Bidding War: A Scenario
By John W. Gahan III
15 min read
Weighing Experience vs. Price
Whoever coined the phrase “no rest for the weary,” must have known someone trying to develop affordable housing, Gerry General mused as he left port for a Sunday afternoon sail. Lake Erie’s waters were a calm oasis for Gerry away from the frenetic pace of the office and Gerry had a lot on his mind.
Just months earlier, Gerry had wrestled with what to do with a tax credit property nearing the end of its compliance period. A tedious negotiation with his long-time investment partners at Insatiable Investors LLC had ended with an expensive, but acceptable, buyout of Insatiable’ s interest. Good Life Lofts was now owned 100% by Gerry’s family. In due time, Gerry could advance his estate and succession-planning objectives by turning over control of Good Life Lofts to his two millennials, Gina and Greg, who were interested in starting their own career as developers.
Meanwhile, an exciting and challenging opportunity had surfaced in a neighboring state. Once a metropolis with a thriving coal mine industry, the mines had closed one-by-one and with no new jobs available, the young and mobile moved to other states. The local parochial school, Holy Inspiration, had been sitting empty for years. Now there weren’t even enough parishioners to fill the adjacent church on Easter Sunday. The senior parishioners were retired and looking to downsize, but their homes were no longer worth much more than the mortgages and they could not find affordable housing alternatives.
The Archdiocese could not continue to subsidize a large complex that had only a few elderly parishioners and decided to put the church, the parish center and school, up for sale. Gerry was the successful bidder with his offer contingent on securing the resources needed to redevelop the site as affordable senior housing. The state housing finance agency recognized the need for this type of housing and encouraged Gerry to apply for Low-Income Housing Tax Credits in the upcoming funding round.
Raising the Equity
But now Gerry worried he had been too aggressive on the bid and an LIHTC allocation alone might not be enough. Traditional sources of “soft” money for development deals had dwindled. Competition among investors looking to invest tax credit equity was fierce and price wars among investors were common. High credit prices would help but Gerry still needed to bridge the sources- and-uses gap.
Mulling over solutions while he sailed around the lake, Gerry reflected back on discussions of “twinning credits” at a National Housing & Rehabilitation Association conference years before. Historic tax credits, alongside Low-Income Housing Tax Credits, might be the extra boost he needed to make this deal work. His thinking anchored, he headed for shore.
Back on land, Gerry whispered a quick prayer to Saint Jude, the patron of lost causes, for some help. He googled the Church website and his prayer was answered: Norma Newuse, a veteran on the Parish council, was also a historic preservation consultant. She informed him that, with a little work and a generous consulting fee, it was possible the Holy Inspiration site could be deemed historic.
Now Gerry had the shell of a successful development forming in his mind. He had:
• a site with buildings worth preserving under his control
• a local community eager to help its senior population
• a state agency looking to reward developers sponsoring smaller deals
What he needed was money – someone else’s money.
Calling Insatiable
Gerry asked his children, Gina and Greg, to join him for a call with his longtime investor, Insatiable. While Gerry had most recently interacted with Adam Avaricious, and Gerry knew Adam handled dispositions (not new investments), Gerry nonetheless decided to try Adam first.
“Adam, Gerry General here, along with my two next generation developers, Gina and Greg. We were the successful bidder on the Holy Inspiration property. The Archdiocese liked our price but we had to commit to preserving the buildings and providing housing for local seniors. We are applying for credits, LIHTC and historic, state and federal both ways. If we get awards, is Insatiable in the market?”
Adam jumped at the chance to send a deal to the originators who always accused him of killing relationships with developers by his aggressive disposition negotiations. “We’re always in the market. Send me what you have and I’ll take a look at it. How soon do you need an answer?”
“Tax credits applications are due Thursday of next week. We are required to name an investor and submit an expression of interest letter with some pricing in it,” Gerry said.
“We can give you a barebones proposal, Gerry, but it will be strictly non-binding. We can’t do anything without a ton of due diligence and we need to get committee approval.”
“Also, Gerry, I need to clear the air. Rumor has it you are bad-mouthing me and Insatiable over the Good Life Lofts deal.”
“Adam, I was upset at first because I thought there was a disconnect between the sales pitch I received when your originators were chasing my business and how your disposition group acted when it came time to sell. Once I understood that the issue really was based on some language the tax lawyers required in the LPA, I got over it. The lesson I learned was I need to understand the deal, soup to nuts, right from the start. Who at Insatiable will be in charge of this?”
“David Dottheize – you will really like him. Been doing deals since the late 90’s. Has seen it all and is very detail-oriented. Gerry, he is even more OCD than your attorney but trust me, he gets it done. Knows what is important and what isn’t.”
“That’s great,” said Gerry. “Both of my kids will work on this but Gina will be manning the leading oar, excuse the expression. Please let David know he should contact her directly.”
Within a week, Insatiable produced the necessary expression of interest letter, quoting a market price for the LIHTC credits. As he pushed “Send,” forwarding the completed application to the funding agency, Gerry was feeling good about the deal and proud of the work Gina did on the application.
Curveball – Another Investor Offers More
Gerry asked Gina to keep him apprised of any developments. It didn’t take long for a curve ball to come their way. The next week, Gina walked into Gerry’s office with a concerned look on her face.
“Dad, I just got a call from Candy Callow at Fledgling Finance. She heard through the grapevine that we had the Holy Inspiration property under agreement and were looking for credits. She offered to beat Insatiable’s price by four cents per dollar of credit, give us a quicker pay in schedule and minimal developer guarantees.”
Gerry agreed that they needed to hear what Candy had to say. They called Candy and, somewhat surprisingly, she answered on the first ring.
“Gerry,” said Candy Callow, “we’ve met before at conferences. Years ago, I worked as an acquisition intern at Insatiable, then I left to raise a family. Now, I am looking to restart a career and make some serious money so I can pay for my kids’ education. Everyone seems to be making money on LIHTC deals so I signed on with Fledgling trying to jump-start the tax credit business here. Fledging is committed to this business long term, so they are cutting margins to get business. I heard that Insatiable offered .935. Would you come to us if I gave you .975?”
“Candy, I love the price and we need all the capital we can get but I really need to know more about the terms and execution. I have done dozens of deals with Insatiable and I know exactly what the drill is when I work with them. I planned to let Gina run this deal. Not sure it makes sense to have a rookie and a new syndicator.”
“Gerry, don’t worry about a thing. I know what I am doing and Fledgling is hungry. Let me give you an LOI. I bet we match or beat them on everything. What do you have to lose? You’ll have my letter in the next 24 hours.”
A day later, Fledgling’s proposal arrived in Gerry’s inbox. After a quick review by counsel, Gerry and Gina called Candy.
“Candy, Gerry here. I looked at your LOI and sent it to my lawyer. He said it’s pretty sparse. It’s not clear as to what guarantees I need to make. There’s nothing in here about what happens after the stream of credits end and I want to sell the property or recapitalize. There are a lot of places I need Fledgling’s consent. Lots of important subjects are not addressed.”
“But, did you like my price?”
“Yes, but it isn’t all about the money.”
“Maybe not, but it starts with the money. You’re never going to do a deal with us unless we put in more money than Insatiable has offered. Don’t worry about the exits; we’ll work those out. What if I add another penny?”
“We have to think this through. I just don’t understand how you can possibly offer to do the deal for a nickel more than the market.”
“Gerry, here is how I see it. I really want you to do a deal with us. We don’t need to make any money in our first few years while we build up our portfolio. We go very lean on our staffing and expenses and keep third-party costs down. We’ll make some fees now and down the road, we’ll make our money when the asset is sold.”
Gina interrupted, “Candy, are you telling us that you don’t have a team of folks who underwrite and review the deal, soup-to-nuts?”
“Nah,” Candy replied. “Why should I do that? You guys know what you are doing. We’re just here to help you close the deal. Then we are along for the ride.”
“Whoa!” Gerry exclaimed. “I rely on my investor to do real due diligence. I want them to look at the title, economic assumptions, environmental concerns, analyze risk, get proper insurance coverages, make sure our rental projections make sense and that we do everything we need to satisfy the Section 42 rules. You are making me nervous talking about being “along for the ride.” I agree that once the property is placed in service there isn’t much for you to be involved with, but we both need to be engaged until we close with lenders and the agencies. As for an exit strategy, I learned the hard way that my family needs to control the disposition of the property down the road.
Gerry finished, “I am not saying no, but Gina, Greg and I need to figure out whether we are comfortable with you and your approach.”
Creating A Competition
Gerry, Gina and Greg were conflicted. Candy’s offer represented several hundred thousand dollars of additional equity on a deal begging for capital. They decided to create a competition between Fledgling and Insatiable.
They started with a call to David of Insaitable. “David, I got a problem here. Gina got a call from Candy Callow at Fledgling Finance…She saw what we submitted in our application for credits and she tells me they will beat your price by five cents per dollar of credit, all the way around, give us a quicker pay in schedule and fewer things I have to guarantee. I know they are the new kids on the block but that’s a lot of money.”
David jumped in, “You’ve got to be kidding me. We give you a market price and you are shopping us on the street? What about our long term relationship?”
“David, you weren’t listening. We weren’t shopping your deal. Candy called us. We haven’t decided on anything but we’d be fools not to listen to her offer. Anyway, I have talked with my kids – they think they should go with the best deal, which, to them, means the most money, the fastest. I don’t want them to make a mistake on their first deal.
Gina jumped in with a suggestion. “Insatiable needs to send us a firm commitment letter with all of the usual stuff in it. You know, total capital contributions, pay in schedule, all your credit adjusters, all the gobbledygook on ‘bad boy’ events and, our obligation to repurchase, etc. Your letter should spell out, in detail, the exit provisions so we don’t run into the same problems as we did on Good Life Lofts. Equally important, a time line for when you are going to complete particular tasks. We have Fledgling’s LOI and once we get yours, we can compare apples to apples.”
Focus on What Matters
This transaction was turning out to be an even bigger learning experience for Greg and Gina than Gerry originally anticipated. Gerry called his kids into his office for a lesson.
“Here is how we are going to do this. Before we compare the LOIs, let’s each of us write down the five most important things to us in order of importance. Then, we will each grade the LOIs against our wish list.”
Greg read his list first.
• price;
• pay in schedule;
• how quickly can we close;
• cost to get there; and
• price
Gina took a different approach.
• for me, it’s about trust, do we really, really trust them to deliver everything they promise;
• price;
• will they work with us if there is a problem (do they remember whose deal it is); and;
• what happens when it is time to exit? Are we in control of a sale or refinancing?
“Okay, let’s see what they have for us,” said Gerry.
Later, as he reviewed Fledgling Finance’s letter of intent, Gerry grew increasingly concerned.
“Greg, I understand why you like the price,” Gerry said. “But, these new guys are scaring me. Especially Candy and her asset manager, Ned Neophyte. They say they can work with us on any problems but it’s clear they’ve never seen bad times.”
“Gina’s first priority is trust, and I think that’s a good instinct. Fledgling Finance has the more profitable deal, but how do you know we can trust it? Insatiable and I have had our battles over the years. They are tough, bordering on rigid and unreasonable, but bottom-line, they have always been straight with us.”
“Okay, let’s call David again,” said Gina. “Let’s tell him we want to work with him, but we need his best deal. No more posturing.
Gerry placed the call. “David, these new guys at Fledgling say yes to everything I ask for. That makes no sense to me.
“I am seventy. I can’t take the risk that these young hotshots know how to handle a real downturn in the economy or the housing market or a funding issue at the government level.
“David, we have had our battles with Insatiable over the years. You guys always tell me what you can do, and what you can’t or won’t do, and more importantly, you tell me why I always feel better about my deals when Insatiable is involved because, despite my whining, by the time we satisfy your due diligence demands and questions, and before you have put in your first dime, the entire development becomes better. There are fewer uncertainties, it becomes a true partnership and that translates into fewer risks.”
“So, please, re-issue your letter. Give me your best economic deal. Stretch a bit. Certainty and ease of execution have got to be worth a few pennies for both of us.”
Explaining the Decision to Candy
Once word was out that Insatiable had succeeded, at several hundreds of thousands less than Fledgling offered, Candy called Gina.
“Gina, what the…We were way over market in our offer and with very few bells and whistles. What didn’t we do or offer?”
Gina responded, “Candy, my dad meant it when he said it isn’t all about the money. Terms and execution matter to us.
“One of our good friends from Boston has an expression, ‘The tough part of this business is that someone actually has to do the work.’ We want our business partners to do a deep dive on everything. And everything means doing a lot of work before we close.”
“We were fearful your team wasn’t ready to or set up to be our backstop…to question us…to double check every assumption. None of us make money if the deal isn’t structured right or vetted on the income projections. We need our financial partners to worry about our deals just as much as we do, especially at the outset.
“We wish you well and would be happy to have you as our investor if our approaches can be more closely aligned.”
