Anchor Pacifica Creates new Liquidity Risk for Housing Investors

The federal government recently announced an initiative that aims to invigorate the housing market through the sale of Fannie Mae- and Freddie Mac-owned houses to third-party investors, who will be required to rent these homes for a specific period of time. Investors hope to rent these properties until the housing market rebounds, at which point they will sell their investments for a considerable profit - or so they think. Following the 2nd District Court of Appeal's April 23 ruling in Anchor Pacifica Management Company v. Green (Anchor Pacifica), investors now must consider a significant liquidity risk that could undermine their exit strategy from this investment: the federal government's involvement may trigger constitutional protections prohibiting investors from evicting tenants at the conclusion of their leases.

With rental prices on the rise, the idea of purchasing Fannie Mae- and Freddie Mac-owned homes recently caught fire with large investors, with potential purchasers including mortgage-backed securities traders Amherst Securities Group, hedge fund manager Paulson & Co., private equity investors Colony Capital LLC, and a fund run by Lewis Ranieri, the co-inventor of the mortgage-backed security. And with good reason: while a 10-year treasury note yields little more than 2 percent, economists at Goldman Sachs calculate that rental property investments yield more than 6 percent on average, nationwide.

But potential investors should consider the long-term liquidity risk created by Anchor Pacific and its federal counterparts before purchasing Fannie Mae- and Freddie Mac-owned homes, especially if these transactions are contingent upon the federal government's continued involvement in the oversight, administration and control of the REO-torental process.

Anchor Pacific involved a city redevelopment agency that entered into an agreement with a private developer to build a low-income senior housing complex. In exchange for a 55-year lease of the property, the developer agreed to develop the land pursuant to the agency's specifications, maintain the development with agency oversight, and pay the agency a portion of the net proceeds of the development. When the developer attempted to evict a tenant (without cause) at the conclusion of her lease, the tenant asserted that any attempt to evict her without cause violated her federal and state rights to due process.

Relying on a host of federal authorities, the Anchor Pacific court agreed with the tenant based on two critical findings.

First, according to the court, the agency's inception and regulation of the low-income housing program and continued oversight and maintenance of rent levels at the apartment complex constituted sufficient private-public entanglement to treat the developer's seemingly private conduct as that of the government itself; the developer's conduct was so intertwined with governmental policies that the developer became subject to the constitutional limitations placed upon state action.

Second, the court found the agency's policy of inducing a private enterprise to supply low-income housing, coupled with the tenants' acceptance and reliance of that low-income housing, created in tenants a "status by entitlement," a species of property, protected by constitutional guarantees of due process of law. A necessary corollary, according to the Anchor Pacific court, is that tenants at the senior housing complex possessed a protected property interest in the renewal of their leases that could be terminated only upon a showing of "good cause."

So what is the impact of Anchor Pacific on investors considering purchasing Fannie Mae- and Freddie Mac-owned houses? At this juncture, the terms of these transactions remain confidential in order to ensure compliance with applicable securities laws, making it difficult to discern whether these deals will trigger constitutional protections in favor of tenants. Critical factors will include whether the federal government sells these homes contingent upon its ability to dictate rental rates, control the length of leases, vest in tenants the right to lease renewals and/or demand a percentage of the net rental proceeds.

This much is for certain - investors' long-term exit strategy is predicated, in part, on their unfettered right to swiftly remove tenants without cause at the conclusion of their leases; under Anchor Pacifica, this right may not exist.