Affordable Housing Finance

MARKET OPPORTUNITIES

REHAB AND PRESERVATION

The Case for Preservation

AFFORDABLE HOUSING FINANCE • September 2008

BY BENDIX ANDERSON

Last September and October, housing officials sat across a table from the owners of Starrett City, the nation’s largest privately owned affordable housing complex, located in Brooklyn, N.Y.

Armed with a stack of market studies and financial statements, officials argued Starrett City would provide the owners a stronger and more predictable return if kept affordable than if Starrett City Association attempted to remove the property’s income restrictions.

“We are establishing what could be a different way of talking to owners,” said Deborah VanAmerongen, commissioner of the New York State Division of Housing and Community Renewal (DHCR).

Housing advocates have found a new weapon in the fight to keep properties like Starrett City affordable: hard economics. Many owners overestimate the amount of money they could raise by taking their properties out of affordable housing programs, whether by raising rents or developing new luxury housing on a site. Owners also often underestimate the difficulty of the transition and the dollars the property could produce if kept affordable, said Van Amerongen.

This is a burgeoning issue, as thousands of properties originally financed under Department of Housing and Urban Development (HUD) programs are in danger of being taken out of those programs. Federal Sec. 8 rental subsidy contracts will expire at 7,850 properties over the two-year period starting October 2007. That represents nearly half a million apartments, according to Washington, D.C.-based advocacy group the National Housing Trust.

With many owners licking their chops at the profit potential they could realize from converting these affordable properties to market-rate housing, local officials who want to keep the properties affordable are discovering that an appeal focused on the bottom line can be the most effective.

In Michigan, the four partners who owned Wingate Management Corp. seemed in favor of selling the company and its 901 apartments in the Detroit suburbs to affordable housing developer National Church Residences (NCR), based in Columbus, Ohio.

However, Wingate’s owners were unused to the amount of time it can take to put federal, state, and local financing together to make a deal work. “The youngest [of the four original partners] was in his 70s,” said Michelle Norris, senior developer for NCR. “They are no longer deal people.”

In 2006, after delays in Michigan’s programs held up the sale for more than a year, one partner’s son attempted to lead the partnership in a different direction and sell the project as a market-rate rental property.

NCR eventually convinced the owners to keep the property affordable, in part because several of the properties were located in very weak markets. A market-rate buyer would probably cherry-pick the best two properties and leave the rest, NCR told Wingate. Keeping all the properties affordable was a less complicated, more competitive option. NCR purchased Wingate in 2006 and finished a full rehab last December.

Where the preservation pitch works

In stronger housing markets attractive to lenders, it’s tougher for local officials to make a bottom-line pitch for preservation, as private buyers offer a few advantages. Not only can they pay more for the properties and put down more earnest money that they can afford to lose, they can sometimes close in just a few months. However, the number of strong markets has dropped sharply as housing prices fall nationwide.

The pitch to preserve affordable housing is strongest in weak markets where lenders are cautious and private buyers have difficulty finding financing—and preservation-minded buyers can give the market-rate boys a run for their money.

“There are people in Miami and Illinois who had been looking at condo executions that are calling us back and asking if we can close,” said Bart Lloyd, manager of acquisitions for Boston-based affordable housing developer Preservation of Affordable Housing, Inc. “Our financing is now a bit more solid than anyone else’s.”

Even in a strong housing market like Boston, keeping a property affordable can offer a competitive yield to investors, once the real risks of going market rate are taken into account, said Richard Henken, a principal with Boston-based affordable housing owner and consultancy Schochet Associates, Inc.

Henken uses a building in which Schochet Associates owns a general partnership interest as an example. The 135- unit property is located in an extremely pricey neighborhood between Boston’s South End and Back Bay neighborhoods. As condominiums, the units would probably sell for $200,000 to $400,000 even at today’s soft prices.

That’s more gross income than the building could ever raise as affordable housing, said Henken. However, the money would come at a risk. Units could not be sold immediately, he said. If the building opted out of its program, current tenants would receive enhanced Sec. 8 vouchers from HUD and could stay as long as they want. “If I wanted to sell to condo, I might not have anything to sell,” said Henken. “It’s going to be very hard to find a condo converter buyer that is willing to speculate in that way.”

In contrast, keeping the apartments affordable will provide a relatively certain yield to investors, said Henken. After owners put the project through HUD’s Mark-to-Market program, the rents HUD pays will rise from an average $800 a month to close to $2,000. That’s more than $1,000 in new income per apartment per month, or roughly $1.6 million annually for the building, said Henken. Roughly half of that would go straight to investors.

Preserving Starrett City

The owners of Starrett City also carefully weighed their options before committing to keep their property affordable, according to owners’ representatives.

Under current law, Starrett City is now eligible to leave its affordable housing programs after giving a full year’s notice. Along the way it would give up $20 million a year in property tax breaks and millions more in HUD subsidies. In 2007, the owners had planned to give notice and sell the 5,881-unit complex for $1.3 billion, a price that works out to $221,000 per apartment.

Housing officials not only refused to approve the sale before the completion of the one-year waiting period, they also pointed out to Starrett’s owners that simply raising rents to market levels would not justify a $1.3 billion price, assuming the owners could still find a buyer to pay that price in 2008. Rents simply aren’t high enough in Starrett City’s submarket far from the center of town, said DHCR’s VanAmerongen.

With the housing market softening earlier this year, the owners committed to sell their property only to buyers that would keep Starrett City affordable. In June, eight affordable housing partnerships made bids ranging from $700 million to $900 million, according to local news accounts. The owners plan to choose a winning bid in September.

Officials say Starrett City may provide a model for the future negotiations with affordable housing owners.

“We’ve lost so much affordable housing over the last couple years,” said VanAmerongen. “You can’t sit back and wait for the occasional victory.”