An ostensible $80 million financial shakedown at an Oahu public housing project has led to a legislative effort to prevent similar schemes, which are spreading on the mainland, from happening in Hawaii.

State lawmakers are contemplating how they might guard against what has been described as predatory investors trying to reap financial gains from developers that use federal and state tax credits to finance construction or rehabilitation of low-income rental housing.

Such credits have been used, by nonprofit developers in many cases, to help produce most low-income housing in Hawaii in recent decades.

The effort by lawmakers, initiated via two resolutions introduced in March, stems from an incident involving Palolo Homes that began three years ago and allegedly included an unsuccessful attempt by a mainland investor to more than double the rent for all tenants at the 306-unit project in Palolo Valley.

Nationally, the problem, often triggered by “aggregator” investors that buy out original tax-credit investors, has been described as an emerging threat to tax-­credit-financed affordable housing in recent years.

“Such efforts, increasingly being made by ‘aggregator’ investors, frustrate congressional intent, violate long-held norms and expectations in the industry, are costly for nonprofits to litigate, jeopardize the ongoing affordability of an already scarce federally assisted housing stock, and threaten to displace low-income tenants,” Brandon Weiss, an associate law professor at American University Washington College of Law in Washington, D.C., wrote in an October research report.

The problem centers on Internal Revenue Service policy applying to low-­income housing tax credits intended to help nonprofit developers raise money by selling tax credits to investors. In turn, the investors receive a limited partnership stake in the housing project with a provision that the nonprofit can acquire the investor’s stake for what is typically a nominal price based on project debt and any tax resulting from the acquisition.

For-profit developers, which also can receive and sell such tax credits to help finance low-income affordable housing, have been targeted as well by predatory investors aiming to extract extraordinary payouts for exiting their minority partnership positions after receiving their tax benefits.

These once-routine transactions may take place only at least 15 years after origination of such financing per IRS rules.

In recent years, however, investment firms with tax-credit partner interests have deployed novel arguments to oppose and then profit from the transfer, and in some cases wrest ownership of the housing and raise rents to market rates.

“It’s sweeping the country,” said David Davenport, a Minneapolis attorney who has represented well over 100 affordable-housing developers fighting such investor tactics in roughly 40 states. “No one is really immune to it.”

‘Extortion’ in Palolo

David Nakamura, executive director of the Mutual Housing Association of Hawaii, a local nonprofit affordable-­housing development firm established in 1994, said he was stunned when what he described as attempted extortion occurred with Palolo Homes.

“It was traumatic,” he said of the ordeal, which led to litigation and could have resulted in lost jobs for his employees and financial hardship for around half the roughly 1,200 people living at Palolo Homes, where monthly rent ranges from $613 for one-bedroom units to $1,387 for five-bedroom units.

Palolo Homes dates back to the early 1950s and had long been an example of deplorable state-owned public housing. In 2002, Mutual Housing obtained a 55-year land lease for $1 a year, spent $17.5 million on renovations, followed by new programs for residents, and has managed the property where rents must remain affordable to low-income households throughout the lease term.

To help finance improvements, Verizon Capital Corp., though California­-based Newport Fund 2000 LP, contributed $8.9 million in return for tax credits, according to Mutual Housing.

But after the 15-year period, Mutual Housing was rebuffed when it tried to acquire Newport’s partnership interest for no money based on IRS regulations.

Nakamura said Verizon/Newport objected to the nominal acquisition, and soon a new investor stepping into the Verizon/ Newport position, Denver­-based Oceanside Capital Advisors LLC, sought over $80 million for the minority interest.

Oceanside, according to Nakamura, claimed that Mutual Housing violated its fiduciary duty to the partnership by not raising rents to maximum levels allowed under federal rules, and moved to oust Mutual Housing from control of Palolo Homes while also threatening to sue the nonprofit’s board for $30 million.

Nakamura said Oceanside pressured Mutual Housing with strong-arm tactics to raise rents.

“I call it extortion,” he said. “It just blew our mind.”

The academic report by Weiss noted that some nonprofit developers don’t have the means to fight off such attempts. Other nonprofits have challenged similar efforts in court and lost.

Mutual Housing prevailed after filing a lawsuit in state court against Newport and Oceanside in late 2019.

According to the legal complaint, Verizon/Newport received $12.9 million in tax benefits from its $8.9 million investment, yet Oceanside threatened to seek damages of around $75 million or more if Mutual Housing acquired the investor’s interest as long anticipated for little to no money.

Mutual Housing said in its complaint that Oceanside’s claim appeared to be based on an $83 million appraised value of the project that factored market rental rates and 32 acres of land owned by the state.

After an unsuccessful attempt by Oceanside to have the case heard in federal court, the two entities settled the litigation in April 2020 with Mutual Housing completing its buyout at no cost.

Oceanside did not respond to a Honolulu Star- Advertiser request for comment.

Sitting targets

Though Mutual Housing prevailed, Nakamura said Hawaii’s very high market rent and land values make affordable-housing projects financed by tax credits an attractive target for unprincipled investors.

State Rep. Nadine Naka­mura (D, Hanalei-Prince­ville-Kapaa) introduced House Resolution 104 and House Concurrent Resolution 108 on March 11 in an effort to explore what can be done by state entities to prevent events similar to what happened with Palolo Homes.

“We don’t want this (proliferating) practice on the mainland to happen here,” she said. “It’s just greed.”

The House Committee on Housing, chaired by Naka­mura, passed the resolutions March 22.

Rob Van Tassell, president and CEO of Catholic Charities Hawai‘i, which has developed low-income housing, supported the resolutions in written testimony that called the practice by predatory investors a “great danger” to Hawaii’s affordable rental stock and its tenants.

“Investigation and action to combat these predatory practices is needed to ensure the safety and health of the residents in these projects,” he said.

Denise Iseri-Matsubara, director of the Hawaii Housing Finance and Development Corp., which in recent years has managed the allocation of federal and state low-income housing tax credits, told the committee that she’s not sure what HHFDC can do to protect developers that use the program. She said the conversation should continue over how to ensure that predatory investors don’t block developers from long-term ownership and control of affordable housing.

There have been some so-far unsuccessful efforts in Congress to address the problem, though affordable-­housing advocates urge a collective approach.

“We’re in a critical time right now with these issues,” Preservation of Affordable Housing, a national nonprofit organization, said in a December article. “Collective action by housing stakeholders with a common interest is needed for a satisfactory resolution, as it has in the past.”