On the last multifamily apartment deal that he bid on, managing director of acquisitions for Chicago-based real estate investment management firm RREEF Brian McCauliffe was pretty sure his team was going to be on the short list of finalists.

"It was a property in Washington, D.C., called Pallantine that traded in March,” McCaullife said on a Capital Markets and Apartment Investments Strategy panel at the Multifamily Trends Conference held June 9 in conjunction with the Pacific Coast Builders Conference in San Francisco. "We thought we were among the best bidders on the property, and we weren’t even among the last dozen."

Rockwood Capital made it to the finals. "You want to know what the cost of entry was?" asked the firm’s senior managing director Bob Gray, who joined McCauliffe, Freddie Mac managing director of multifamily Steve Griffin, Wells Fargo senior vice president Eric Smith, and Vancouver, Wash.-based Holland Partner Group CEO Clyde Holland on the panel. "You had to carry a $5 million cashier's check to the courthouse steps in the middle of a snowstorm. The bidding hit $100 million very quickly, several public REITS took it into the $110 million to $115 million range, and then [condo converter] Crescent Heights waited until activity petered out at the $115 million range and then bid $118 million to take the transaction."

Pallantine isn’t an isolated incident either: Stacks of multifamily capital are being thrown at Class A product for sale across the country as firms who amassed cash for distressed real estate opportunities chase the relatively few deals that are coming to market. Despite the competition, investors are showing little variance from luxury market plays as they look for cash flow properties while waiting on an expected renter demographic surge and corresponding rent growth expected to power the apartment industry through the next decade.

"Our investment clients are corporate and public pension plans," McCaullife said. "So the primary bucket of capital that RREEF is looking to place is in core investments with steady, consistent income returns to satisfy client yield expectations. We want to identify Class A communities in primary markets, and that’s not too different than most of the players out there. Even as we are spending more time on the construction strategy, it is still a build-to-core type strategy to match the existing asset focus in Class A."

According to Holland, compression in the cap rate delta between product types is further sweetening the pot for portfolio owners looking to trade up to A Class property holdings. "The bid delta between Class A core and Class C tertiary got down to 50 to 75 basis points, and when you can trade Class C tertiary for Class A core, you are doing it as fast as you can," Holland said.

According to Gray, competition for even borderline B-plus product is beginning to heat up as buyers chase the best-of-the-best deals. On Rockwell’s last bid, which Gray describes as "barely Class A older product but in a good Seattle location," 30 bidders ran the deal up to $110 million at a mid-4 cap on trailing twelve-month income.

Despite the obvious bullish underwriting on some of the more recent deals, panelists warned that there are risks in the market, including college debt and limited job prospects facing the Gen Y cohort, in addition to severe depreciation in single-family home prices coupled with historically-low interest rates. According to Holland, the propensity to own versus rent peaked at 69.2 percent, is now back down to 67.1 percent, and is expected to normalize over the next couple of years to 64 percent or 65 percent. For each percentage point decrease in the homeownership rate, 1.7 million new renter households are created, Holland noted, which, when added to 2.2 million Gen Yers now entering peak rental years, could combine for close to 6 million new renters over the next several years.

"That’s the feel good story," countered Gray. "But home prices and interest rates are hitting historic lows. We don’t think the balance goes all the way back."
Despite concerns of recession affecting the broader multifamily capital markets, Griffin noted that lending was brisk at Freddie Mac and apartment sector distress is largely absent from the agency’s books. "Our watch list had grown exponentially over the past 16 months, but defaults have not materialized," Griffin said. "Out of roughly a $100 billion core market portfolio, there’s maybe 20 to 25 basis points of delinquency, and out of those 9,000 to 9,500 loans, we own maybe eight to ten."