Last year, respondents to MULTIFAMILY EXECUTIVE'S annual Strategies Survey recognized the debilitating effects of the credit crisis heading into 2008. But no one imagined the economic maelstrom that would engulf the country in recession, render non-agency financing nearly impossible, and put a strain on the employment engines powering industry growth. While underlying real estate fundamentals in the multifamily sector seem stable—or at least preferable to any other asset class—respondents to MFE's 2009 Strategies Survey are nonetheless wary of continued economic storminess in single-family housing and on Wall Street. As companies batten down the hatches sailing into next year, most point to an increased use of technology, lean operating tactics, and strong portfolio management as allies in successfully emerging from the storm. For an exclusive look into how your multifamily peers plan to attack financing, operations, property management, development, and acquisitions, read on.
Like virtually every American business person, Alan Hammer's clients sense uncertainty in the economy. “Instead of looking for opportunities, we are waiting for opportunities,” says the real estate investment attorney and partner at Philadelphia-based Wolf-Block. In addition to operating his own multifamily investment portfolio, Hammer advises similar multifamily owners nationally, with a heavy concentration in the northeast markets.
“We don't seem to know how to look for opportunities in the current environment,” he says. “We want to be poised and ready—and so does everyone I speak to. But nobody is sure what that means. What should we do? It has not even been bad that long, and I think it's going to be longer before things are over.”
The “things” Hammer alludes to are pretty clear: the collapse of the single-family housing market, a subsequent surge of subprime foreclosures, the credit crunch, and the resulting volatile, downward spiral that has become the American economy of 2008. Though the multifamily side of real estate—powered by great operating fundamentals and backed by the lending liquidity of Fannie Mae and Freddie Mac—seemed at first insulated from broader market woes, it's becoming clear to developers, owners, and operators of multifamily housing that a sea change has come.
Consider recent top-of-mind trends such as building for sustainability and tailoring business models for Gen Y and other hot market demographics. Those efforts are taking a backseat as the industry focuses on money markets, Wall Street, and any indicator with a remote bearing on finance and the economy. According to MFE's 2009 Strategies Survey, the availability of financing, the current tumult on Wall Street, and the decline of the housing market are the three trends shaping the multifamily industry in 2009 (see Figure 1 on page 43).
“The big thing on everyone's mind is capital,” says Matt Slepin, a principal and co-founder of San Francisco-based executive placement and market research firm Terra Search Partners. “Whether it is the availability of debt capital or the meltdown on Wall Street, it is all coming down to the same thing—a realization that we are multiple years away from a new plateau of stability.”
Even Fannie Mae and Freddie Mac, the government-backed lending entities once thought to be liquidity stalwarts, are entering 2009 with an uncertain future. When their stock prices plummeted this summer, the U.S. government established a conservatorship and took over both agencies, dismissing the boards of directors and executive officers. Despite the turmoil, Fannie and Freddie have continued to lend steadily into multifamily markets. At the two-week, four-week, and six-week points, both agencies had completed larger volumes of loan originations than in the two-, four-, and six-week periods prior to the conservatorship.
Multifamily operators seem to appreciate that stability. Less than a third of respondents to the Strategies Survey feel the future of Fannie and Freddie is likely to be a top trend in the coming year, equal to the amount of respondents who still see green building as critical to operating strategies.
“I can't speculate on where the conservatorship will take us, but I'd take it as a positive that respondents rated the future of Freddie and Fannie on the lower end of the importance scale,” says Michael McRoberts, Freddie Mac's national head of underwriting and credit and vice president of multifamily. “I think there is a confidence level that we are going to be there for them.”
Regardless of any industry goodwill toward the agencies—or perhaps in spite of it—multifamily operators are embracing a “cash is king” mentality. Whether amassing war chests for future acquisition or focusing on the bottom line, the industry has become dollar-conscious, eliminating overhead, cutting costs, stocking up cash reserves, and securing lines of credit where possible.
At Freddie Mac, McRoberts says structured lending volume is five times that seen in 2007. “The major REITs and super-regional companies with $300 million and $400 million needs are very anxious to lock up a facility today to ensure lending capacity for the next two or three years,” he says. “We will beat our previous best year by a factor of five. Our flow business is probably flat, but the structured business is off the chart.”
That uptick is due in large part to a contingent of companies positioning for the opportunistic acquisition of distressed assets as the market turns. When that bottoming out occurs is still anybody's guess, and as a result, the current deal flow for multifamily real estate is practically nonexistent. Even looking into 2009, more than half of the respondents to the Strategies Survey say deals this year will be of the single-asset variety. Another 23 percent indicated that they'd consider single portfolio deals—slightly less than the 24 percent who did not know what their deal flow would look like (see Figure 2 on page 44).
“In 2008, we bought one deal, and we sold one deal. That was our transactional volume for the year, and 2009 we expect to be the same: On a net basis, it should be zero,” says Greg Lozinak, chief operating officer for Chicago-based Waterton Associates, an owner and operator of about 16,000 units in 13 states. Lozinak still has some deals coming across his desk, but nothing that Waterton would consider a diamond in the rough. Nor does the COO feel like his company is missing out on deals to competitors. “We expect volume to be pretty low across the industry throughout next year and quite possibly into 2010 at this point,” he says.
Despite economic hard times, distressed assets have yet to significantly hit the market, and cap rates—although showing some modest 100 basis point expansion in tertiary markets—are not adjusting to what buyers say are the new realities of the marketplace. Less than a third of respondents to the Strategies Survey expect further cap rate compression. And while 23 percent of those surveyed see a flat cap rate environment, 44 percent of respondents expect rates to trend either slightly or significantly higher (see Figure 3 on page 45).
Until that happens, deal flow is a contradiction in terms. “What I see is a dearth of transactions, probably the least I have ever seen,” says WolfBlock's Hammer. “You'll hear all the time that transactions are down because of the credit crunch, but I believe that there is money available to do deals.
“Still, there is a tremendous disconnect between buyer expectations and seller prices,” Hammer continues. “Aggressive purchasing at gigantic prices and low cap rates have stopped because buyers are not going to lose money on a buy when they can lose money on the portfolio they've already got.”
DEVELOPMENT & OPERATIONS
That argument seems to hold true for construction and development pipelines, which have significantly tightened in light of inactive capital markets and uncertainty in the economy. The average development pipeline among respondents to the Strategies Survey is a modest $10 million to $24.9 million, and although there are some players still operating in the $100 million and above range (see Figure 4 on page 45), the industry's median developer is looking at investing only $1 million to $10 million in development next year.
“We have several transit-oriented developments under construction and several in the negotiating phase,” says Art Lomenick, a managing director with Dallas-based Trammell Crow Co. and president of the company's High Street Residential urban development division. “The challenge right now is financing. Whereas a year ago we'd just pick a lender because it was the easiest piece, right now the quotes we are seeing have unacceptably large amounts of equity and personal assurances, so we're getting into our design work and city negotiations and holding off on the lender for awhile, at least through the first quarter.”
Some builders feel the drop-off in industry-wide development activity will offer opportunities in 2010 and 2011 similar to those on the acquisition and disposition front. Take Lane Co. After building no rental units in 2006, the Atlanta-based firm aggressively attacked the market in 2007 and pulled 3,000 apartments out of the ground. Company chief information officer and asset management president Dan Haefner says Lane will likely dial back from that volume in 2009, but the company would like to position itself with plenty of new product as the market turns.
“We'll continue to be cautiously aggressive to the extent that we can get some equity to do acquisitions or development,” Haefner says. “Next year, the competitive advantage goes to anyone that can get something started. There will be so little product in the next two years. We think it is a great time to buy or develop.”