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Money Grows on Trees and Affordable Housing is Easy, Right?

“This is a case of collective amnesia and it’s not a good omen.”

Local news is abuzz about the Serenity Apartments in the City of Larkspur. The project is now in technical default because their revenues (rental income minus operating expenses) is insufficient to cover the proforma income-to-debt payment ratio requirements of the project’s loans. The property is also failing to meet the projected percentages of its intended, moderate-income tenant mix – the so-called “missing middle.”

Serenity Apartments was acquired in 2019 by Catalyst Housing Group and funded by tax-exempt municipal bonds issued by the California Community Housing Authority (CalCHA). The project is considered "essential housing" and enjoys exemption from paying property taxes.

CalCHA is “a political subdivision of the State of California.” It was established by Kings County and the Housing Authority of Kings County, California, under the Joint Exercise of Powers Act. It is called a Joint Powers Authority (a “JPA”) and cities and counties can join if they wish. Larkspur was one of those cities.

According to their website,

“CalCHA issues governmental purpose bonds to finance projects that provide, preserve, and support affordable local housing for low-income, moderate-income, and middle-income families and individuals.”

CalCHA claims to offer “a creative approach to providing public services” and allows “public agencies to provide services more efficiently and cost-effectively.” It was ostensibly formed to address California’s housing “crisis” and “benefit” its member cities and counties. Theoretically, it is "governed" by the Kings County Board of Supervisors, but CalCHA is a separate legal entity managed by a hired program administrator and its staff.

As a JPA, CalCHA’s debts, liabilities, and obligations, if any, accrue to the entity itself, rather than to the membership's government agencies, which at first glance, appears to be advantageous for participating agencies such as Larkspur. If the property runs into financial trouble, they are off the hook. Or so it seems.

As an added “protection,” the bonds CalCHA issues are “project-based” debt, meaning that the only financial recourse for bondholders, in the event of a bond default, are the revenues from the project, not the other assets of the owner or CalCHA or the general funds of the JPA members.

The ‘coup de grâce’ is that the debt is “non-recourse” so the developers/owners of Serenity can simply walk away if the project goes “upside-down” -- its operating and debt service expenses exceed its revenues.

Projects like Serenity Apartments also have to agree to operate within strict limits for the rents they can charge and they must meet specific tenant-income ratios (in the case of Serenity, a certain percentage of moderate-income tenants) within agree-upon timelines or there are penalties. This rental rate restriction, of course, puts downward pressure on the long-term, financial feasibility and viability of the undertaking.

But with all the layers of buffers in the deal, JPA members tend go into these ventures with a "what me worry?" attitude.

This is why the fate of the Serenity Apartments now rests on the slender hope that the owner can succeed in going back to the market for an additional 29.3 million dollars of debt. This will buy time, but unless the restrictions and conditions and the original goals and agreements between the town and the property owner are altered, the property will be even more "upside down" than it is now and it will only compound the project’s long-term, financial problems.

All this considered, any middle-schooler might reasonably ask, What are the odds of a debt default? Apparently, Larkspur never asked.

Somewhat akin to Claude Rains being “astonished” that there was “gambling in Rick’s Café (Casablanca), Larkspur officials are now suddenly having revelations that the City has lost $13.9 million in property taxes and $6.9 million in fees to CalCHA and others, over the past five years.

In 2022, Community Venture Partners wrote an assessment of the methods CalCHA was using and issued a warning. This commentary was published in the Marin Post: “What a great idea! Project-based bonds.” (Click on the highlighted title to read the entire article)

We concluded that CalCHA's business model was perfectly legal but a highly questionable way to reap profits from upfront fees and charges and leave all the risk to the bondholders and the JPA members on the back end. Yes, even though cities and counties are not technically liable to for financial losses in the event of a loan default, what are local, elected officials going to do if the property can no longer operate? What are they going to tell the tenants who will be out on the street if there's a foreclosure action filed by the bondholders?

We’ve seen this all before.

In the early 1990s, a company I owned was a "workout contractor" for the Resolution Trust Corporation – the federal agency tasked with cleaning up the mess after the Savings and Loan Crisis in 1988. Most of the multi-family housing projects in the defaulted portfolios of failed lenders were financed with project-based debt.

In the end, defaulted properties were sold to new investor for ten cents on the dollar after their debt was dismissed in bankruptcy court. Then the new owners – who were free of all the prior restrictions on rents and tenant mix – renovated them and turned them into luxury, market rate properties.

Now, I'm not trying to be a Cassandra about this and not suggesting that this is going to happen to the Serenity Apartments. But at the end of the day, one has to ask what is really the public benefit of trying to create affordable housing using this elaborate scheme, compared to other available options?

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