VALUATION Viewpoint Fall 2019 Vol 24 No 3 Minneapolis Mulls Renter Protections by Brock Boatman Housing is one of the largest challenges facing The Act classifies D.C. rental housing into three tiers: communities across the country, particularly providing single-family housing, 2- to 4-unit housing, and 5+ unit housing for those in lower- and middle-income brackets. housing. Until recently, all three tiers were treated One of the ways in which these groups are being relatively equally. This proved onerous for several affected is by the common purchase and repositioning important reasons, including discouraging rentals of of Naturally Occurring Affordable Housing (“NOAH”). Accessory Dwelling Units (“ADUs”) on single-family In an effort to preserve NOAH, communities are properties. ADUs are quite common in D.C., taking considering various vehicles for preservation, including the form of English basements, carriage houses, and variations of Washington, D.C.’s Tenant Opportunity to “Granny Flats,” allowing single-unit rentals on existing Purchase Act (“TOPA” or the “Act”). TOPA was enacted single-family properties. However, the renters of in 1980 to address the housing crisis at the time, and single-family homes yielded extraordinary power to remains in place today. States and cities across the delay sales. As a result, landlords would commonly country are now considering some variation of the TOPA either keep potential rentals off the market, find ways to framework, including Minneapolis. In this article, we terminate leases, or refuse to renew rents at reasonable explore the process by which property owners would rates to avoid the often costly alternative, which would comply with these new proposed laws based on TOPA, be to buy-out the tenant lease. These results ran and how the Act affects the multifamily real estate counter to many of TOPA’s goals. Under the revised market in D.C. D.C. rules, the only single-family tenant protection that remains is the right to occupy a unit for 12 months after sale under the current terms. TOPA now applies Market Trends & Value Indicators: Office Buildings – Downtown Office Buildings – Suburban Retail Centers Industrial Buildings Apartments New Housing Starts – Midwest Productivity U.S. Unemployment Consumer Confidence Index to D.C.’s second and third classifications, the 2 to 4 unit and 5+ unit properties, with the primary difference being the timeframes in which the tenants have to act. 0.0% For purposes of our discussion, we focus on the 5+ unit 2.0% properties as they typify multifamily properties as we 2.0% generally think of them. This discussion assumes typical market rate rentals and tenants; additional legislation in Valuation Viewpoint Minneapolis Mulls Renter Protections continued from page 1 D.C. applies to special situations, particularly involving seniors and persons with disabilities, but those minutiae are beyond the scope of this discussion. The key factor affecting a seller is the timing of all the required notices and the tenants’ response periods. When the owner of a multifamily property enters into a sale agreement, they must notify the tenants. The following chart visualizes the various steps required to complete a sale. After receiving notification of the sale, the tenants may request information regarding the property: floor plans, rent rolls, and income statements – the same information any buyer or investor would typically request. After review, the tenants may form an association (comprised of 50% or more of the tenants of the occupied units) to exercise their tenants’ rights. At this stage, they have four options. The tenants’ association may: Attempt to purchase the property with terms roughly equivalent to the proposed third-party deal. In these cases the ownership has a responsibility to negotiate in good faith with the tenants’ association, and not attempt to re-trade the deal with terms different than with the third-party buyer. If the purchase goes through, ownership is then typically controlled by the tenants as a cooperative or limited equity cooperative, with tenants holding the right to purchase their units. Transfer their rights to purchase to a new investor/developer, in which case the tenants have the right to negotiate how the property will be managed by the new owner. This option can also stipulate renovations and rental increases for existing and future tenants, keeping the property cost-controlled, and may involve public assistance, non-profit involvement, or the creation of a public-private partnership. Offer to release their rights to purchase the property to the existing owner for some consideration, effectively being bought out in exchange for not slowing the sale process. A key component in this arrangement is that some form of consideration must be given by the current ownership, which can become costly for the seller or new buyer when cash consideration is involved. Opt to do nothing, and the sale proceeds just as we would see today. This option is most often seen with highend and luxury developments in which new ownership intends to keep the property “as-is,” with no significant plans to renovate or reposition the property. Valuation Viewpoint 3 Under the D.C. law, a tenants’ association can easily tie complexes (50+ units) were 25% to 30% lower in D.C. up a deal for 285 days, or longer. The owner has 360 than in the Virginia markets, and properties in D.C. days in order to enter a sale contract; if not, the TOPA typically spent 50% to 55% more time on the market. process starts over. This protracted period is necessary Both of these factors lead to downward pressure for the tenants’ association: they need time for on values. This makes multifamily buildings a less research, analysis, and organization in order to decide attractive investment type in a TOPA market, and what their course of action will be. However, this also lowers the real property tax base for municipalities. creates major challenges for the seller. First, there is the financing issue; most lenders will not commit to a term TOPA rules exempt new construction as properties sheet that they might have to hold for over nine months. under construction do not have tenants. This creates Changes in market rates can cause a deal to fall apart a strange quirk in the market as new construction while a property owner is negotiating with the tenants’ properties often sell 100% vacant before tenants are association. Second, it makes using a multifamily able to occupy units and trigger the TOPA process. property as the upleg of a 1031 exchange nearly These laws affect both pure merchant developers impossible, given that there needs to be compliance as well as groups that intend to retain ownership with the 180-day rule. As a result, tenants can leverage positions in their projects. extraordinary power and money over property owners looking to sell. TOPA rules also prompt the question of what constitutes a sale. Up until the mid-2000s, owners So what effects do these laws have on the apartment could sell 95% – and some argued up to 99.99% – of market? Anecdotally, market participants will say that their ownership and still avoid triggering the TOPA these laws drive down values. However, we found the process based on the courts’ interpretations of what two largest outcomes were that 1) deal volume reduced constituted a sale. Clearly, this went against the spirit dramatically and 2) properties remained on the market of the Act, and has since been nixed by subsequent for an extended period of time. court decisions. However, the definition of a sale continues to be debated. A court case this summer In order to isolate the effects of TOPA legislation, we asked whether a reallocation of ownership interests aggregated the last five years of apartment sales in D.C. constituted a sale. The court ruled that a third party and compared that activity to the nearby Alexandria was necessary to define a sale and trigger the TOPA and Arlington, Virginia markets, which are not affected process. More importantly, the case demonstrates by TOPA laws. After controlling for market size, we that TOPA legislation still provokes questions and found that transactions of apartment buildings and challenges almost 40 years after its passage. continued on page 4 4 Valuation Viewpoint Minneapolis Mulls Renter Protections continued from page 3 Advocates for renter protections gathered outside Minneaplis City Hall this summer. Source: www.thealliancetc.org/renter-rights-mpls/ So why pursue such legislation? Again, the goal of the opportunities for those with more moderate means legislation is to give renters, particularly those that occupy to purchase their apartment through the creation NOAH, seniors, and disabled people, tools to maintain of a co-op. However, as much as the legislation can rents and remain in their homes. Generally, these help empower renters, it can create substantial populations are renters “by circumstance” as opposed challenges in capital markets. As the data shows in to those who rent in the newer luxury developments “by the closest “apples to apples” comparison, available choice.” People renting at top of the luxury market, say deal velocity and timing will be affected, particularly $3,000 for a two-bedroom unit in newer projects here in for larger investors. If TOPA legislation passes in the Twin Cities, are generally not at risk of being displaced Minneapolis, it will take years to fully measure its by new ownership. Additionally, TOPA legislation creates effects on housing and the real estate market. Valuation Viewpoint 5 Real Estate Transaction Buyer: Seller: Property: Sale Price: St. Armands Circle Investments LLC Entity related to Rush family 9s on Nicollet $10.1 million Sale of 9s on Nicollet The City of Minneapolis requires 60% of a building’s the buildings for $10.1 million. The entity’s portfolio street frontage on Nicollet Mall be retail. Many building includes properties throughout western Europe and owners question whether this zoning requirement is still the southeastern United States; it purchased the 9s a good idea as downtown retail has declined over the to diversify the geography of its holdings. Standard past several years. Some owners are optimistic about Commercial, a Minneapolis-based boutique commercial downtown retail and others are pessimistic. With the real estate investment service, represented the buyer. retail landscaping changing, many hoped the Nicollet Mall renovation would help fill the empty spaces. Many The seller was an entity related to the Rush family of the also hope the residential construction bringing an influx former Rush Bridal store, which was located in the 9s of downtown residents will make Nicollet Mall retail until the store closed in 2016. Upland Real Estate’s Deb more lucrative. Vannelli and North Central Commercial Real Estate’s Russ McGinty represented the seller. Several recent transactions along Nicollet Mall demonstrate both interest and opportunities. The The 9s has 31,440 square feet of leasable area. owners of The Andrus, formerly known as Renaissance Originally built in 1912, the Rush family invested Square, has asked the City of Minneapolis for a approximately $4 million in building upgrades several variance to lease street level space to an office tenant. years ago, including a skyway, an elevator, and tenant Walgreens moved from 8th Street to a new store in improvements. The building is home to Barrio, Rojo, the Gaviidae Common; the store’s previous building remains Stable, the Wilko Group, and Escape the Room. Barrio for sale. The Minneapolis Downtown Improvement just extended its lease for 10 years and restaurants District (DID) opened a pop-up satellite office in street along Nicollet Mall have reported increased patronage level space at 6th Street and Nicollet Mall in Gaviidae since the completion of the Nicollet Mall renovations. Common. The façade of City Center is being renovated to improve the building’s corner on Nicollet Mall and 7th Street. Brit’s Pub sold this summer as did the connected buildings called the 9s on Nicollet Mall. The 9s on Nicollet, which encompasses 915 and 927 Nicollet Mall, is valued at $4 million for property tax purposes by the City of Minneapolis. Over the summer, St. Armands Circle Investments LLC, a private, family-­ run commercial real estate entity based in Naples, Florida, purchased 6 Valuation Viewpoint Business Valuation by Jim Clancy, Managing Director, Hennepin Partners Private Equity Firms are Pushing Software Valuations Higher Private equity firms have historically been attracted to established businesses with consistent cash flows that can be used to pay down acquisition debt. Meanwhile, start-up technology companies have been the domain of venture capital investors. In recent years, owing to new business models with stable cash flows, PE firms have become active bidders for software companies. Percent of PE Deals Targeting Software Companies 13.9% 12.3% 6.5% 2009 7.1% 7.1% 7.3% 2010 2011 2012 Value of PE Acquisitions Involving SaaS Targets ($ in billions) $24.7 $14.8 $11.1 $5.0 2015 2016 2017 Source: 451 Research 2018 9.3% 8.9% 2013 2014 2015 9.9% 2016 2017 2018 Source: Pitchbook Growing competition in the M&A market for software businesses has led to higher valuations and expanded deal volumes. In large part, this competition is coming from PE buyers. According to Pitchbook, PE buyers now account for nearly 40% of software acquisitions. In the bulge bracket, PE groups are competing head-on with Silicon Valley’s elite. PE buyers outspent strategic acquirers on software deals larger than $1 billion in 2019 Q2. 8.9% Total Value of Software M&A Deals ($ in billions) $241.8 $187.6 $62.0 $80.1 $91.1 $152.0 $144.4 2014 2015 $164.5 $95.1 $33.9 2009 2010 2011 2012 2013 2016 2017 2018 Source: Pitchbook PE Demand is Particularly Strong for Subscription-based Software Companies Software-as-a-service or “SaaS” businesses have seen PE investments grow five-fold between 2015 and 2018. This exploding PE interest is driven by subscription-based business models that produce recurring monthly revenues and highly predictable cash flows. Adding to their allure, SaaS businesses often grow in excess of 30% per year. Valuation Viewpoint Hennepin Partners Advises IndustrySafe on Its Sale to Vector Solutions The rising trend of SaaS M&A activity is displayed in a recent transaction arranged by Hennepin Partners. IndustrySafe, a Philadelphia-based developer of environmental, health and safety (“EHS”) management software, was acquired by Florida-based Vector Solutions. Vector Solutions delivers award-winning online education, safety, compliance and performanceoptimization solutions to customers in a variety of industries including architecture, engineering, construction, industrial, facilities management, public safety, IT, and education. With its acquisition of IndustrySafe, Vector has added highly sought-after EHS capabilities to its product portfolio. Vector can now give its clients a more complete array of solutions to increase compliance and improve safety. Hennepin Partners LLC is a boutique investment bank that provides M&A advisory services and strategic advice to entrepreneurs, private equity firms, and corporations. Member FINRA/SIPC. For more information, visit www.hennepinpartners.com 7 88 South Tenth Street, Suite 400 Minneapolis, Minnesota 55403 612.333.6533 Fax: 612.344.1635 www.shenehon.com RETURN SERVICE REQUESTED VALUATION VIEWPOINT NEWSLETTER INSIDE SHENEHON COMPANY IS A REAL ESTATE AND BUSINESS VALUATION FIRM, serving both the private and public sectors throughout the United States. Our unique combination of real estate and business valuation expertise allows us to provide a wide range of services to offer innovative solutions to difficult valuation issues. Shenehon Company is committed to equipping its clients with the tools necessary to make informed and knowledgable decisions regarding their capital investments. Allocation of purchase price Gift tax evaluations Marriage dissolution Asset depreciation studies Going public or private Mortgage financing Bankruptcy proceedings Highest and best use studies Multifamily residential properties Charitable donations Industrial properties Municipal redevelopment studies Commercial properties Insurance indemnifications Potential sales and purchases Condemnation Intangible asset valuation Railroad right-of-ways Contamination impact studies Internal management decisions Special assessment appeals ESOP/ESOT Investment counseling Special purpose real estate Estate planning Land development cost studies Tax abatement proceedings Feasibility analyses Lease and rental analyses Tax increment financing General limited partnership interests Lost profit analyses Utility and communication easements Contributors: Robert Strachota, President Jim Clancy, Managing Director, Hennepin Partners Wendy Cell, Senior Vice President Brock Boatman, Senior Valuation Analyst Victoria Mercer, Communications Coordinator Copyright 2019. Valuation Viewpoint is prepared and published by Shenehon Company. Opinions regarding business and real estate valuation issues have been carefully researched and considered by the authors. While we hope you find the information relevant and useful, it is important to consult your own advisors before making business decisions.
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