The sale of a 5,881 unit affordable housing complex in Brooklyn, N.Y., could bring hundreds of millions of dollars of bonds to the market by the end the year.

Four finalists must submit a bid by Sept. 25 and each is seeking tax-exempt bonds to be issued through the New York State Housing Finance Agency to finance the purchase of Starrett City. The bonds would be issued on behalf of 501(c)(3) non-profit corporations that are associated with each of the bids and would not use private-activity bond volume cap. A source familiar with negotiations said the deal could price early next year, rather than this year because of its complexity.

According to published accounts, a final bid ranging from $600 million to $1 billion could be approved by the current owner next month. The four bidders were narrowed down from a group of eight in July. The current owner, Starrett City Associates, needs federal and state approval in order to sell the complex.

The bidders have been working with state and federal agencies to avoid the fate of Clipper Equity LLC. That partnership bid $1.3 billion for the complex last year only to have its offer rejected by the U.S. Department of Housing and Urban Development and New York State Department of Housing and Community Renewal commissioner Deborah VanAmerongen.

The regulators expressed concern that the high price would force the new owner to raise rents beyond what was affordable to many residents in order to make a profit or that greater subsidies would be required to keep units affordable.

"We've been meeting on the financing," said Priscilla Almodovar, the HFA's president and chief financial officer. "HUD's been meeting with them on eligibility and qualifications of their proposed budget managers and who their owners would be. DHCR's been talking to them about the rent."

In February, HUD, HFA, the New York State Department of Housing and Community Renewal, the New York City Department of Housing Preservation and Development, and the owner entered into a memorandum of understanding that laid out a preferred framework for the sale designed to maintain affordability at Starrett for at least 20 years, keep it in the Mitchell-Lama program and protect existing residents from the impact of rent increases. The use of HFA bonds, which typically have maturities out to 30 years, means that some affordability will be preserved for the life of the bonds.

"The hope that a lot of people have is because a not-for-profit will own Starrett that they might even go beyond that," Almodovar said. "We don't know who the final buyer is, we don't know their structure but at a minimum it [the affordability] would be for the life of the bonds."

The 140-acre complex borders Jamaica Bay and the neighborhoods of Canarsie and East New York. It includes eight parking garages, a shopping center, a community center, and a power plant. It was built in the 1970s under the state Mitchell-Lama program under which it received mortgages financed through HFA bond proceeds.

The complex receives a property tax abatement in return for keeping rents affordable. So long as the complex stays in the Mitchell-Lama program it can keep the tax abatement, which was worth $13.3 million last year, according to audited financial statements of Starrett City Inc., a limited profit housing company that operates the complex on behalf of the owner.

The complex has federal subsidies which help make it profitable and the new deal would as well. Total income at the complex in 2007 came to $120.3 million, which included income from apartment rentals and HUD interest reduction subsidies, according to audited financial statements. Those subsidies, called interest reduction payments, are attached to the existing mortgage, which runs through 2020, and require the owner maintain affordability based on a formula.

HFA sold bonds in 1973, 1979, and 1980 to provide a mortgage for Starrett and in 1996 it refunded those bonds. At the beginning of this year, the complex's mortgage had $223.2 million of principal remaining. The new owner would have the option of pre-paying the existing mortgage and would be allowed to keep that interest rate reduction payments through a process called "section 236 decoupling."

Federal rental subsidies cover up to 3,586 units, about 61% of the units. Under Section 8, very low income residents pay 30% of their income for rent and HUD makes up the difference based on fair market rent. The Housing and Economic Recovery Act of 2008, which was signed into law in July, provided for up to 60% of the units at Starrett to be covered by a new Section 8 contract for 20 years.

HUD has undertaken a "mark-up-to-market" study to establish new rent levels. Those figures, which are essential to figuring out the rent rolls that will support the bonds, will become available to the bidders the week of Sept. 22. The bids had been due on beginning of the month, but because the owners are asking for non-conditional bids, the deadline was pushed back so the study's figures could be included.

The remaining 40% of the units will get a rent increase that will be determined by DHCR and is subject to approval by HUD. According to the MOU, the rents are expected to be below market rate.

"None of us know the rents on the 60% that will be under the new Section 8 contract, and the 40%, that's the big unknown," Almodovar said.

Expenses at Starrett in 2007, which included mortgage principal payments totaling $11.2 million, came to $107.4 million, leaving a $12.9 million profit, according to audited financial statements.

The winning bidder could potentially build more housing on the site. The MOU states that up to 1,000 additional units could be built on the site, subject to approval of the city's land use review process.

"Our goal would be working to build workforce housing working together with the New York City Central Labor Council and also build senior housing," said William Rapfogel, chief executive officer of the Metropolitan Council on Jewish Poverty, which has teamed up with Westbrook Partners, a real estate investment firm, and Citi. "It's quite a large resource for the city in terms of untapped land."

The Christian Cultural Center is working with the Housing Partnership Development Corp., the Cogsville Group, Clarett Group and Prudential Real Estate Investors, as well as with bankers at Credit Suisse and JPMorgan.

"In the future there would be opportunity to bring affordable and workforce housing and potentially other commercial amenities," said Don Cogsville, chief executive officer of the Cogsville Group. "We're looking at local economic development initiatives which is associated with workforce housing, in terms of bringing jobs, improving transportation to have Starrett more connected to where people may work so we've been in heavy dialogue with the state."

Ghebre Selassie Mehreteab, chief executive officer of the NHP Foundation, which is working with the Related Cos. and Goldman, Sachs & Co., said that his group could build housing financed by the sale of tax credits. "

That place invariably has a long waiting list which from there one could develop similar housing," Mehreteab said. "We certainly know there's always a demand for the same quality of housing."

The Allen A.M.E. Cathedral Housing Corp. is working with JPMorgan.

"We have specialized for our entire development career in affordable housing we see this development which is both affordable housing and some workforce housing as a model that should be preserved," said Rev. Edwin Reed, chief financial officer of Allen A.M.E. Cathedral. Reed said he wasn't sure if they would build additional housing on the site if they were chosen.

Any bonds issued will have to be rated at least triple-B. The HFA will consider issuing some unrated and unenhanced 501(c)(3) bonds under certain conditions. Some of those conditions include restricting the unrated bonds to 10% of the total debt issued and selling them in denominations of not less than $1 million.

The State of New York Mortgage Agency will consider providing up to $200 million of mortgage insurance for the financing.

One wildcard is the use of credit enhancement by the troubled Fannie Mae and Freddie Mac. Three of the four bidders are expecting to use credit enhancement from those companies.

"We all have our fingers crossed that Fannie and Freddie will have some role in Starrett," Almodovar said.

Joe Darcy, senior portfolio manager at Dreyfus Corp., said that the bonds have the potential to do very well as a new name in the New York market because investors are often "starved for diversification."

"To the extent that the pricing represents the fundamental credit structure it could be something that is in high demand in a market that has capacity constraints in it," Darcy said. "But until we get the details of what it looks like and what's behind it, it's very difficult to say."

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