The funds are here. The opportunities, not so much.

While many opportunity funds have been raised over the past two years, investors continue to bang their collective heads against the wall as they survey a scarce acquisition market.

Class A assets in solid locations are inspiring frenzied bidding wars, while the volume of deeply distressed assets has yet to reach a critical mass.

But some of that pent-up equity waiting on the sidelines may re-adjust its expectations in the second half by shifting away from acquisitions and to new development in high-barrier markets.

“We are seeing capital, both debt and equity, come back to development much more quickly than we thought it would,” says Joseph Keough, COO and CFO of Atlanta-based Wood Partners. “A lot of our institutional partners are having trouble sourcing higher return acquisition opportunities, especially in high-barrier coastal markets, and as a result, they’re turning back toward development.”

Wood Partners currently has five developments under construction and has another five planned to break ground in the second half. To date, the company has financed its developments through one-off institutional equity and debt partners but is looking to programmatically source debt and equity going forward.

“The acquisition opportunities within multifamily just haven’t manifested at the return or volume levels these funds need,” Keough says. “So they’re looking for higher return opportunities and risk-adjusted development is looking more and more attractive. In markets like Boston, D.C., Northern and Southern California, we believe the best opportunities are to develop, and our capital partners agree.”

Brokers are reporting a jump in institutional capital looking for new construction deals, and expect more investors to follow. New development candidates are few and far between, and each deal is being heavily scrutinized, but investors are realizing that the yields they targeted will likely not be met through today’s acquisition market.

“Six months ago, you couldn’t get anyone to talk to you. Now we are starting to see the stirrings of some equity for new construction—we just got one deal done and are working on another,” says John Fenoglio, a senior vice president at Charlotte, N.C.-based Grandbridge Real Estate Capital. “It appears the insurance companies are leading the charge—they’ve been virtually dormant the past two years, but now they’re looking selectively.”

Like many investors, PRP Real Estate Investment Management is frustrated at the pace of the transaction market. The company raised a $60 million opportunity fund focused on acquisitions about two years ago, looking to leverage it at 75 percent. But like many investors, it has had a hard time placing the capital.

“Two years ago, I would’ve thought we’d be fully invested by now,” says Loren Balsam, managing director and senior investment officer at Washington, D.C.-based PRP. “I thought the environment would be littered with distressed deals—we all thought the movie would look like the early '90s, but unfortunately it turned into a different movie.”

The company has seen better acquisition opportunities in other asset classes such as the office sector. PRP is looking for cash-on-cash returns in the low double digits but doesn’t see that panning out in the multifamily industry.

While it’s not pulling the trigger on new development, PRP is seeing more its peers move in that direction. “Investors are saying, ‘If I can build to a 7 percent or 8 percent cap, maybe it’s worth taking the construction lease up risk if the market is that tight for acquisition,” Balsam says.
Still, the scarcity of deals and prevalence of bidding wars speaks to the multifamily industry’s desirability. Many funds are now overpaying to park their money in the multifamily industry, wooed by the demographic and constrained-supply dynamic that points to aggressive rent growth in two years.

“People with closed-end funds or qualified allocations need to get money out and feel they have to overpay to at least deploy capital,” Balsam says. “What’s the alternative? To hand it back to their investors? I don’t think anybody wants to do that.”

Wood Partners, for one, is having success attracting institutional capital to its new developments. One example is the recently announced City Walk development, a 264-unit Class A apartment and retail project in downtown Oakland. The development was only about half complete when its general contractor, UPA, filed bankruptcy three years ago. Designed as a condo project, the original developer invested $83 million into the project, and Wood Partners purchased it for just $5 million in late 2009. The company was able to secure equity from Berkshire Property Advisors, while American National Insurance Company provided the construction debt.

Wood also recently purchased a 2.5-acre site in Sandy Springs, Ga., in a distressed land deal, and plans to quickly break ground on Alta Glenridge Springs, a 168-unit mixed-use project. Funding for the acquisition and development was provided by the CB Richard Ellis Strategic Partners U.S. Opportunity 5 fund, a commingled private equity real estate fund.