For Kitty Wallace, the lead multifamily broker in the Southern California office of Sperry Van Ness, it was a familiar challenge. Her client, a private investment group, was looking to sell its 2,271-unit apartment portfolio, a mix of 15 Class A and B properties spread across the central California markets of Fresno and Bakersfield. Buyers seemed interested, but only when it came to the trophies: the larger Class A properties valued at $30 million or more. The smaller Class B buildings —valued between $8 million and $10 million—just weren't getting enough attention for the client, which hoped for a clean exit from the entire portfolio in light of a market where competition for renters was stiffer and bids were coming in lower than the asking price.
To increase her client's exposure, Wallace recommended a two-pronged approach: First, list the smaller properties individually; meanwhile, fold them into the larger portfolio as well, and market them as an integral part of a franchise-changing opportunity, instantly establishing a notable presence for any buyer looking to enter California's Central Valley market.
“Nobody wants to fly cross-country to visit a few teeny buildings,” Wallace explains. “This way, we rolled them up and said, ‘You can buy them separately if you want, but here's also the portfolio as a whole.' That's a lot better reason for someone from New York or Florida to come and take a look.”
The approach worked. And while the entire portfolio didn't go in one fell swoop, Wallace was able to put 13 of the 15 properties under contract to one buyer, with the remaining two slated for a second purchaser. Both deals are set to close in the second quarter. “Neither had any presence in that market to begin with, so it worked out well to give them both a place to start,” Wallace says.
Wallace's client was poised to get something as well: a $140 million divestiture and a desirable exit from his investment. Similar portfolio sales scenarios played out during the entirety of 2007, a record-breaking year for transactions with $19 billion in portfolios changing hands, according to New York City-based research firm Real Capital Analytics. Successfully placing such deals in 2008 will become increasingly challenging, though, as the flow of debt and equity financing has slowed to a trickle in the wake of the global credit crunch that began last August. One noteworthy exception is UDR's planned sale of 86 properties for $1.7 billion to DRA Advisors and Steven D. Bell & Co., announced in January.
NO MORE BIG DEALS Take, for example, the watershed deal of 2007—the privatization of Archstone-Smith Trust by Tishman-Speyer and Lehman Bros. for $22.2 billion, which closed early in the fourth quarter. Many analysts say that transaction was nearly stillborn, only to be salvaged by the backing of Fannie Mae and Freddie Mac. It likely would not be possible in today's uncertain economy. “Those kinds of megadeals just cannot happen without a robust debt marketplace,” says Dan Fasulo, managing director at RCA. “We expect portfolio activity to be down at least 50 percent in 2008.”
With that sort of headwind, multifamily dealmakers say selling portfolios will only get harder. But there are still ways to make sure your deal gets done, if you approach the market in the right way. “You need to evaluate the current market, analyze issues such as the tax implications of a large-scale sale, and find a broker to expose your properties to as much of the market as possible,” says Kraig Kast, CEO of Redwood Shores, Calif.-based Atherton Trust, which provides trustee services to multifamily owners.
THE SUM OF YOUR PARTS As Wallace did for her client, Kast says it's critical to examine the pros and cons of a single portfolio transaction, versus a piecemeal sale. A portfolio sale often results in a faster close, but selling properties one by one can result in a higher price—sometimes. Brokers often provide estimated valuations for both scenarios. If you're undecided on the right path, start by taking stock of what you own in the first place. Sound obvious? For many in the real estate market, even those with billions of dollars in holdings, it's not always a given.
“Many times, when you're building a company, you're so focused on growth in assets that you don't actually take inventory of what you have,” says Jared Kushner, principal of Kushner Cos., which sold its 17,500-unit apartment portfolio for about $2 billion last June to American International Group and Morgan Properties. By hiring brokerage firm CB Richard Ellis to underwrite the deal, Kushner says he gained a deeper understanding of his portfolio—and its underlying value—than he'd ever had before. “Basically, they did a colonoscopy on our real estate portfolio,” Kushner says. “It's a good exercise to go through, even if you're not fully interested in selling. Our company became much better organized as a result of going through the process.” Kushner believes the deal has allowed the company to return to its core competency as a dealmaker, not portfolio manager.
DIFFERENT REALITIES Of course, the Kushner portfolio sold in markedly different market conditions. Now, with financing scarce, smaller packages should rule the day; there are likely to be more $20 million deals than $200 million transactions. Yet, for buyers looking to pick up new portfolios at a bargain price, observers say opportunities may start to proliferate in 2008, especially as failed condo conversions come back onto the market. Why? As market dynamics evolve, many of the portfolios up for sale are likely to be ones where the current holder has no other choice but to sell. Observers say that in the current environment, cap rates and prices have begun to stagnate, though neither buyers nor sellers have made significant moves to bridge the gap between asking prices and bids. Given that scenario, the buyers who do give in will likely do so grudgingly, if their hand is forced.
“Most portfolios you see today are going to be sold by the lender, not the developer,” says Bob Sheridan, founder of Robert Sheridan & Partners, a Chicago-based developer focusing on condo conversions. “If you're a developer, you don't want to sell right now unless you have to.” That's especially true when it comes to broken condo conversions. In many cases, developers abandoned those properties after converting 20 percent of the units because they were unable to service their debt before completing the conversions or selling the remaining units. That problem can be compounded by the fact that many conversion deals were made with little regard to the underlying cap rate paid in a transaction, since the plan was to ultimately sell those units.
As more of those situations unwind this year, and lenders begin to take them back, dealmakers can expect a wider selection of property portfolios to emerge. “I think a lot of people are beginning to test the waters,” says Adrian Zuckerman, who heads the real estate practice at New York City-based law firm Epstein Becker & Green. “I don't know that we're at the point where we're seeing large [multifamily] packages going into foreclosure yet, but unfortunately, I don't think we're that far away.” Zuckerman recommends developers who are in that situation approach their lenders first to see if they can restructure a deal; in many cases, financiers have become more flexible, especially if they see little possibility of getting their money back in foreclosure.
Joe Bousquin is a freelance writer based in Sacramento, Calif.
ACTION ITEMS -- CLEARING HOUSE
- Know what you own. One of the keys to successfully exiting a portfolio is knowing the extent of your holdings. Sound obvious? You'd be surprised. In the course of building your portfolio over the years, you may have lost track.
- Gain maximum exposure. Work with a broker who will list your properties as a portfolio, and as one-off opportunities to maximize your exposure to all buyers in the market.
- Consider the conversion crunch. For buyers, dealmakers say portfolios of busted condo conversions will start showing up in 2008, and opportunities could proliferate.