Roundtable Participants

  • Doug Bibby, National Multi Housing Council
  • Daryl Carter, Avanath Capital Partners
  • Adrian Corbiere, Cohen Financial
  • David Dewar, Trillium Residential
  • David Fitch, Gables Residential
  • R. Lee Harris, Cohen-Esrey Real Estate Services, Inc.
  • Rich Kelly, LumaCorp, Inc.
  • Jack Kern, Kern Investment Research Counselors
  • Charles Krawitz, KeyBank Real Estate Capital
  • Holli Leon, PNC ARCS
  • Brent Little, Place Properties
  • Dee McClure, CWCapital
  • Howard Smith, Green Park Financial
  • Kitty Wallace, Sperry Van Ness
  • Robert White, Real Capital Analytics

Board members and special guests took part in the magazine’s annual Apartment Industry Leadership Roundtable as part of the APARTMENT FINANCE TODAY Conference here in April.
Some panelists said they had seen little increase in cap rates in early 2008. On the other hand, they said deal velocity had slowed substantially as sellers resisted lowering their prices, leaving a substantial gap between what buyers are willing to pay and what sellers will accept.

However, the panelists said there had been some decline in cap rates in secondary markets and for Class C properties. Cap rates are as high as 7 percent for some Class B properties in middle America, one panelist said.

Most panelists agreed that interest rates are likely to stay low for the rest of the year, but they said it’s very hard to predict where loan pricing will be later this year due to uncertainty among lenders. While Fannie Mae and Freddie Mac are very active, some other lenders are not in any hurry to “put money out the door,” as one panelist put it.

Decreasing homeownership rates, rising foreclosures, and job losses could benefit multifamily, said R. Lee Harris of Cohen-Esrey Real Estate Services, Inc. “But we have got to figure out the affordable product beyond the tax credit and the low-income housing program. Affordable workforce housing, with some public/private partnership concepts, may be an opportunity to deliver that kind of rental housing,” he added.

Here are some highlights from the transcript of the discussion:

Robert White, Real Capital Analytics: First off, I think this credit crunch has lasted longer than any of us thought originally. The recovery process in the debt markets hasn’t really even started yet. Maybe in the past 10 days there has been some improvement in the spreads, but that market has been so volatile that it’s tough to say that’s a trend that’s going to hold.

The fact is, the conduits are still sitting on so much paper that they need to get it off of their books first before they can originate more.

Local and regional banks are under such scrutiny that they are not stepping up as we were hoping, especially in the apartment sector. So it looks like we are going to be living with this situation for at least another six months, probably through the end of the year, I think, is the general consensus. I think we will see things start looking better by September, but I tend to be a little bit more of an optimist.

But the good news for all of us in the apartment sector is, no matter how bad we think it is here and how tough it is to ink a deal, it is so much more difficult in the office, the industrial, and the retail sectors.

Our first-quarter numbers are still being compiled, but property sales are going to be down about 75 to 80 percent compared to the first quarter of last year. Apartments are going to be the best performer, down only about 35 percent, which is a big drop, especially if you have a fee-driven business. But at least it’s not 80 or 90 percent like in office and retail.

Surprisingly, cap rates really haven’t seen an inflection point that we noted in the apartment sector yet looking at just a national average. I know certain markets—especially the tertiary markets and the lower-grade properties—are starting to see some softening in prices. But the Class A stuff is still trading just as competitively as it was not too long ago or even a year ago, which is surprising.

On the sell side, there has been a lot more selling activity. Throughout most of the fall and up until really the past month, new offerings of apartment properties have grossly exceeded what has closed.

So there is a lot more on the market for sale, which you think would naturally bring prices down and cap rates up. But we really haven’t seen all that many situations of distressed sellers. A lot of people are testing the market, but the sellers are being slow and fairly resistant to accept too much of a discount, at this point anyway.

David Fitch, Gables Residential: We have had reasonably strong operating performance in Texas, Atlanta, Washington, D.C. But we have had very disappointing performance in South Florida and Southern California, particularly Riverside, not particularly San Diego. And so all in all, we have gone from a year that produced slightly over 5 percent net operating income (NOI) growth to trying to achieve something in the 3 percent range, which isn’t a bad NOI growth relative to sort of a 10-year average.

So we are feeling pretty good a quarter into the year in meeting the budget. We are in the development business, and we are looking to bring in joint-venture partners in some of our larger developments. And the way the game is played has changed. What used to be fairly generous allowances for rent growth on a pro forma basis, it’s pretty much stopped. Everything now is based on untrended rents.

What used to be doable at a cap rate of 6 probably now has to be closer to a 7, or in markets like D.C., where they had to be in the 5s, stabilized returns on invested capital now are 100 basis points higher.

Kitty Wallace, Sperry Van Ness: The market has adjusted dramatically over the past 12 months. If someone came to me in Southern California a couple of years ago and said, ‘Well, let me see your client’s actual numbers,’ I would look at him and say, ‘Well, if you’re going to buy on those numbers, you need to go find a different market to buy in, because you’re not buying here in Southern California.’ Now, we can’t turn around and just sell a deal, throw something out to qualified clients and get five offers. We have to be able to be very knowledgeable in the market, have some alternate suggestions on how to get deals done, and really work our deals.

Dee McClure, CWCapital: So what are we seeing in the economic downturn? Lots of interesting things. We are expanding our relationships with some of our older relationship borrowers who have stuck with us through thick and thin and acknowledge and understand the value that we bring to the table.

We are not cherry-picking per se, but we are looking at transactions and the developers and owners behind those transactions probably more carefully than we have before and as other lenders have as well. We are seeing two areas of growth. We’re doing a lot of direct balance sheet lending. And we are seeing a lot of activity in the government-sponsored enterprise (GSE) and the Department of Housing and Urban Development world.

Because of the residential fallout, we’re seeing a lot of new construction of multifamily—all over the country, except Michigan. We are seeing construction costs down significantly, both in the hard costs, and now we’re seeing labor being freed up. That is all specifically relating to single-family impacting the residential side of the market. Generically, the fundamentals, we think, are good across the country. There are pockets that we’re a bit careful in. But overall, it’s a wonderful time to be a lender.

Harris: Last year, I used the term ‘bubble-ized thinking,’ and some of you were here and you may remember that is defined by, ‘We know what we’re doing, but we do it anyway.’ And I guess maybe there has been some evidence of that. But this year, I’m going to use the term ‘opportunized thinking.’ This describes an opportunity to strategically take advantage of the turmoil and chaos that prevails in today’s economy.

There are a number of examples of opportunized thinking that are available to us. One is targeting a demographic niche to serve and then creating the product accordingly. There are some real opportunities where there are folks that just cannot become homeowners right now, that if we can create the right kind of product, we can keep them in the rental market a little longer.

Another opportunity is utilizing historic tax credits. Historic tax credits are a great way to create some neat product in tandem with conventional financing in a number of our urban areas, and then certainly utilizing more complex capital and financing structures, the GSE opportunities in conjunction with lower floater bonds on a Freddie or Fannie swap—complicated transactions, but the rates are phenomenal.

Rich Kelly, LumaCorp, Inc.: I have to say that the fundamentals are good in most markets in Texas. The population growth statistics that were released about 10 days ago [showed that] four of the top 10 metros in the country were all in Texas, and Dallas-Fort Worth was No. 1. So the rate of household formation is still going on, and the basic underlying demand for affordable housing— and I use that without it being a defined term, but basically that’s housing that starter households can rent—is still there, and it’s going strong.

As more product is coming to market, a lot of it doesn’t sell. We’ll find that a lot of people will float packages out either priced or unpriced, and it just doesn’t sell because they don’t get their number. They’re going fishing for the bigger tuna. And the bigger tuna is not out there this time to pay the kind of prices they would have paid 12, 18 months ago.

This is not a credit-crunch opportunity for buying apartments like it was in ’88, ’89, and ’90. There’s just too much money out there that you don’t have a collapse of apartment prices as we did in the late ’80s. So I don’t see that kind of buying opportunity. We see two basic buying opportunities in the middle of the country. One is [that] the real estate investment trusts are all redeploying. They are emptying out and selling from the middle of the country. The other place where there appears to have been a big dislocation is in the Cgrade quality properties that relied on the conduits for their financing. The C-grade deals are not getting refinanced as easily as they were. In that market, I think there may be some opportunities brought on by that inefficiency.

David Dewar, Trillium Residential: I’m the local guy in the group with Trillium Residential based here in Phoenix. Our market has been a little interesting too, being a high-growth market like Phoenix has been recently. We’ve seen a little bit of slowdown, but that is all relative. This year we’ll still add somewhere around 90,000 people to greater Phoenix, probably 30-some-oddthousand jobs here. So relatively speaking, it’s still good. We are going to produce this year probably around 4,000 to 5,000 units in the Valley. We’re going to see that dwindling off because guys are dropping deals right now. The supply has been controlled by this little correction, which is good. It was getting a little crazy there for a while.

Rental growth for this year is flat. The good news though, on the housing side, is that people can’t leave our properties in droves to buy a home like they used to. Real downpayments are required. That, combined with the price increases that we have seen in the single-family side of things, has created the largest gap I have seen between affordability of rental and for-sale housing in the last 15 years. So the net-net of that all is that we are cautiously optimistic.

Brent Little, Place Properties: The news from the student housing business right now is primarily still very good. The demographics are still behind us. The 18- to 20-year-old sector is still growing as a result of primary demographic movers. And the universities are still broke, and they are becoming more broke as there are more and more budget crises in California and elsewhere. So we still feel that the student housing business will be good, because we can provide it better, faster, cheaper than the government can, which is made obvious all of the time. On the operations basis, we’re seeing leases very, very strong in all of our markets.

Charles Krawitz, KeyBank Real Estate Capital: I’m very cautious about the increase in occupancy that we are seeing. A lot of the folks are moving out of singlefamily homes into rental situations. At some point, they will return to the single-family market place, as those homes get recycled as rentals.

Adrian Corbiere, Cohen Financial: The one thing I guess I have learned that I have always been talking about with all of the younger people is that relationships are important. Relationships with both borrowers and lenders are critical in this environment.

Mortgage bankers do have value again. We find that the developers are spending a lot more time talking to them—answering the phone, if you will. In terms of the markets, I still see a big disconnect in multifamily between buyers and sellers. I think there were so many acquisitions done over the last couple of years that how much is left to be bought and sold? Certainly those that were bought over the last couple of years can’t be flipped the way they were in the past.

Holli Leon, PNC ARCS: We have a large Fannie Mae portfolio. I can tell you that the agencies are smiling right now. We have a tremendous amount of opportunity. Both Fannie Mae and Freddie Mac are very, very busy. We’re on our way to a record year this year at PNC ARCS. The market has drastically changed. Much of the competition has vacated the marketplace. Lending practices have returned to the fundamentals, so I think a lot of us sleep better at night.

The lending parameters have definitely pulled in. We are watching and thinking that perhaps the pie is going to be smaller this year than it has been in the past years.

I would disagree with some of the comments that have been made about cap rates. The most recent appraisals that we are seeing, the cap rates are higher than they have been. We are watching buyers and sellers continue to wrestle over what the right price is.

Jack Kern, Kern Investment Research Counselors: I was in New York and Boston meeting with New York analysts. There’s a perception that multifamily is out of favor. The big concerns that they have on Wall Street right now have to do with composition of rental demand. It has to do with what’s really going on with the foreclosures. There’s a fear that these foreclosures are going to end up being sold at very low prices and that people are going to rush out of apartments to buy them, and that the laws of demand are going to decline generally. There’s a lot of inventory concerns about all of these unsold condominiums that are coming online right now, plus the ones that have been sold and put into foreclosure.

Fundamentally, from the CEOs that I talked to and the markets that we cover, this is a pretty good time for us. The industry is doing OK. Not huge rent increases, but generally OK.

Daryl Carter, Avanath Capital Partners:We’re focused on the affordable sector and the urban housing sector. One of the reasons I really like the affordable sector is there is tremendous disarray in that sector, on one hand in terms of the capital side, but there’s still an overwhelming need and demand for affordable housing, you know, tax credit properties, particularly on the two coasts. There are a number of reasons why the market is in disarray. One is, obviously, a lot of the large investors, which are banks and other financial institutions, if you are writing off—charging off lots of losses, then you don’t have the need for tax credits, because you aren’t paying taxes.

The second reason is that one of the underpinnings of affordable business has been the credit enhancement market. Companies like Ambac and MBIA have just had a huge impact both in terms of funds that they guarantee as well as the 4 percent bond deals.

Howard Smith, Green Park Financial: Underwriting is completely based off of historical rental income data now. There’s no way around it. You can come up with a great story, snake oil or not, and you’re just not going to get very far. Interest-only terms on the full term of loans are gone except for the lowest loan-to-value loans.

Cap rates are always hard to follow, because by the time you learn about them, they have already happened. That’s happened in the past. We have not seen them move much at all. The sales that seem to be closing tend to be in the secondary and tertiary markets, at least on the sales that we see.

Shashaty: What do you see happening with cap rates?

Harris: While we may not have seen a lot of fluctuation in the cap rate, when you look at the velocity of transactions, in fact, if you look at it just in January and February, apartment sales, apartment transactions of $5 million or more, are off 50 percent.

We are not seeing the velocity in the mid part of the country, particularly with Cs and Bs. We are seeing anywhere from a 50 to 100 basis points increase. We are talking macro here.

Corbiere: One of the things that lenders look at very closely is value by the pound, or value per unit versus cost per unit. I can tell you the lenders are going back to that right now. So it’s not so much a cap rate as what’s the cost per unit? What is the value per unit? And what am I really in this at?

Audience member: What is happening with mezz debt?

McClure: We were a very big mezzanine lender. We have pulled back on that quite a bit. Kitty and I were just chuckling about what is mezzanine these days? Is it up to 70 percent? Is it 75 percent? Really, the equity investors are driving the deals. I will tell you that internally for CWCapital, our return expectations and requirements for mezz debt have certainly gone up.

On the lending side, we’re seeing a lot of new equity investors coming into the market. But just as lenders are now loved, equity investors are actually loved more. They are very much cherry-picking deals. We’re actually seeing their return requirements going up fairly dramatically at this point, if you can get someone to answer the phone.

Shashaty: Does anybody want to comment on the forecast? What is next? Is the Fed going to take the discount rate down to 1 percent or even zero percent? And, if they do keep cutting aggressively, do we start to see mortgage rates go up instead of down because of the inflationary issue?

Carter: I’ve never been a big proponent of looking at interest rates in an absolute sense and judging the flow of capital into any sector. I feel very bullish on the capital inflows into real estate … large corporate pension funds, by and large, are still flush with capital.

They are always looking for relative value. They are looking at how real estate returns compare to bond and stock returns. It’s all relative value. And they are still deploying a lot of capital into the real estate space.

There is a tremendous amount of foreign capital that’s coming to the real estate space. So I am generally one that is very bullish on capital deployment. I am one that doesn’t believe that cap rates are going to necessarily trend up as high as people think.

I think there is a big differentiation between the As and Bs, and over the last 24 months, everything had kind of merged together. The spread between Moline, Ill., B, and Beverly Hills A, was a lot lower. I think that’s going to widen those discrepancies.

Shashaty: So what are the best opportunities available to apartment firms in 2008 and 2009?

Wallace: Over the past six months, my hottest sector has been student housing. I have had multiple offers on my student housing opportunities. But as a buyer, there are opportunities across the board, because there are fewer buyers. There are some opportunities to find some deals without having to compete with 30 borrowers. And so the person who has a banking relationship and … some cash in the bank can find a deal, where I used to have 30 buyers on the table, and you had to give us $3 million nonrefundable up-front to buy a deal. If you take the time to find an opportunity, because I think the fundamentals in the real estate market, especially in a couple of particular markets, are fabulous.

As a seller, your price may not be as great today as 12 months ago or 18 months ago, but it’s still far better than three years ago, five years ago, and seven years ago.

Fitch: We have a significant amount of older apartment stock that the cities have grown up around that are still held by private individuals that probably have been fairly freaked out about what is happening in the market over the last six months.

It seems like the dollars invested to take those from Cs to Bs in good solid markets will attract a lot of capital and could be a very enticing place to be in the next couple of years.

Wallace: I think there’s also an opportunity in affordable housing.