What's the word on the street? More distressed acquisition opportunities will come to the multifamily market next year, while the dearth of Class A assets trading hands will likely continue.
And that's not all: The cap rate compression that characterized much of 2010 isn’t expected to continue, according to a survey of 168 senior-level multifamily finance professionals conducted by Apartment Finance Today magazine this month.
The survey also uncovered a growing consensus that the worst of the recession is over. Fewer multifamily firms expect to lay off staff or reduce employee benefits in 2011. What’s more, a growing number of developers will pursue value-add rehabilitations in 2011, a sign that many expect fundamentals to strengthen next year.
Forecasting Deals
While the wave of distressed auctions that many expected hasn’t yet materialized, investors are increasingly optimistic that next year will be different. Nearly 62 percent of those surveyed expect more distressed acquisition opportunities to be unearthed in 2011.
| Table 1. Asset types expected to be available in 2011. | |
|---|---|
| Distressed properties | 61.9% |
| Class B | 39.2% |
| Value-add | 34.5% |
| Class C | 33.3% |
| Niche (student, seniors, etc.) | 24.4% |
| Class A | 22% |
| None of the above | 4.7% |
Many feel that it’s just a matter of time before all of those short-term, interest-only CMBS loans made at the peak of the market finally come due. And balance-sheet lenders can only extend-and-amend for so long—as banks slowly return to health, they’ll be able to take greater losses as they clear their balance sheets of distressed notes.
But as investors line up to capitalize on distress, it’s a different story for core assets. Throughout 2010, Class A assets in strong locations inspired bidding wars so heated that most players walked away shaking their heads at the size of the winning bid. That feeding fenzy will likely continue: More than three-quarters of respondents (78 percent) believe there will be fewer stabilized Class A assets hitting the market next year.
Meanwhile, in a sign that valuations have reached a sort of equilibrium, half of all respondents expect capitalization rates to remain flat in 2011. Only 23 percent of respondents expect to see cap rates continue to fall next year, compared to 27 percent that expect them to rise next year.
| Table 2. Trends in Cap Rates in 2011 | |
|---|---|
| Stay flat | 50% |
| Rise | 27% |
| Fall | 23% |
Market Upsides
In last year’s survey, Atlanta emerged as the top distressed market with the most upside. But this year’s survey shows investors are increasingly pessimistic about Atlanta, as it enters a last-place tie with distressed poster child Las Vegas.
| Table 3. Distressed Markets with the Most Upside. | |
|---|---|
| South Florida | 27% |
| Southern California | 25% |
| Phoenix | 11% |
| Atlanta | 10% |
| Las Vegas | 10% |
But confidence is rising around the prospects of South Florida and Southern California. More than a quarter (27 percent) of respondents think South Florida has the most promise, making it the No. 1 distressed market with the most upside. And prospects for Southern California, which barely beat out Phoenix last year, have also grown: 25 percent cited Southern California as presenting the most potential long-term growth, an improvement of 9 basis points over last year’s survey.
Cost-Cutting Continues
Renegotiating vendor contracts and fighting tax judgments continue to be among the most popular cost-cutting strategies employed by firms. More multifamily firms also plan to pass utility costs on to residents and use software to automate business processes than they did last year.
A deeper look at the list of cost-cutting measures reflects some encouraging signs. Last year, reducing the development pipeline ranked fourth, but that category drops down to ninth this year. Similarly, headcount reductions were the second-most popular cost-cutting strategy in last year’s survey. This year, staff cuts dropped down to fifth.
Table 4. Top 5 Cost-Cutting Strategies Likely to be Employed |
2010 Rank ('09 Rank) |
|---|---|
| Renegotiate vendor contracts | 1 (1) |
| Fight tax judgments | 2 (3) |
| Pass utility costs to residents | 3 (T6) |
| Use software to automate processes | 4 (T7) |
| Reduce headcount | 5 (2) |
Editor's Note:The survey of 168 senior-level multifamily finance professionals was conducted from August 5 to August 19, 2010. The respondents included senior-level finance staff from merchant developers, owners, managers, and multifamily financiers. Additional results can be seen in the September/October 2010 issue of Apartment Finance Today.
