The Guru Is In

The missing skill in asset management

By David A. Smith
July 26, 2017 5 min read

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If asset management is the core competency of durable developers and investors, then asset valuation is a core skill of durable asset managers, and one that’s often under-resourced.

Over the last seven years, we’ve seen liquidity and pricing efficiency come to the tax-advantaged part of LIHTC ownership positions – but what about the economic positions? While we hear about limited partner exits, what about general partner exits, or intra-general partner exits?

While a demotivated institutional limited partner may be deadweight to some properties or some funds, a demotivated, no-longer-capable or downright dubious general partner can stall or imperil the property and indeed the whole general partner platform. Moreover, from the perspective of an outside investor, the ‘general partner’ may appear to be a unified entity, but on the looking glass’ other side, inside the general partner’s organization is a competitive fraternity/sorority where each executive has the natural parallax of ego (“my contributions are more valuable than yours”), and where relative capacity, value and satisfaction is always in flux.

Time and market change mean constant shifting of worth. Young-buck executives become extended-vacationing chairmen and grandparents. Rising juniors demand stakes in the platform – or leave and start competitor companies. Business lines that thrived wither, and when it comes to deal pipelines, memories are short. Over the years and decades, all that buildup of emotional atherosclerosis can cause misalignment of incentives and control, internal entropy and friction and diminishing effectiveness. The time comes, therefore, when new blood is needed and some assets should trade: a controlling general partner interest, a partial-controlling interest, or a fractional share within the general partner entity.

To trade, the asset needs to be valued. Aside from ego and control, big money can be at stake.

This valuation bears little resemblance to the initial LIHTC pricing, because the investment profile, benefit mix and control/optionality/risk elements are entirely different. If LIHTC is Diet Coke, the residual LP or general partner positions are the recyclable plastic bottle the Diet Coke came in – and the resale and valuation rules of thumb used for LIHTC-flowing limited partner positions are wholly misleading if applied to the economic, controlling or general partner positions.

Such a position’s economic value isn’t simply the ratable share of the real estate’s net asset value (NAV), because the property is encumbered by LIHTC restrictions (including extended use or a Qualified Contract) and often shrink-wrapped in accruing financing with balloon or contingent-payment features. Conversely, a control position offers fee opportunities (such as property management), aggregation possibilities and transaction optionality – the ability to return the bottles and fizz them up with new LIHTC from which bubbles forth new development fees.

At Recap, valuation of complex structured affordable housing economic positions has become a steadily rising component of our business, and in this work we’ve identified at least eight major factors to address:

1. What value standard: fair market value, holding value, post-acquisition value? Fair market value is the cash price to the seller if the asset were sold in the open market between independent parties dealing at arm’s length. Holding value is the position’s worth in the hands of the current owner, and post-acquisition value is what it may be worth to a particular buyer after aggregation. Which is appropriate depends on what the valuation will be used for and what transaction may ensue.
2. Isolation, collection and the aggregation premium. Because these assets are complex and often owned inclusters, any given slice of ownership may have one value if sold as a one-off, a different (often greater) value if sold within a portfolio of similar slices, and a third value after it is sold to a holder that already owns some slices of the same entity and is building a position. Is there an aggregation premium, and if so, should be it valued?
3. Control. Just as lack of control impairs value, the presence and potency of control is worth money: more if whole and unilateral, less if blocked or subdivided.
4. Optionality and non-economic capture. Affordable housing properties are resource magnets whose attractive power varies among time, place and property. That too has value the market will pay for. Some of it is entrepreneurial premium, some is inherent in the asset itself.
5. Transferability. Rights to approve successor general partners, or successor controlling parties within a general partner entity, are often custom-negotiated, and the documents will not necessarily say what ‘everyone remembers’ they say. The more bystanders who can veto the incomer, the less value for the outgoer.
6. Benefit mix. Economic benefits can flow from operations, from a controllable transaction (e.g. market refinancing), or from an uncontrollable one (e.g. new volume cap). The more the future realization is unreliable or dependent on the skill of a particular entrepreneur, the less it is worth inherently in the asset itself.
7. Principal-agent risk. It’s one thing to buy the managing member position, another to buy a non-managing member share with no prospect of dislodging the managing member and heaving dependency on future entrepreneurial nimbleness. A glittering opportunity won’t have much value if you can’t grab it.
8. Political risk. To realize economic value from affordable housing investment the owners have to disturb the status quo, and that can upset state agencies, community advocates and editorial writers. The more economic potential, the more political flak, so the valuation has to assess the cash-to-flak ratio.

If you can’t value, you can’t asset manage effectively because you can’t track performance or judge tradeoffs. Unlike capital markets traders, you don’t need to value every position at all times, but any time it’s important, you do need to be able to value every position, accurately and with confidence.