“NOTHING IN THE WORLD IS WORTH HAVING or doing unless it means effort, pain, difficulty, ” Teddy Roosevelt once said. Never was that more true than in 2010.
A mountain of pent-up equity began to come off the sidelines this year as more distressed owners started to wave the white flag. The ensuing bidding wars on high-quality assets drove cap rates lower each successive month as property values began to bounce up.
The deals highlighted here illustrate a wide variety of trends—from the preeminence of agency debt to all-cash buyers of distress and from FDIC intervention to the return of value-added plays. What emerges is the picture of an industry in transition—a slow bleed of distressed properties entering the market even as fundamentals began to stabilize.
Nobody knows if today's historically low interest rates—and continued cap rate compression—can be sustained much longer, and whether the window of opportunity is still opening or beginning to close.
But one thing is for sure: The creativity and patience on display in the following 10 deals offer a template for success during turbulent times.
Starrett City, Brooklyn, N.Y.
This is the largest loan Freddie Mac had ever done for one single asset, and it's no ordinary asset—a 46-building, 5,881-unit complex with its own power plant, commercial center, schools, and community centers. Wells Fargo originated a $531.4 million refinancing loan for the massive affordable housing complex in Brooklyn, N.Y., which allowed the owners to pull out equity while agreeing to keep the complex affordable for the next 30 years. The new 10-year loan paid off an existing $215 million mortgage. The loan was also the end of a saga. In 2007, the owners, Starrett City Associates, had a deal to sell the complex to Clipper Equity for $1.3 billion. Clipper planned to convert the affordable units to market-rate. The outcry that followed led to HUD blocking the deal, and the owners decided to refinance instead. A new law had to be created to allow Starrett to refifor more than the original project cost, previously not allowed under New York's Mitchell-Lama program.
River Tower, 777 Sixth Avenue, and Longacre House, N.Y.
In early February, Equity Residential bought three New York towers from Macklowe Properties, scooping up 910 prime Manhattan units in all-cash transactions.
The properties cost $475 million (or $470,000 per unit), about 40 percent lower than what the three towers— River Tower, 777 Sixth Avenue, and Longacre House—could have fetched at the market's peak. But the deal underscores Equity chairman Sam Zell's sense of timing. In 2007, Macklowe Properties purchased a portion of Equity's office portfolio for $7 billion, and the debt on that portfolio acquisition soon went into default. Those losses spurred Macklowe to dispose of assets to cover its losses.
Macklowe contacted Zell about the Manhattan apartment properties in early December 2009 to discuss a deal. Zell—who once characterized his investment strategy as “dancing on the skeleton of other people's mistakes”—sent Equity representatives to Macklowe's offices the next day to begin hammering out the acquisition.
Bethany Group Portfolios, Texas, Maryland, Arizona
The 2010 sale of four Bethany Group portfolios coming out of Chapter 11 illustrate the navigation, and clarification, of receivership laws. The buyer? Standard Portfolios, a Chinese investor group which paid about $430 million for 8,000 units spread across Texas, Maryland, and Phoenix.
In January, Standard paid $296 million for approximately 5,000 units across 16 properties, reaching an agreement with Midland Loan Services to extend and amend the original loan. In August, Standard grabbed the 2,759-unit, sevenproperty Bethany Arizona portfolio from receiver Trigild, paying about $48,000 a unit, well below the $78,000 that Bethany paid in 2007. Standard paid $13 million in cash, with the assumption of $120 million in restructured debt—but sealed the deal with a $1.75 million nonrefundable deposit. Trigild had to obtain legal authority to sell the portfolio since the lenders had not yet foreclosed. “A receiver selling property which has not yet been foreclosed was unheard of until recently,” says Bill Hoffman, Trigild's president.
Resort at Pembroke Pines, Pembroke Pines, Fla.
CB Richard Ellis Investors' (CBREI) purchase of the 1,520-unit, 85-acre Resort at Pembroke Pines in September for $193.5 million was the largest South Florida deal in three years. It was also the largest deal that CBREI—the third most active apartment buyer this year, spending roughly $500 million—had ever done.
Pembroke Pines, about 20 miles from Fort Lauderdale, Fla., and Miami, was built in the late 1980s. CBREI was attracted to the deal because fundamentals in the submarket strengthened rapidly—concessions fell from three months to one month in less than a year.
And the buildings' exteriors were recently renovated by the sellers, the California State Teachers' Retirement System and Heitman, which purchased the complex in 2005 for about $180 million. CBREI paid about $127,000 per unit, but estimates replacement cost at nearly $200,000 per door. CBREI plans to take the property from a B-plus to an A-minus and bump up rents next year.
1st & M, Washington, D.C.
Archstone had never used FHA financing in its nearly 50-year history until this year, when it needed to procure construction funds for 1st & M, a 469-unit Class A property in Washington, D.C. The $151 million nonrecourse loan, arranged by CWCapital, features a 90 percent loan-to-cost, the maximum allowed under the (d)(4) program at the time.
(The new limit is 83.3 percent.) It was the largest apartment construction loan of 2010, and one of the largest FHA-insured loans in history.
The development broke ground in July in the NoMa section of Washington, D.C., which is undergoing a big transformation, with a new metro station and several new financial incentives. To encourage development, the District rezoned the area for up to 10 stories (the maximum allowed in the city) and passed a 10-year tax abatement for the first 3,000 units built in NoMa.
Skyline at MacArthur Place, Santa Ana, Calif.
Talk about patient money. To close its $128 million deal for the luxury highrise Skyline at Mac- Arthur Place, Essex Property Trust endured a year-long negotiation with the project's financier/owner iStar Financial. Essex hoped to buy the note but had to wait for the foreclosure to play out. The two-tower, 349-unit property in Santa Ana, Calif.—the tallest residential buildings in Orange County—was built as condos.
The price accounts for roughly 55 percent of construction costs.
Essex will rent out the units, at least until the for-sale market comes back. “We're underwriting them as apartments so we're getting apartment returns with the upside of, when the condo market comes back, they're ready to sell,” says Michael Dance, CFO of Essex.
The Palatine, Arlington, Va.
The foreclosure auction was held in the middle of a blizzard, and investors had to bring a $9 million certified check just to get in the door. Nearly 100 people showed up on the courthouse steps, so the auction was moved to a nearby Hilton.
In the end, The Palatine, a 262-unit Class A high-rise in Arlington, Va., went to Crescent Heights. The bidding began at around $80 million and when it hit $104 million, there were only three bidders left: UDR, AEW Capital Management (representing an undisclosed investor), and Crescent Heights, which won the property for $118 million, at a 4.5 percent cap rate. The sellers were lenders iStar Financial and Allied Irish Bank, which had foreclosed on the project's $94 million construction loan to developer Monument Realty.
Oak Hill Apartments, Pittsburgh
Oak Hill Apartments, a mixed-income redevelopment of a public housing community in Pittsburgh, already had 639 units completed in 2003 when work on the next phase hit an impasse. A dispute over the land broke out between the neighboring University of Pittsburgh and Oak Hill's co-owners— developer Beacon/Corcoran Jennison and the Oak Hill Residents Council. The Housing Authority of Pittsburgh wanted to terminate its agreement to sell the land to Oak Hill and strike a deal with the university.
Legal maneuverings ensued. In 2007, an agreement was reached whereby the university could purchase the 12.5 acres, with the $13 million purchase price then being lent to Oak Hill to develop the next phase nearby.
The development received low-income housing tax credits in 2008, but by then, the tax credit market had collapsed.
An investor walked away from the deal in late 2009. In stepped PNC Bank, which provided $8.4 million in tax credit equity. The $29 million next phase broke ground in March 2010.
Palms of Monterrey, Fort Myers, Fla.
Behringer Harvard emerged as one of the top buyers of the year, second only to Equity Residential. The $25.4 million acquisition of Palms of Monterrey in Fort Myers, Fla., was one of the firm's tougher deals. In September 2009, Behringer Harvard was all set to close on the note acquisition with Corus Bank but a week before the closing, Corus was seized by the FDIC.
Behringer Harvard funded the purchase price into escrow and signed all the documents, but the FDIC never showed up at the closing table and then wouldn't return the company's calls. So the firm began a letterwriting campaign, canvassing politicians and the FDIC chairman until another closing date was set. But then the FDIC agreed to sell the Corus loan portfolio to Starwood Capital, requiring further negotiations.
With the note in hand, Behringer Harvard moved to foreclose. And since Florida has judicial foreclosure laws and the original borrower threatened a protracted process, the proceedings could've lasted a year or more. The company negotiated a settlement 180 days after buying the note, while arranging a Freddie Mac permanent loan, which closed 30 days after the foreclosure.
Ivy Hall, Atlanta
Camden Property Trust had just five days—120 hours from touring to buying—to close on its acquisition of Ivy Hall, a 110-unit luxury community in Midtown Atlanta.
The community was nearly complete when the original developer, The Providence Group, defaulted on its construction loan. But then, the original lender Georgian Bank itself failed and was bought by First Citizens Bank, which engaged in a short sale of the asset. The property was under contract to a buyer that lost its equity on a Wednesday, six days away from the scheduled closing. That's when Camden got involved. The REIT met with the stakeholders on a Thursday afternoon in July, flew to Atlanta on Friday to tour the asset, and then worked through the weekend to tour competing assets, underwrite the deal, and prepare a committee memo for Monday morning. On Tuesday, Camden tapped its line of credit for the all-cash transaction. The original developer had put more than $200,000 per unit into the development, and Camden paid about $15 million, less than $140,000 a unit, budgeting about $2 million to finish the remaining units.
—Additional reporting by Les Shaver and Chris Wood