Sometimes too much of a good thing can be, well, too much.

"This is as difficult an investment climate as I've ever seen," says David Schwartz, managing member of real estate investment firm Waterton Associates in Chicago.

Schwartz's problem? A continuing overabundance of capital. "There is a tremendous amount of money chasing multifamily–institutional money, opportunity fund money, condo converters, small and large syndicators, and public and private REITs. I've never seen so much capital in the market," he says. "As a buyer, it's a tough market. As an owner/seller, it's a good market."

As many apartment execs know, much of that money is coming from condo converters, who accounted for 35 percent of all apartment acquisitions in 2005, according to research firm Real Capital Analytics.

But portfolio diversification, especially by institutional investors, also accounted for a substantial portion of the dollars being spent. "The biggest and smallest investors are under-allocated in real estate," says Robert M. White Jr., president of Real Capital Analytics. "There is incredible demand by investors, especially institutional investors, for apartments as rental units."

It's resulted in some staggering numbers. "In 2005, we tracked $87 billion of significant apartment sales–properties with values of at least $5 million," White says. "That is a 72 percent increase over 2004, and 2004 had a 70 percent increase over 2003."

But such growth curves won't last forever. While apartment sales volume will increase in 2006, White predicts it won't be close to the 70 percent annual growth rate of the past two years.

Responsive Decisions

Between all the capital and all the competition, multifamily owners and investors are turning to a variety of investment strategies.

Most of the clients of real estate investment advisor and manager RREEF are capital-rich institutional investors, giving them lots of options in today's market, according to Brian McAuliffe, a RREEF partner and managing director in the company's Chicago office. While some institutional investors are increasing the portions of their funds allocated to real estate, that isn't the case at RREEF. "[Our investors are] just continuing to satisfy those allocations," McAuliffe says, whose firm prefers to purchase infill apartment communities where lack of land in the area precludes competition.

Like RREEF, Waterton Associates has competition criteria: Acquisitions must be in markets where there's no threat of over-supply. Schwartz currently has a $330 million equity fund, mainly CalSTRS money. It's a discretionary fund, requiring no approval from CalSTRS for a deal. "This lets Waterton react quickly, which is an advantage in the current buying environment," Schwartz says. He can leverage the sum into $1 billion worth of buying power, which he'll use to purchase properties that Waterton can renovate and reposition at higher levels.

This fund and its discretionary nature are no different from previous Waterton funds, with one exception: It's bigger. Return hurdles for this fund are in the low teens, however, versus the mid-teens for recent funds. "That allows us to price a little more competitively," Schwartz says.

Waterton is also trying a few new tricks to deal with the current investment climate. "We have a larger acquisition team on the ground and are really focused on finding off-market transactions," Schwartz says. "We are doing more creative types of transactions such as keeping the seller in the deal to offer tax protection, purchasing partnership interests, or assuming above-market debt rate."

Half of one property that Waterton is currently buying was converted to condos; Waterton is buying the other half and converting it back to apartments. "Sellers have plenty of buyers," Schwartz says. "Today, you have to think creatively to make you the preferred buyer. We do that by helping a seller solve a problem."

With most major apartment buyers requiring outside sources of equity to complete today's deals, Deutsche Bank Berkshire Mortgage has repositioned itself to seize new opportunities. "We aren't just lenders, we help choreograph the whole capital structure from debt to equity," says Jeff Day, managing director and co-head of the bank. "We can help arrange mezzanine financing or preferred equity so a borrower doesn't have to give away too much ownership."

Working with entrepreneurial, private partners, Boston-based BayNorth Capital also purchases tired or troubled A- or B- assets, which once upgraded, are either sold or kept. BayNorth also does ground-up development of Class A properties. Why build rather than buy? "A lot of buyers, both foreign and domestic, will pay very high prices for Class A properties," says Charles Wu, managing director. "I'd rather build Class A properties and sell them to those investors."

Regardless of the transaction, Wu says that in the current climate, BayNorth must move a lot faster to execute it. "We are traveling more frequently and on short notice to be responsive, and we are perhaps putting more 'at risk' money down earlier than we are accustomed to," Wu says. "By definition, we are assuming more risk upfront to tie up deals."

Because the capital flood is so daunting, BayNorth chose a different direction for its latest fund. "We purposely raised a smaller $400 million fund to allow us to do smaller deals and be more selective," Wu says. "It is very competitive out there."

Others are buying aggressively. By mid-January 2006, Hamilton Zanze and Co., a San Francisco-based investment and asset management firm, was involved in $150 million in deals either under agreement or closed–a dramatic increase from the past. (The company closed nine deals in 2005 totaling $190 million.) "We're staying the same in terms of type of investment–apartments–but we're growing," principal Mark Hamilton says. Despite the challenges for apartment firms right now, he says, "low fixed-rate debt costs have put apartment investing into a golden age."

But some are swearing off buying apartment properties altogether. Fifteen Group, an owner, developer, and manager based in Miami Beach, Fla., hasn't bought any property–apartment or otherwise–since 2003. In 2006, Fifteen Group will be buying again, but CEO Mark Sanders says his strategy will be a pure land play. "We're looking at anything that has a land component for what we can turn it into through re-zoning," he says. For example, he's assessing a golf course in an undisclosed location. "We plan to do adaptive re-use and create housing where there isn't any right now on non-residential property or land."

Sales Time

Fifteen Group is in good company. Many multifamily firms would like to be more aggressive property buyers–Chicago-based Laramar says it would like to invest $200 million to $300 million in 2006, for example–but given the current market, most are spending more time selling properties than purchasing them.

Sales have been vital for Fifteen Group, which owns mainly non-subsidized affordable housing. "The flight of people to single-family homes has hurt us," Sanders admits. "We've had horrific fundamentals from the third quarter of 2001 to today. On an operational level, we have assets that from 2001 have put less cash in the bank every month than the month before, yet they're worth more."

Marianna Day Massey/ZUMA/Corbis

Due to that irony, Fifteen Group has continued to make money, selling 3,000 units in 2004 and 2005, mostly to condo converters. "We took advantage of property values when they were hot, and we're still selling, just not as much," says Sanders, who expects to sell at least seven properties totaling about 2,000 units in 2006. "There are a handful of other deals on the bubble, which we could sell or keep."

Others are continuing to sell, sell, sell. In 2005, Waterton Associates disposed of $375 million worth of properties, about 25 percent of its portfolio. And Schwartz says he expects to sell a similar amount in 2006.

Where is he unloading apartment buildings? Only in markets with substantial appreciation, such as Florida and Las Vegas. Among his keepers: properties under renovation, because he won't be able to realize their full value until the work is completed. Schwartz is also holding on to properties in markets where rents are beginning to rise, such as Austin, Phoenix, and others. But not for long. Once these markets stabilize, Schwartz says he'll start selling properties there too.

Condos and Capital

Condos have been a hot topic for months, as condo converters bid up sales prices against multifamily buyers at the same time as they benefited multifamily sellers.

Even Post Properties, the Atlanta-based apartment REIT, has gotten into the condo business, converting three or four of its existing properties at a time to condos. (The company is also developing new condo buildings.) This approach allows Post to generate what CEO and president David Stockert calls "a nice, diversified stream of cash flow."

But rapids may be coming soon for the condo market, which has recently seen high-profile cancellations for new projects in Las Vegas. (See "High Stakes," page 17.) Interest is also softening in other key markets. Last year, Apartment Realty Advisors' Boca Raton, Fla., office, which handles the Florida market, completed 51 transactions worth a total of $2.7 billion. "Of our transactions, the vast majority were condo conversions," says ARA principal and broker Marc DeBaptiste, who says that situation started changing in the last quarter of 2005. This year, DeBaptiste says, "the bloom is coming off the rose for condo conversions because some condo markets are saturated."

Beyond the Bend

As 2006 progresses and apartment fundamentals improve, many expect buyers to become more competitive and able to offer higher prices for apartment properties because they can anticipate more income from their acquisitions. "In the past few years, we had declining occupancies that impaired landlords' ability to raise rents," says Chris Wimmer, an analyst with Moody's Investment Services in New York City. "That trend bottomed out in 2004 and 2005. Now occupancies are increasing, so rents can grow."

Condo conversions are also expected to slow, with such deals representing only about 20 percent to 25 percent of the apartment deal market, according to White of Real Capital Analytics. But don't expect multifamily investing to turn into a buyer's market. "Instead of a seller getting 25 or 30 bids for each property," he predicts, "they'll only get 15 or 20."

–Bridget Mintz Testa is a freelance writer in Houston.