Last fall, two REITs, not known for being apartment builders, announced construction deals in Tennessee. Memphis-based Mid-America Apartment Communities announced construction of a 39.8-acre property in Franklin, which it purchased for $6.4 million from Charlotte-based Crescent Resources. Earlier in the month, a joint venture controlled by Cleveland-based Associated Estates Realty bought a $6.74 million property from Nashville-based Bristol Development Group.
Haendel St. Juste, an analyst with Keefe, Bruyette & Woods (KBW), an investment banking and security brokerage firm based in New York, thinks more of these deals could happen in the future. It’s obvious that REITs can provide a much-needed equity injection for a struggling developer, but it can also pay off huge dividends for the REITs, who are seeing strong competition for Class A assets.
“I definitely think this is an area to keep an eye on,” St. Juste says. “Buying entitled land takes a bit of the entitlement risk off the table and speeds up the development process a bit as well. This is a way for them to add new product at more attractive entry point and without significant development risk.”
The Inner Workings
In both cases, the developers had done work on the project beforehand. Crescent Resources, which had already completed pre-development and entitlement work on the site, risked losses if it didn’t meet in the fourth quarter, according to report from Robert W. Baird & Co., a Milwaukee-based wealth management, capital markets, asset management, and private equity firm. Crescent, however, didn’t have the ability to meet that requirement so Mid-America bought the parcel and contracted with Crescent to build the 428-unit community for the $52.5 million.
Mid-America closed two of these deals for $105 million, which they call value developments. “We have purchased the land and development rights for high-quality deals from developers that have completed the entitlement process, but that can benefit from our balance sheet strength and continue to participate in the deal through the development agreement,” says Al Campbell, CFO for Mid-America.
The Bristol-AEC deal was different. Bristol retained a minority interest (about 10 percent) in its Nashville project with AEC. AEC’s subsidiary, Merit will handle the construction of the project. “We had done some business in the past [with them],” says Jeffrey Goldberg, senior director of corporate finance and investor relations at AEC. “They have local market expertise.”
Earlier in the year, Chicago-based Equity Residential made a similar move when it bought a site for 111 market-rate apartments and 10,000 square feet of retail space in the Chelsea section of New York from a struggling developer. “The REITs have the capital to take deals like this down without financing and many have in-house development teams to hit the ground running,” says Andrew McCulloch, an analyst with Newport Beach, Calif.-based Green Street Advisors.
More Deals Coming?
But REITs aren’t the only companies out there that could provide development equity. In the past, Greensboro, N.C.-based Bell Partners provided funding for Atlanta-based Wood Partners in Virginia, North Carolina, South Carolina, Georgia, Florida, and Texas projects. “We typically put in most [sometimes all] of the equity, and the developer signs the construction loan recourse guaranty and also provides a guarantee on construction costs [with some asterisks],” says Jon Bell, president of Bell Partners. “As the investor, we typically get a preferred return and a return of all originally invested equity prior to splitting the upside with the developer. The preferred return level and promote/carried interest to the developer vary depending on the deal and where we are in the cycle.”
Bell has invested development equity in the past six months, but is currently looking at proposals, according to Bell. “I hope and suspect that there will be folks [developers] coming to us saying that they need a partner that can bring equity to the table,” says Steven D. Bell, chairman and CEO of Bell. “I think there are some good opportunities. We’re talking to several people right now.”
