Competition Fierce for Choice Assets But Deals Aren't As Prolific in the First Half of Year as Some Analysts Expected
With apartment vacancies appearing to have peaked, and U.S. rents even starting to edge up slightly, offerings of quality multifamily assets have attracted multiple bidders and secured premium prices in the first half of 2010, with investors having an especially keen appetite for institutional-grade assets in attractive coastal markets.
However, as with most asset classes in the current commercial real estate market, multifamily sales are largely divided between the asset haves and have-nots. With few high-quality performing apartment assets for sale and an abundance of pent-up capital seeking to invest, some properties have drawn multiple, even dozens, of bids.
Recovery and transaction activity in the broader investment market for apartments and condominiums has not been nearly as swift or as strong as some experts predicted at the beginning of the year, despite modestly improving occupancies and rents, according to CoStar Group Real Estate Economist Mark Hickey.
Through the first six months of 2010, $11.6 billion in multifamily property traded hands, up from $7.7 billion in the first half of last year, according to preliminary 2010 CoStar first-half sales statistics. The first half total is expected to increase as CoStar continues to tabulate market transactions that closed in the second quarter. Despite a flurry that brought $19.9 billion in activity at the end of last year, the prorated dollar volume for all of 2010 still pencils out to $23.3 billion, or a 17% increase over 2009, Hickey said. Although this year’s projected volume would still be a 44% drop from the bubble-driven sales level in 2008 and a 74% drop from 2007, he said.
CoStar real estate economist Katie Pelczar memorably likened the scramble for the highest grade Class A assets seen on both coasts to old wartime photos where "hundreds of people are pushing and shoving to get their hands on a single loaf of pumpernickel." Deals for those coveted morsels, in this case well-occupied and higher priced properties in core markets like Washington, D.C. or New York, have thus far accounted for much of the sales activity this year.
Buyers in general are assuming they’re going to see hefty rent increases and continued demand recovery due to the shutdown of the supply pipeline and the improving economy, said CoStar Global Strategist Michael B. Cohen.
“The flip side to that is people are looking at the velocity of transactions and beginning to feel like the market is getting a little frothy,” Cohen said. “We’re generally seeing cap rate compression in those high-quality assets in coastal markets that people are paying high prices for. The returns are not the type of opportunistic returns investors thought they would see a year ago. Instead of a heavy distress play, we’ve seen a heavy core play.”
Meanwhile, supply is tightening, home ownership remains soft and vacancies appear to have topped out, even declining in some markets. While asking rents are trending flat, the market is seeing some positive growth in effective rents as concessions burn off in such markets as Phoenix. Landlords are starting to feel the balance of power shift in their favor, Cohen said.
The appetite of investors for the prime markets, however, has largely driven the increase in dollar volume, while the number of trades has flattened. The weighted average price per unit, which was about $28,000 in the first half of 2009, is an estimated $40,400 in first-half 2010, according to available data.
REITs and other investors flush with equity are the most active players in the apartment sales arena, with financing challenges still playing out across the market.
"Gap financing continues to be an issue for buyers that need some amount of leverage before an asset stabilizes," noted a participant in the second-quarter PricewaterhouseCoopers Korpacz Real Estate Investor Survey. The bid-ask gap has narrowed, mostly because sellers have acknowledged current market conditions. Betraying continued uncertainty, Korpacz survey participants offered mixed views on asset values, with some foreseeing increases of as much as 15% and others expecting continued declines of as much as 25%.
Investor interest isn’t relegated solely to Class A properties, and pockets of strength have turned up in some interesting markets, notably Phoenix, hard hit by the single-family housing crisis and shadow supply of homes and condominiums.
"There’s more of an investor appetite for Class A properties, but at the same time, you’ve seen more price declines and fundamentals declines on the lower properties. There’s a large number of groups that want distressed assets, B-minus and under," said Jack Hannum, vice president with Transwestern. Hannum and Vice President Bret Zinn are co-leaders of Transwestern’s multifamily team in Phoenix. "There’s just a tremendous appetite for all multifamily product here. If a deal goes to market, there’s high demand for it."
On the financing side, government-sponsored entities Fannie Mae and Freddie Mac have long been the dominant providers of debt capital in multifamily, a trend expected to continue despite the political and market challenges the agencies face. However, one increasing trend since the beginning of the year is the growing participation of life insurance companies, noted Jeff Majewski, executive managing director, capital markets, for Grubb & Ellis. For most of 2008 and 2009, the insurers were out of that market and effectively ceded that business to the GSE agencies, but they’re back strongly this year.
"The life companies have come into the space and they are aggressively competing with the agencies -- and in many instances winning many of the top-tier Class A projects -- primarily because they’re willing to take on a little bit more lease-up risk," Majewski said. "We think that’s going to continue through 2010. We don’t see any slowdown in their appetite for multifamily."
Hannum and Zinn recently represented Weidner Investment Services, based in Kirkland, WA, in a $16.65 million off-market acquisition of the 258-unit Monterra apartment community in Phoenix from Aslan Realty Group, a deal which closed in under two months. Weidner said it plans to hold onto the property long term to take advantage of increasing net rental income and falling vacancies as the Phoenix market continues its expected recovery over the next 18 months.
Weidner "just flat-out told Jack and I they wanted to buy 3,000 units and wanted to be in Phoenix," Zinn said.
With so much demand and lack of high-end product on the market, apartment buyers are willing to pay the so-called ‘scarcity premium’ for quality assets, Zinn said. At the same time, many investors who raised funds two or three years ago but were forced to wait on the sidelines for the market to stabilize may now face deadlines to deploy that capital.
"We get calls daily from new groups that want to be in Phoenix and are ready to buy. We just don’t have enough product to show them," Zinn said. "A year ago, no one in the market was convinced we were at the bottom. Over the last three to six months, there’s a lot more investor comfort in Phoenix that the market is at bottom and now is the time to buy."
"Prices are where they were 10 years ago. In the C market, prices are where they were 15 to 20 years ago," Hannum added. "Net effective rents aren’t going any lower. You’ve still got good sources of financing with Freddie and Fannie. A lot of these buyer groups aren’t concerned with timing the bottom perfectly; they’re going to cost-in their acquisitions and average in the bottom."
Also in the Phoenix market, Colliers International recently negotiated the sale of two Class B apartment assets in Mesa, AZ, to San Mateo, CA based Acacia Capital for $33.35 million. The 304-unit Verona Park property sold for $15.2 million, or $50,000 per unit. Argenta, 395 units, sold for $18.15 million, or $45,949 per unit.
"We had a very strong response with multiple offers at, or over, list price," said Brad Cooke, vice president with Colliers’ Phoenix office, who along with vice president Cindy Cooke, represented the undisclosed seller. "It came down to who had the funds to close all-cash on both properties, could move fast, and had an in depth knowledge of the two submarkets."
REITs and institutions targeted large properties in major markets this year, but private equity players were also in the mix. A sampling of other significant multifamily transactions tracked by CoStar in the first two quarters includes the following:
- Equity Residential (NYSE: EQR), the largest apartment REIT, in the first quarter acquired three luxury apartment complexes in Manhattan from Macklowe Properties, River Tower, 777 Sixth Street, and the Longacre House, for more than 900 units in deals totaling $475 million.
- A private equity firm identified only as Standard Austin acquired multifamily portfolios totaling 5,000 units across 16 properties in Maryland and Texas from Irvine, CA-based Bethany Group out of Chapter 11 bankruptcy for a reported $327.7 million.
- Select Investment Realty Advisors, LLC on June 7 closed on the sale of the Fairhaven Multifamily Garden apartment portfolio in Long Island, NY, seven assets totaling 1,666 units located in Nassau and Suffolk counties. Eagle Rock Management, LLC acquired the portfolio for $229.75 million.
- Equity Residential acquired 425 Mass, a 559-unit condo/apartment property in Washington, D.C. for $167 million, in a bankruptcy deal.
- Watermarke Properties bought the Gardens at Wilshire Center mixed-use apartment project, a Class-A asset with 159 units between Beverly Hills and downtown Los Angeles, for $48 million. Watermarke was among 30 bidders for the asset.