Joe Dejesus has stopped counting how often he fixed leaks and repaired walls at the rent-controlled housing block in Brooklyn where he works as a superintendent.
The community organization that rents the apartments had been preparing to install a new roof and heating system, but stopped when an investment group stepped in to claim broad rights to the property, according to people familiar with the charity’s plans.
Instead, the owner, RiseBoro Community Partnership, is entering the third year of a legal battle with insurance company American International Group over who has long-term ownership of the towering century-old block.
It’s one of at least a half-dozen fights between charities and powerful investment groups over affordable apartments financed with federal tax credits, a trend that activists say could displace families whose homes were built with billions of dollars in government subsidies.
Those homes are now coveted by private equity firms. Last month, RiseBoro learned that AIG’s disputed stake in its building in the Bushwick section of Brooklyn would be sold to Blackstone, part of a pending $5 billion deal that represents the investment group’s most politically charged foray into the U.S. housing market in the years following 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 agree to crippling financial deals with Wall Street investors, or that they will be stripped of custody of real estate 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 run rampant through Bushwick,” 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 the company is buying expire over the next 20 years.
But Wall Street’s latest land rush worries Bobby Rozen, who helped design the low-income housing tax credit program when he was an aide to Democratic Sen. George Mitchell in the 1980s. “Private equity has discovered this sector of the housing market,” he said. “And they’re trying to make big profits by taking money out of affordable housing in ways that weren’t contemplated by Congress.”
Turning tax credits into billions
The affordable housing assets Blackstone has agreed to buy are built with bricks, mortar and legal artifice. Underneath their $5 billion valuation is a corporate structure that distributes ownership among local housing groups that operate the buildings and financial investors who assumed part of the cost in exchange for billions of dollars in tax credits.
To see how that structure works, it is useful to trace the U.S. government financing that paid for the 35 units RiseBoro operates on Stockholm Street in Brooklyn. Converting the building into apartments cost far more than a landlord could hope to earn in a poor neighborhood in 1999. The building was “configured to be a hospital wing, not suitable for residential at all,” said RiseBoro CEO Scott Short.
Unable to pay for the work itself, RiseBoro received a subsidy in the form of tax credits, taking advantage of a scheme that costs the U.S. government about $11 billion a year, according to the Congressional Research Service.
But tax credits only reduce the tax bills of companies that pay taxes in the first place. RiseBoro is a tax-exempt charity, so it enlisted the help of AIG’s SunAmerica subsidiary, which in the 1980s had hired an accountant named Mike Fowler to find ways to make money off the federal tax code.
In more than two decades at SunAmerica, Fowler assembled much of the $5 billion 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 of their savings to affordable housing block developers. The result of Fowler[ed]’s efforts in billions of dollars in profits “for SunAmerica and AIG, according to court documents filed by his attorneys in 2017.
In 1999, RiseBoro transferred its Bushwick building to a partnership 99.9 percent owned by AIG. The insurer paid $2.5 million toward the project’s costs, court documents show, and in return is expected to receive tax credits worth $3.3 million over 10 years, among other fees. RiseBoro operated the building and received most of the building’s rental income. Charity executives have said they expected the partnership structure to dissolve after 15 years.
In 2015, RiseBoro notified AIG that it intended to repurchase the building for a nominal sum, a move that would have removed restrictions imposed by the partnership structure on RiseBoro’s ability to fund capital improvements and repairs.
“THESE PROPERTIES ARE NOW WORTH A LOT OF MONEY. NO ONE THOUGHT THEY WOULD BE WHEN THEY WERE BEING BUILT IN THESE DEPRESSED NEIGHBORHOODS IN THE 1990S.
But the charity received what its lawyers characterized as an unpleasant surprise. AIG said it was not interested in selling. The insurance company offered to settle the dispute if RiseBoro paid a sum in excess of $1 million, according to a person familiar with the talks, but RiseBoro rejected the offer. AIG declined to comment on this claim.
Eventually, RiseBoro filed a lawsuit to try to force the transfer. A federal court ruled in favor of AIG earlier this year; the case is now on appeal.
According to a former AIG executive, such conflicts may have become more common after the 2008 financial crisis led the insurance company to slow or stop its pursuit of new affordable housing deals and instead focus on the partnership interests it already owned.
“The [agenda] becomes, what can we get out of these 1,200 properties? ” the executive said. In some cases, the person added, “if we can be difficult or uncooperative, then we can get somewhere . . .[closer to]the actual market value of the property.”
In legal filings, AIG has disputed RiseBoro’s interpretation of its partnership agreement, which invoked language in a 1989 federal law that allows nonprofit owners to claim a “right of first refusal” on properties they operate.
The financial executives argue that, far from trying to extract additional value from their affordable housing partnerships, they are forced to go to court to preserve the long-term property rights for which they bargained. It is the charities and housing operators, these executives argue, who are trying to take assets for their own and disrupt the status quo.
They add that investors have a financial interest in maintaining the buildings and are willing to cooperate to provide the necessary funds.
Short, the CEO of RiseBoro, had a different view. “These properties are now worth a lot of money,” he said. “No one thought they would be when they were being built in these depressed neighborhoods in the 1990s. But investors can only unlock that value if they deregulate the apartments and push out existing tenants, which is something we would never do.”
Blackstone made huge profits during the mortgage crisis by building a rental empire out of suburban homes bought out of foreclosure. With its bet on rent-controlled apartment buildings, the group is wading into a debate over how to balance the economic rights of homeowners with the need to house low-income families in some of the most expensive regions of the United States.
The executives behind the Blackstone transaction see themselves as part of the solution. “We will make significant investments to improve the apartments while making sure they remain affordable and comply with all rent regulations,” said Kathleen McCarthy, Blackstone’s co-head of real estate, when the deal with AIG was announced last month.
However, the private equity firm is inheriting strained relationships with some of the nonprofit operators of its new housing portfolio, which comprises 678 buildings spread across 46 states.
RiseBoro Community Partnership is battling AIG for control of a Brooklyn apartment block that has risen sharply in value © Financial TimesIn 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 improperly in trying to regain control of a retirement community held by an AIG-sponsored association. That decision is also on appeal.
A person familiar with the case said a finding of a breach of contract by the charity could trigger a clause forcing the church-aligned group to relinquish control of 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 to make significant investments as it manages these assets.”
Blackstone has sought to reassure low-income tenants that its acquisition of tens of thousands of apartments will only bring improvements. “Our intention as landlords is to maintain affordability for these communities,” the firm told the FT. “We don’t intend to convert any of them to market rate; we want them to be affordable.”
Wall Street also wants to present itself as a constructive partner for housing charities. Blackstone said it “intend[s] to provide capital and approved financings for needed repairs and maintenance.” The $450 million program 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 largest private equity group seeking gains in older low-income housing, it joins a group of niche investment firms that have bought stakes in some of the 3 million apartments built with low-income housing tax credits since the program began. in 1986.
In 2019, one of those investors, Alden Torch Financial, which is run by a former AIG executive, won a legal ruling in federal court against a Seattle-based housing charity that had claimed it was entitled to buy several properties on the cheap.
That case was cited in a report by the Washington State Housing Finance Commission, which said that “some private companies have begun to systematically challenge the transfer rights of nonprofit projects and disrupt the normal exit process in hopes of selling the property at market value. . “The reforms the commission subsequently introduced have been challenged in court.
OUR INTENTION AS OWNERS IS TO MAINTAIN AFFORDABILITY FOR THESE COMMUNITIES.
The elaborate financing structures needed to capture federal tax credits may have made disputes inevitable. Attorneys said the Internal Revenue Service can challenge any transfer of assets made solely to avoid taxes, and contracts often appear to be unclear about who will own a property when tax credits are exhausted.
“I feel terrible,” said one attorney, who has represented investors in dozens of deals that were paid for by the low-income housing program. “I’ll never again say, ‘Don’t worry, my client is going to do this, they’ll be gone after 15 years.'”