BLOGS: Multifamily Focus

2008-08-25, 16:07

REIT's and Senior Housing Now More Compatible

By: Multifamily Real Estate Industry Team
Prior to the enactment last month of the Housing Assistance Tax Act of 2008 (the "Act") (for a detailed explanation of the Act, you can go to the following link , a real estate investment trust (a "REIT") could not in a tax-efficient manner derive the economic benefit of operating or managing a "health care facility," a term that includes a nursing home, assisted living facility, congregate care facility or a qualified continuing care facility. Instead, most REIT's that owned senior housing facilities with a health care component triple net leased those facilities to a third-party lessee and operator who would not only provide health care services to the senior residents, but would have to bear the rental risks associated with such a facility. Even a "taxable REIT subsidiary" (a "TRS") of a REIT was prohibited prior to the Act from directly operating or managing a health care facility such as a nursing home or an assisted living facility. For an illustration of how a TRS could own, but not operate, such a "health care facility," you should look at the following link.

By way of background, a REIT must derive at least 95 percent of its gross income from passive sources and at least 75 percent of its gross income from real estate sources. While rents generally qualify as income under both of those tests, rents may be disqualified under those tests if they entail provision of non-customary services to tenants, such as health care services. Several years ago, Congress allowed the provision of certain non-customary services through a TRS, resulting in the incurrence of a corporate level tax on income derived from such services.

Unfortunately, Congress in its infinite wisdom decided that a corporation that operates or manages a health care facility or a hotel or other lodging facility cannot qualify as a TRS. Significantly, however, Congress also decided that a TRS could provide rights to an "eligible independent contractor" to operate and manage a lodging facility if such rights were held by the corporation as a franchisee, licensee or in any similar capacity and the lodging facility was either owned by the TRS or leased to the TRS by the REIT. Moreover, under its arrangement with the "eligible independent contractor," the TRS could bear the expenses for operation of the lodging facility and could receive the revenues from the operation of the facility, net of expenses of operation and management fees payable to the independent contractor. In other words, for a number years, a TRS has been able to derive the economic benefit of operating a hotel or lodging facility, so long as that facility is actually managed by an independent third-party contractor. Such a TRS can reduce its corporate tax liability by paying deductible rent to its parent REIT that actually owns the hotel or lodging facility. Prior to the Act, a comparable arrangement was not possible for a health care facility.

Under the Act, a REIT can now own a senior housing facility, such as a nursing home or an assisted living facility, that provides health care services, and lease that facility to a TRS. The TRS, in turn, can derive the economic benefit from, and assume the rental risks associated with, such a facility so long as it is operated by an independent third-party contractor that is otherwise engaged in the business of operating those types of facilities. Because the rent payable by the TRS to the REIT is deductible by the TRS and is qualifying rental income to the REIT on which the REIT need not pay tax if it distributes the income to its shareholders, the Act creates a potentially tax-efficient structure for a REIT to own and indirectly operate senior housing facilities that provide health care services. Because real estate private equity funds with tax-exempt investors often employ REIT's to block "unrelated business taxable income," it will be interesting to see whether this change in the law correspondingly changes the investor profile for senior housing.

(This entry posted by Howard Solodky, a member of Womble Carlyle's Tax Practice Group)

2008-08-22, 10:26

The saying in Washington goes the federal government works in two ways; inaction and over-reaction

By: Multifamily Real Estate Industry Team
The long awaited housing bill has been enacted H.R. 3221, the Housing and Economic Recovery Act (HERA) is in reaction to the inaction of the federal government in the run up to the subprime housing crisis. Whether this legislation is an over-reaction is yet to be seen. More importantly, how is this 260-page bill going to effect the multi-family housing market?

HERA makes significant changes to the Low Income Housing Tax Credit (LIHTC) program increasing the available credits by ten percent from $2.00 to $2.20 per capita. In addition, on July 22, HUD made major changes to FHA Multifamily Mortgage Insurance program and the LIHTC program through Mortgagee Letter 2008-19 I would recommend anyone interested in these programs take a look at the excellent Washington Update put out by the National Multi Housing Council on July 31 (Membership required).

But the headline on this bill has to be “Reform of the Government Sponsored Entities!” Section 1101 of HERA creates a new federal agency the Federal Housing Finance Agency (FHFA) by merging OFHEO (the regulator of Fannie Mae and Freddie Mac) and the Federal Home Loan Banks. This at a time when Fannie Mae and Freddie Mac are trading below five bucks a share with investor confidence badly shaken. I have concerns that the disruption of setting up FHFA, a new regulator, and all the procedures and movement of desks that entails could lead to LESS oversight in the short-run at a time when Freddie and Fannie are most vulnerable.

That said, it seems to me that anything that settles the markets and makes capital more available for housing should help apartment owners. Patrick Duffy’s has a great blog on this notion. He goes further, however, to state that employment concerns are causing the “Shadow Market” to begin to encroach on the standard rental market. The shadow market is best shown in the movie “Kit Kittredge, An American Girl” where Kit’s family is forced to take in borders to pay the mortgage during the Great Depression. This bears watching and is not likely to be touched by HERA.

As far as home ownership and its effect on the rental market goes, HERA is a mixed bag. It allows moderate income first-time buyers essentially a zero-interest loan of up to $7,500 that has to be paid back over 15 years. That may induce a few folks into the market. At the same time, the legislation prohibits (starting Oct. 1, 2009) seller-financed downpayment programs like ones run by AmeriDream and Nehemiah Corporation. While this prohibition should reduce defaults because buyers have “more skin in the game” by virtue of making downpayments out of their pockets, it will take out of the market a segment of buyers thus reducing the demand and increasing housing supply. These factors could ultimately increase the number of renters because potential buyers that cannot afford closing costs will need to stay in rental housing longer.

It will be interesting to see how the markets react to the now implicit federal guarantee the Freddie and Fannie have received. Also, will lenders start lending again to either single- or multi-family housing buyers? Will the new Congress and President pull back on home ownership efforts by focusing on improving incentives for the rental market or will the concept of “a chicken in every pot” be replaced by a house for every family? Time will tell, but my money is still on the enthusiasm of wealth creation made possible by ownership.

(This entry posted by Mark Harkins, a member of Womble Carlyle's Federal Government Affairs team)

2008-08-21, 12:20

By: Multifamily Real Estate Industry Team
On August 13, the US Attorney for the Southern District of New York filed suit against AvalonBay Communities and other development partners in Avalon Chrystie Place, a mixed-use property in Lower Manhattan which opened in 2005. At issue in the litigation are the requirements of the 1991 Fair Housing Act Amendments regarding accessibility for individuals with disabilities - a phrase which, in the FHAA context, deals principally with those who use wheelchairs. As a press release by AvalonBay points out, the suit does not claim that any specific person was discriminated against by the defendants; instead, the seven-page complaint is the standard Department of Justice pleading, with general allegations concerning the design of the property: inaccessible common areas, plus units lacking accessible routes (hallways wide enough for a wheelchair to be turned around), reinforcements for installation of grab bars in bathrooms, and other wheelchair-related problems in kitchen and bath areas. The defendants contend they complied fully with New York City's Local Law 58, which has been deemed the functional equivalent of the federal statutory requirements.

This filing is being heralded by DOJ as "the government's first lawsuit in Manhattan alleging violations of the Fair Housing Act in the design and construction of multifamily housing," while the disability rights community asserts that the law's requirements are often being disregarded in a conscious and knowing manner. Additionally, the New York Times reports that the US Attorney has sent letters to leading architects and landlords in the city, warning them of possible noncompliance and suggesting they may be next.

It should be remembered that legal complaints are only contentions. The Fair Housing Act Amendments are broadly-worded, and the requirements of the statute are subject to exceptions and interpretations which make any comment on the merits of the government's claim inappropriate. There is a great deal of room for differences of opinion, as well as for unpredictable variances in outcomes, and the prudent multifamily industry player makes use of every available resource to attempt to avoid these issues where possible. However, neither the Department of Justice, HUD, nor private or public-interest plaintiffs are required to afford a defendant any sort of warning or opportunity for discussion before the litigation trigger is pulled. Devising an action plan entails a thorough knowledge of legal requirements starting at the design and construction stages as well as a multi-disciplinary response plan (architectural, communications, and legal) which is ready to put into action quickly. Operating in an environment in which the public is being told that the industry is acting in knowing disregard of the law requires that this issue be given a very high priority and that the record be corrected at every opportunity.

(This entry posted by Charlie Edwards, a member of Womble Carlyle's Labor and Employment Practice)

2008-08-20, 09:12

Looking for Bad News

By: Multifamily Real Estate Industry Team
I opened the newspaper this morning to again find more bad news about Fannie and Freddie, not that it came as a surprise. The New York Times is reporting that a government bailout of the mortgage giants is virtually inevitable.

By my estimation, we have been slugging through this financial crisis for a little more than a year. (I can almost recall to the day last summer when my 900 mile an hour real estate practice came to a screeching halt.) Rather than continuing to wallow in my depression about the nation’s dismal financial circumstances and the fact that the capital markets remain virtually shut down, I am adopting a new mental approach to the situation.

First, I have resigned myself to the fact that more bad news is coming. We are not at the bottom yet. (Again no surprise.) Second, I believe that instead of holding our breaths and hoping for the best, we need to get to the bottom of this mess as quickly as possible, no matter how far down the bottom leads us and how painful it will be once we get there. That is the only way we can start to climb back up again. Therefore, I want to immediately hear from all companies about their upcoming and anticipated losses, failures, bulk sales, bankruptcies and the like. Don’t hold back. Let it rip right now. Bring it on.

Finally, I am forcing myself to believe that as more bad news is released, there will be less bad news left to be disclosed in the future. By definition, there will occur some moment in time, whenever it should take place, that the all of material financial company losses and failures -- that are so dramatically affecting the capital markets and real estate valuations -- will have been disclosed. At that point, I am willing to believe that the markets will stabilize and little will be left to do but to evaluate the next course of action for those companies that are still left standing and are materially intact.

According to Alan Greenspan, an end to the decline in housing prices is “a necessary condition for an end to the current global financial crisis." "Stable home prices will clarify the level of equity in homes, the ultimate collateral support for much of the financial world's mortgage-backed securities. We won't really know the market value of the asset side of the banking system's balance sheet -- and hence banks' capital -- until then." Clearly, we need to get to the bottom of this crisis sooner rather than later to achieve that necessary market housing market stabilization.

Consequently, I am now going to be looking for bad news. I am going to take pleasure in learning that Lehman is negotiating the bulk sale of enormous portions of its real estate portfolio so as to better enable Lehman to withstand further losses on mortgage securities
I am going to eagerly await news that more companies are filing bankruptcy or disclosing their mounting losses.

At some point, and the sooner the better for me, we will move from being in the middle of the crisis (which is where some experts believe we now reside and proceed to the bottom of it. I eagerly look forward to the moment we hit the lowest point, so that we can start to lick our wounds, put on the bandages and get going again.

(This entry posted by Pamela V. Rothenberg, a member of Womble Carlyle's Real Estate Development group)

2008-08-19, 15:08


By: Multifamily Real Estate Industry Team
The U.S. Census Bureau recently released projections that the U.S. population will rise from just over 300 million today to 439 million by 2050. The effect is akin to adding 17 additional New York Cities. It has been estimated that in addition to the 36,000 new schools and transportation infrastructure necessary to handle a projected 106 million more passenger vehicles, there will need to be at least 52 million new housing units.

Unless trends reverse dramatically, most of those additional 135 million souls will live in the nation’s metropolitan areas. This is not only because America’s rural areas will continue face stagnant or declining populations due to lack of job opportunities.….as of 2042, the Census Bureau estimates that for the first time in U.S. history, whites will be in the minority. The Census Bureau has concluded that by then the non-white Hispanic population will reach 133 million and the African-American population, 66 million. These and other minority groups and immigrants have historically clustered in and around urban areas, and there is no indication that this paradigm will shift dramatically anytime soon.

Given such demographic trends, along with increasing fuel costs, stifling traffic congestion and tighter restrictions on developing open spaces, much of the needed 52 million new housing units will be located around public transportation hubs and/or near employment clusters. It is simply not conceivable that most or all of the necessary housing could take the form of single-family homes surrounded by spacious lawns or in bucolic country cottages. Instead, most of the housing will take the form of multifamily communities---condominiums, apartments and densely arranged townhomes.

Even if the market seems rather unpredictable at the moment, the multifamily industry has many good reasons---about 52 million of them---to be optimistic about its long-term prospects.

(This entry posted by Mark Polston, a member of Womble Carlyle's Real Estate Development group)

Freddie and Fannie – the Bright Spots

By: Multifamily Real Estate Industry Team
In the face of today’s depressing economic conditions, there are fewer and fewer options for even the most qualified real estate borrowers to finding financing for their deals. At a recent real estate event that I attended in the DC Metropolitan area, I was intrigued (and agitated) to hear a top level executive at one of the preeminent DC-based real estate companies admit that his company (one with an unblemished track record that you would never think would have the slightest difficulty finding debt) had been unable to attract lenders for some transactions they had on their drawing boards. He indicated that he was “taking the summer off.”

To make matters worse, virtually all of the news that we hear about Freddie and Fannie is bleak – their stock prices are dropping like rocks and it seems as though the question of whether they will require a bailout is one of “when” and not “if.”

Given that the two mortgage giants are two of the very few number of lenders actively advancing loans to the multifamily sector in today’s gloomy market, I was quite encouraged to read a recent New York Times article entitled “Mortgage Giants Find a Bright Spot in Rental Financing.” While financing for multifamily housing represents only a small portion of their portfolios, multifamily debt “has been a rare bright spot” for Fannie and Freddie. Currently, according to the Mortgage Bankers Association, they hold about one-third of the outstanding multifamily debt. “As a result, both Fannie Mae and Freddie Mac, though often associated exclusively with single-family housing, are rapidly increasing their multifamily portfolios.”

Multifamily players should take some comfort not only in the fact that Fannie and Freddie are actually advancing loans in today’s investment climate (that continues to evolve on a daily, if not hourly basis), but that the apartment sector is the “bright spot” in Fannie and Freddie’s portfolio. I submit that the multifamily sector will continue to be a focal point for Fannie and Freddie (and one would hope other lenders as well as the markets settle down), given that the apartment industry is benefiting in a perverse way from the subprime melt down and its ripple effects, as fewer renters moving out of apartments to buy homes.

(This entry posted by Pamela V. Rothenberg, a member of Womble Carlyle's Real Estate Development group)

2008-08-11, 14:19

Senior Housing

By: Multifamily Real Estate Industry Team
As baby boomers start to reach retirement age, it is becoming increasingly important to establish the proper housing to support this enormous generation. Indeed, the senior population is on track to double between 2010 and 2030, and by this latter date, about one in five Americans will be at least 65 years old. These demographic trends are anticipated to vastly affect the supply and the type of senior housing to be built in the next decades as older people choose to downsize by moving out of their houses and into more manageable living situations. Baby boomers will likely seek out rental based multifamily properties, whether they are geared toward independent living, assisted living, or common-age retirement communities. While they are choosing to leave home ownership, the baby boomers do not seem to be looking for institutional-style housing. The preferred multiunit homes will tend to have a residential feel and a homey touch. It is worth noting, also, that although these seniors are expected to move into rental spaces, they will not comply with the typical, often short-term, rental cycles of traditional multifamily units.

Baby boomers may be the most important source of demand for apartment developers and, more importantly, apartment owners in the coming decades. Thus, multifamily housing must be specialized for this group. The new generation of seniors seems to prefer high-end units with access to quality care and amenities. There is a market, also, for seniors who want to rent with the advantages and services that are associated with high-end condos. Moreover, longer life expectancies will create a demand for excellence in assisted living and elderly housing. These increasing needs make room for growth in this sector, and, combined with the lack of opportunity in other areas of real estate, give investors reason to start focusing on the baby boomer generation.

(This entry posted by Jessica Hamilton.)
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