Credit: Jack Hornady

In 2005 and 2006, hungry apartment investors competed vehemently to amass staggering amounts of property. In many cases, these buyers were paying unsustainably low cap rates. To make these numbers work, the buyers banked on forcing out low-income renters, upgrading their units, and jacking up rents for a new class of residents. Then the recession hit, and these plans went bust. The most high-profile example of this overbidding, overextending behavior may well have been the $5.4 billion purchase of New York’s massive Stuyvesant Town–Peter Cooper Village from MetLife by Tishman Speyer Properties and BlackRock.

They weren’t alone. In another high-profile debacle, British investment firm Dawnay Day ponied up $225 million for 47 rental buildings, the bulk of which were in east Harlem. The New York Times reported that Dawnay Day wanted to follow a template it had laid out in south London by rehabbing and gentrifying the portfolio. But when the market crashed in 2008, Dawnay Day found itself in trouble, unable to move rents enough to justify what it paid for (and leveraged with) its assets.?The company declared bankruptcy in July 2008. “While the east Harlem transaction was by no means the primary cause of Dawnay Day’s insolvency, it is representative of the numerous highly leveraged transactions that began to unravel for the firm as the financial crisis accelerated during 2008,” says Ben Thypin, senior market analyst for New York–based Real Capital Analytics (RCA).

Unfortunately, the mistakes of Tishman Speyer and Dawnay Day are short-lived in the collective memories of apartment owners. Today, as the markets recover, investors once again see opportunity in multifamily. The risk remains, however, of getting swept up in another buying frenzy. “You have a lot of capital chasing assets,” says Haendel St. Juste, an analyst at Keefe, Bruyette & Woods (KBW), an investment banking and security brokerage firm based in New York. “You have debt that’s plentiful and available, no new supply, and NOI [net operating income] growth is looking strong. I don’t know how much better it can get for apartments.”

That optimism is making itself known: In all, $23 billion in apartment assets traded in the first half of 2011, which marked a $104 million year-over-year improvement from 2010, according to RCA. 2011’s second-quarter tally was equally as impressive, with volume surging 132 percent on a year-over-year basis, after the first quarter’s 72 percent increase.

As sales rise, cap rates are falling in some key markets around the country. For those who have seen this before, the risk of greedy asset grubbing may soon re-emerge. Overall pricing has been flat, staying at about $100,000 a unit, but “intense competition for the top assets” has driven down yields on trophy properties, according to RCA. The data provider says that 10 percent of properties that traded in 2011’s second quarter traded at cap rates of 4.7 percent or lower.

These top-of-the-line trophy assets and turnaround projects are just the beginning, observers say. The real test will come as noncore markets heat up, begging the question, will this investment fervor lead to a repeat of the behavior of the mid-2000s? “Some prices look pretty high in primary markets; it remains to be seen when it becomes unsustainable,” Thypin says. “I don’t think there’s sufficient evidence to say that there are any troubled valuations going on. But that’s something that should be watched in the next 12 months.”

Others are less concerned. With low rates and big rent growth potential, the atmosphere is entirely different from the last multifamily boom, says Paula ­Poskon, a senior research analyst with Robert W. Baird & Co., a Milwaukee-based wealth management, capital markets, asset management, and private equity firm. “Can fundamentals justify the frenzy?” she asks. “In my opinion, yes, because rental rate pricing power is going to remain strong for the next two years.”