A burgeoning roster of opportunity funds and related investment vehicles are poised to pounce on distressed assets, including debt secured by struggling apartment properties and failing condo development and conversion ventures. Meanwhile, the list of public and private debt holders looking to shed these assets continues to lengthen.

But now comes the hard part— making deals amid a crunched credit environment, failing financial institutions, a slowing economy, and a massive federal bailout plan. Not to mention that the multifamily sector's two biggest debt sources just went into conservatorship.

While several opportunistic investment groups are targeting the multihousing sector, experts wonder just how much corresponding debt trading activity lies ahead near-term. All those factors create uncertainty about the amount of assets going on the market, and what constitutes attractive pricing— for buyers as well as sellers.

Most opportunity fund managers targeting internal rates of return in the high-teens and low-20s percent range typically aim to pay no more than about $0.70 on the dollar when acquiring distressed income-property debt, explains Rick Williamson, Chicagobased principal of WLJ Partners.

But it's hard to gauge whether many multifamily assets priced in that vicinity will be on the market any time soon, Williamson acknowledges.

Apparently topping the list of wildcards is the federal fund established under the new Emergency Economic Stabilization Act to buy up distressed real estate debt and properties. Meanwhile, commercial and investment banks keep failing and merging at a head-turning pace, leaving shortbreathed fund managers wondering how each event will affect the supply of and demand for distressed debt.

And while apartment distress hasn't become a huge issue as of yet, condominium loan defaults are rampant in some markets.

Even with the ultra-aggressive multifamily mortgage underwriting seen in recent years, defaults have so far remained in check relative to the retail and office sectors, notes Stephen Emery, director of sales and trading with New York-based Mission Capital Advisors. But condo construction/conversion loans have gone bad left and right in over-supplied markets such as South Florida, he adds.

While that may provide attractive opportunities for specialists able to navigate the tricky condo-to-rental “reversion” route, opportunity funds may not end up buying as much distressed apartment debt as had been expected just a few months back, says Russell Dixon, CEO of RedHill Realty Investors.

RedHill is raising capital for a fund looking to buy distressed high-density housing assets, including struggling condo development and conversion projects likely to perform better as rental communities. But given some of the newsworthy developments in recent weeks, Dixon wonders whether some investors committing to vulture funds might pull out amid uncertainty about the depth of opportunities.

Early estimates have the federal bailout fund competing with other buyers in absorbing some $180 billion worth of distressed income-property assets—augmenting well over a halftrillion dollars of residential debt and properties. But it's impossible to say at this stage just how many debt-holders will look to sell assets to the government rather than private-sector buyers, Dixon and others relate.

Now that it's clear Fannie Mae and Freddie Mac will continue aggressively providing liquidity for apartment properties while under conservatorship, fewer teetering owners will end up in default as would be the case otherwise, Dixon adds. And after all, the National Association of Realtors estimates apartment rents nationwide will rise a respectable average of 3.9 percent this year, and 4 percent in 2009.

Dixon also cites the so-called “denominator effect” as another factor potentially prompting pension funds and other investors to pull back from opportunity fund commitments. In other words, Wall Street's woes have already increased the real estate components of many pension funds' investment portfolios, at the expense of asset classes (i.e., stocks) seeing value declines.

Nevertheless, various commercial banks are continuing to bring additional assets to market, engaging Mission Capital and other advisers to auction off distressed commercial real estate loans, REOs (real estate owned by banks), and portfolios—in addition to single-family assets. For instance, Colonial Banc- Group, Wachovia Corp., National City Corp., and Fifth Third Bancorp have tapped services at the likes of Mission, First Financial Network, The Debt Exchange (DebtX), Eastdil Secured, Carlton Group, and others.

The Federal Deposit Insurance Corp. (FDIC) has also actively looked to move distressed assets as it takes over insolvent institutions. The FDIC has been adding to its stable of note-sale advisers and recently—perhaps ominously— contracted with First Federal for a fiveyear term.

And special servicers looking to resolve troubled conduit loans on behalf of commercial mortgage-backed securities investor groups have in some cases hired advisers to dispose of distressed apartment mortgages. With conduit defaults rising from their historically low levels, Emery expects more special servicers to take this route in the near future.

Meanwhile, it's unclear how the shocking balance-sheet strains seen at such household-name investment banks as Bear Stearns, Lehman Bros., Merrill Lynch, and Morgan Stanley will ultimately play out with respect to distressed real estate debt.

As for the buy side, a few groups boasting both patient capital and development expertise are targeting entitled land at generally huge discounts from the debt securing it. The RedHillmanaged fund wouldn't shy away from opportunities to pick up assets that include developable land adjacent to existing structures, Dixon notes, as his firm has in-house development capabilities and might eventually look to structure ventures with development partners.

But the bulk of the opportunity fund activity involves seasoned incomeproperty asset managers looking to buy distressed debt in bulk and “resolve” individual situations via foreclosures and recapitalizations, and stabilize properties, within relatively short timeframes.

In some cases, hands-on operations specialists raise capital for opportunistic investments on their own, including Miami start-up Outlook Capital, which aims to buy distressed condo units and rent them out until values recover. But the traditional model has investment managers assembling opportunity funds as WLJ has done, and working with local expert operators to maximize returns on individual assets.

Even some investment managers traditionally focusing on institutionalgrade apartments, such as Waterton Associates and Carmel Partners, are now pursuing opportunistic distresseddebt acquisitions.

While activity hasn't been particularly heavy as of yet, at least one fund manager has already acquired, resolved, and resold high-profile assets. Working with Dallas-based specialty operating partner Triumph Land & Capital Management, a fund managed by New York's Hudson Realty Capital quickly acquired distressed debt on Texas apartments previously owned by struggling MBS Cos., took the properties through foreclosure, and flipped them to other investors.

With many efforts to sell distressed notes and portfolios so far, debt holders and opportunistic buyers have had tough times coming to terms on pricing, Williamson and others are quick to acknowledge. The key to generating reasonable risk-adjusted IRRs in distressed situations is to pay no more than a property's replacement cost for the debt, advises Williamson, who's looking to cut deals mostly in the $0.50 to $0.70 on the dollar range.

“That's when things start to click,” Williamson says. “If you can own the real estate for less than it would cost to replace it, that's a fundamental [pricing] floor.”

But as RedHill's Dixon cautions, it can be pretty tricky to estimate replacement costs these days, what with the value of the land component falling rapidly in so many submarkets.

As for investment groups thinking they might find decent deals buying assets from the federal bailout fund in short order, they'll probably have to wait a while, predicts Andy Little, principal with real estate investment banker John B. Levy & Co. in Richmond, Va. Little expects the fund's overseers to wait until liquidity returns to the marketplace before looking to sell the distressed assets they acquire.

“The intention [in creating the fund] was to bring a back-stop to the whole distressed-asset mess, so I think the government will just hold on to these assets” until values recover substantially under normalized capital markets conditions, he adds.