Choosing the Right Equity Partner
How to Analyze Financial Strength, Track Record
Choosing an equity partner is one of the biggest decisions that an
affordable housing developer will ever have to make.
A developer and an investor are committing to a long-term relationship,
as long as 15 years for low-income housing tax credit projects. So,
choose wisely.
“Like in anything else, you want someone who will be a good partner
and who will work with you and not against you,” said John Simon, partner
and head of the affordable housing practice at the Sidley Austin Brown
& Wood law firm in Chicago.
Since the tax credit program began in 1987, most syndicators have compiled
a track record of reliable performance. But there have been some problems
along the way.
Finding the right equity partner takes time and effort. When evaluating
potential partners, it is critical to analyze their financial strength,
track record and reputation.
Before signing up with an equity investor, check the firm’s finances,
said Simon. While that may sound facetious, he said, it’s important.
“Every once in a while you get someone who comes into the market and
says they are going to have a big program and will invest in affordable
housing, but then it turns out they don’t have all their internal approvals
or couldn’t get their internal approvals,” Simon said.
It is a good idea to make sure the investor has experience closing
deals and money in the bank to do so. Experts say one way to ensure
that funds for your capital contributions will be available is to have
the investor escrow or provide a letter of credit. Many investors have
no problem with doing this. If they object, it may be a red flag.
Just like any other business, the tax credit industry has investors
with varying financial strength and stability. In 2001, at least one
well-known and respected syndicator left the market, citing difficult
business conditions. Several others were operating on razor-thin margins
and shaky lines of credit.
Most equity capital for tax credit projects come from corporate investors.
Some corporations are very sophisticated and look for individual projects
they can buy directly. By participating in a direct investment and being
the sole buyer of equity in a single project, it allows the company
to increase its yield by eliminating fees a syndicator would charge.
The most likely candidates for direct investment are those with real
estate experience such as banks.
Banks often invest to meet their obligation under the Community Reinvestment
Act, which calls on them to invest in low-income parts of their service
areas. Most corporate investors invest primarily for economic reasons
and expect tax credit projects to deliver a minimum target yield that
is predetermined.
Many other corporations invest through diversified tax credit funds
sponsored by syndicators and nonprofit equity funds. It is those organizations
that acquire tax credit projects and negotiate deal terms.
Private equity funds raise money from small groups of corporate investors
for investment in portfolios with some diversification. Large transactions
are preferred.
A large portion of corporate equity also flows through national nonprofits,
such as the National Equity Fund and the Enterprise Social Investment
Corp, or state and local nonprofits. These organizations appeal to companies
that invest for social as well as economic reasons and concentrate in
nonprofit-sponsored projects and smaller projects.
Dealing with a major syndication firm offers developers many advantages,
including an increasing array of financial services. To win the battle
for tax credit acquisitions, many firms are now providing debt as well
as equity financing.
One-stop shopping has its advantages, including the cost savings of
combining the debt and equity applications and underwriting and closing
processes. Several major companies, including Boston Capital, GE Capital
and Related Capital, offer debt and equity programs. Several others
are considering adding debt financing to their services.
Meanwhile banks are coming at the same idea from the other direction.
Wachovia Securities (formerly First Union) and Key Corp. were among
the first to start offering equity investment as well as mortgage financing
for tax credit deals.
What to look for in a partner
Experience. Experience is critical, said Mark McDaniel, president
of the Michigan Capital Fund for Housing, a nonprofit that has raised
more than $250 million in equity and is credited with producing about
4,000 units of housing across the state.
The group focuses on deals in Michigan. It’s a specialty that his group
uses to its advantage. “From our viewpoint, local knowledge and local
staff and local relationships make a big difference in getting a deal
done and for the long term,” McDaniel said.
There are, however, many national, for-profit syndicators that make
fine partners.
Whether using a local group or a national one, it is a good idea to
study how they have closed deals, how they have operated over the long
run and what kinds of projects they have been involved in.
Analyze how a company’s past equity funds have worked and how they
have performed.
Resources. Evaluate the resources the investor can bring to
the partnership. Do they bring skills you don’t have?
Practical problem-solver. It is important to find investors
who approach problems practically, added Simon. Look for investors who
will be sensible when a problem occurs and one almost always will. You
want someone you can work with and not someone who is going to want
something that comes out of left field.
Reliability and reputation. Are they making timely payments?
Are they working will in other partnerships? Attorneys and accountants
specializing in the tax credit industry are knowledgeable sources.
Their team of professionals. It is also good to learn not only
about the investors, but also their attorneys and accountants. The wrong
attorneys, yours and/or the investor’s, can increase legal fees and
drive you crazy. Find out about their experience as well.
To find out about a potential partner, call other developers and even
state housing and tax credit allocation leaders to learn about their
experiences with a particular investor, suggested McDaniel. Always try
to get references from independent sources. Those will ultimately be
the most valuable.
Madison Avenue has come to the tax credit industry. Many investors
have slick ads and flashy Web pages that won’t tell you what you need
to know. Obtain a comprehensive list of investors, consult with those
who know the investors and pick six to 10 to talk to, advise experts.
Also, beware of trade magazine articles that make an investor seem too
good to be true.
Stay on top of the industry by reading news about the field and attending
conferences. This will help keep you informed about the affordable housing
market and provide you with better insight to choose a partner.
What to look for in a deal
Prices. It will be tempting to go with the highest price. But,
first make sure there are no catches. Find out if there are any hidden
fees. Is there an investor expense reimbursement? Is there bridge loan
interest? The strongest investors may not offer the highest prices or
the best terms. Investors desperate for business may offer seductive
prices to sign the business, but then spring costly surprises later.
Equity pay-in. Not all investors operate in the same manner.
It is important to learn if the syndicator will provide equity at once
or over time? If provided over time, how many months or years and in
what amounts? Will the equity be provided during construction?
Deal-breakers. Find out if the investor has any major issues
early on in the process, advised Simon. This will save valuable time
and money. If there are any deal-breakers, it’s better to know them
right at the beginning rather than be surprised by them after considerable
work has been done. If any equity investor won’t give you a security
interest, that’s something you want to know upfront, Simon said.
Time. You want someone who will perform due diligence and close
the deal in an acceptable time frame and not get bogged down with other
projects, or worse, change their deal terms or back out altogether.
Project disposition. This is an important issue for nonprofits
that wish to continue to operate a project as low-income housing after
15 years. Many syndication agreements fix the price at which a nonprofit
can buy out the limited partners after 15 years in advance. The price
is often set at the assumption of debt and payment of an amount equal
to the limited partner’s exit tax liability or fair market value as
low-income housing.
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