Earlier this year, the owners of Trellis Square in Sunnyvale, Calif., and Adagio at South Coast in Santa Ana, Calif., sold their properties. In each case, it was difficult. They saw each asset fall out of escrow, and only about 10 bidders competed for each of the deals.
A few months later, in similar submarkets, two new property owners, who couldn’t be identified because the deals haven’t been closed, put similar assets on the market. This time, they both received more than 40 offers and saw multiple rounds of bidding. “In each round, the groups increased their offers,” said Aaron Hancock, acquisition director of Raintree Partners in Laguna Niguel, Calif.
Hancock and other industry observers spotted a trend that many people thought would be nearly impossible just a few months ago—another feeding frenzy on apartment properties. Hancock and Mike Kelly, president and co-founder of Caldera Asset Management in Greenwood Village, Colo., thought that could indeed be the case. “We’re back to 2005 and 2006,” Kelly said. “We’re chasing our tails to get deals done.”
And that has the potential to have dangerous repercussions. “I’m a little concerned pricing fundamentals are getting a little aggressive,” Hancock admitted.
In fact, Kelly is concerned that the scarcity of deals is causing buyers to overestimate the assets on the market. Through September, he said there have only a little over 400 apartment deals nationally, after approximately 3,700 properties sold per year from 2005 to 2007. “There are lots and lots of people looking and nothing is trading,” Kelly said.
But scarcity isn’t the only thing driving prices up in some cases. Low interest rates, agency debt, and equity investors frightened by commercial real estate are also fueling interest. “They [equity investors] are looking at apartments because of the availability of debt,” Hancock said.
But with expectations that distressed assets could hit the market in the next couple of years, the job situation not growing any better in the near future, and interest rates likely to rise, Kelly wonders if these buyers could be asking for trouble. “You may eventually get 60 percent rent growth, but it won’t offset the increase in cap rates,” Kelly added (ultimately Kelly sees rent growth moving three to five percent from 2011 to 2013).
Tim Argo, vice president and director of financial planning for Mid-America Apartment Communities in Memphis, thinks that if buyers are comfortable with their hold time, cost of capital, submarket, and starting point, they can still make shrewd deals. “If you are comfortable with the key points, you should feel comfortable in any market,” he said.