Jim Hurley, portfolio manager for the California State Teachers' Retirement System, known as CalSTRS and one of the largest pension funds in the country, seems anxious. With cap rates below 4 in some markets (an indicator of high apartment prices) and interest rates rising, CalSTRS and other investors risk negative leverage if they put debt on a property.
"You have to have the wherewithal to cover the cash flows until you see rent growth," Hurley says. "If you're an optimist, you need to plan on 12 to 24 months of negative cash flow. If we see continued increases in interest rates, we will need to pause [buying] until sellers revise their pricing." The fund buys nationally, and its expectations vary by region. Hurley isn't alone in these thoughts. Many multifamily owners who work with institutional investors and pension fund advisers say funds have become wary. But some owners say pension funds see long-term prospects in multifamily investing.
The Tipping Point
While Hurley is watching to see if prices come down–and continuing to invest in multifamily properties, albeit less heavily than in year–he doesn't have a magic number at which he would flat-out quit buying. "The going-in cap rate versus the interest rate and 10-year Treasury [bond rates] are the things we look at," Hurley says. "If interest rates go up another 50 or 100 basis points without any change in cap rates, we'll have a real issue. It's a very tough time to be a buyer."
David Libman, acquisitions manager for Fieldstone Properties in Parsippany, N.J., works with pension funds that want to put money into multifamily property in Florida and New Jersey. The company specializes in buying class B and C properties and upgrading them with new kitchens, baths, roofs, paint, and windows. In that segment of the industry, Libman thinks trepidation is seeping in, especially in Florida. However, lower cap rates are not the only problem.
"We see pension funds wanting to be in the market, but they are keeping an eye on insurance rates and taxes," Libman says. "They wonder what will happen with insurance costs in the market if hurricanes hit again."
Weighing these factors, Libman says he's identified exactly when his investors would abandon multifamily. "I think the breaking point is 6 to 6.5 percent in cash-on-cash yields at the end of year one," he says. "That moves as bond rates change. If I can get 5.5 percent in the bond market with little risk, why am I investing in real estate at 5.5 percent with more risk?"
Even if institutions snub the American multifamily market, they can still stay in multifamily and beef up investment in other parts of the world. CalSTRS, for instance, is investing in Latin American and Eastern European apartments and looking at multifamily in both China and India.
"Globally, there is a shortage of housing," Hurley says. "There's a shortage of housing in East Asia and in Latin America, for instance. The numbers are dramatic. In Latin America, there's a shortage of 12 million houses. Forty million Russians don't have indoor plumbing. The middle class in China, India, and Brazil is doubling every three years. These people want houses. They want a decent roof over their heads."
Other real estate sectors may also present some options, Libman says. "I think they will shift into office and maybe industrial," he says. "With the trade imbalance and more products coming into the country, they could go to ports. You may see secondary ports picking up traffic. There will be opportunities to get in with industrial plays."
Sticking to Their Knitting
However, Hurley sees price increases in all real estate markets. "We're seeing the same thing across all product types," he says. "It's the same dynamic." Besides, the apartment market is clearly recovering.
"Six to 12 months ago, the fundamentals side improved dramatically, even in the worst, overbuilt markets," says Brad Muth, a partner with Concert Realty Partners, a fund manager in Chicago. "Occupancies are in the low to mid 90s, especially in the [Class] A side of the market. Job growth is taking hold, interest rates are popping up, and the condo markets slowed tremendously."
Even if the multifamily market were a disaster, Daniel N. Kaplan, CIO with Fowler Property Acquisitions, a San Francisco-based company that partners with institutions and other investors to buy properties, says it would be difficult for them to change investments very soon.
"They can't stop buying," Kaplan says. "It's their business. Through the downturn, real estate returns have been the strongest performer and the bailout asset class for these large funds. They look and see that if 8, 10, or 12 percent of their money is allocated to real estate, it's proven that it will outperform [other sectors] in the long run."
Instead of leaving multifamily, some pension funds have found ways of buying properties more economically, including locking up new developments early in the process. Institutions get a better price that way, but they're taking the lease-up risk. "A lot of these people have promises up front to buy the properties when they're built," Muth says. "I'm seeing more of it. It was common in the '80s but went away in the '90s."
In cases where they know they're going to face negative leverage, investors may offer the apartment operator a break to make things easier during the first couple of years of ownership. Instead asking for 8 percent returns the first year, investors may ask for 6 percent. But down the road, investors will have to get the balance of what they're owed before the operator collects, according to Libman.
Of course, institutions don't want to make such concessions forever. If prices fall with interest rates going up, things could get back to normal. The only problem is that no one knows when that might happen. "Sellers always lag behind [the market trends], but I don't know how long it will take in this cycle," Hurley says. "There will be an adjustment period."
Irvine, Calif.-based Western National Realty Advisors' $50 million private equity fund, Fund I, acquired Monte Vista, a 207-unit apartment community in La Verne, Calif., a submarket of Los Angeles. The 207-unit community has 119 one-bedroom units, 64 two-bedroom units, and 24 three-bedroom units.
Regency Pacific, in Issaquah, Wash., has refinanced two properties: Good Samaritan Health Care/Samaritan House, located in Yakima, Wash., and Fair View Transitional Health in Grants Pass, Ore. Red Mortgage Capital structured an interim refinancing and construction loan for the Good Samaritan property and FHA-insured mortgage loan financing under HUD's Multifamily Accelerated Process program for the Fair View property.
National Church Residences in Columbus, Ohio, acquired Vanderbilt Apartments, a nine-story, 155-unit affordable senior housing community in Asheville, N.C. NCR assumed $3 million of existing debt and is performing a $5 million renovation to convert vacant efficiency units into one-bedroom apartments. The property, named after industrialist George Vanderbilt, was built between 1910 and 1912 as the Vanderbilt Hotel building and was converted to senior apartments in the 1970s.
Ashkenazy & Agus Ventures in Boca Raton, Fla., bought Cypress Pointe at Lake Orlando, a 236-unit luxury garden-style apartment community located in Orlando, Fla., for $19.1 million, or $81,000 per unit. The Florida headquarters of Apartment Realty Advisors brokered the sale. The property has 11 two- and three-story apartment buildings. It also has a two-story, lofted clubhouse and leasing office.
Biltmore Condominiums at the Palms in Phoenix bought the Biltmore Palms Apartments, also in Phoenix, from Biltmore Palms in Carmichael, Calif., for $9.17 million. The buyer plans to turn the property into condos. The property, which was built in 1982, has 106 apartment units totaling approximately 84,570 square feet.
Watt Genton Associates, an affiliate of Watt Commercial Properties in Santa Monica, Calif., secured a two-year, adjustable-rate loan for the Coronado Bay Club Apartments in Las Vegas. The company received the $40 million bridge loan for a condominium conversion of the property. The property, completed in April, has 29 buildings with 346 one-, two-, and three-bedroom units averaging 1,018 square feet.
San Francisco condo developer and converter Acquest Residential, a division of AGI Capital Group, bought three apartment communities in Hayward totaling 148 units from Felson Cos. in Hayward, Calif., for $41 million. The East Bay office of Moison Investment Co. in San Leandro, Calif., represented both the seller and the buyer. The buyers plan to convert the properties to condos.
Atherton-Newport Investments in Irvine acquired a $114 million multifamily portfolio in the greater Seattle region. The portfolio consists of seven apartment communities and a total of 1,215 residential rental units. The company plans to rehabilitate and reposition the properties.
The Lynd Co. in San Antonio recently entered the Atlanta market, purchasing two value-added properties: The Magnolia at Sandy Springs, a 268-unit community, and Ashley Mills, a 468-unit property. Both properties feature one-, two-, and three-bedroom apartments.
Vision 193 in Florida bought the 5th Avenue Apartments in St. Petersburg, Fla., for $16.5 million, or $85,492 per unit and $103.62 per square foot, from Florida-based 5th Avenue Apartments. Marcus & Millichap's Tampa office represented the seller, and its Ft. Lauderdale office represented the buyer. The 193-unit garden-style apartment community comprises eight four-story buildings on 6 acres of land.
Phoenix Property Co. and Lincoln Property Co. acquired Grand Marc Minneapolis, a 370-bed student housing complex next to the University of Minnesota in Minneapolis. The building offers ground-floor retail stores and underground parking.
Meta Housing Corp. is developing Courtland Senior Apartments, a 108-unit affordable senior community in Arroyo Grande, Calif. Amenities will include a clubhouse with kitchen, computer/business center, pool and spa, arts and crafts room, and laundry facilities.
Winkle Pioneer Court in Ft. Worth, Texas, bought Pioneer Court, a 30-unit apartment community in Irving, Texas, from Pioneer Court Condo in Arlington, Texas. The two-building community, built in 1986, is 90 percent occupied and includes a mix of one-, two-, and three-bedroom units. Its monthly rents range from $550 to $850.
Trimarchi Management in Schenectady, N.Y., bought the 1,032-unit AMLI of North Dallas apartments from AMLI Residential Properties in Chicago. The property is near three of the metro area's top employment centers and is within minutes of major retail. The sale was arranged through the Dallas office of Apartment Realty Advisors.
–Listings compiled by Les Shaver