Submitted by David Stockman – The Contra Corner Blog
Washington’s capacity to foster crony capitalist larceny and corruption never ceases to amaze. But according to the Bloomberg story below, Wall Street’s shameless thievery from US taxpayers is about to get a whole new definition.
To wit, Freddie Mac is handing three private equity billionaires deeply subsidized debt financing in order to undertake $18 billion in rental apartment deals. According to no less an authority than Morgan Stanley, the subsidy embedded in this cheap financing amounts to 150 basis points or roughly $150 million per year on the loan amounts in play.
Yet this largesse will serve no discernible public purpose whatsoever. Indeed, over the 10-year term of these loans the bonanza will amount to billions, but it will not generate a single new unit of housing. Nor will it provide a single dollar of incremental rent relief to any low or moderate income tenant.
That’s because the purpose of these giant loans is not to fund new construction of rental housing—– for which there is currently an arguable shortage. And it’s not even to incentivize owners to convert existing apartment buildings to so-called “affordable” housing.
Instead, its sole effect will be to put the taxpayers in the business of highly leveraged Wall Street deal making. That is, it will fund what amounts to apartment company LBOs being undertaken by the largest players in the private equity world including Barry Sternlicht’s Starwood Capital Group, Steve Schwarzman’s Blackstone Group and John Grayken’s Lone Star Fund.
Each of these cats are billionaires many times over and their remit most definitely does not include bolstering the social safety net. What they are doing is buying giant apartment companies in high priced takeover deals. These LBOs will shower sellers and speculators with windfall gains, and Wall Street dealers and themselves with prodigious fees now and the prospect of pocketing double, triple or quadruple their modest cash equity investments not too far down the road.
Freddie Mac, of course, is the one and same crony capitalist monstrosity that helped push the US financial system to the brink in 2008. If Washington had any common sense and gumption at all, it would have taken it out back and shot it years ago.
But the K-Street lobbies kept it alive during the dark days after the crash and have now invented a new mission to purportedly facilitate affordable rental housing. But that’s a crock, and the true purpose could not be more blatantly obvious than in the three deals described in the Bloomberg article.
Thus, Freddie Mac will loan the Lone Star Fund $5 billion to finance an LBO of Home Properties. Folks, the latter is a rental housing REIT that is publicly traded, more than adequately financed and in no need of help from the nation’s taxpayers whatsoever. In fact, it already has about $2.4 billion of plain old market debt.
But it can be well and truly said that the punters and hedge funds which own the stock have made out like bandits. Its share price has tripled since the March 2009 bottom, but more importantly, was up by 35% just in the 18-months prior to the June 2015 LBO announcement.
Did Home Properties earnings take-off in the last year or so, thereby warranting the stock price surge shown above?
No they didn’t. During the 12-months ended in June 2015, Home Properties earned $177 million or 4% less than the $185 million of net income it posted two years earlier for the June 2013 LTM.
So here is what was accomplished by putting US taxpayers in harms’ way in this instance.
A rental housing REIT with more than 100 communities and 40,000 apartment units, and which currently is comprised of about 30% “affordable” units under Freddie Mac’s elastic definitions, has been shuffled from public to private ownership.
The transaction was accomplished at the bubble era price of 25X net income—–a vastly inflated valuation which had been reached in June and which reflected the fact that the fast money boys had earlier piled on for the rumored takeover ride.
Yet without Freddie Mac’s funding of the takeout at this absurdly inflated price, the arbs and speculators who sold their stock into the recently completed deal would not have had a snowball’s chance of retaining their winnings.
That’s some public policy accomplishment, and its all there is.
Its proud new billionaire owner won’t be required to add a single additional unit of so-called “affordable” housing, and that term doesn’t mean much anyway. Freddie Mac’s definition includes about 60% of US households!
Well, there is one aspect which has changed, and not in a good way. What was a public REIT with $4.4 billion of equity market cap and $2.4 billion of debt has become a private LBO with $5 billion of debt and a deal fee tab in the order of $300 million.
As to the latter, it was some kind of Wall Street feast. Yet all of the deal commotion implied by this listing amounted to dead weight cost to society. This pointless LBO deal never would have happened on the free market:
BofA Merrill Lynch acted as financial advisor to Home Properties. BofA Merrill Lynch and Houlihan Lokey provided fairness opinions to the Home Properties Board of Directors in connection with the transaction. Goldman, Sachs & Co. acted as exclusive financial advisor to Lone Star. Hogan Lovells US LLP acted as legal advisor to Home Properties. Gibson, Dunn & Crutcher LLP acted as corporate legal advisor, Hunton & Williams LLP acted as real estate legal advisor, and Skadden, Arps, Slate, Meagher & Flom LLP acted as tax legal advisors to Lone Star Funds. Sidley Austin LLP acted as legal advisor to BofA Merrill Lynch, and Cleary Gottlieb Steen & Hamilton LLP acted as legal advisor to Goldman, Sachs & Co.
In other words, the fools in Washington have descended so far down the rabbit hole of “help for housing” that they have managed to double the debt on these 40,000 rental units in order to cash out public equity investors who had no claim whatsoever to taxpayer support. Oh, yes, and to pay enormous fees to the deal banker, Goldman Sachs, which by all rights should be paying back taxpayers for its 2008 bailout, not scalping them yet again.
But when it comes to lunacy in the rabbit hole nothing comes close to another deal mentioned in the article—— the $5.3 billion LBO of Stuyvesant Town-Peter Cooper Village by Blackstone. It appears that Freddie Mac will provide $2.5 billion of the takeover financing, meaning the annual subsidy will be in the order of $40 million.
Let’s be clear about “Stuy Town” as its called. It has absolutely nothing to do with poor people or any plausible notion of a social safety net. It is a monster housing complex on the lower east side of New York which encompasses 80 acres, 11,000 apartment units and upwards of 35,000 middle class inhabitants—–a good sized city in most of America.
It also happens to be ground zero for one of the more spectacular housing debt crashes last time around. It had been a $5.4 billion leveraged buyout in 2006 by Tishman Speyer and a BlackRock fund. The deal predicate was that this legendary rent-controlled complex originally built by MetLife for returning servicemen after WWII would slowly return to free market pricing as grandfathered tenants passed away or moved on.
But the Greenspan credit bubble expired before the rent-protected tenants did or before mysteriously failing heating, plumbing and electrical services could induce enough of the remaining rent-protected tenants to move along on their own two feet in order to make the pro forma financials work.
Not surprisingly, the deal blew sky high during the financial crisis and resulted in billions of losses for the mortgage lenders. For the past five years it has been operated by a consortium of creditors whose foolish investments in this fiasco deserved no quarter whatsoever from the nation’s hard-pressed taxpayers.
Indeed, as time passed the creditors consortium had become desperate to find a mullet stupid enough to buy them out at a premium to their written down loan values, but the going was exceedingly tough. After all, the giant complex was still financially radioactive after upwards of $3.5 billion of losses from the 2006 LBO.
Moreover, additional headwinds arose from the fact that Stuy Town is a perennial object of local politicians demagogueing on behalf of “affordable” housing.
Then again that’s why we have oily politicians like Senator Chuck Schumer. As a real estate industry publication described it,
Their proposal was almost the exact opposite of Tishman Speyer’s 2006 bid: They would take on little debt and keep the apartments as rentals, eyeing steady returns instead of swift profits. And they deemed it essential to win over the city, tenants and local politicians — perhaps in part to New York’s senior senator, Chuck Schumer.
At a tenant meeting at Stuy Town last week, Schumer said the Tishman Speyer saga had taught him the need for “outside leverage.” “And I found a way,” he added. “I realized that to get such a huge mortgage, you need the backing of Freddie Mac and Fannie Mae.
So here is what’s going to happen. The busted lenders to the 2006 deal are going to make a killing by getting $5.3 billion for positions which are not remotely worth that.
At the same time, Blackstone will get subsidized financing from Freddie Mac, $225 million worth of benefits from New York City through an additional loan and uncollected taxes and the rights to sell the complex’s 700,000 square feet of air rights, which could be worth hundreds of millions.
Why all this largesse?
At the end of the day it will mean that a mere 500 units out of the 11,000 will be reserved for families making no more than $62,000 per year, and another 4,500 for families making up to $128,000 per year.
That’s right. The taxpayers of America are being dragged into a $5 billion LBO on the very site where an identical one blew up less than seven years ago—–purportedly to help families that are in the top 10% of income earners in the nation.
Needless to say, there is a simple alternative. Abolish Freddie Mac, Fannie Mae and all the rest of the Washington’s crony capitalist machinery and turn housing finance over to the free market where it belongs.
If there are citizens in need who can pass a means test and can’t work owing to age or genuine disability give them cash to fund their own shelter choices. And if they are able bodied and willing to work, top up their wages with earned income tax credits or similar cash transfers.
But let’s stop being stupid. Blackstone is not the United Way.
Who do billionaires turn to when they want to buy apartment complexes? The U.S. taxpayer.
Barry Sternlicht’s Starwood Capital Group and Stephen Schwarzman’s Blackstone Group LP are in talks with Freddie Mac to finance two transactions totaling more than $10 billion, according to people with knowledge of the negotiations. Those discussions come after the government-owned mortgage giant already agreed to back Lone Star Funds’ $7.6 billion deal to buy Home Properties Inc. and Brookfield Asset Management Inc.’s $2.5 billion takeover of Associated Estates Realty Corp.
The mortgage guarantor — which along with its larger counterpart Fannie Mae was rescued in a $187.5 billion taxpayer bailout in 2008 — is boosting its multifamily lending as their regulator eases restrictions on that part of their business. Cheap debt from the U.S.-backed companies is helping sustain a five-year surge in values for apartment buildings and fueling some of the biggest real estate deals since the financial crisis.
“They wield a very big stick,” said John Levy, a principal at a real estate investment banking firm in Richmond, Virginia, that bears his name. “It takes more time and it’s going to be more expensive” to get transactions done without the two companies, which can lend at rock-bottom rates because their deals have implicit government backing.
Buying apartment buildings in the U.S. has been a winning bet for the past several years as rents rise amid a shift away from homeownership. That’s attracting investors such as Starwood, which on Oct. 26 said it agreed topurchase 72 rental communities across the country from Equity Residential for $5.4 billion. The announcement came just days after Blackstone reached a $5.3 billion deal to buy Stuyvesant Town-Peter Cooper Village, Manhattan’s largest apartment complex.
Freddie Mac’s deals are getting bigger as its regulator expands the definition of affordable housing, enabling the company to make more loans. Properties that are deemed affordable by the Federal Housing Finance Agency are exempt from a $30 billion cap that limits how much the government-sponsored entities can lend to apartment landlords each year.
“We’re helping to push more capital into this part of multifamily,” said David Brickman, head of multifamily operations at McLean, Virginia-based Freddie Mac. “A very small percentage of what we’re doing is luxury.”
Freddie Mac provided $34.1 billion for multifamily acquisitions and refinancings this year through September, more than double the $14.1 billion for the same period in 2014.
At Stuyvesant Town, home to about 30,000 New Yorkers and one of the last bastions of affordable housing in Manhattan, Blackstone worked out a deal with the city to protect residents from skyrocketing rents. The New York-based private equity firm and its partner in the transaction, Canadian investor Ivanhoe Cambridge Inc., agreed to keep about half of the more than 11,000 units affordable for 20 years.
Relatively cheap financing supplied by Fannie Mae and Freddie Mac makes large debt loads for projects such as Stuyvesant Town more manageable. Interest rates on mortgages from the agencies can be below 3 percent, compared with average financing costs of 4.5 percent from Wall Street banks, according to Richard Hill, an analyst at Morgan Stanley.
Other than the government-sponsored companies, there aren’t many lenders that have the capacity to fund a purchase as large as Blackstone’s, according to Sam Chandan, president of Chandan Economics, a provider of real estate data and analysis.
“You could argue convincingly that the deal wouldn’t get done in its current form without agency financing in the market,” he said.
Freddie Mac granted its largest apartment loan ever to Lone Star, a $5 billion mortgage to fund the private equity firm’s takeover of Home Properties. More than 30 percent of that deal met the FHFA’s guidelines for affordable housing, Brickman said.
Lone Star, based in Dallas and founded by billionaire John Grayken, said in June that the acquisition of Home Properties — with 121 communities, primarily along the East Coast — was consistent with its strategy of buying second-tier apartment complexes, such as workforce housing, rather than expensive newly built properties.
Representatives from Blackstone, Lone Star and Starwood declined to comment on their financing strategies.
U.S. multifamily-building prices are 33 percent higher than they were at the prior peak in 2007, according to Moody’s Investors Service and Real Capital Analytics Inc., a jump stoked partly by the abundant financing from Fannie Mae and Freddie Mac. That’s raised concerns that a bubble is forming that might pop when interest rates rise, according to Levy, the investment banker. Taxpayers could be on the hook for losses incurred by the mortgage companies if apartment values were to fall sharply.
The losses that dragged Fannie Mae and Freddie Mac to the brink of insolvency seven years ago sprung from the companies’ single-family portfolios, which dwarf their apartment holdings. The multifamily segment of their businesses emerged from the financial crisis relatively unscathed and stayed profitable during the recession.
At Freddie Mac, private investors would shoulder about the first 15 percent of losses on multifamily deals, providing a cushion in the event of a decline in building values, Brickman said.
“It would be extremely unlikely that we would ever be called upon to support our guarantee,” he said. “We are sticking to our principles and underwriting prudently.”
Detractors argue that providing subsidized loans to deep-pocketed real estate investors isn’t in line with the mandate of the government-sponsored entities.
“If the purpose of the GSEs is to provide liquidity to the secondary mortgage market, in an effort to promote homeownership, a focus on funding multifamily rental properties seems inappropriate,” Josh Rosner, an analyst at research firm Graham Fisher & Co., said in an e-mail. “This approach only serves to deliver a public subsidy to private players.”
Brickman said Freddie Mac doesn’t view its business through the prism of the institutions it lends to.
“Our focus in on supporting middle-income and workforce housing,” he said. “Who owns it is somewhat irrelevant.”
Fannie Mae, which hasn’t been involved in the year’s biggest multifamily deals, said it evaluates each request for financing based on its terms.
The company “is committed to providing critical financing for multifamily housing in all markets,” Andrew Wilson, a spokesman for Washington-based Fannie Mae, said in an e-mailed statement. “We’ve done this throughout the year, working to effectively maintain our business and support rental-housing needs.”
The real power of Fannie Mae and Freddie Mac is that they continue to lend in times of difficulty, according to Warren Friend, executive managing director at Situs, a commercial real estate consulting firm. They kept the multifamily market humming in the depths of the recession in 2009, he said.
“What they provide is that stability when everybody else shuts down,” he said.