Developers are searching harder to find equity as capital providers grow more cautious this year.

With lenders providing lower loan-to-value ratios, developers need more equity to pencil out deals. But equity prices have increased significantly over the last six months, and conservative underwriting standards have slowed access to it.

Last year, both debt and equity providers often stretched underwriting standards to make deals work in a rush to place capital. Those days are long gone as equity sources take a much closer look at deals, and adjust underwriting and return expectations accordingly.

“Four years ago to one year ago, everything was the same—whether you were in Dallas or Des Moines or Denver,” said David Fitch, president and CEO of developer Gables Residential, at the recent APARTMENT FINANCE TODAY Conference in Phoenix. “Now there’s much more scrutiny about property types and what the submarket is like, and tailoring specific returns. ”

Gables Residential is working on deals in Austin, Texas, and Dade County, Fla. “One market is great, the other is a disaster,” Fitch said “The same equity players showed up for both deals, but the underwriting was much different.”

Equity investors are no longer assuming aggressive rent growth as a matter of course when underwriting deals. Many projections are being built assuming flat rents, even in strong metro markets, in the first half of 2008.

And sellers are saying, “show me the money” when engaging with buyers now. “Buyers have to demonstrate that they have the financing and not that they’ll just put it together on the fly, which was the case last year when all that money was there,” said Tyler Anderson, a vice chairman at CB Richard Ellis’ multi-housing group. “Today, if I’m a buyer, I’m making sure I get my capital stack completely lined up.”

Search party

As a result of the increasingly conservative capital markets, developers are firing up the searchlights to find equity. Developer Trillium Residential has engaged a mortgage banker for the first time in years in its search for equity investors. “In the past, the equity found us,” said David Dewar, Trillium’s founding partner and principal.

Large life insurance companies such as Northwest Mutual and Prudential are still providing equity, and many developers are also sourcing both debt and equity from pension funds and other financial services firms such as CalPERS, CalSTRS, and TIAA-CREF. “We’re talking to life insurance companies now that we haven’t talked to in the last five years,” said Fitch.

Opportunity funds are also getting more active as the commercial real estate market grows more distressed. At the end of March, Blackstone Group closed a $10.9 billion opportunity fund called Blackstone Real Estate Partners VI, and another opportunity fund, Lone Star Funds, is trying to raise $10 billion to also take advantage of the down market.

With a dearth of capital on the market, some creative financing strategies are emerging. Trillium Residential recently received a quote from a large mutual fund looking to provide equity on a new construction deal.

“Rather than quote one deal, they wanted to tie a construction deal with one of our stabilized deals to take some of the risk out,” said Dewar. “It was the first time I’ve seen two assets in different stages being tied together like that.”

Expensive money

Mezzanine financing providers have significantly upped their return expectations over the last year. For transitional, unstabilized properties, mezzanine providers are asking for returns in the high teens and low-20 percent range, up from between 13 percent and 15 percent a year ago.

The higher mezzanine rates have “caused a sea change in the attitude of equity investment,” said Stephen O’Connor, president of the O’Connor Group, a consultant to the housing and community development industry. Most equity providers now begin negotiations expecting mid-20 percent returns, and as high as 30 percent, up from the high teens and low-20 percent range a year ago.

But it’s not just conventional market- rate deals that are having a hard time. Equity is especially difficult to come by for affordable housing deals, as the prices of low-income housing tax credits (LIHTCs) continue to plummet. The weakened demand for the credits has pushed prices into the low-80 cent range in some markets, O’Connor said, as many large financial institutions hit by big losses see little need to reduce their tax liability.

“The primary source of equity for the last 20 years has been LIHTCs,” said O’Connor. “But now, you’ve got institutions writing off $8 billion, $12 billion in losses, so they no longer need the credits. Institutions are walking away from it.”

Foreign capital

As domestic equity providers grow cautious and the U.S. dollar remains weak, it’s a great time for foreign capital to step in and fill the void. But while the depressed commercial real estate market has attracted opportunity funds, foreign capital providers have been skittish in the first half of 2008.

“The Australian funds and Middle Eastern funds will be looking at the United States more and more, especially once all of the bad real estate news settles down,” said Fitch.

Accessing foreign capital can be a dicey proposition, especially in navigating the long time frames that many foreign equity providers take to assess a deal.

“The trick with foreign capital is how fast the capital comes to us,” said Anderson of CB Richard Ellis. “It takes some firms in London 90 days just to look at a deal sometimes. If you want to tap that source, you have to do it through their U.S.-based advisers.”

Some cities are beginning to strike partnerships with overseas investors in hopes of spurring a capital infusion. The mayor of Phoenix, Phil Gordon, has formed a global trade initiative that seeks to facilitate direct foreign investment in Phoenix, according to Dewar, who is based in Tempe.

The initiative will initially focus on developing relationships in Dubai, United Arab Emirates, and a group of local business leaders, including Dewar, will travel to Dubai this summer.

One aim of the initiative is to establish direct international flights between Dubai and Phoenix, an important consideration. In talking to representatives from a German pension fund recently, Dewar found that a big inhibitor to German companies investing in Phoenix was the length of the flight, which can take up to 24 hours.