Marcus & Mellichap

SWEET SPOT: Mid-sized deals, such as the $42.8 million sale of Waterford Commons, a 303-unit community in Manchester, Conn., are seeing traction today. Last fall, real estate attorney Pam Rothenberg started working on a contract to help her client buy a 386-unit apartment property in the Atlanta area. Valued at about $18 million, the property was in an area where her client wanted to buy and the seller was motivated by a loan that was coming due. In most cases, transactions in that price range had been closing in 60 to 75 days.

But then “the Armageddon market” hit. That's how Rothenberg, a managing member of Winston-Salem, N.C.-based law firm Womble Carlyle Sandridge & Rice, refers to the current multifamily dealmaking environment. “It took eight months to get the deal under contract and then closed,” Rothenberg says. “We amended the contract at least six times, including on the day of closing.” What's more, arranging financing for the buyer was a battle. The investors wanted an internal rate of return of 21 percent, instead of the original 18 percent they requested. Over the course of the negotiation, the lending source changed three times, despite the deal's relatively small size.

“It was not a huge deal, which is why it was even more astonishing it took so long to get closed,” Rothenberg says. “But that deal hit right when the market deteriorated. It's just representative of what is going on in this market right now.”

Indeed, small- to mid-sized deals, those valued at $100 million or less, seem to be closing. But the demands of lenders and pre-close requirements of investors are unlike anything the industry has seen in more than a decade. That has multifamily players scouring to find the right kinds of deals—at the right size—to push ahead.

TRICKLING THROUGH For most of 2007, deals wrapped up in a matter of weeks. But getting deals closed today is no longer a sure bet, even when you have willing participants at the table. Much of that is due to the turmoil in the capital markets.

Take the “conduit” lenders, those high-power finance firms that bundled various loans into complex derivatives such as commercial mortgage-backed securities (CMBS) and resold them to investors on Wall Street. They have all but fled the market. As a result, more traditional lenders—banks, savings and loans, or funds that specialize in real estate investment—are the main sources of money today, and they are determined to see sound numbers.

“From an investor's standpoint, there are still a lot of deals out there, but 95 percent of them make no sense,” says Paul Dougherty, president of Washington, D.C.-based Perseus Realty Partners, a private equity real estate investment firm.

One deal that did make sense? Ansley at Princeton Lakes, a 306-unit, Class A project in Atlanta developed by Atlanta-based Hathaway Properties. Perseus provided $4.6 million in equity on the $29.7 million deal. Montgomery, Ala.-based Colonial Bank provided the balance of funds through a traditional construction loan, based on a few factors—the equity Perseus put up, Hathaway's proven track record in that that market, and the project's adjacency to a 1.2 million-square-foot retail center. “That size deal—from $20 million to $70 million—is in our sweet spot,” Dougherty says.

Steve Witten agrees. “In [that] range, we are dealing with institutional or larger private buyers that have both discretionary equity and well-established relationships with lenders to ensure that the deal closes,” says the senior director of the National Multi Housing Group for Marcus & Millichap.

That may also be one reason mortgage giant Fannie Mae recently unveiled an initiative to focus on micro-sized loans for multifamily deals up to $5 million in value. Having invested more than $20 billion in the sector in the first half of 2008, the government-sponsored mortgage giant said the strategy will help alleviate “stress in the capital markets and a downturn in the [CMBS] market.” The firm announced the initiative just as concerns emerged about the viability of Fannie and its sister agency, Freddie Mac. Both companies say that they're not at risk of becoming insolvent.