Private equity’s affordable housing land rush leaves trail of disputes


Joe Dejesus has stopped counting how often he has patched leaks and repaired walls at the rent-controlled Brooklyn housing block where he works as superintendent.

The community organisation that rents out the apartments had been preparing to install a new roof and heating system, but held off when an investment group stepped in to claim sweeping rights over the property, according to people familiar with the charity’s plans.

Instead the landlord, RiseBoro Community Partnership, is entering the third year of a legal battle with insurance company American International Group over who is the long-term owner of the imposing century-old block.

It is one of at least half a dozen fights between charities and powerful investment groups over affordable apartments funded by federal tax credits — a trend that activists say could displace families whose homes were built with billions of dollars of government subsidies.

Those homes are now coveted by private equity firms. Last month RiseBoro learnt that AIG’s disputed stake in its building in the Bushwick section of Brooklyn would be sold to Blackstone, part of a pending $5bn deal that represents the investment group’s most politically charged incursion into the US housing market in the years after the mortgage crisis of 2008.

Housing advocates worry that a private equity takeover of affordable housing could spell trouble. Some fear that housing charities will have to accede to crippling financial settlements with Wall Street investors, or face being stripped of their custodianship of housing assets that provide a bulwark against rising rents.

Others worry about what will happen if financial firms are in charge of affordable housing assets when rent control regulations finally run out. “Gentrification has been going through Bushwick quite rampantly,” Dejesus said. “I’m worried about the families in my building — where are these people supposed to go?”

Blackstone has said it intends to maintain affordability, even after federal and state rent controls on many of the 83,000 apartments that the firm is buying expire over the next 20 years.

But Wall Street’s newest land rush worries Bobby Rozen, who helped design the low-income housing tax credit programme when he was an adviser to Democratic Senator George Mitchell in the 1980s. “Private equity has discovered this sector of the housing market,” he said. “And they are attempting to earn big profits by taking money out of affordable housing in ways that were not contemplated by Congress.”

Turning tax credits into billions

The affordable housing assets that Blackstone has agreed to buy are built of bricks, mortar, and legal artifice. Beneath their $5bn valuation lies a corporate structure that apportions ownership between local housing groups that operate the buildings and financial investors that shouldered part of the cost in exchange for billions of dollars of tax credits.

To see how that structure works, it helps to trace the US government funding that paid for the 35 units that RiseBoro operates on Stockholm Street in Brooklyn. Converting the building into apartments cost far more than a landlord could hope to earn in a hardscrabble neighbourhood in 1999. The building was “set up to be a hospital wing, not suitable for residential at all,” said RiseBoro chief executive Scott Short.

Unable to pay for the work itself, RiseBoro instead received a subsidy in the form of tax credits, tapping a scheme that costs the US government about $11bn a year, according to the Congressional Research Service.

Flow chart showing how the Low-Income Housing Tax Credit works as a simplified example

But tax credits only reduce the tax bills of businesses that pay tax in the first place. RiseBoro is a tax-exempt charity, so it enlisted help from AIG’s SunAmerica subsidiary, which in the 1980s had hired an accountant named Mike Fowler to find ways of making money out of the federal tax code.

In more than two decades at SunAmerica, Fowler assembled much of the $5bn portfolio that Blackstone is now buying. His innovations were copied by an entire industry of financial groups that claim low-income housing tax credits from the government and send a portion their savings to the developers of affordable housing blocks. Fowler’s efforts “result[ed] in billions of dollars of profits” for SunAmerica and AIG, according to court papers filed by his lawyers in 2017.

In 1999, RiseBoro transferred its Bushwick building to a partnership that was 99.9 per cent owned by AIG. The insurer paid $2.5m towards the project’s costs, court filings show, and in return expected to receive tax credits worth $3.3m over 10 years, among other rights. RiseBoro operated the building and received most of the building’s rental income. The charity’s executives have said they expected the partnership structure to be dissolved after 15 years.

In 2015 RiseBoro notified AIG that it intended to buy back the building for a nominal sum, a move that would have lifted restrictions that the partnership structure imposes on RiseBoro’s ability to finance capital improvements and repairs.

But the charity received what its lawyers characterised as a nasty surprise. AIG said it was not interested in selling. The insurance company offered to settle the dispute if RiseBoro paid a sum exceeding $1m, according to a person familiar with the talks, but RiseBoro declined the offer. AIG declined to comment on this claim.

Ultimately RiseBoro filed a lawsuit to try to force the transfer. A federal court ruled in AIG’s favour earlier this year; the case is now under appeal.

According to one former AIG executive, such conflicts may have become more common after the 2008 financial crisis prompted the insurance company to slow or halt its pursuit of new affordable housing deals, and instead focus on the partnership interests it already owned.

“The [agenda] becomes, what can we squeeze out of these 1,200 properties?” the executive said. In some cases, the person added, “if we can be difficult or not co-operate, then we can get somewhere . . . [closer to] the real market value of the property”.

In legal filings, AIG has disputed RiseBoro’s interpretation of its partnership agreement, which invoked the wording of a 1989 federal law that allows non-profit landlords to claim a “right of first refusal” over properties they operate.

Financial executives argue that, far from trying to squeeze extra value out of their affordable housing partnerships, they are being forced to go to court to preserve the long-term ownership rights that they bargained for. It is the charities and housing operators, these executives argue, who are trying to take assets for their own account and disrupt the status quo.

They add that investors have a financial interest in the upkeep of the buildings and are willing to co-operate to provide the needed funds.

Short, the CEO of RiseBoro, had a different view. “These properties are now worth a lot of money,” he said. “No one ever thought they would be when they were being built in these depressed neighbourhoods back in the ’90s. But investors can only unlock that value if they deregulate the apartments and kick the existing tenants out, which is something that we would never do.”

Strained relationships

Blackstone made enormous profits during the mortgage crisis by creating a rental empire from suburban homes it bought out of foreclosure. With its bet on rent-controlled apartment buildings, the group is inserting itself into a debate about how to balance the economic rights of property owners with the need to shelter low-income families in some of the most costly regions of the US.

The executives behind the Blackstone transaction see themselves as part of the solution. “We will make significant investments to improve the apartments while ensuring they remain affordable and in compliance with all rent regulations,” Kathleen McCarthy, Blackstone’s co-head of real estate, said when the AIG deal was announced last month.

Yet the private equity firm is inheriting strained relationships with some of the non-profit operators of its new housing portfolio, which comprises 678 buildings scattered across 46 states.

RiseBoro Community Partnership is battling with AIG for control of a Brooklyn apartment block which has greatly increased in value © Financial Times

In the city of Pontiac, outside Detroit, AIG won another battle against a local housing charity when a court ruled in February that Presbyterian Village North acted wrongly in trying to regain control of a retirement community that was held by an AIG-sponsored partnership. That ruling, too, is under appeal.

A person familiar with the case said the finding of a contractual breach by the charity could trigger a clause forcing the church-aligned group to surrender control of the apartments it built on donated land.

AIG said it was proud of its 30-year record of investing in affordable housing, and added: “We are confident that Blackstone will continue making important investments as they manage these assets.”

Blackstone has sought to reassure tenants on low incomes that its takeover of tens of thousands of apartments will bring only improvements. “Our intention as owners is to maintain affordability for these communities,” the firm told the FT. “We do not intend to convert any of them to market rate; we want to keep them affordable.”

Wall Street is keen to present itself as a constructive partner for housing charities, too. Blackstone said it “intend[s] to provide capital and approved financings for necessary repairs and maintenance”. The $450m programme would include projects to replace roofs, rectify structural defects and improve energy efficiency, according to a person familiar with the plans.

While Blackstone is by far the biggest private equity group hunting for profits in ageing low-income housing, it joins a group of niche investment firms that have bought stakes in some of the 3m apartments built with low-income housing tax credits since the programme started in 1986.

In 2019 one such investor, Alden Torch Financial, which is led by a former AIG executive, won a legal ruling in federal court against a Seattle-based housing charity, which had claimed it was entitled to purchase several properties at a low price.

That case was cited in a report by the Washington State Housing Finance Commission, which said that “some private firms have begun to systematically challenge non-profits’ project-transfer rights and disrupt the normal exit process in hopes of selling the property at market value.” Reforms that the commission later introduced have been challenged in court.

The elaborate financing structures needed to capture the federal tax credits may have made disputes inevitable. Lawyers said that the Internal Revenue Service can challenge any asset transfers that are made solely to avoid taxes, and contracts often seem to be fuzzy about who will own a property when the tax credits run out.

“I feel horrible,” said one attorney, who has represented investors on scores of deals that were paid for by the low-income housing programme. “I will never once again say: ‘Don’t worry, my client is going to do this, they will walk away after 15 years’”.


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