Blackstone has suffered a legal setback in a dispute with housing non-profits that are trying to seize some of the apartment buildings it bought for $5.1bn from AIG last year.
The world’s biggest private equity firm bought housing assets worth more than $20bn during the coronavirus pandemic, including student halls of residence, a rent-to-buy landlord and AIG’s portfolio of 678 rent-controlled developments funded through a federal low-income tax credit programme.
The deals represent Blackstone’s biggest push into the US housing market since the financial crisis. The former AIG portfolio, now known as April Housing, is among the biggest investments in Breit, Blackstone’s $63bn unlisted real estate investment trust that is popular with wealthy retail investors.
But Blackstone’s future earnings from some of those rent-controlled apartment blocks have been clouded by a dispute with non-profit housing operators over the meaning of contracts that AIG signed more than a decade ago when it advanced money for construction in exchange for an allocation of tax credits.
Among the disputed developments is a subsidised retirement community in Michigan known as Presbyterian Villages, which was refurbished with construction financing from AIG. In return, the insurer received tax credits that reduced its payments to the federal government by more than its original outlay, allowing it to make a profit over 15 years.
With those tax credits exhausted, the church group that operates Presbyterian Villages invoked a contractual clause that is common in housing finance deals to try to force the vehicle through which AIG held its stake to sell for a nominal sum.
AIG sued to stop the transaction, arguing that it could not be forced to sell, and Blackstone inherited the litigation when it bought the portfolio in December.
That case, and others like it, had mainly been going AIG’s way ahead of the Blackstone deal, with courts in New York and Michigan largely accepting the insurer’s interpretation of the contract it signed.
But that dynamic changed with a ruling handed down by the Cincinnati-based US court of appeals for the sixth circuit in May.
The appeals court was asked to resolve a technical dispute concerning a mechanism enshrined in the US tax code that non-profits say should allow them to reclaim ownership of the buildings they run without paying the market price to a company such as Blackstone.
The sixth circuit sided with non-profits who have argued that the so-called “right of first refusal” can be exercised even if no outside bidder has made an enforceable offer to acquire the property.
But in a wide-ranging ruling, the judges went further, setting out a view of how the tax credit programme is supposed to operate, which legal experts say could spell trouble for investors seeking to earn a return from rising property values in gentrifying neighbourhoods.
Presbyterian Villages’ financing contract allowed AIG and Blackstone to “reap the benefits from the housing tax credits, not from the property’s long-term appreciation gains”, the judges said.
“The hope is that these recent decisions put non-profits in a more favourable negotiating position vis-à-vis outside investors who are demanding cash pay-offs,” said Robert Rozen, a lawyer who helped design the tax credit programme in the 1980s and now works with housing non-profits.
“The courts have begun to delve further into what Congress intended, and this is resulting in decisions going against these outside investors,” Rozen added.
April Housing brushed aside the sixth circuit ruling, saying it had “no impact on the economics of the deal or how we engage with our partners”.
But David Davenport, a lawyer for the church group that operates the retirement community in Michigan, said the Blackstone-owned company changed its position towards his client after the sixth circuit published its ruling on May 10.
“April Housing first contacted Presbyterian Villages of Michigan to discuss potential resolution of the case on May 11,” Davenport said, adding that discussions are continuing.
If no settlement is reached, then the property’s fate will be decided after remaining legal issues are dealt with by a lower court.
While the sixth circuit’s ruling is only binding in Michigan and three other states, it follows similar rulings against other housing finance providers in jurisdictions including Massachusetts and Delaware.
Blackstone is seeking to resolve two other lawsuits in which it is asserting ownership rights over properties that are operated by non-profits, according to people familiar with the situation.
The private equity firm told an appeals court in March that it was “in the final stages of a business resolution” with a New York-based housing non-profit that has sought to reclaim full ownership of an apartment building in Brooklyn. The proposed solution would reflect both sides’ “commitment to affordable housing [and] would result in a settlement of this case”, a lawyer for the firm added.
Three days after the sixth circuit handed down its ruling, April Housing withdrew its bid to have a state court in Virginia throw out a lawsuit filed by another non-profit, Wesley Housing, opting to cancel a scheduled hearing and pay its opponent’s costs.
April Housing did not say why it abruptly decided to withdraw the Virginia motion, which advanced some arguments that were similar to the ones that failed in the Michigan case. The company has since filed a document indicating that it denies Wesley’s claims.
The Blackstone-backed company said in a statement that it was “proactively working with these partners to resolve the inherited litigation since our acquisition less than six months ago”.