HPET supports access to affordable and sustainable housing through property acquisitions throughout the United States.
Note: This case study features an innovative structure that— although not a guarantee—uses a contract to address liquidity risks associated with an investment, catalyzing the flow of additional capital into impactful investments in affordable housing.
Background
The Housing Partnership Equity Trust (HPET) provides low- and moderate-income communities with access to sustainable and affordable rental housing throughout the United States. Founded in 2013, HPET is a social-purpose real estate investment trust (REIT) sponsored by the Housing Partnership Network (HPN), a Boston-based membership organization of nonprofits focused on housing and community development. HPET partners with 14 nonprofit housing developers, offering them low-cost, long-term capital to acquire multifamily residences across the country. The trust is capitalized with USD 85 million in equity from Charles Schwab, Citi, Morgan Stanley, Prudential Financial, the John D. and Catharine T. MacArthur Foundation, the Ford Foundation, HPN, and its nonprofit members.
HPET and its partners purchase existing multifamily rental properties to ensure that they remain affordable. The Trust targets buildings that are currently affordable for residents with incomes between 50 and 80 percent of area median income and that are at risk of being acquired and redeveloped into higher-priced apartments. HPET also targets properties developed under the Low Income Housing Tax Credit program that are nearing the end of their 15-year period of restrictions on rent and income use. HPET’s nonprofit partners implement practices and deliver on-site services to enhance building sustainability and resident well-being, such as health and wellness resources and educational opportunities. To reduce the carbon footprint of its buildings, HPET partners install Energy Star appliances, retrofit apartments with low-flow faucets, implement recycling programs, and utilize energy-tracking and reporting software.
The Risk Addressed
At its launch, HPET was capitalized with common equity and corporate debt. Citi played a key role in the establishment of HPET, providing a sizeable amount of debt as a line of credit. The MacArthur Foundation, contributed common equity. By 2015, HPN and HPET set out to raise preferred equity to scale their operations and enable the purchase of properties with fewer restrictions than debt required. HPN approached the original debt investors—Citi and Morgan Stanley—as well as Charles Schwab Bank, which was interested in participating in part because such an investment could help the bank meet its Community Reinvestment Act mandate to serve the credit needs of low- and moderate-income communities. According to Rebecca Regan of HPN, investors were also interested in HPET’s innovative and collaborative model.
HPET sought long-term capital to support its mission to hold and operate real estate rather than selling properties for a profit. However, investors are often more comfortable with shorter time horizons. As Michael Solomon, a Vice President at Charles Schwab explained, “10 years is a long time to not get any portion of your money back…. How do I convince people at Schwab that we’re going to be in there for 10 years and not get any of our money back?” An additional risk was that HPET had a mere two-year track record, despite its good performance to date.
To attract preferred equity investments, HPET needed to address the liquidity issues arising from the uncertainty that there would be a secondary market to allow investors to exit. The MacArthur Foundation had been committed to the model from the beginning, especially given its “collaborative leadership and cooperative style of ownership. They liked the long-term nature of our goals and the investment not just in real estate but ultimately, in the members themselves as they received dividends as a diversified source of revenue,” said Rebecca Regan of HPN.
MacArthur agreed to enhance liquidity for senior investors through a standby purchase agreement to buy stock beginning in year five of the investment cycle, allowing the first group of preferred equity investors the option to partially redeem shares over time. The standby purchase contract stipulated that in year five, senior investors could sell 12.5% of their original investment to MacArthur, followed by an additional 2.5% annually thereafter. Additionally, 20% of each new dollar invested in HPET is set aside to provide a redemption option to these seed investors.
The deal was structured as a blended capital stack that included first-loss positions. Preferred equity investments are sheltered by a layer of common equity funded by the nonprofit members and program-related investments (PRIs) from the two foundations. This structure, with senior and subordinate risk tranches, provided Charles Schwab (and other investors) the opportunity to invest in a high-impact program while staying within their liquidity requirements and risk tolerances.
Negotiations
Sticking points included triggers for payment and the term and amount of the liquidity facility. These were resolved through the “negotiating process by hard work, relationships, and the tenacity to make this vehicle get to the next stage,” said Rebecca Regan of HPN.
Results
MacArthur leveraged its balance sheet to ensure liquidity for the fund’s senior investors, enabling them to participate in high-impact, affordable, and sustainable housing investments. This USD 12.5 million facility unlocked an additional USD 50 million of capital without requiring MacArthur to immediately liquidate investments in their endowment. Ultimately, the instrument’s impact reaches far beyond the additionally unlocked investment capital, because it enabled HPET to continue building a track record and provided resources to purchase additional properties. As of September 2016, HPET owns 2,600 units in twelve properties across six states worth a total of USD 244 million.
One especially effective aspect of HPET is that the large amount of ready capital allows nonprofit partners to close competitive deals quickly, within a period of two-to-three months. Tax credit deals, by contrast, which are often used to fund affordable housing projects, can take up to two years to finalize. HPET’s nonprofit partners are able to act swiftly, competing with for-profit, market-rate
developers to successfully acquire buildings that might otherwise not remain affordable.
Another benefit of this liquidity facility is that it allows investors to redeem even if everything goes well, while in contrast, guarantees protect against potential losses and are only called in the event of an investee being unable to pay. HPET’s structure allows for both downside and liquidity protection through the first-loss capital stack and the standby purchase commitment, respectively.
Conclusion
The need for liquidity is a commonly cited concern among impact investors, yet impact investments often require patient, long-term capital to achieve their impact objectives. Respondents to the GIIN’s 2016 Annual Impact Investor Survey listed a “lack of suitable exit options” as the third-most-critical challenge to the growth of the impact investing industry.29 Many investors perceive long-term capital to be risky, preferring more liquid investments. As Michael Solomon commented, “the two things you have to make sure of are exit strategy and liquidity.”
The GIIN’s report Scaling U.S. Community Investing explains that, “in many cases, there is a resulting mismatch between what investors want and what the field can provide—such that some kind of subsidy from philanthropic or government sources would be needed to substantially increase investment activity (such as a credit or liquidity enhancement).”30 Innovative structures like that used by HPET help alleviate liquidity risk, which often poses a barrier to entry for risk-averse investors. Many other sectors face similar liquidity risk and could benefit from the use of a similar tool to help solve this challenge.