Getting investors to play ball
By John W. Gahan III
10 min read
Larry Lawyer was exhausted. He had spent all day at Insatiable Investor’s annual conference in Jackson Hole. The conference was abuzz with speculation on the newly elected president. Would there be corporate tax reform and would that kill the tax credit investment market? Yields for investors were already at historic lows. Larry worried that investors might abandon the LIHTC, given the volatile capital markets and the political climate. Why take 15 years of risk for a sub-6 yield? Indeed, was the tax credit itself threatened? Developers were near panic and having flashbacks to the days of unfunded deals. The usually reliable industry was, at best, in a holding pattern going into 2017. It was time for a quick nightcap.
As he neared the bar, Larry spied two of Insatiable’s employees, Ozzie Oldpro and Kendra Kashout, locked in a heated conversation. Ozzie was a VP in charge of equity production. Kendra was a recent hire with a background in accounting and a penchant for reducing everything to a monetary value. The hope was that she would bring discipline to the disposition process.
Larry liked them both. Better to join them than to drink alone. But, Larry wondered, what could they possibly be arguing so intensely about? Two minutes of eavesdropping and he knew. They were talking about one of Dated Developers’ properties, which had run into an issue with a non-profit right of first refusal agreement.
Larry always considered right of first refusal agreements a ticking time bomb. If the non-profit were unrelated to the developer, it could become the owner at an advantageous (not market) price, and one which provided little to no monetary return to the developer or its investors. From a developer’s perspective, the blood, sweat and tears involved in rehabbing a tired, old property, turning it into decent affordable housing and watching the value of the property escalate could turn to ashes if the developer could not capture the increased value and put real money in its pocket. In addition, investors, increasingly focused on the “back-end,” would not receive the 10 percent to 20 percent of residual value they had come to rely on to justify the value of social investing.
Ozzie and Kendra were getting louder. Their words crescendoed throughout the bar.
“Ozzie…I was hired for one reason: to improve our bottom line and that of our LIHTC investors. That is my job. Don’t talk to me about relationships. I don’t have developer relationships and I don’t care about them. Hell, I’ve been married three times and none of them lasted half as long as a tax credit period. I care about what the documents say. I care about turning pieces of paper into money. I cannot rely on everyone’s self-serving interpretation of the deal. Most of the people who did the first deal are retired or dead. Some were older than dirt when this property was first syndicated in the late 1980’s and the current partnership dates back to 2002.”
Ozzie was exasperated with Kendra. “I know you are new here, but you can’t just ignore what happened when we invested in Dated Developers’ project 14 years ago. You have to look at more than the money. Have you even reviewed the closing binders?”
“Ozzie, don’t lecture me like I am some novice,” Kendra said. “I spent my Thanksgiving weekend looking at closing binders. I looked at the partnership agreement, the right of first refusal agreement and the purchase option. They are poorly drafted, inconsistent, conflicting, and with holes large enough to sail a developer’s yacht through.
The property is worth way more than anyone expected 15 years ago. We can’t just let this asset be turned over to the non-profit organization for close to nothing. We risk being sued by our investors and Insatiable’s corporate investors. We have a legal obligation to maximize disposition proceeds.
Ozzie, this is 2017. Different times, different people, different perspectives – what you see as expectation, I see as something that you had to say “yes” to in order to get a deal done. I parse through old agreements, looking for a new opportunity to make money for Insatiable and its investors. That’s how I get ahead in the world and if I do it enough, I can kiss all this tax credit mumbo jumbo good-bye by the time I turn 50 and retire. You, on the other hand, were always more interested in the next deal and the next commission.”
Ozzie interrupted, “Kendra, everyone knew the property would be sold to the non-profit tenant organization. The Code has provisions addressing such sales. The QAP gave our sponsor extra points when it promised to give the non-profit the right of first refusal. Everyone involved when Insatiable made the investment was fully aware that, once the Compliance Period expired, the tenants’ organization would own and operate the property.”
Kendra replied,“I know all that. How many times must I tell you? I don’t care. I am stuck with crappy documents and pressure from my boss to get a fair deal. We can just not cooperate. We can throw up roadblocks. We can yell and scream about how the GP owes his LPs—like us—a duty to maximize our return. The partnership agreement says the partnership can’t sell the property without our consent. I am not consenting until they pay us. We should receive some compensation for consenting. I get squeezed from both sides of these deals and I have to find some money somewhere.”
Ozzie countered, “What is your reason for not consenting to a sale to the nonprofit?”
“I just told you. I don’t like how the investment documents are written. They are open to interpretation.
I am not certain that I understand them. Besides, the partnership agreement doesn’t say I need to have a reason to withhold consent. It just says Dated Developers needs Insatiable’s consent.”
“Kendra, you do realize that if we ever had to produce the ‘model’ we did 14 years ago, it would show we have already received every benefit we expected or hoped for? We told our investors there was no residual value.”
“Ozzie, after all of your years in the business, you still don’t understand the investors’ perspective. Investors do not carry LIHTC residual values on their books because they would have to ‘Mark to Market’ the residual values each quarter, which is an accounting nightmare. Plus, they write down the entire investment over ten years so by year 11 they have no basis. All the cash we produce for them through disposition proceeds boosts their earnings. I know exactly what I am doing and why. Think of how happy our investors will be when I turn your bad documents into something. I am a bean-counter. I have no emotion for this property and no obligation to these tenants. I don’t care what anyone expected. I care what the documents say. They can pay me to exit.”
“You may be right in the short-term, Kendra, but in the long-term, that’s bad for business. We will never get another deal with Dated Developers. How is this going to fly when we want to do another deal in this state? Word will get around to other developers. In this business, you are only as good as your word.”
“Ozzie, wake up. Loyalty went out of vogue in this business with the fax machine. Dated Developers has done three deals in the last five years with our biggest competitors. Every time, we get beaten on price or terms. We are in six deals of theirs and all have the same metrics and the same documents. We can either walk away, getting our exit taxes or we can muscle up for more. Who is our loyalty to – our company owners and our fellow employees or some people we don’t know who are in line to refinance the property after we are gone and make millions? Heck, even Dated Developers isn’t sharing if the tenants exercise their rights. Our sponsor did all this work and now they too won’t get anything or be a part of the next recapitalization.” Kendra persisted, “What if the non-profit buys the property because we cave in and then they go out and re-syndicate with one of our competitors? We will look like fools and our new big-shot owners will not be happy with me.”
“Kendra, you make a good point, but one I think we can address,” Ozzie said. “Maybe we can help Dated,” Ozzie proposed. “The tenants’ group is not experienced at this. Maybe they should partner with Dated Developers and do another tax credit rehabilitation. We should be helping them get together.”
“Is that legal?” Kendra asked, “Can we do that? Ozzie finally focused on Larry, sitting at the bar a few seats down from them. “There’s Larry. Let’s ask him.”
By now, Larry had heard enough and was eager to join the conversation. “I couldn’t help but overhear you. Let me share some thoughts on what I heard:
- It does matter what was done 15 years ago. Words matter but so does context.
- The fact that this result was predictable – and maybe even intended – counts.
- Equally foreseeable was increased value (foreseeable, not guaranteed). If you wanted to negotiate about who should reap the financial benefits, that was the time to do it – that it would not have succeeded then is not a reason to try now.
- Finally, consider the consequences of going Kendra’s way. If Insatiable reneges on what it agreed to 15 years ago, why should any developer or state housing finance agency expect Insatiable to honor its agreements in the future?”
“Kendra’s anxiety about looking bad if the property were sold to the tenants and an immediate financing/syndication produced millions of revenue but none for Dated Developer or Insatiable is well-placed. But, maybe – I agree with Ozzie – we can make this work for everybody.
“As Ozzie said, the tenants are not experienced in property management or going through the tax credit allocation process. We are and so is Dated Developers. Why not gather everyone involved and see if we can all partner together? The tenants can own the property and be in charge of how it is managed and operated. The tenants and Dated Developers can split a developer fee. The property can get a facelift and an upgrade – like a computer learning center and a media room. If we help everybody get through the disposition and quarterback another tax credit syndication, maybe we can earn a fee and have first crack at being the investor in the recycled deal.
“That is the business we are in.”
“I love it.” Kendra exclaimed. “Let me run some models. I am totally on board and I can sell this to the investment committee. This is a reasonable approach for our company and for the investors. Doing fair deals quickly with our sponsors produces more profits than a scorched earth battle on each deal.
“But, Ozzie, before we stick Larry with the check, lets you and I agree that if Insatiable does another deal with Dated and the nonprofit, we will have three well-drafted pages regarding disposition, not three badly drafted paragraphs. I hope to be here in 11 years when the Investors want to exit and I don’t want to have this fight again.”
