While apartment development may be a risky proposition given the continuing slump in tenant demand, many of the big equity players partnering with multifamily entrepreneurs around the country these days are nevertheless becoming more liberal with development and major rehabilitation capital.
Firms like GE Real Estate have been surprisingly active in funding development and other value-added joint ventures at the expense of acquisition joint ventures. Indeed, an “overwhelming majority” of the GE joint-venture equity group’s 2002 investments were development deals – a reflection of the premium investors are now paying for existing communities – noted Frank Marro, managing director of the Alpharetta, Ga.-based group.
Marro’s team had anticipated more acquisitions activity than actually materialized, but the group and its partners ultimately shied away from the falling capitalization rates driven by aggressive competition for stabilized properties. GE Real Estate interests, in fact, took advantage of the premium by selling more multifamily real estate last year than ever before, Marro explained.
Meanwhile, nearly three-fourths of the over $350 million in joint-venture equity that Marro’s unit doled out last year landed in apartment projects. Combined with the contributions and leverage of its partners, that will ultimately translate to nearly $1.5 billion worth of investment in multifamily real estate ventures.
GE Real Estate’s overall 2002 joint-venture capital outlays were predictably down slightly after having risen “steadily” since the credit giant launched the partnership program in the mid-1990s, Marro noted. But as GE and partners have tackled developments in some of the nation’s higher-cost marketplaces, the group has seen its average deal size rise in recent quarters, he added.
“We’re not facing any kind of ‘use-it-or-lose-it’ pressures,” Marro stressed. “It’s a matter of whether or not we see opportunities to make money with our partners.”
Talented developers with entitlements in place around the country appear to be the beneficiaries of the renewed emphasis equity players are putting on development. As they forge and strengthen relationships with proven players, GE and its peers seem to be offering more generous joint-venture terms today than they were even when markets were stronger a few years back, some observers suggest.
With so much opportunistic and other capital now targeting apartment acquisitions, proven developers are frequently encountering more favorable joint-venture financial structures as some equity sources refocus on new construction, said Dana Ostenson, managing director of property finance specialist Johnson Capital’s equity group in Los Angeles.
On development deals that team institutional capital with top-notch apartment pros, residual profits are typically split equally after the financial partner receives its preferred-return rate (generally in the 10% vicinity these days). Not long ago, even when supply/demand fundamentals were better, comparable deals were more likely to be structured with higher preferred-return rates and “skinnier” profit splits, Ostenson said.
In fact, GE, GMAC and other big institutional players have stepped up joint-venture development terms to the point that most opportunity funds are no longer willing to compete with them, Ostenson added. “Opportunity funds just aren’t very competitive today when it comes to joint-venture equity for apartment developments,” unless a venture is too small or entails too much risk for the big institutional sources, he elaborated. Meanwhile, terms today don’t seem to vary substantially among the top-tier institutional equity sources, he pointed out.
In such an environment, relationships and certainty of execution have become more important than financial and structural minutiae, added new GE Real Estate development partner Ron Meer, principal of Meer Capital Partners in Newport Beach, Calif. While working with other institutional and Wall Street-sponsored equity partners in recent years, the developer became acquainted with key GE personnel knowledgeable about Meer’s preferred markets.
While seeking a partner for his latest high-end community in the Sacramento area, Meer was particularly attracted to the company’s reputation for expeditious execution. “And as we expected, they closed on the terms we had discussed from Day One.” While stressing that GE’s terms are quite competitive relative to the competition, he added that “getting the cheapest money is secondary to establishing a strong relationship between two partners.”
GE contributed $6.5 million to that first venture with Meer Capital, which was a townhome development capitalized at $40.9 million in a fundamentally strong suburban submarket. Corus Bank provided a $32.7 million construction loan for the 285-unit Westlake Villas – one of the Sacramento area’s most costly rental developments ever, which is slated for completion in July.
GE also contributed $10.5 million toward Concierge Asset Management’s $42.5 million acquisition and renovation of the Overlook at Lakemont in Bellevue, Wash.
In addition to its professional talent and strong balance sheet, the Marro-led team’s “willingness to do a value-added contrarian deal in a softening marketplace” was particularly meaningful to the Concierge group, said Paul Odland, its president. While many institutional investors “get too focused on the current climate,” the GE equity team concurred that “this is exactly the time to make the best buys,” Odland added.
As an investor infusing preferred equity into joint ventures, GE Real Estate is now typically cutting deals factoring to internal rates of return (IRRs) around 20% for development projects, Marro specified. With acquisitions of stabilized properties, IRRs are typically in the mid- to high-teens these days, depending on risk profile.
While the joint-venture group infrequently honors customer requests for mezzanine layers, the vast bulk of GE’s deals remain structured as “true” joint ventures, Marro explained. Under certain negotiated circumstances, the developer’s percentage share of a successful venture’s eventual profits (the so-called promoted interest) can exceed its percentage share of the project’s original equity contribution.
GE contributes the bulk of the required upfront equity capital, which starts around 75% for first-time partners but can be “substantially higher” after successful ventures, Marro noted without elaborating. Leverage represents 70% to 80% of cost – and Marro said debt remains so cheap that all deals tap outside sources these days rather than GE’s considerable credit facilities.
Geographically, GE’s joint-venture group is mostly attracted to growing, high-demand marketplaces such as Sacramento, where various barriers tend to limit the supply pipeline. But the team also tends to avoid markets where exceptionally prohibitive barriers simply make development too costly and time-consuming, he added. The primary product type for GE Real Estate and its joint-venture operating partners remains high-quality garden-type communities in suburban or semi-suburban settings.
So how does the joint-venture group hedge against the risks of funding ongoing development in an environment with limited demand and with an economy still struggling to avoid a double-dip recession? One key strategy entails greater flexibility in exit plans, Marro noted.
GE Real Estate and its operating partners typically shoot for a three-year venture period with apartment developments. However, arrangements build in the flexibility to exit at the right time rather than setting any rigid hold periods. “I’m not sure we’ve ever sold something in exactly three years. We’ll sell sooner if a market is hot or later if we need more time” to get the best stabilized-asset pricing, Marro elaborated.