The REITs are back.
With interest rates rising and cap rates stable, the well-funded institutional owners and public apartment firms have returned to the buying arena as leverage buyers find themselves financially pressured and pushed to the side.
It represents quite the switch in the multifamily deal-making environment, where last year public apartment REITs such as AvalonBay Communities in Alexandria, Va., went so far as to establish their own funds to compete more effectively against private buyers.
Though AvalonBay bought Versailles at Aberdeen Station in Aberdeen, N.J., for its fund, it should be able to buy more on balance sheet now.
Photo Credit: AvalonBay Communities
"[REITs] have been sitting on the sidelines because they've been beaten up by the leverage buyer," says Daniel N. Kaplan, chief investment officer for Fowler Property Acquisitions, an owner and operator of apartments in San Francisco. "But right now, for the leverage buyer, it doesn't make a lot of sense [to buy apartments]."
Why? Because cap rates have not followed interest rates upwards, leaving leverage buyers facing the prospect of losing money until cap rates inch up.
So REITs and institutions (which have cash to spend and don't have to rely on leverage) have jumped back into the buying arena because they can make the numbers work. Once cap rates follow interest rates up, this trend could change. But no one knows when that might occur.
Lost Leverage
Live by leverage. Die by leverage. During the past few years, low interest rates allowed private buyers to stretch their dollars even further and buy properties that they may not have been able to afford in the past. Then interest rates went up, and things started changing.
"If I'm a leverage buyer and I go in today, when the 10-year Treasury [note, which is a benchmark for lending rates] is 5.22 percent, spreads have widened," Kaplan says. "The average spread is 100 [basis points] over. So I'm at 6.22 percent. Even if I'm [going for an] interest-only [loan], the spread between where my cap rate is and where my interest rates are is 200 basis points negative. I've got negative leverage."
And this is starting to keep leverage buyers away. "It's definitely happening," says Tim Naughton, president of AvalonBay Communities. "With leverage buyers, it's cash out of their pocket for a year or two. They tend to shy away from those opportunities."
Others see this as well. "There's definitely less guys showing up at the dance on any one auction than there used to be," says Keith Harris, executive vice president of Investments for The Laramar Group, a Chicago-based apartment owner and operator. "That has to be a symptom of the debt and private guys not doing stupid things."
With the increase in rates, high-leverage deals are starting to fall through, which may be a blessing in disguise for the leverage buyer.
"We've seen a couple of deals come back to us," says Mark Wallis, senior executive vice president of United Dominion Realty Trust, a REIT headquartered in Richmond, Va. "We've got a feeling that there's going to be a lot more of that. There's the perception that if a guy has to secure debt, it may take longer and his numbers may be a little tighter."
Filling the Gap
So now that the leverage buyers are fading from the picture, it opens the door for the formerly beaten-up REITs and institutions. Earlier this year, people were talking about the competitive demise of these powerhouses in terms of their ability to buy properties and portfolios. That isn't the case anymore.
"The all-cash buyers can swoop in and get the deals because the leverage buyers can't make sense of the return right now," Kaplan says.
This is especially true in certain product types. "Especially on well-located B properties or Class A properties, purchasers less reliant on maximum loan proceeds will have a distinct advantage," says Blake Okland, principal at the Charlotte office of Apartment Realty Advisors, an apartment broker.
And which purchasers are least dependent on leverage to make deals? The very well-heeled private and institutional buyers are two of the biggest beneficiaries, but REITs may be at the top of the list. "If I'm a large REIT or a pension fund advisor and I'm taking yield within a fund, I can buy all-cash, finance it, and not have the negative leverage," Kaplan says.
"The leverage buyer, including condo converters and private individuals, have been replaced by pension funds and REITs, who are more cash and equity buyers," Naughton agrees.
The disappearance of condo converters cannot be overstated. "REITs are now becoming more active in the investment market because they don't have to compete with the condo converters," says David Baird, national director of multifamily for Sperry Van Ness, a broker based in Irvine, Calif.
Still, not everyone sees REITs taking control of the market. "Our return thresholds are different," says John Smith, senior vice president and chief investment officer for HOME Properties, a REIT based in Rochester, N.Y. "We want some kind of return from day one. Some of the leverage buyers are not looking for cash-on-cash [returns] for the first couple of years. Their overall yield for the five years may be based on the belief that they can still sell for higher price in five years. We may not be as optimistic because we have to hedge our bets for the shareholders to reduce risk."
What Next?
When cap rates do eventually go up, the leverage buyers will probably return, since they'll be able to make deals pencil out again. But that probably won't be happening anytime soon.
"You have a window before prices get adjusted downward where all-cash guys control the market, especially on the high quality [Class] A properties," Kaplan explains. "For the A market, it will probably stay open for the rest of the year. For the [Class] B market, you will see [price] revisions in the third and fourth quarter as the B owners realize if they don't sell now, they might get stuck with a property."
Others, such as Naughton, predict this part of the cycle will last even longer–perhaps a year or two.
If that happens, it won't be any easier to find top-of-the-line product, pushing buyers who can't compete toward less and less attractive properties.
"I think the added liquidity in the market at the institutional level will change the landscape in the immediate future," Kaplan says. "The 'core' and 'core-plus' product is so highly sought after by the institutions that the private groups and even some smaller institutions will be forced to compete on the less 'sexy' product. This much liquidity in a market isn't good because it forces people to overpay for real estate to get their money allocated."
Where to Find Bargains Today
As interest rates rise, it's becoming harder for the leverage buyer to find a bargain. Here are three places to look:
1 The Midwest: With many major REITs focusing on coastal, high-barrier-to-entry markets, the Midwest has opened up for smaller, leverage buyers. "In the Midwest, those cap rates are up and will be inching up more," predicts Mark Wallis, who has monitored the market as senior executive vice president of United Dominion Realty Trust, a REIT headquartered in Richmond, Va.
2 Formerly Hot Condo Markets: "Some apartments in Southern California are seeing as much as a 10 percent reduction," says David Baird, national director of multifamily for Sperry Van Ness, a broker based in Irvine, Calif. "Additionally, Florida markets are seeing a reduction as well."
3 Class C Assets: Whenever there's a price correction in apartments, people often say Class C assets are first to suffer, according to Wallis. But he says that isn't happening yet. "You're still seeing guys rehab good Cs," he says.
Robert B. Simpson in South Pasadena, Calif., bought 411 N. Summit Avenue in Pasadena, Calif., for $2 million from the George A. Colletta and Anna M. Colletta Family Trust in Portland, Ore. Simpson plans to rehab the property and raise the rents to market. The Pasadena office of Hendricks & Partners negotiated the sale.
The Cabraloff Family 1998 Trust in Whittier, Calif., bought Fano Gardens in Monrovia, Calif., from The UCLA Foundation for $6.3 million. Before selling the 37-unit apartment community, the UCLA Foundation did extensive improvements to the property and raised the rents to market. Hendricks and Partners brokered the deal.
Atherton-Newport Investments in Irvine, Calif., bought Asbury Park, a 234-unit apartment complex in South Florida for $15.4 million from Hialeah Realty Group. The property is close to several major malls and sits just behind a Wal-Mart Supercenter. Both Miami International Airport and Fort Lauderdale Airport are nearby.
TIAA-CREF bought an 18-property apartment portfolio consisting of 4,471 luxury apartment units in Chandler, Mesa, and Scottsdale, Ariz., and Houston. The Arizona portion of the portfolio contains seven Class A properties totaling 2,176 units. The 11 Class A communities in Houston total 2,295 units. CB Richard Ellis negotiated the transaction.
Steven D. Bell and Co. purchased nine properties containing 2,753 units from United Dominion Realty Trust. Eight properties are in the Triad area of North Carolina and one property is in Memphis, Tenn. A Bell-sponsored ownership group also bought the Lincoln Green Apartments, a 616-unit community on New Garden Road in Greensboro. The company will spend more than $8.5 million to renovate the properties, including kitchen upgrades and amenity enhancements.
California-based Elliot Trust bought the Devling Place Apartments, a 100-unit apartment community in Kansas City, for $5.7 million. Built in 1986, the property consists of 24 separate four-plexes and includes 20 three-bedroom/two-bathroom units, 60 two-bedroom/two-bathroom units, and 20 two-bedroom/one-bathroom units. Its monthly rents range from $500 to $800. Sperry Van Ness in Long Beach, Calif., and NMI Apartment Brokerage brokered the deal.
Mutual Assets in San Luis Obispo, Calif., bought the Windsor Palms Apartments, a 146-unit property, from Thunderbird Property in Santa Monica, Calif. The Phoenix property totals approximately 65,876 square feet and is near job centers and major roads. Cushman & Wakefield represented both the buyer and the seller in the deal.
Fowler Property Acquisitions in San Francisco bought Chapel Hills, a 183-unit apartment community in Colorado Springs, Colo., from private investors from Colorado for $9.4 million. The property, originally built in 1969 and renovated in 2000, has seven buildings and is situated on 5.85 acres. Sperry Van Ness and CB Richard Ellis represented the buyers and sellers.
Equity Residential, a REIT in Chicago, bought two properties in Florida. The company bought Gables King Colony, a 480-unit multifamily complex in Kendall, Fla., from ING Clarion for $67.5 million. The REIT also bought Archstone Turtle Run, a 257-unit multifamily complex in Coral Springs, Fla., for $51.4 million from Archstone-Smith. CB Richard Ellis Florida brokered the deal.GFI Capital Resources Group bought a four-property portfolio from the Fifteen Group in Miami Beach, Fla. The 1,328-unit portfolio, located in Houston, saw a dramatic surge in occupancy after Hurricane Katrina, going from between 70 percent and 80 percent occupancy to more than 90 percent occupancy. Apartment Realty Advisors represented the Fifteen Group.
Desert Sunshine in Mesa, Ariz., bought The Entrada/Prado Apartments in Phoenix from Tempe-based Encanto Partners for $8.9 million. The properties, which were built in 1973, contain 214 apartment units totaling approximately 172,100 square feet. Cushman and Wakefield's Southwest Apartment Group negotiated the sale transaction.
The Collins Group in New York bought the 2,331-unit Landmark Birmingham Portfolio, six communities in Hoover and Homewood, Ala., from Florida-based Landmark Properties Trust. The portfolio is the ninth acquisition in Alabama for Collins, which bought the property in a partnership with New Jersey-based Lightstone Group. All six properties have undergone upgrades since 2002.
–Listings compiled by Les Shaver