The Guru Is In

Beyond the event horizon(s)

By David A. Smith
July 30, 2018 5 min read

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As the Road Runner said to cliff-speeding Wile E. Coyote, always think beyond the event horizon.

For affordable housing transactors, the goal line is the closing, and as it approaches, vision narrows until nothing exists but that. The instant it’s achieved, the stereotypical transactor is off hunting the next, leaving asset management with custodianship of a future containing at least ten event horizons:

1. Stabilization: 2½ years. With the potential for changing basis or credit amounts; permanent debt sizing, interest rate, or inaugural debt service coverage; and equity adjusters.
2. Equity pay-in: Three to five years. Though payments are supposed to be due when scheduled, callability issues occasionally arise, and when they do, negotiation (always an event horizon in its own right) occurs.
3. Green technology’s economic obsolescence: Eight to 15 years. Green technology continues to leapfrog, so the ‘economic obsolescence lifespan’ of a particular green tech may be shorter than its physical lifespan, and hard to predict.
4. LIHTC delivery: Ten years. By then the limited partners have itchy feet and want to exit our vehicle – and it’s usually as wise to accommodate them as the squirming child in the minivan’s back seat.
5. LIHTC recapture/resyndication eligibility: 15 years. Is the property obsolete or appreciated? You decide!
6. Major building systems: 20 years. HVAC, elevators and roofs all have functional useful lives that center on 20 years. Of more potential concern, they can all go together when they go.
7. LIHTC use restrictions: 30 years. While some states (hello, California!) have pushed the mandatory use period out further, in most cases affordability sunsets at 30.
8. Trunk infrastructure: 40 to 60 years. Subsurface utilities—water and sewer pipes—wear out, age beyond the cost-effective tipping point of maintenance, or simply are overtaxed by higher human demands. Above-grade systems, like municipal electrical (transformers, power lines), decline likewise.
9. Urban street grids: 50 to 60 years. The increasing verticalization of America’s big cities and the concomitant disruption in modes of urban transportation means that large chunks of most cities have to be re-platted at least twice a century.
10. Land use: 99 years. Although freehold ownership is legally in perpetuity (subject to eminent domain, and uninsurable political counterparty risk), Mother Nature has a way of shortening that – unpredictably and sometimes for good.

Because these event horizons overlap, each later event horizon looms as the backdrop to the one at hand. To succeed, asset managers can orient by these strategic principles:

1. Anticipate how any event-horizon decision today affects later event horizon possibilities. Because what you choose also defines what you did not choose, each decision that opens some new future possibilities forecloses others.
2. Be most thoughtful and strategic when assessing the most distant event horizons. The enduring issues are always the most fundamental; if they’re correctly decided, everything else builds on that. If they’re wrongly chosen, the suffering will likewise endure.
3. Embed optionality into everything you decide. Optionality always has more value than you think it will, so pay a premium in the short-term to own better optionality in the long-term. Optionality comes in three main groups:
   • Evolving technology. The technological house is an assemblage of components, and the more modular the unit’s long-lived design (e.g. building shell, major systems, interior walls), the easier to replace and upgrade components as technology advances them. All walls should have tubes that run in parallel through them like circulatory, nervous and lymphatic systems, able to carry everything from new wires to new signals to new clever nano-robots (say, to spot and repair cracks before they become broken pipes).
   • Evolving households and home uses. The permissible configurations of ‘American affordable household’ continuously increase, and floor plans need to be adaptable. As home uses change, rooms are repurposed either formally or informally. Are you ready for home-based work using virtual reality? For walk-in closets converted to grow-lit legal marijuana gardens?
   • Negotiation discontinuity in every event-horizon decision. Every event horizon is a potential future discontinuity – a conscious opportunity to change the property’s physical configuration, financing, resources, players or agreements. At each decision point, there are those whose consent is needed, and those whose isn’t. Those with consent rights do better, often much better.
4. Sprinkle mid-course-correction optionality into longer-lived decisions and agreements. Mid-course optionality can be incorporated into land lease extension periods or rent resets; mortgage earnout/step-up provisions; mortgage prepayment privileges (if necessary, with yield maintenance); rights or consent to change general partners (or the managing members of GP entities); and subsidy contract renewals.
5. Define effective contractual decision protocols. Clear, transparent and binding decision protocols save costs, reduce fights, speed decision resolution and hence add value overall. Arbitration versus litigation. Three appraisers in a two-then-one approach. Two-or-zero consent blocs for major changes of course. Intra-investor majority or super-majority voting procedures. Required notice, disclosure, interaction and informed binding choice.
6. Fully document and then archive your agreements, your decisions, and your thought processes. Memory fades; worse, memory selectively edits and reimagines. The clause you negotiated last month will be adjudicated a decade hence by people who were not there. In litigation, contemporaneous documentation wins so consistently that its mere existence shapes the pre-litigation negotiation, and even the pre-negotiation maneuvering. If you think it, write it down. Then file it somewhere your successor’s successor can find it.

At every decision opportunity, don’t focus solely on the steps right ahead, but lift your eyes to the wide and receding event horizons. Who thinks farthest wins.