Small private equity groups are flooding the marketplace and investors are targeting cash-on-cash returns over internal rates of return, according to panelists on the equity investment session at the recent Apartment Finance Today Conference.
The most active equity investors today are smaller private syndicators or funds raised more at the grass-roots level in country clubs and other groups of wealthy individuals. Many of these individuals are pulling their money out of the stock market and putting it into private investments, attracted by the relatively hefty returns.
CB Richard Ellis (CBRE) recently completed three multifamily deals in Phoenix, Ariz., and of the 45 offers received for those deals, only one group was not a private investor. “The capital we’re dealing with now truly is individuals and private,” said Tyler Anderson, vice chairman of CBRE’s institutional group.
Many in the industry believe there is a great deal of pent-up institutional equity waiting on the sidelines, but that may not be the case, according to Michael Lowinger, a senior regional director with equity investor Wrightwood Capital.
The capital that his company represents, mostly from pension funds and life insurance companies, are still digging out from losses in real estate investments. “There’s some paralysis in the marketplace in regards to decision-making, and it remains to be seen whether that capital will put its foot on the accelerator to invest in the near future,” Lowinger said.
For instance, when an institution says it has raised a $1 billion fund, it really means that it has $1 billion in commitments. But those commitments are fluid. Investors in institutional opportunity funds have the right to redeem their commitments and are increasingly doing so. “There is a peril that the commitments from investors will not be there in the short run,” Lowinger added.
Another perception in the multifamily industry is that distressed assets will soon flood the market, but that’s only partially true. While the large amount of CMBS and bank loans coming due in the next year may cause more distressed assets to hit the market, lenders are pursuing an “amend, extend, and hope” model in the near term.
“Lenders are giving extensions and the government is getting involved, so I’m not sure the distress will be the level that is generally thought of,” said Eric Snyder, a senior vice president with investment manager Buchanan Street Partners.
And the distressed assets that are available are mostly on the low-end. CBRE is currently working on deals for between 40 and 50 real estate owned (REO) properties, or properties seized by banks after foreclosure. A year ago, the company was only working on three REO opportunities.
“A lot of them are [Class] C assets,” Anderson said. “But the banks aren’t begging people to take it off their hands; they’re trying to figure out what the asset is, manage it as best they can, and sell it at the appropriate time.”
While some institutional buyers are asking for internal rates of return (IRR) of more than 20 percent over a five-year term, the active investors today are focusing on cash-on-returns of between 8 percent and 12 percent.
Cash-on-cash returns are easier to underwrite since they look at immediate cash flow. Simply put, cash-on-cash deals work like a certificate of deposit (CD): When a bank pays a 5 percent return on a CD, it means you 5 percent of the deposit amount.
IRR executions are more complex and underwrite for differing amounts of annual cash flow. In today’s economy, most underwriting assumes a year of declining rent growth and a year of flat rents before expecting growth in the third year.
Sellers should target cash-on-cash buyers, who will typically pay more for an asset than IRR-driven investors. “You don’t want an IRR-driven buyer, because when you run the numbers, it really drives down the value of the property,” Snyder said. “Most of the time, a cash-on-cash buyer will pay quite a bit more than anybody else, so that’s a good buyer to be targeting.”