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By all accounts, 2009 was supposed to be the Year of Distress. Yet the tsunami everyone anticipated was more of a drizzle. Why did nothing happen?

There was blood in the streets last year. More than 130 banks failed in 2009. Fundamentals, from effective rents to occupancy levels, declined to record lows. There were fewer sources of debt all around. A number of large multifamily owners—including Fairfield Residential, Babcock and Brown, and Bethany Holding Group—went under. And a wave of loan defaults had vulture funds salivating as they hunted for easy prey at wholesale discounts.

Yet, despite the fact that a new opportunity fund seemed to close every week in ’09, the pace of distressed acquisitions was slow, to say the least. Distressed sales only accounted for about 15 percent of the overall multifamily sales volume through November 2009, according to New York-based market research firm Real Capital Analytics (RCA). And while the volume of distressed apartments decreased in September due to increasing resolutions, it climbed again in October and November, reaching $27.9 billion in total, according to RCA.

While the pace of distressed acquisitions is expected to pick up in the coming years, “it won’t be the bloodbath that a lot of people expect,” says Linwood Thompson, managing director of Encino, Calif.-based Marcus & Millichap. “The amount of money being raised for distressed asset purchases is going to be a lot harder to place than most people think.”

Take Alliance Residential. From the start of 2008 to November 2009, the Phoenix-based company had underwritten more than $4 billion of potential distressed transactions—but only closed on $100 million. “The level of distress is certainly as much if not greater than we ever thought it would be,” says Jay Hiemenz, CFO of Alliance. “But the level of dispositions are not.”

Or how about Bainbridge Cos., an apartment owner with 8,188 units based in Wellington, Fla.? In early 2009, the firm announced that it had launched Bainbridge Distressed Property Services, which could, among other things, acquire distressed properties from owners and lenders. Bainbridge had commitments from a handful of institutional investors interested in a distressed platform but hadn’t done many deals. In recent months, the company has entered the home stretch on a few transactions. Still, none have closed. “On the deals that were really far down the road, we found during due diligence that there were a lot more structural type of problems on the older deals in great locations,” says Rick Giles, Bainbridge’s managing partner of acquisitions and dispositions.

The experiences of Alliance and Bainbridge were not uncommon in 2009. Most of the opportunity funds raised in 2008 and 2009 were expecting returns of around 25 percent. But as more buyers entered the market chasing the same few opportunities, those return expectations fell fast. And now, investors and fund managers are looking back and wondering if “wait and see” was the right approach or if they missed the time to strike.


Most industry observers headed into 2009 believing there would be terrific buying opportunities. “[They thought it would be] like during the RTC [Resolution Trust Corp.] days,” says Eric Bolton, CEO of Mid-America Apartment Communities, a Memphis, Tenn.-based REIT with 42,252 units. “So a lot of funds were put together and a lot of platforms were created to go out and buy these deals. I think we’ve all been a little bit surprised that we haven’t seen the level of deal flow that we would have liked to have seen.”

Others had the same experience. “We’ve tried [to buy distressed assets], and we’ve looked at a lot of REO loans and any other paper that’s been shopped,” says Robert Lee, senior vice president of JRK Birchmont Advisors, a company with 38,000 units in 26 states. “Frankly, we haven’t seen a lot of investment opportunities.”

A lot of hungry buyers and brokers point to the banks and, more specifically, their prolific extend-and-pretend policies, which seemingly delay the inevitable, as the culprit for this distressed logjam. “People are finding that lenders extend loans rather than recognize losses,” says Steve Bram, a co-founder and president of George Smith Partners, a Los Angeles-based lender. “The government and lenders did not feel pressured to pay off loans that were upside down or headed to foreclosure. So, they just allowed them to sit in limbo.”

When banks did put assets on the market, many bidders felt strongly that they were not at distressed pricing. “We’ve seen a lot of deals where the lenders will come out and test the market,” says Jerry Dunn, CEO of A10 Capital, a lender based in Boise, Idaho.

In many cases, it was the underlying loan being sold, not the asset itself, that was the culprit. “Right now, the banks and special servicers are inundated with problem situations—and note sales are the easiest way to dispose of assets,” says Dale Conder, COO and chief risk officer with A10 Capital.

The equity and mezzanine debt in these distressed deals also played a role in preventing their sales. “It’s so complicated to unwind these assets given equity,” says Lili F. Dunn, senior vice president of investments at AvalonBay Communities, a REIT with 50,114 units based in Alexandria, Va. “There are many complicated layers of equity and financing. You have to get consent from several investors that have conflicting investment objectives. It’s very difficult to get everybody to agree.”

With this sort of leeway, a lot of owners felt no rush to sell. “If the market isn’t liquid, most people hold tight,” says Chad Christensen, president and a co-founder of Cottonwood Capital, a Salt Lake City-based real estate investment and asset management company with approximately 6,000 units. “If the bank is not forcing them to panic, they’re not panicking.”

Buyer Beware

To a certain degree, stagnated buyers are right to accuse banks of dipping their toes into the sales market. But in some instances, the people who were looking to scoop up the distressed apartment buildings were just as culpable as the sellers and banks.

“Brokers say they have 30 or 40 offers on a single deal,” says Mike Kelly, president and co-founder of Greenwood Village, Colo.-based Caldera Asset Management, a turnaround management and restructuring consulting company specializing in multifamily loans. “That’s true. But if you boil it down, there are only a handful of guys who can and will step up and close those deals at those prices. A lot of people are putting offers out there to stay busy, get a feel for the market, and keep their bonuses going.”

Even if a buyer wanted to move, sometimes it’s challenging to get equity to follow in lockstep. A number of buyers report that they were in the final stretches of recent deals before their equity backed out. That, though, doesn’t surprise Pat Barber, president and CEO of Encore Enterprises, a Dallas-based commercial real estate firm with 436 units.

“You have investors with high expectations for equity,” Barber says. “Up until a few months ago, they didn’t really get comfortable with the deals. Now, with markets thawing out, there are more lenders. On our first couple of deals, we were lucky to have three, four, or five lenders. Now we’re getting anywhere from 15 to 20 lenders bidding on our business.”

But Barber admits that, upon closer inspection, he’ll continue to pass on some deals. That’s not surprising, considering a lot of the distressed properties hitting the market have been fractured condos or lower-grade apartment complexes with dozens of problems, such as deferred maintenance issues or a degraded renter roll. “You may be able to buy [a property] for $5,000 or $10,000 a unit, and it seems like a great deal, but maybe the buyer didn’t put money in it, or you have a ton of down units, including some with mold damage and things of that nature,” says Lee of JRK. “Those properties are 50 percent to 60 percent occupied, and they stay like that unless you invest a lot into it.”

When these assets do come out on the market, Barber says the pricing isn’t exactly distressed. And that leaves buyers still searching for the bargain-basement deals that they anticipated in early 2009. [For more on when distressed deal flow might ramp up, see “Hedging Their Bets.”]

“We’re seeing brokerage groups say if you can get to this number, you can do a preemptive buy,” Barber says. “But we’re just not finding that those numbers really work.” — Les Shaver and Jerry Ascierto

What Will the Money Do?

The offers—and cash—are out there, but that may cause problems for asset valuations and cap rates.

Over the past year, antsy investors have lined up to strike on what they believed would be an avalanche of distressed properties. And while the volume of distressed multifamily assets reported more than tripled from 2008 to 2009, the wave that was expected hasn’t materialized. And some industry executives wonder how investors will react.

“Some of these funds and some of this money were probably put out there based on buying opportunities that are not going to be as attractive as originally hoped,” says Eric Bolton, CEO of Mid-America Apartment Communities, a Memphis, Tenn.-based REIT with 42,252 units. “It’s going to be an interesting sort of scenario to watch unfold. Will they give the money back and fold up shop or will they proceed and deploy anyway based on very aggressive underwriting expectations and hope that they can get there? We’ll see.”

Some industry observers believe that these groups have shifted their focus to non-distressed apartments or, at least, properties that are being peddled by motivated sellers.

“There’s no product, so the money that is out there is chasing the very small amount of product in any class,” says Mike Kelly, president and co-founder of Greenwood Village, Colo.-based Caldera Asset Management, a turnaround management and restructuring consulting firm specializing in multifamily loans. “There’s no product in the system. If you look from the Class A to C product, there is very little coming through the system from the servicers or lenders. So whatever money is out there right now is chasing the same deals. It’s driving up prices, which is a false positive.”

Market watchers have seen this affect cap rates, too. Kelly thinks the phenomenon has pulled rates down 25 to 50 basis points in some markets.

Lili F. Dunn, senior vice president of investments at AvalonBay Communities, a REIT with 50,114 units based in Alexandria, Va., thinks cap rates have moved down 25 to 50 basis points in good markets. “We’re seeing an unusually high number of offers for well-located core and core-plus assets,” she says. — Les Shaver