Fox Pointe Case Study - Piping Rock Partners

The Global Financial Crisis: We Partner With a Veteran Investor

The Fox Pointe Story

Simple Per Annum Return (to date): 24.45%

Equity Multiple: 3.4x

NCREIF Benchmark Return: 9.4%

From closing through June 30, 2023, Fox Pointe has generated an annualized net return to investors of 24.45%* vs. the NCREIF benchmark return of 9.4% and an 9.01% average annual return from the FTSE NAREIT Equity REIT Index over the same period.

The Opportunity

It's difficult to add to what's already known about the global financial crisis other than to emphasize the complete lack of liquidity in the equity and debt markets. As a result, the owners of Fox Pointe were unable to refinance their mortgage at its 2010 maturity, even though they were the original developers with over 3,000 units owned and managed throughout the Midwest.

Given the difficult credit environment and the forced sale, we were able to put the property under contract at a very attractive price with almost no competition. We liked the property because it was located in an MSA with exceptionally strong demographics. In addition, a unique opportunity was developing in multifamily housing due to the elimination of the subprime mortgage market, which would ultimately increase demand for rental housing.

The Problem

No matter how much we liked the MSA and its demographics, we had the same problem as the seller: the capital markets were virtually frozen, and we did not know how we were going to finance the acquisition. In addition, the MSA was very small, and the local economy is heavily reliant on automobile manufacturing. With both GM and Chrysler heading into bankruptcy, this was not a good story. In addition, the property began life in 1990 under the Low Income Housing Tax Credit ("LIHTC") program, and it had just completed the Qualified Contract Process. This meant that it could be removed from the LIHTC pool and converted to market-rate housing, but also that it suffered from deferred maintenance after almost 20 years of rent restrictions. Fox Pointe would need a lot of capital to successfully convert to market-rate housing.

No Agency DUS lender would even provide a soft quote. Numerous banks were experiencing severe liquidity issues of their own, and the leading locally-based bank was going into receivership. Accordingly, banks were not providing quotes either. Given the economic and credit environment, our strategy from the start was to de-risk the purchase by financing it with non-recourse, fully-amortizing debt under HUD's 223(f) loan program. In normal, healthy market conditions, closing a 223(f) loan can be a 9-12 month process. However, this was not a normal market, and we did not have 9-12 months.

What We Did

We got an introduction to an investor who saw the same opportunity developing in multifamily housing that we saw. She was COO (now CEO) of an NYSE-listed asset management firm with $1.5 trillion under management, and she had influence over a healthy bank that could provide debt financing. We reviewed the opportunity together and explained that we were looking for a bridge debt product that could allow us to close but also be prepaid at low cost within 9-12 months. Ultimately, she offered to (i) provide the debt through the bank, (ii) provide a personal guarantee to the bank and (iii) provide 60% of the equity personally. In return, we offered her control rights via Major Decisions, as well as a share of the general partnership profits.

Prior to closing, she was able to fully optimize the debt even futher in order to de-risk the acquisition as much as possible: the bank provided us with 10-year fixed rate, amortizing debt that was fully prepayable at any time without cost. In addition, the debt was priced on par with 10-year Agency debt. The 10-year term and Agency-equivalent pricing would protect us from any further economic shocks, including the possibility that HUD might stop lending under the 223(f) program. But unlike Agency debt, we could prepay at any time without any penalty whatsoever. We closed the acquisition on December 21st, 2010 and refinanced without issue into the new HUD 223(f) debt the following September. In the first year of operations, we invested almost $1 million in interior and exterior upgrades and curing deferred maintenance.

Epilogue

Our original business plan was to use the 223(f) debt as permanent financing and hold long term for cash flow, but NOI continued to grow due to the upgrade program. Within six years of closing, we had far exceeded our NOI targets. Ultimately, we discovered that Columbus was an even stronger market than we thought. This led us to refinance into brand new HUD 223(f) debt yet again, and the refinancing proceeds were sufficient to return 100% of initial equity capital plus a significant tax-deferred profit. In 2023, we refinanced again, producing yet another tax-deferred profit. We still own the property today, it's still cash flowing, and we did not need to execute a 1031 exchange with any of the refinancing proceeds because unlike income from sales proceeds, income from refinancing proceeds is tax deferred.

Clubhouse Prior to Closing