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Fasulo

[IMAGE(1)]NEW YORK CITY-The tidal wave of turmoil that has washed over Wall Street seems to have spilled over to the property markets. For the apartment market, sales totals were on track to grow--that is, until the federal takeover of the GSEs and crisis among the banking institutions came into play. Property trades, for now, appear to have stalled.

There were $4.5 billion worth of multifamily trades at the beginning of September, with another $6.5 billion in contract. That would have brought the quarterly total past $9.3 billion. But once news of the Fed’s conservatorship of Fannie Mae and Freddie Mac, along with the Wall Street crisis, came out, buyers and sellers delayed, re-traded or called off deals. "With the events of the past few weeks, all bets are off," says Dan Fasulo, RCA’s managing director of research. In the past decade, he adds, "I’ve never seen such uncertainty in the market and such a lack of investor confidence."

The bid-ask gap is another hurdle. The pace of sales will continue to remain low until that spread narrows. And with fundamentals in most apartment markets doing relatively well, sellers are under little pressure to put their properties on the block or decrease their asking prices.

But that doesn’t mean there aren’t buying opportunities around the bend; according to Real Capital Analytics, the number of distressed sellers in the market has ticked up, and that figure should only grow as the market continues to correct itself. Over the past year, there really hasn’t been much sales activity due to the standoff on pricing, says Joseph Mullen, senior vice president and director of multifamily investments for BPG Properties Madison Apartment Group. "Over the last 30 to 45 days, it seems to be lightening up a bit and there appears to be more deals starting to get done now," he relates.

The concept of distress among sellers isn’t new; owners of failed condo projects have been exiting their deals since the collapse of the for-sale market in 2006. But with more than 8% of recent apartment trades involving a distressed seller--a four-fold increase over the past year--it’s clear that troubles are surfacing in other parts of the multifamily market. By dollar volume, distressed sales peaked at nearly 10% at the end of 2007, and ranged between 4% and 6% for most of the past year, with smaller properties the most affected, for now. Whatever the measure, those levels are greater than the distress seen in retail or industrial space, and--thanks to those failed condo projects--the number of trades of troubled apartment assets is far above those in the office segment as well.

And because the number of distressed sales is considerably greater than the reported mortgage delinquency rates, it’s evident that sellers are under increasing pressure. RCA maintains there’s potential for a variety of different sellers to enter into a distressed situation, though there hasn’t yet been a noticeable shift in seller composition.

"The one thing about the credit crunch is that it’s been awfully democratic," says Fasulo. "It’s impacted every market and investment player. We’re an industry that relies on the debt markets in our everyday course of business. When the debt markets shut down, there’s no question we’re going to feel some pretty significant impacts."

The good news, he points out, is that the GSEs, despite their troubles, continue to lend on multifamily deals, although with tighter underwriting. Debt capital is also trickling in from local and regional banks, as well as insurance companies, for the right types of deals.

For investors looking into the multifamily sector, there is potential to make some interesting plays. One area to watch is the asset dispositions by institutions that were active acquirers of apartment properties, but now have gone under, such as Lehman Brothers, which helped to take Archstone Smith private in 2006. Since June, points out RCA, sales of former Archstone assets account for 12% of all apartment sales.

"Those assets are coming to the market," says Fasulo, but most investors are waiting to see what

Mullen

transpires after those firms go through bankruptcy court and the assets are packaged and put on the market. In Lehman’s case, he explains, "they always operated with a partner--in the Archstone deal, it was Tishman Speyer. Lehman partners with pretty sophisticated local and national players who are very aware of what’s going on and are trying to replace Lehman with another partner of their choice. There’s no question there’s going to be significant demand from the institutional community for those assets, at the right price."

Another source of potential distress are owners of apartment communities that were highly leveraged in the past few years. With those loans coming due in 2009-2011, several of those players will be unable to refinance in the now tougher market. Many developments and value-add plays in particular, which tend to use floating-rate debt tied to LIBOR, will also see debt service spike, pulling their NOIs lower.

[IMAGE(2)] The credit issues in the market, says Mullen, will create significant opportunities over the next 12 to 24 months. "It will only increase as we go into next year," he states. "What’s happening is a lot of deals that were done in the 2002 to 2004 timeframe are now coming due. And all of a sudden there’s financing pressure because you can’t get a loan at the same terms you got before. That’s where you’re going to start to see the distress." While most of these types of deals in the market today involve weak housing markets, such as Florida, the executive believes conventional deals, including core and value-add, come to the market in other areas.

Yet the extent of the opportunities, and when they materialize, remains to be seen. The outlook is too cloudy to give any specifics as to the direction the market will likely head, maintains Fasulo. It’s unlikely that we’ll see an uptick in sales activity--or much change from current conditions, for that matter--in the next several months. "There’s just too much uncertainty over the bailout plan and its impact," he explains. "First you’ve got to remove all the bad assets from the books. The second part of that is going to be figuring out how to give the banks the confidence to start lending en masse to the market again."

Add to that the other opportunities available to investors today, he continues, which is funneling capital away from the apartment property ownership arena. "Look at the battering that REIT stocks have taken over the past few weeks," says Fasulo. With certain REITs, he relates, "if I were an institutional investor, I could buy their apartments by owning their stock at a valuation that’s much lower than if you were to buy their apartment assets right now, based on recent asking prices, and that’s really pricing in a severe recessionary environment. That is a really huge disconnect to me. Many investors are going to take a second look at what makes the most sense in this environment."

Debt plays, he adds, also make sense for those with capital to place. "By buying debt at a discount, you can get returns that are better than on the equity side, and it’s almost risk free, if the LTV is low enough," he says. "So there are other options within the commercial real estate space that’s very attractive and can take investors’ attention away from buying the actual assets.

As far as the short-term prospects for the investment market picking up, continues Fasulo, "I don’t see it materializing. But in a type of environment where you have fewer buyers and more forced sellers appearing, it’s no question you’re going to have downward pressure on pricing and upward pressure on cap rates."

According to RCA, the volume of properties put on the market again exceeded closings in August, with the year-to-date ratio coming in at 1.5 offerings for every completed transaction. And cap rates have moved up slightly to more than 6.5% on closed deals, while asking caps came in at 6.2% in August.

For apartment conditions, Mullen relates, that while they’re doing well today, it’s all tied to job growth. "I don’t think the credit issue will have much of an impact on the fundamental side," he notes. "It’s more related to job growth. If the credit market doesn’t strengthen itself out on a macroeconomic basis, it will probably start to lead into some sort of a recession. And if we don’t have job growth, that’s where the fundamentals of our business will really get hurt."

"At the end of the day, time will tell," he adds. "The markets are pretty efficient when it comes to pricing, and I think that’s what you’ll see over the next 12 to 24 months."