Date: Thu, 24 Aug 2006 04:33:40 -0400
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From: "Tenant" tenant@tenant.net
Subject: Poverty Pimping on Steroids: Steve Ross
Dual Track
Affordable-Housing Empire Fuels Developer's Upscale AimsMaster of Tax-Credit Deals, Stephen Ross Sets Sights On Pennsylvania Station
Buying Apartments in Queens
By ALEX FRANGOS
August 22, 2006; Page A1
Wall Street Journal
NEW YORK -- Stephen M. Ross erected the $1.7 billion Time Warner Center, twin 80-story towers stuffed with offices, shops, a hotel and expensive apartments overlooking Central Park. He is planning to transform downtown Los Angeles with a more-than-$2.5 billion retail and residential complex, and with a partner, to rebuild a chunk of central Manhattan, replacing both Pennsylvania Station and Madison Square Garden.
Behind his soaring ambitions and colossal budgets is something unusual in the world of commercial real estate: a financial engine based on government-subsidized housing that funds these risky endeavors.
The Ocean Park apartment complex in working-class Far Rockaway, Queens, is one cog in his machine. The twin brick-and-concrete towers, perched atop a parking garage overlooking the Atlantic Ocean, are typically drab affordable housing from the 1970s. Mr. Ross's real-estate firm, closely-held Related Cos., owns the buildings and collects just $848 a month for each two-bedroom apartment -- below-market rates that are set by the New York State Housing Finance Agency. Mr. Ross turns a profit because he has mastered the complex business of tax credits that help finance the nation's low-income housing.
Ninety percent of the 37,700 apartments Related owns in 16 states are government-subsidized units. And Mr. Ross's involvement in low- and moderate-income housing extends far beyond that. He founded and is the chairman of CharterMac, a publicly traded finance company that sells tax credits to investors and invests in tax-exempt bonds that also help to finance low-income housing. CharterMac has financed more than 400,000 apartments.
This massive low-income housing operation throws off a river of cash for Related that runs fairly steadily through real-estate boom and bust. It helps Mr. Ross bankroll some of the nation's ritziest -- and riskiest -- commercial developments.
"The consistent stream of fee income from the affordable side enables us to take on larger scale market-oriented projects," explains William Witte, president of Related's California operation. For the planned Los Angeles project, for example, Related beat out competing developers in part by plunking down a nonrefundable $50 million deposit.
Mixing high-end and low has turned Mr. Ross, 66 years old, into a wealthy man. Through Related, he controls $11.5 billion worth of property, although Related does not disclose how much debt those properties carry. He lives in a Time Warner Center penthouse and is a major philanthropist. In 2003, he gave $100 million to the University of Michigan Business School, which bears his name.
These days, with the luxury-condominium market cooling, Mr. Ross's high-low strategy may be put to the test. In June, a much-hyped, $3 billion Related condo project in Las Vegas in which actor George Clooney planned to invest was scrapped before it got off ground. Related blamed rising construction costs.
Nevertheless, Mr. Ross is forging ahead with preparations for his two most ambitious and expensive projects ever. In its Los Angeles project, Related is leading the planned redevelopment of a dilapidated stretch of Grand Avenue in the downtown area into a mixed-use neighborhood of condominiums, hotels, stores and parks.
And in New York, Related is working with Vornado Realty Trust, a real-estate investment trust, on plans to rebuild Madison Square Garden one block to the west, then raze the current home of the sports and entertainment arena. In the process, Pennsylvania Station, Manhattan's underground railroad hub, would become two connected stations, one of them within the historic building that now serves as the city central post office. In addition, there would be tall office buildings, condominiums and retail space. All told, it could cost more than $7 billion. "I've never been involved with anything that would have that much impact," says Mr. Ross.
Trained as a tax lawyer, Mr. Ross realized years ago there was money to be made though tax incentives created by the federal government to produce affordable housing. Although the details of government programs have changed over the years, their premise has stayed the same: private developers will build and preserve affordable rental housing if they are given adequate tax breaks.
Currently, the federal government distributes $5 billion in affordable-housing tax credits each year to private developers who agree to keep rents artificially low for periods ranging from 15 to 40 years. The housing is reserved for tenants earning no more than 60% of an area's median income. State housing agencies administer the credits.
The developers, however, typically don't use the credits to offset their own taxes. They sell them to syndicators, who bundle them and sell them to investors looking to offset their own tax bills. Syndicators charge fees to these investors, who are mostly large financial institutions. Developers use the money from selling the credits to build or renovate the low-income housing.
The tax-credit business is sufficiently complex that few real-estate developers handle it themselves, and few syndicators, for their part, build apartments. "Most syndicators don't want to get their feet muddied tromping around on bare dirt," notes John McIlwain, senior resident fellow at the real-estate trade group Urban Land Institute, who spent 20 years as a lawyer in the tax-credit world. "By the time you figure out the tax-syndication business you deserve free psychiatric care."
Mr. Ross, however, does both. Related builds affordable housing, buys and renovates existing buildings, and manages the properties. CharterMac, which is 14%-owned by Related, invests in such housing to secure tax credits, generates fees by syndicating the credits to investors, and invests in tax-exempt bonds sold to finance such housing. CharterMac also provides mortgages on both affordable and market-rate apartment projects. In 2005, it reported net income of $59 million on $295 million in revenue.
Mr. Ross grew up middle-class in Detroit and Florida. His uncle, the late Max M. Fisher, a billionaire oil and real-estate investor, paid his college tuition. After completing law school, Mr. Ross went to work on Wall Street as a finance executive. While working at Bear Stearns Cos., he says, he put together a business plan for what he envisioned as an affordable-housing company that would both build apartments and handle tax-credit financing. The finance side would generate steady income, he explains, but "the big picture was in development."
Bear Stearns declined to fund his plan, so in 1972, Mr. Ross started Related Housing Co. By the early 1980s, he had built 15,000 apartments and was a leading syndicator of tax credits. He spun his profits into more-lucrative commercial developments. In suburban New York, he built offices for CA Inc., International Paper Co. and Nestlé SA.He expanded his affordable-housing business to Florida, starting Related Group of Florida with housing entrepreneur Jorge Pérez. Today, that company, which is majority-owned by Mr. Pérez, is the largest developer of apartments in the state. Messrs. Ross and Pérez are also partners in Related investments in Las Vegas and California.
Mr. Ross pushed employees hard. After a 1982 skiing accident left his leg in a cast for nine months, he barked at underlings from a couch in his office. One evening a few years later, he emerged from a meeting to find the office apparently empty. "If anyone is still here, I'll give you $500," he shouted, according to both Mr. Ross and an employee. Dozens of heads popped up from the cubicles. "It cost me," he recalls.
In the 1980s, Mr. Ross began to combine affordable and luxury units in the same buildings, utilizing a new federal program known as 80/20. In exchange for reserving 20% of apartments for low-income tenants, Related was allowed to sell tax-exempt bonds. Mr. Ross's first such building, on the fringe of New York's Upper East Side, rented quickly and remains nearly 100% occupied.
He discovered that luxury projects were considerably riskier and more difficult. He spent the 1980s trying unsuccessfully to build an apartment complex called Riverwalk on piers in Manhattan's East River. Eventually, the city canceled his permit.
When commercial real-estate markets collapsed in the early 1990s, Mr. Ross had $120 million in loans outstanding on speculative projects. Banks began calling for repayment, and Mr. Ross canceled several condominium projects. If the loan problems had become public, investors might have steered clear of Related's tax-exempt deals, threatening its otherwise stable affordable-housing operations, according to two people familiar with the matter.
"How did we survive?" says Mr. Ross. "I had the other sources of income coming in from my financial-services business, the syndication doing all these tax-credit deals." It paid Related's overhead while he looked for additional money to keep the banks at bay. Eventually, he got a large cash infusion from several investors, including his wealthy uncle, Mr. Fisher, and he restructured the loans.
"My whole philosophy is totally different since then," says Mr. Ross. "We generate enough cash flow to put in to the projects internally from our profits...I control my destiny." He says Related now carries no debt other than short-term construction loans and nonrecourse mortgages, secured only by specific properties and not by Related's other assets or by Mr. Ross personally.
In order to obtain such financing, developers must put up significant equity. For the mammoth Time Warner Center, Related relied on more than the profits of its affordable-housing operations and other businesses. Mr. Ross tapped Apollo Real Estate Partners as an equity partner.
Income from the subsidized-housing business plays a vital role in the large-scale developments. "We've been working on large projects in and around L.A. for three years," says Mr. Witte, who heads Related's California unit. "We've had to carry the staff that are working on those. We have the financial capacity to do that in large part because of the success we have on the affordable side...All this comes into play when negotiating with lenders."
Following Related's near collapse, the commercial real-estate market once again boomed. Much of Related's projects since then have been high-end, including CityPlace in West Palm Beach, a massive mixed-use complex; Time Warner Center, and dozens of luxury condominium towers around the country. In recent years, these luxury projects have contributed a significant portion of Related's profits.
On the affordable-housing side, Mr. Ross was confronted with a separate set of problems. Related had begun selling tax-exempt bonds to investors through Prudential Securities. In a class-action suit filed in Manhattan federal court, investors accused Prudential, Related, and several other companies that sold limited partnerships of improperly characterizing bonds as more liquid than they in fact were. To settle the suit in 1997, Related paid $2 million and agreed to take its bond funds public so that investors could sell their investments more easily.
But that didn't end the problems. Related began collecting fees as outside manager of the newly public company, which became CharterMac. Investors didn't like that either. They were wary of having a private company manage a public one, which they saw as a conflict of interest, according to a 2002 CharterMac filing with the Securities and Exchange Commission. A second restructuring ensued, which shifted the management of CharterMac from Related to CharterMac itself. In exchange for the lost revenues, Mr. Ross received $50 million and CharterMac stock then valued at $181 million. Four other Related executives received $83 million of stock.
Before the deal was put to a shareholder vote, some shareholders sued in New York state court, claiming the deal amounted to Mr. Ross -- as both the principal owner of Related and the chairman of CharterMac -- negotiating with himself. CharterMac's independent directors had handled the negotiations for that company. One of those directors, Arthur Fisch, says the deal resulted from a "brutal negotiation." He insists that Mr. Ross "did not have any undo sway, certainly not over me." To settle the suit, Mr. Ross and his four Related partners agreed to vote the same way as the majority of outside shareholders. Those shareholders voted in favor of the deal.
These days, Related receives about $24 million a year in dividends -- most of it tax-free -- from its CharterMac stock holdings. But that is only part of the income it squeezes out of its investments in glamourless buildings such as the Ocean Park apartment complex.
In June 2005, Related agreed to buy Ocean Park for $34.5 million from Cord Meyer LLC, a small Queens real-estate company. In exchange for its promise to keep the apartments affordable for 40 years, Related received $11 million in federal tax credits, which it then sold to CharterMac. To raise the rest of the money needed to buy and renovate the building, Related received authorization from the New York State Housing Authority to sell $38 million in tax-exempt bonds.
Related and CharterMac earned money from the deal in several ways. Related took $2.2 million of the money it raised as a fee to manage the renovation of the property.
A CharterMac spokeswoman declines to say what the company's fee was for selling the Ocean Park tax credits to investors, but says it typically takes around 4% to 5% on such deals. CharterMac charges investors a separate fee to guarantee the tax credits if something bad happens to the property.
During the past year, Ocean Park tenants got new windows, stoves and refrigerators. Mark Carbone, president of Related's affordable-housing unit, says the property "will just purr along" for the 40 years Related has pledged to keep it affordable. And when that commitment runs out, the two buildings overlooking the Atlantic may turn into even more lucrative beachfront property.
Write to Alex Frangos at http://us.f374.mail.yahoo.com/ym/Compose?To=alex.frangos@wsj.com
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