We seek to achieve attractive risk‑adjusted returns through a combination of rental income, management and development fees and value appreciation from the acquisition, ownership, management, preservation and redevelopment of affordable housing and workforce housing properties, often utilizing attractive rental assistance and financing options, including HAP contracts, housing choice vouchers, LIHTC financing, FHA‑insured loans and other financing programs supported by federal and state governments
We seek to achieve attractive risk‑adjusted returns through a combination of increasing cash flows and value appreciation from the acquisition, ownership, management, preservation and redevelopment of affordable housing and workforce housing properties. Key components of our strategy include the following:
We believe our management team’s experience in affordable housing and workforce housing development, management, ownership and finance leaves us uniquely qualified to source, underwrite, finance and close acquisitions of affordable housing and workforce housing properties.
We source acquisitions through multiple channels, including a network of workforce and affordable housing investors, owners, developers, syndicators, mortgage lenders, attorneys and brokers. Acquisitions sourced “off‑market” and quietly marketed transactions arranged through an intermediary are preferred. Each transaction, whether related to the purchase of property intended for LIHTC rehabilitation or, in the case of workforce housing, value‑added repositioning, is underwritten by our acquisition and investment team according to industry best practices.
An initial financial underwriting is completed by a member of our acquisitions and investment team prior to submission of a non‑binding letter of intent to acquire an asset. This underwriting is based upon preliminary financial data provided by the seller or the seller’s intermediary and often supplemented with interviews involving market participants. Site visits by one or more members of our acquisitions and investment team prior to LOI submission, or following execution of a definitive purchase contract, are completed.
Our underwriting and due diligence processes are focused on several key areas of evaluation, each essential to informing the investment decision‑making process and asset pricing determination:
We utilize a number of government housing assistance programs and financing options that either are available only to owners of affordable housing properties or may have more favorable underwriting criteria if the property meets the financing program’s definition of affordable housing, including HAP contracts, housing choice vouchers, the LIHTC program, debt guaranteed by Fannie Mae and Freddie Mac or insured by FHA, HOME funds and CDBG funds. Our properties that utilize these programs and financing options must meet certain requirements, which are described below.
The LIHTC program is administered by the IRS pursuant to Section 42 of the Code. In exchange for providing financing to develop affordable housing properties, tax‑credit investors receive the pass‑through of LIHTCs and federal income tax deductions. The value of the LIHTCs is not impacted by the recent reduction in U.S. federal income tax rates because the LIHTCs provide a dollar‑for‑dollar reduction in tax‑credit investors’ U.S. federal income tax liabilities. However, such lower federal income tax rates will reduce the value of the federal income tax deductions that the tax‑credit investors receive, from 35 cents per dollar to 21 cents per dollar, and, while no assurances can be given, we do not believe that this will materially reduce the number of tax‑credit investors interested in LIHTC investments. We generally structure acquisitions of our GP Properties through limited partnerships that deliver LIHTCs to tax‑credit investors, which allows us to acquire affordable housing properties while providing less than 1% of the equity required for the acquisition. Over the life of the limited partnerships that own our GP Properties, we generally receive 80% to 90% of the net cash flows generated by the GP Properties, including through fee arrangements related to development, redevelopment, management and other services we provide to the limited partnerships, though in the earlier years of a project we may receive as much as 95% of the net cash flows in the form of development or redevelopment fees, all of which are eliminated upon consolidation of the limited partnerships in our consolidated financial statements. In addition, we receive the substantial majority of the net proceeds from the sale of a GP Property.
We acquire GP Properties by syndicating LIHTC transactions with tax‑credit investors. We believe our typical investment in GP Properties can be divided into three stages:
Acquisition and Redevelopment: We first identify a property that we believe has strong fundamentals and would benefit from a redevelopment financed through the LIHTC program. We then create a business plan for the redevelopment and the operation of the property. Next, we seek to obtain an allocation of private activity bonds tied to 4% LIHTCs from the applicable public housing agency. After receiving a LIHTC allocation from a public housing agency, we partner with tax‑credit investors through limited partnerships in which we serve as general partner with an equity ownership interest of less than 1%. The tax‑credit investors own the remaining equity interests in the limited partnership and their capital contributions cover 30% of the redevelopment costs. The remaining costs are covered by tax‑exempt bonds and mortgage indebtedness secured by the property. We serve as general partner of each of the limited partnerships that own our GP Properties.
LIHTC Delivery Period: When the redevelopment is completed, we begin delivering the LIHTCs to the tax‑credit investors over a 10‑year period and we seek to stabilize the occupancy at the property, which typically takes one to two years. During the 10‑year LIHTC delivery period, we ensure that the LIHTCs are delivered to the tax credit limited partners and that the property is managed in compliance with Section 42. We generally continue to receive 80% to 90% of the net cash flows from GP Properties during the delivery period through fee arrangements and residual cash flows.
Completion of Delivery: Following the 10‑year LIHTC delivery period, we begin to strategically evaluate multiple options for the property, including purchasing the tax‑credit investors’ interests in the property and transitioning the property to our Wholly Owned Portfolio or, after the expiration of the initial 15‑year compliance period, selling the property or redeveloping and re‑syndicating a new LIHTC investment in the property. The properties will remain subject to LIHTC program requirements, including the affordability restrictions, until at least the end of the initial 15‑year compliance period and an extended use period that is typically for an additional 15 years if we do not go through the qualified contract process, which allows us to end the extended use period early subject to certain conditions. If we opt out of the extended use period through the qualified contract process, we can reposition the asset as a market‑rent property.
Our ability to expand through acquisitions for our portfolio is integral to our business strategy. Our ability to successfully achieve our business strategy requires that we identify and consummate suitable acquisition or investment opportunities in affordable housing and workforce housing that meet our investment criteria and are compatible with our growth strategy. Our failure to identify and consummate attractive acquisitions or take advantage of other investment opportunities without substantial expense, delay or other operational or financial problems would impede our growth and could materially and adversely affect our business.
On February 8, 2018, we completed the acquisition of Deville Manor for a purchase price of $4.2 million. Deville Manor is a GP Property located in Meridian, Mississippi consisting of 104 units. The acquisition and redevelopment of the property are being financed with approximately $7.4 million of tax‑exempt bonds and approximately $3.0 million of equity provided through the sale of LIHTCs to a tax‑credit investor. The redevelopment will occur with residents remaining in place. We expect to receive a redevelopment fee of approximately $1.0 million, including $0.95 million paid during the estimated 18‑month redevelopment period. We made a nominal equity investment and will receive 90% of the residual cash flows of the limited partnership that owns Deville Manor. The property is subject to a HAP contract that provides rent subsidies for 103 of the 104 units at the property and is scheduled to expire in 2035.
We will continue to seek new acquisition and redevelopment opportunities in mid‑sized cities and submarkets of larger cities throughout the United States that are characterized by many or all of the following attributes: quality school districts, relatively low unemployment, a diversified base of employers, prospects for job growth, a relatively lower cost of living, positive net population migration and favorable supply and demand fundamentals. We regularly evaluate demographic and other trends in selected markets, including the review of near‑term prospects for job growth, expansion or relocation of major employers, and evaluation of positive net migration trends or recent population increases. We also may consider acquiring properties located in markets or submarkets that, while not meeting our typical investment criteria, benefit from existing HAP contracts that provide relatively stable HUD‑supported rents.
In addition, we believe our management team’s extensive experience, existing relationships, track record of regulatory compliance and operating history will provide us with access to high quality affordable housing and workforce housing investment opportunities that new market entrants may have difficulty accessing as a result of the substantial barriers to entry to owning and managing properties subject to government housing assistance programs. For example, qualifying for LIHTCs generally requires robust compliance programs in order to satisfy regulatory requirements and to ultimately deliver the LIHTCs to tax‑credit investors. Furthermore, there is a limited supply of HAP contracts as the nationwide number of units covered by HAP contracts is generally restricted to its current level due to lack of statutory authority to fund new HAP contracts and HUD must approve of a sale of any property with a HAP contract. As a result, we believe that our size and scale, combined with our track record of successful management of HAP‑covered properties, will put us in a favorable position to acquire additional properties with HAP contracts.
While we intend to grow the number of Wholly Owned Properties, including by purchasing limited partner interests from our tax‑credit investors and transitioning some of our GP Properties to Wholly Owned Properties at the end of the LIHTC delivery periods, we also intend to increase our revenue and cash flows by acquiring additional properties for our GP Portfolio through the syndication of LIHTCs to new tax‑credit investors. We believe the GP Properties provide a compelling risk‑adjusted return profile throughout the life cycle of our investment. In particular, during the LIHTC delivery period, the GP Properties provide us with the substantial majority of the economic benefit from the property notwithstanding that we generally provide less than 1% of the equity investment to acquire the property. We serve as the general partner of and maintain an equity ownership interest of less than 1% in, each limited partnership in our GP Portfolio. Tax‑credit investors make capital contributions in exchange for the remaining equity interests in each limited partnership. Over the life of the limited partnerships, we generally receive 80% to 90% of the net cash flows generated by the GP Properties, including through fee arrangements related to development, redevelopment, management and other services we provide to the limited partnerships, though in the earlier years of a project we may receive as much as 95% of the net cash flows in the form of development or redevelopment fees, all of which are eliminated upon consolidation of the limited partnerships in our consolidated financial statements. In addition, we receive the substantial majority of the net proceeds from the sale of a GP Property. As a result of this structure, we can grow our GP Portfolio with limited equity investment from us and receive a substantial portion of the cash flows over the life of the limited partnerships that own our GP Properties. According to the HUD LIHTC database, an average of more than 130,000 LIHTC‑financed units were built each year from 2001 to 2008, and we believe there will be significant opportunities to acquire and redevelop these properties through the syndication of new LIHTCs as these properties reach the end of their initial 15‑year compliance periods through 2023.
Selectively Purchase Tax‑Credit Investors’ Interests in Our GP Properties and Transition to Our Wholly Owned Portfolio.
As of December 31, 2017, our GP Portfolio was comprised of 51 properties with an aggregate of 7,454 units, including 6,980 units benefiting from LIHTC financing. Of these properties, 43 have LIHTC delivery periods that have already expired or that will expire in the next three years. As properties near the expiration of their respective LIHTC delivery periods, we will selectively seek to acquire the tax‑credit investors’ interests in the cash flows of certain of these properties and transition these properties to our Wholly Owned Portfolio, in certain cases not subject to rent or income restrictions. We believe that acquiring the limited partners’ interest in certain of our GP Properties for our Wholly Owned Portfolio is an economically attractive way to grow our Wholly Owned Portfolio. In particular, because we manage our GP Properties, we believe we have unique insights into the value and operational performance of those properties and can transition the GP Properties into our Wholly Owned Portfolio without the need for additional management resources or significant costs that might otherwise be necessary if we acquired properties for our Wholly Owned Portfolio from third parties for whom we do not provide management services. Furthermore, the purchase price of the tax‑credit investors’ interests is often less than the replacement cost of the underlying property and thus may offer us opportunities to organically grow our Wholly Owned Portfolio at attractive prices, thereby creating long‑term value for our stockholders.
We intend to leverage our third‑party management relationships to selectively acquire additional properties for our portfolio when the owners decide to sell their properties. Many of these owners are institutions or other entities that often do not have the regulatory and compliance expertise to manage these properties, and we believe that there will be increased demand for third‑party management businesses such as ours. For example, we currently manage five affordable housing properties owned by one of the largest affordable housing preservation funds in the United States. We believe that our existing management platform and our increased profile as a public company will enable us to continue to procure new property management engagements with institutional and other owners of affordable housing and workforce housing, and we intend to utilize those relationships to acquire additional Wholly Owned Properties and GP Properties. We believe that, in many cases, the increased institutional demand for affordable housing properties, in particular, is tied to the desire of institutions to preserve affordable housing properties in order to secure and maintain the tax benefits associated with LIHTCs. We will seek to syndicate LIHTC transactions with these institutional property owners for whom we manage properties in order to acquire Managed Properties for our GP Portfolio.
We believe our management team’s extensive relationships and history of successful redevelopment and operation of affordable housing and workforce housing properties will drive external growth by providing a pipeline of acquisition opportunities in our target markets, some of which may be “off‑market” transactions that do not involve an open competitive bidding process, thereby potentially allowing us to realize acquisition synergies and transactional cost reductions that may not be achievable by our competitors. In recent years, strong demand for rental units has exerted upward pressure on rental rates, contributing to a 260,000 unit decline in the total number of moderately priced multifamily units renting for less than $800 per month between 2005 and 2015, according to the Joint Center for Housing Studies of Harvard University, or JCHS, and we believe the substantial unmet need for affordable rental housing creates an attractive market opportunity for us. According to JCHS, in 2016 approximately 40% of newly built multifamily units rented for more than $1,500 per month while only 18% of new units nationwide rented for less than $850 per month. Additionally, according to JCHS, nearly 900,000 affordable housing units financed by LIHTCs or subsidized under Section 8 have affordability restrictions or HAP contracts with expiration dates between 2017 and 2027. As one of the leading operators and developers of affordable housing, we believe the expiration of these restrictions creates an opportunity for us to acquire and redevelop properties as they near the end of these restrictions, as owners seek to exit their investments. Furthermore, we believe that the owners of many of the properties nearing the end of their compliance periods will have substantial built‑in gain as a result of appreciation in the value of their properties and, as a result, owners seeking to sell their properties will likely desire to defer income taxes upon the sale of a property. We believe that our ability to use OP units to acquire properties from owners who seek to defer their potential taxable gain and diversify their holdings will provide us with a strategic advantage over other potential buyers. In addition, due to the structure of LIHTC transactions, we have the opportunity to grow our GP Portfolio without requiring us to make significant equity contributions while still receiving the majority of the cash flows from such properties during the initial 15‑year compliance period, which can then be deployed to acquire additional properties for our portfolio.
We seek to drive organic growth by increasing operating cash flows from our portfolio by implementing rent optimization strategies and making capital investments at select properties to increase rental rates and occupancy. In addition, following the 10‑year LIHTC delivery period, we begin to strategically evaluate multiple options for the property, including purchasing the tax‑credit investors’ interests in the property and transitioning the property to our Wholly Owned Portfolio or, after the expiration of the initial 15‑year compliance period, selling the property or redeveloping and re‑syndicating a new LIHTC investment in the property. We also evaluate our Wholly Owned Properties and, from time to time, will redevelop and syndicate or re‑syndicate such properties for new LIHTC projects to be added to our GP Portfolio. Since 2014, we have successfully transitioned 16 properties from our GP Portfolio to our Wholly Owned Portfolio. Furthermore, we believe we can leverage our third‑party management relationships to selectively acquire additional properties for our portfolio when the owners decide to sell their properties.
Our executive management team is led by Daniel Hughes, our executive chairman, Pierce Ledbetter, our president and chief executive officer, Jeffrey Ezekiel, our chief financial officer, and Terri Benskin, our chief operating officer. Messrs. Hughes and Ledbetter each has at least 25 years of experience in the affordable housing and workforce housing industry. Our executive management team has extensive experience in multifamily real estate, affordable housing and workforce housing, asset management and property management, as well as in the specialized financing strategies available only to affordable housing and workforce housing projects, such as LIHTCs.