Luxury apartment or essential housing? How America’s most notorious junk municipal bond peddlers are getting rich off California’s affordability crisis.
by Matt Schifrin with Isabel Contreras and Rachel Sandler
AMONG CALIFORNIA real estate developers, Jordan Moss has an exceptionally big heart. His Marin County firm, Catalyst, is dedicated to developing affordable housing—no small challenge in a state in which small one-bedroom apartments routinely lease for more than $3,000 a month and rents can climb at double-digit rates annually.
“I quickly came to the conclusion that I don’t have the temperament for that business, when you’re waiting years and years to find out if you’re going to get an allocation of [low-income housing tax] credits and bonds, and all the other things needed to make that sausage,” says Moss, a former UC Davis basketball player.
But in 2019, he partnered with a group of municipal-bond wizards and has since acquired 14 fully occupied luxury apartment buildings in some of California’s most expensive Zip codes—places like Sausalito, Larkspur and Huntington Beach. Even better, because he promises to turn these buildings into so-called “essential” or “workforce” housing, his deals were 100% financed by $2.5 billion in tax-exempt municipal bonds, mostly courtesy of a little-known governmental entity he helped create: the California Community Housing Agency (CalCHA).
Moss’ Catalyst has already reaped more than $25 million in upfront fees from his apartment deals, and over the 30-to-40-year lifespan of the bonds he stands to make hundreds of millions more. More than 20 California counties and cities have signed up with CalCHA, including tony Menlo Park, Mountain View, Napa and Berkeley. Moss plans to buy another dozen apartment complexes in 2022.
“When we connected the dots, we had an ‘aha’ moment,” says Moss, who recently hosted Forbes on a tour of one of his purchases, the 342-unit Serenity in Larkspur, with two saltwater swimming pools and a yoga studio. “The key to success and scalability was governmental ownership.”
Welcome to the most exciting innovation to hit the municipal-bond business in decades. Essential housing bonds issued by quasi-governmental agencies like CalCHA aren’t limited by state municipal volume caps and cleverly sidestep the bureaucratic red tape required for tax credit–based financing. Since 2019, over $6 billion in muni bonds have been issued to acquire more than 35 upscale apartment buildings at nosebleed prices.
Bankers from firms such as Goldman Sachs and Jefferies, property managers like Greystar and white-shoe law firms are feasting on hundreds of millions in fees. Then there are the sellers, like Equity Residential REIT and Lennar, getting top-dollar prices, and yield-hungry municipal-bond funds snapping up the 3% to 5% tax exempt debt as fast as it hits the market.
“These are California exempt, and that’s a huge benefit because they’re also federally exempt. For a top tax bracket, especially a California investor, it’s pretty nice,” says John Miller, head of municipals at Nuveen, which has already slurped up some $800 million in bonds. “And these are some pretty nice buildings.”
Not everyone is a fan of California’s housing-bond boom. Besides the front-loaded fees, these highly leveraged deals rely on rosy 30-plus-year recession-free forecasts. For the cities and counties that will ultimately own the buildings, it means forgoing millions in property tax revenue for decades. And it’s doubtful whether the often-modest rent discounts being offered to middle-income tenants will ever make up for the lost tax revenue.
“It’s like getting a slight discount on a Ferrari and calling it affordable,” says Matt Schwartz, president of California Housing Partnership, an affordable-housing advocate.
Be wary. The muni-bond industry’s solution to California’s affordable-housing crisis may soon be coming to your neighborhood. These deals are the brainchild of a small group of Northern California financiers who are also behind the market’s most controversial player, the Public Finance Authority of Wisconsin. In the last 11 years, PFA, which is only nominally headquartered in Madison and is managed by the same private financiers running CalCHA, has issued hundreds of bonds in 44 states for entities ranging from retirement homes in North Carolina to a zoo in Alabama, New Jersey’s American Dream Mall and proton-treatment cancer therapy centers in five states. According to Municipal Market Analytics, Wisconsin’s PFA has the worst default record of any municipal issuer, a charge the Public Finance Authority vigorously disputes, saying instead that its financings contribute to the social and economic growth of communities.
Counters Thomas Doe, president of Municipal Market Analytics: “You want to do a bond deal, you contact the Wisconsin PFA. They will accept anybody.”
INNOVATION COMES SLOWLY to the municipal-bond market. Despite dating back to financing the Erie Canal in 1812, the entire market is only $4 trillion, compared to $11 trillion for corporate bonds. Munis are supposed to have a higher purpose. They are tax-exempt because their mandate is to finance essential public services, things like roads, hospitals, airports—and affordable housing.
Since many smaller cities and towns lack the expertise to issue their own bonds, some states have passed a law known as the Joint Exercise of Powers Act. This allows counties and cities to band together to create a governmental entity known as a Joint Powers Authority, which in practice outsources their bond-issuance powers to private financiers. Unlike traditional issuing authorities such as the Dormitory Authority of the State of New York, which has more than 450 staffers, JPAs are often shell companies that are run by a handful of financiers and lawyers.
Tax-Exempt Havens: By selling to muni-backed buyers, REITs like Equity Residential and UDR and developers including Lennar got top dollar for these prime properties—now ready for California’s missing middle. (Clockwise from left) Oceanaire in Long Beach, Anaheim’s Parallel and Sausalito’s Summit apartments, including its outdoor lounge area.
One of the oldest and most prolific JPAs is the California Statewide Communities Development Authority (CSCDA). It was created in 1988 with help from two former Alameda County officials, Stephen Hamill and Jerry Burke, who formed a private advisory firm called HB Capital Resources. CSCDA counts more than 530 California counties and cities as members. Since inception it has raised more than $65 billion through 1,700 different bond issues to finance everything from charter schools to sewer plants.
In 2004 HB Capital petitioned the California Legislature to allow CSCDA to finance projects outside the state. That effort was rejected. So Hamill and Burke took their show on the road, convincing the Wisconsin Legislature to create the Public Finance Authority in 2010 to issue tax-exempt and taxable conduit bonds nationwide.
Got a charter school, assisted living facility, chain of radio stations, hotel or otherwise well-intentioned project in need of low-cost financing? Simply visit PFA’s website and pick from a menu of choices: 501(c)(3) nonprofits, affordable multifamily housing, manufacturing, waste facilities, commuter transportation. Then fill out an application and wait. Since it began issuing bonds in late 2010, Wisconsin’s Public Finance Authority has been responsible for 464 bond issues worth nearly $13 billion, according to Refinitiv. In the last three years, less than 1% of its projects were in Wisconsin.
Many of PFA’s deals fall in the junk category—they tend to be unrated by S&P or Moody’s and offer tax-exempt coupons as high as 10%. Many have paid bondholders well, but others have ended in disaster. In 2015 a former bond salesman named Victor Farias filled out PFA’s five-page application and was able to secure $10.8 million in 8% taxable munis to finance his Boerne, Texas, startup, Integrity Aviation Finance. Farias promised that his company would buy commercial jet engines at a discount, refurbish them and lease them to major airlines. PFA reviewed no audited financials or feasibility studies before issuing the bonds.
Today those bonds are nearly worthless. According to an SEC complaint, Farias was running a Ponzi scheme. In addition to the $11 million in bonds he sold through PFA and Austin, Texas, broker National Alliance Securities, he raised $14 million in 12% promissory notes mainly from retired police and first responders in San Antonio. Farias was recently sentenced to 11 years in federal prison.
Other troubled PFA bond issues include $43 million in 10% tax-free municipals issued for eight retirement facilities in Georgia and North Carolina, a chain of Goodwill stores in Nevada financed with $22 million in tax-exempt debt, an osteopathic college in Minneapolis that never even opened and a maritime academy in Palm Beach, Florida.
“These apartments are being bought for 33 times net operating income. Historically, it’s the very top of the market.”
Free-standing proton-therapy cancer treatment centers are a new source for bond deals and fees for Wisconsin’s PFA. Since 2017 they have financed the acquisition of no fewer than five cancer therapy centers across the country, raising more than $700 million in tax-exempt bonds paying between 6% and 8.75%.
All are in financial trouble. Some of their woes stem from the pandemic. Says PFA attorney Andrew Phillips: “The bonds issued in the vast majority of all PFA projects, including the proton treatment centers that treat cancer patients across the country, are professionally underwritten by financial institutions, supported by feasibility studies and sold to institutional investors.” Still, some may never recover from the malignant effects of heavy debt and high interest costs.
PFA’s Maryland proton center lost $20 million on revenue of $29 million in the nine months ending September 2021. Nearly all the loss came from debt costs including fees to PFA. Its “cash on hand” to cover operating expenses is a mere 12 days, down from 120 prior to its deal with PFA.
OUTSIDE MUNI-BOND circles, little is known about Michael LaPierre and Scott Carper, the financial wizards behind Wisconsin’s PFA. The duo declined repeated interview requests from Forbes. Both learned the ropes at CSCDA under Hamill and Burke at HB Capital. In 2014, after PFA deals began getting negative press, LaPierre moved a few miles away in Walnut Creek and, with backing from HB Capital, formed GPM Municipals, taking the Wisconsin PFA contract with him. HB Capital continued to manage California-focused CSCDA, and in 2015 LaPierre set up his own California Joint Powers Authority, called the California Public Finance Authority. CalPFA has so far issued 34 bonds worth $1.3 billion.
California’s workforce-housing gold rush may be LaPierre and Carper’s most lucrative gambit yet. CalCHA is calling its luxury-to-affordable multifamily deals “essential” housing bonds. LaPierre and Carper’s former colleagues at CSCDA are issuing bonds even faster, labeling their workforce-housing deals “social” bonds, with an endorsement from ESG research firm Sustainalytics. So far, CSCDA, with help from developer Waterford Property of Newport Beach and others, has completed 19 deals backed by nearly $3 billion in bonds versus CalCHA’s 14 apartment complexes backed by over $2 billion in munis.
All the deals have similar features. After a private developer and its JPA partner identify a multifamily asset to acquire, the pitch to local politicians goes something like this:
Around a third of the units will be leased to those earning up to 80% of the average median income in the area, and most other apartments will go to those making between 81% and 120% of the average median income. Rents on units will be restricted to 30% to 35% of household income, with a cap on annual increases at 4%. No existing tenants, who are paying market rent in these fully occupied apartments, will be displaced.
And though the local governments will become beneficial owners of these apartment buildings, the deal is sold to them as a no-money-down commitment, with no liability for the bonds and no use of precious tax credits. The JPA and the developer handle everything, from disbursement of funds to management of the properties. And the feasibility studies always provide pages of assurance that rents will easily cover the debt. The catch is that the city or county (and local schools) will have to forgo the income from property taxes. No worries, say the muni merchants: Cities stand to make a windfall because after 15 years, the municipality has the right to sell the building.
“When you look at the value of California real estate compounding over multiple decades, you could pick any starting and ending period in history,” Moss asserts. “The values only go one direction.”
Such rosy forecasts make for highly leveraged deals. In February 2021, the CSCDA, on behalf of the city of Anaheim, purchased a 386-unit apartment complex, Parallel, with amenities including a spa, a pet washing station and a basketball court . The seller, an NYSE-listed REIT called UDR, built the facility in 2018 and sold it to CSCDA, 95% occupied, for $156 million, booking a tidy $51 million gain. Goldman Sachs underwrote $181 million worth of muni bonds for the deal, tacking on an additional $25 million in debt.
Why the extra leverage? Generous fees are a big factor. Goldman; bond counsel Orrick, Herrington & Sutcliffe; and CSCDA shared an upfront fee of $5.6 million. The developer Waterford Property, responsible for securing the deal, booked an immediate $2 million “project administration” fee and will oversee the property manager, Greystar, which will earn at least $144,000 a year. Additionally, Waterford was granted $5 million in subordinate debt designed to pay 10% tax-exempt interest ($500,000) annually as long as the 35-year bonds are outstanding. Municipal-revenue bond rules prevent any equity in the deal, so Waterford’s subordinated debt, or “B” bonds, which are not redeemable until all other bond debt is paid, are a clever workaround, acting as preferred equity.
The fees don’t end there. Waterford is entitled to another $200,000 per year, increasing by 3% every year for 30 years. That amounts to $9.8 million. CSCDA gets its pound of flesh too. It expects to earn $271,515 per year in “authority” fees. Over 30 years the tally comes to more than $8 million.
That’s just one bond deal, for one apartment complex. According to Forbes’ analysis of bond documents, CSCDA will make at least $135 million in ongoing fees if its 19 bond deals are outstanding to maturity. CalCHA, run by the same crew operating Wisconsin’s PFA, has completed 14 deals to date. This fledgling JPA stands to make no less than $87 million.
Moss’ Catalyst stands to do even better. In the last two and a half years, it has collected $27 million upfront on its 14 deals with CalCHA and the California Municipal Finance Authority. Ongoing fees and interest payments could add more than $350 million. Waterford, which has been sponsor of at least eight muni deals with CSCDA, has collected an estimated $18 million and could make more than $260 million over the life of the bonds.
“There’s never a recession in this world, never a sudden operating or rehabilitation expense,” says Gene Slater, chairman of municipal-bond advisory CSG Advisors, who analyzed JPA proposals for several local California governments. “They’re assuming straight-line projections of income from rents going up at the same level as operating expenses.
“Historically, capitalization rates for most multifamily properties in California have averaged 5% or higher,” he adds, referring to the ratio of annual net operating income to market value. “From 1989 to 1990 cap rates got down into the fours. Then we had disasters and lots of defaults. It happened again in 2006. The bond deal I was looking at last week had a capitalization rate of 3.25. Meaning these apartments are being bought for 33 times net operating income. Historically, it’s the very top of the market.”
THE BIGGEST TEST for these new workforce-housing deals is whether they will actually make a difference in California, where middle-income families face a genuine affordability crisis.
“Is this program making a difference? One hundred percent,” says Jon Penkower, CSCDA’s managing director and an HB Capital alum. He says 65 of the leases in one of his buildings in Long Beach have turned over since May, filled with middle-income tenants. “People are leaving California and can’t afford to live here anymore. It’s the most cost-effective innovative way to reduce rent in this income demographic.”
Critics argue that the rent reductions are modest because the JPA deals use nontraditional measures for average median income and affordable rent levels. In affordable-housing deals sanctioned by the federal Department of Housing and Urban Development, for example, rents, including utilities, are set at 30% of average median income. JPA workforce-housing deals often use 35% and exclude utility costs. Last February, Los Angeles consultant HR&A was asked by the city of Long Beach to analyze a $135.7 million CSCDA bond deal to buy the Oceanaire, a 216-unit luxury building with such high-end flourishes as Wi-Fi thermostats, built-in USB hubs and “chef-inspired kitchens.” HR&A’s analysis showed that using CSCDA’s calculations, the cheapest Oceanaire studio apartment for someone earning less than 80% of the area’s median income would be $1,841 per month, versus $1,489 had it used standard HUD calculations. (In reality, managing agent Greystar is currently advertising studios in the Oceanaire starting at $2,351, more than the neighborhood’s market rate.)
Local governments have no power to enforce that these apartments are being rented to median-income tenants. According to bond documents, sponsors are required to make only “best efforts” to bring in middle-income renters. Another provision stipulates that if at any time bond counsel determines that these affordability requirements aren’t needed to maintain the bonds’ tax-exempt status, they can simply be eliminated.
“In virtually all these cases, what we found is that the reduction in property tax is far greater than the reduction in rent,” Slater says.
At Serenity in Larkspur, for which CalCHA issued $220 million in bonds via Jefferies in January 2020, rent receipts are down $1.7 million a year since 2019. But Serenity no longer contributes $3 million annually in property taxes. Had a private buyer purchased it, rather than CalCHA, its new higher assessed value would have contributed significantly more in taxes. Financially, Serenity is experiencing high anxiety. Since the CalCHA deal, its debt burden has nearly tripled interest expenses and ongoing fees (including $873,000 per year to Catalyst) to more than $9 million. The complex reported net losses of $6.7 million in the year ending September 2021 compared to losses of $3.7 million prior to its bond offering.
How affordable are Serenity rents? Despite reductions and a reported average rent of $2,695, Greystar, which is being paid more than $160,000 annually for its services, advertises apartments between $3,368 and $4,038 a month.
Moss admits that rents at Serenity are steep. “The basic math is if you look at the [average median income] levels in Marin County, at 80% of that, for a single young person, let’s say a young teacher who makes $50,000, they’d be asked to pay, like, two-thirds of their income toward rent.”
So Moss has created his own nonprofit, the Essential Housing Fund, to subsidize local schoolteachers wanting to live in his muni-bond-backed workforce housing. “We’re funding it out of Catalyst corporate profits,” says Moss with pride, sitting on a model apartment terrace at Serenity.
He’s less eager to talk about another use for Catalyst profits, which are now being used to prop up his first-ever workforce-housing bond deal with CalCHA, issued in April 2019, for Santa Rosa’s Annadel apartments, located in California wine country. Little more than a year after it issued $194 million in debt, Annadel’s net operating income was falling short of its interest costs. “While project occupancy has remained relatively stable, rental revenues have been lower than projected,” CalCHA told bondholders in late September while giving notice of a potential restructuring. “Operational impacts and restrictive legislation” related to wildfires and the pandemic were apparently to blame.
To avoid raiding the bond issue’s coverage reserve fund, Moss has had to infuse cash three times in the last 14 months, totaling $1.3 million, in exchange for “cash flow notes” bearing 10% annual interest.
Smart move. As Moss and his CalCHA buddies know all too well, a messy default could spoil their plans for sponsoring ever more lucrative bond deals in dozens of cities in California—and, soon, in a city near you.