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OCTOBER 2010

The Wall Street Journal

Citi Goes All In, Again

by Maura Webber Sadovi

Citigroup Inc. has figured out a plan for a portfolio of 26,000 apartments in 34 states and Puerto Rico that it got stuck with after making the mistake of financing an affordable-housing deal during the boom.

Typically, affordable rental apartments aren't the target of speculative buying because rents are limited by the rules under which they were developed with government subsidies. But these assets, too, were occasionally caught up in the housing euphoria.

In 2008, Citigroup made a $100 million loan to a venture of Michael Costa and Victor MacFarlane to finance the purchase of the apartment complexes, which are more upscale than standard affordable housing, with amenities like swimming pools and clubhouses. The venture planned to resell the units to other investors, but the market collapsed. Citigroup foreclosed and for some time considered selling and cutting its losses.

But instead, the bank is upping the ante and contributing the properties to a new venture called Highridge Costa Housing Partners, run by Mr. Costa. John Long, a veteran California real-estate investor, is also part of the venture, and his company is putting an unspecified amount of fresh capital into the deal. The transaction hasn't yet closed.

The move makes sense, said Steven Fayne, a managing director for Citigroup's community development lending and investing arm, because it protects the bank's investment and keeps some 80,000 tenants in affordably priced rental apartments. Another bonus is that the portfolio helps, in part, the bank meet its requirements under the Community Reinvestment Act, a federal law that encourages banks to make loans in low- and middle-income neighborhoods.

Also, it is likely that the sales option looked bleak for the bank. While it is estimated that it would cost about $3.4 billion to replace the apartments, the portfolio's value is likely much lower with the affordable strings attached. Under the government formula, which can vary from state to state, a typical affordable-housing unit might rent for about $550, compared with market-rate units nearby that would fetch $750, Mr. Long said.

While investor appetite for market-rate rentals is recovering faster than demand for many other commercial real-estate sectors, trading of regulated rental properties remains thin, said some analysts. The total dollar investment in U.S. market-rate rental properties rose to $13.9 billion in the first three-quarters of this year compared with $6.4 billion in the same period last year, according to CoStar Group Inc., a real-estate research firm. By contrast, about $163.8 million rent-regulated or subsidized apartments sold in the first three-quarters of this year, compared with $73.4 million from the year-ago period.

That is partly because the potential for rent growth in affordable-housing properties is capped, so most properties don't fit the type of high-end properties with potential for escalating incomes that many investors are now looking for, said Victor Calanog, of Reis Inc., a real-estate research firm. "It probably limits the pool of investors willing to play the game," said Mr. Calanog.

Mr. Costa, 54 years old, has had a long history with the portfolio, which includes some housing for seniors. He began developing the properties in 1994 as part of a unit of a predecessor to KB Home KBH +3.76%of Los Angeles, one of the country's largest home builders. In 2000, the unit was sold to the privately held Simpson Housing of Denver. In 2008, Mr. Costa and Mr. MacFarlane, a real-estate investor, acquired the properties under the understanding that they would quickly sell to other investors. But the deal became one of the many victims of the downturn.

Mr. Long, 62, also worked at the predecessor to KB Home earlier in his career, although not at the same time as Mr. Costa. Mr. Long went on to start Highridge Partners, a privately held real-estate investment company in El Segundo, Calif. which has acquired, developed or financed more than $7 billion in assets over the years. Mr. Long, also the founding chairman of the Ziman Center for Real Estate, at the University of California, Los Angeles, has separately joined with boxer Oscar De La Hoya to build housing and retail projects to underserved urban areas.

Mr. Long said he likes the personally rewarding aspect of providing affordable housing. And while he acknowledged that profits aren't staggering, he said the business is steady and predictable. "There's always a waiting list of people," Mr. Long said.

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