in yield without being bothered by CRA footprint considerations.  (Section 3G)

 

Red-lining by creditworthiness is rational – and legal.  Only redlining by race or ethnicity is illegal.  Some states could be entirely shut out of LIHTC awards. 

 

Unused LIHTC means wasting federal subsidy dollars.  Massachusetts should avoid scoring criteria that, for instance, advantage weaker sponsors, favor complicated financing structures, or add unnecessary deal costs.

 

Unused LIHTC will go back to the national pool, and flee the state.  Isn’t it better, therefore, to sell your state’s LIHTC at a low, low price rather than lose it entirely?

 

What’s it worth if it’s not yours any more?

 

[Continued tomorrow in Part 2.]

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[Continued from yesterday’s Part 3 and the previous Part 1 and Part 2.]

 

You think that’ll impress me?

 

So far, in examining the ruling (available here in .pdf) that remanded back to district court a series of actual questions about whether the Paradise Park residents were entitled to the New Jersey Mobile Home Protection Act, we’ve seen that the appellate court – even though it cannot rule on facts – gave the residents multiple Christmas presents:

 

The more we read the decision, the more presents we found!

 

1. A definition of ‘in contemplation’ that it appears certain the factual record will support – meaning that the residents’ right of first refusal should be triggered.

2. A finding that the seller, Mr. Somers, has to form a good faith view – meaning that more than likely, Mr. Somers will agree that notice should have been given.

3. A road map for plaintiff counsel as to what evidence to put before the trial court as to whether a change in use was ‘in contemplation, and some heavy dicta indicating the appellate court thinks it was.

 

On March 4, 2005, the parties passed papers, and on March 5 the seller gave notice to the residents that they had a new park owner.

 

All hell broke loose:

 

On April 1, 2005, the residents of the Park filed a certificate of incorporation formally creating the Paradise Park Homeowners Association.

 

Behind the scenes, the residents were frantically rushing about to organize themselves.  This takes time.

 

Three days later, the Association filed a notice of rights under N.J.S.A. 46:8C-16(b), with the office of the Monmouth County Clerk. The notice was formally recorded on April 26, 2005.

 

As a public-policy matter, I really favor notice provisions.  Statutory rights are useless unless they are manifested by action, and the beneficiaries of those rights, who are normally just plain folks, have no reason to be expert in the real estate business and no justification for coming together as a group until they are galvanized by an external event/ threat.  So it takes them time to get their act together, find out what rights they have, assemble a team to help them with those rights, and become a viable counterparty.  A notice period is entirely appropriate, provided hat notice doesn’t turn into obstacle (as in Mitchell-Lama) or pillory (as in LIHPRHA).

 

I was just trying to exercise my contractual rights

 

Meanwhile, as a practitioner, I have sometimes spent a lot of management strategic time debating whether our client has to give a notice, and if so when, and what the notice should say.  A notice once given cannot be ungiven, and a notice that imprints people’s consciousness with fear does damage even if one’s motives are entirely pure. 

 

From May to August 2005, the sellers made several attempts to record the deed.

 

From this, I cannot infer whether the buyers had or hadn’t paid the cash consideration; sellers have the obligation to record title because they are the owner of record and the county clerk won’t recognize someone who isn’t on the current title.  Because the residents’ association had filed its notice of rights, the county clerk also was doing what he or she should have

 

The Clerk’s office rejected these attempts because the deed did not contain the affidavit required under the Act. The deed was finally recorded on August 2, 2005.

 

The record is silent on how that one got recorded.  Sometimes a clerk’s office just slips up.

 

Hope that’s not recorded

 

Ever since then, the plaintiffs have been suing Mr. Bollerman, seeking to secure what they believe is their right of first refusal to purchase the land, and hence to preserve their homes.  They previously lost on summary judgment in district court, in an opinion remarkable for its narrow-mindedness:

 

The motion judge accepted defendants’ arguments. Referring first to the exemption in N.J.S.A. 46:8C-13(a), and the affidavit filing requirement under N.J.S.A. 46:8C-14, the court then reasoned as follows:

 

[T]he contemplation of the parties is not just what the parties to the transaction will tell the Court they intended. Instead it is also reflected by the contract as well as the consideration paid at closing.

 

Here, the consideration paid at closing was identical to that provided for in the contract. As such, the contract was clearly not a ruse for a different deal.

 

As we saw above, the appellate court blew up this syllogism.  As it said:

 

Try another argument

 

We also hold that the trial court improperly narrowed the focus of its analysis to the “four corners” of the written contract between Bollerman and Somers, thereby ignoring a wealth of probative evidence of defendants’ state of mind concerning the future use of the Park property.

 

Not content to demolish one trial court conclusion, the appellate court tackles another one, the trial judge’s conclusion that:

 

In addition to that, I accept the certifications everyone filed saying that they have no intention of changing the use, no intention of doing anything further.

 

The appellate court blew this up also, citing the need to consider all the evidence.

 

Keep trying …

 

If I thought for one minute there was one scintilla of evidence here that they were trying to do this deal to circumvent the law, I would not be making the decision that I am making here today. There is no evidence in this record anywhere that that was the case. It is clear to me from the consideration paid and the language of the contract that that’s not the case.

 

Jaw.  Drop.

 

 

Evidently the appellate court was as stunned as I was, for its ruling says early on:

 

Plaintiffs now appeal, arguing that the trial court erroneously limited the focus of its analysis to the terms of the contract for sale, thereby ignoring a plethora of evidence showing defendants’ true state of mind.

 

Specifically, plaintiffs argue that the trial court should have considered Bollerman’s conduct during contract negotiations in light of his attempts to change the property’s zoning scheme to permit high-end residential development. According to plaintiffs, this, together with Somers’s refusal to modify the contract to reflect the buyers’ true future intent, amounted to clear evidence that the sale was made “in contemplation” of changing the property’s use as a mobile home park.

 

[Big snip]

 

According to plaintiffs, these letters and subsequent negotiations leading to the extension of the due diligence period are probative of the parties’ true state of mind with respect to the future development of the Park property. Plaintiffs argue that the trial court’s dismissal of this evidence in the context of deciding to grant defendants’ motion for summary judgment amounted to reversible error.

 

*

 

We agree with plaintiffs’ position.

 

That, dear readers, is what victory reads like.

 

I love the smell of judicial decisions in the morning

 

Why is this important?

 

Aside, that is, from the very human story of the residents who are fighting to preserve their homes?