As fundamentals and transactions continue to rise in the apartment industry, the additions to apartment distress slipped $3 billion in the first quarter, which was the lowest level of additions since the third quarter of 2008, according to New York-based research firm Real Capital Analytics (RCA). That was significantly lower than the average quarterly addition of $6 billion to distress in 2009 and 2010. Overall, distress was at $36.2 billion at the end of the first quarter. That’s 8 percent lower than the year before.
“The low additions to distress for the apartment sector in the first quarter are a reflection of how much progress has been made in the cycle,” says Ben Thypin, senior market analyst for RCA. “There are only so many apartment assets that can potentially fall into distress and barring a double-dip recession, the majority of the apartments to fall into distress during this cycle have already revealed themselves.”
Plus, there’s the issue of improving apartment fundamentals. “The overall data indicates that mortgage performance is improving,” says Ryan Severino, senior economist at New York-based Reis. “Certainly apartment fundamentals have improved over the last year, so that would support NOI.”
Property managers who have picked up a lot of distress deals over the past couple of years have also noticed a decline in the amount of troubled product they’re seeing. “Our growth is not coming from the REO world,” says Andrew R. Livingstone, an executive director with Charleston-based Greystar. “Last year we did so much of that stuff. That’s not what we’re doing now.”
In fact, workouts in the first quarter, which totaled $2.7 billion, almost equaled the number of new product added to the distress tally. That included $650 million in restructurings and $2.1 billion in resolutions.
International Banks, Insurers Lead
International banks have made the biggest dent in pursuing resolutions by working out about 77 percent of their distress, according to RCA. Part of that is because international banks generally have quality assets in terms of class and market, according to Thypin.
“Since international banks don't have a very big local presence, they have an incentive to address troubled situations quickly in order to reduce the likelihood they will have to increase their local footprint or incur costs associated with third party service providers to manage the troubled assets in question,” he says.
CMBS lenders lagged the market by working out just 23 percent of their relatively newer vintage loans. But it's pretty commonly acknowledged that these properties are in rougher shape. “The properties that haven’t been worked out are in more complex and hairy situation,” Thypin says.
Outside of CMBS, all lender groups saw their apartment distress fall, with insurance companies reducing their exposure by 44 percent. “Insurance companies' underwriting is typically very conservative, so they have had less distress to work out,” Thypin says.
Workout activity was almost even at above 40 percent of cumulative distress. Garden apartment distress has fallen by 15 percent over the past year, while mid- and high-rise distress only fell 2 percent in the same timeframe.
Thypin thinks that the first quarter will be the new norm for apartment properties added to the distress tally. Though he cautions that pipeline won’t stop altogether. “The additions on the scale of first quarter or lower are what we will see for the next several quarters as the cycle plays itself out,” he says.