When Irvine, Calif.-based Atherton Newport Investments filed for protection under Chapter 11 of the Federal Bankruptcy Code in the Central District of California, Santa Ana Division, on Jan. 16, many industry observers saw it as a sign of things to come.

No mere mom-and-pop operation, Atherton controls 5,000 multifamily residential units throughout Las Vegas, Phoenix, Seattle, and South Florida. What's more, as recently as last August, the firm noted in a white paper that its internal rates of return since 2001 were clocking in just above 50 percent, more than nine and half times the S&P 500 over the same period. “While uncertainties do exist within the credit markets that may impact us, we continue to monitor the situation closely,” Atherton CFO Michael Kim wrote in the white paper. “However, we are very comfortable with the mix of assets in our portfolio, and we continue to look forward to new opportunities and investments.”

In a statement accompanying the bankruptcy filing, Atherton said only that the Chapter 11 filing was necessitated by “the actions of one of [its] creditors.” While company officials declined to comment on what market forces—if any—might also be stressing the company's business model, most industry observers suggest that a preponderance of overleveraged deals and extremely limited refinancing options for all but the most noted multifamily companies has completely stalled the commercial-backed mortgage securities market.

The 297-unit Chapel Oaks in Dallas scored more than $7 million in refinancing despite a signficant stall in multifamily lending.
Green Park Financial The 297-unit Chapel Oaks in Dallas scored more than $7 million in refinancing despite a signficant stall in multifamily lending.

SKIN IN THE GAME Just how much has multifamily lending stalled? In its 2008 Real Estate Market Outlook issued Feb. 19, New York City-based Ernst & Young notes that there likely won't be any new CMBS issuances until mid-2008. The report says that upwards of $50 billion in loans are still in the CMBS pipeline following the collapse of the credit markets in August 2007, and it remains to be seen how many of those deals will stay in place. “CMBS lenders are pretty much not lending right now,” confirms Ken Miller, a partner in the real estate practice group of Los Angeles-based Moldo Davidson Fraioli Seror & Sestanovich. “They are skittish and backed up waiting for people to buy their paper, and many of them are pulling back, if not entirely out of the market.”

Although multifamily debt is not entirely unattainable, “to do a deal today, you need liquidity, and you want to make sure the property will adequately cover the debt,” says John Dessauer, CEO of Crown Point, Ind.-based multifamily owner The Dessauer Group. “We are going back to the more traditional underwriting standards where you have to make sure that you have some skin in the game.” Indeed, the Ernst & Young report says that even as CMBS lending begins to tick up, borrowers should expect to put 20 percent to 30 percent hard equity into their deals.

The option that remains for most non-equity players is higher risk mezzanine and conduit financing, which in itself could exacerbate any lending crisis. As calls on mezzanine loans come in, borrowers in the current climate are finding virtually no avenues for refinancing. Well, almost no avenues. On Feb. 28, Bethesda, Md.-based Green Park Financial announced it had provided a $7,150,000 refiloan for Chapel Oaks Apartments in Dallas. Green Park structured the loan with a 10-year term and two years of interest-only financing followed by a 30-year amortization. The loan was underwritten to an 80 percent loan-to-value with a 1.23 times debt service coverage ratio. For stressed multifamily firms that are looking for a different refinance play on loan calls, there seem to be three current options: pay, default, or liquidate.

RIDERS ON THE STORM That leaves multifamily stalwarts—especially those with a value-add business model—in decent shape. Firms that amassed development and acquisition funds when the getting was good are likewise well-positioned to acquire property and assets. “We are seeing lots of interesting deals, and more of them,” says Dave Woodward, CEO and managing partner of Greenwood Village, Colo.-based Laramar Communities. “I haven't heard of some of the bigger names having to dump deals yet, but you never know. The lack of financing available coupled with shadow markets has cap rates creeping back up slightly. The distress that is out there hasn't peaked yet.”

Whether or not Atherton Newport successfully navigates out of Chapter 11—with or without a full-scale asset disposition—remains to be seen. If similar foundering firms can hang on through the current doldrums, some market experts predict that steady multifamily fundamentals and an impending demographic tide of Gen Y renters will ultimately boost the entire industry. “We'll see isolated pockets of distress,” says Chris Finlay, CEO of Oakton, Va.-based Mission Residential. “But ultimately, it is going to be a scenario where even people that took very aggressive positions from an underwriting and leverage standpoint are going to get bailed out ... over the next several years.”

Unless of course, the multifamily credit markets follow the path of single-family lending. “Just as we had screwy paper with residential, there might be some paper that was screwy with commercial—who knows until those loans start maturing?” Miller says. “If you get some unusual provisions like there were in residential … That would be the real ripple effect.”