When the founder of a private apartment firm needs a new face at the top to help push growth, he or she has two options—turn to competitors and pick off young talent or promote from within. Lawrence R. Gottesdiener took a different approach. The founder and chairman of Newton, Mass.-based Northland Investment Corp., turned to … his lawyer?
In Gottesdiener's defense, Steven P. Rosenthal, Northland's current CEO, had entrepreneurial experience and a track record running a much bigger firm. As co-managing partner at Boston-based Mintz, Levin, Cohn, Ferris, Glovsky and Popeo P.C., he propelled growth, doubling the number of attorneys from 250 to 500 and opening three offices in California as well as one in London.
Gottesdiener turned to Rosenthal because he wanted someone to grow the company and put the systems in place to possibly take Northland public one day. “He was running a much bigger company,” Gottesdiener says. “He was my most trusted advisor and one of the most capable business people I have ever met. He balances an ability to see the big picture and execute on the details. He is an outstanding strategic thinker and knows how to develop and maintain relationships.”
By the late summer of 2007, after six years of pressure by Gottesdiener, Rosenthal made the jump to Northland. “I was an old-fashioned business lawyer, and Northland was one of my clients. [But] Larry talked me into coming here to run the company,” Rosenthal says. “I wanted to see if I could do it. I've known Larry for 15 years. I was his lawyer as he built and grew the company.”
Now, Rosenthal is bringing an entrepreneurial spirit to the real estate industry. The former lawyer and Gottesdiener, the veteran real estate executive who made it through the early '90s and lived to tell about it, are looking to follow the exact same path as a number of REITs, institutional investors, and opportunity funds right now—find good multifamily assets at discount prices.
So what makes them different? Unlike some of their bigger competitors, they started buying last year. Targeting multifamily assets in six markets, Northland bought up 27 properties—a total of 6,386 units—from 2007 to 2008 (as of press time) and is gearing up to continue its buying streak in 2009. While there's an inherent risk in buying in a market where deal making has been described as trying to catch a falling knife, Northland is a firm that's proud to call itself contrarian.
MULTIFAMILY MANTRA
When Rosenthal officially came on board, the company issued a release saying that Rosenthal would be charged with “stewarding Northland's growth.” If Rosenthal's mandate was growth, then Northland was certainly the right place to go. “Our business platform allows us to shift into regions or asset classes,” Gottesdiener says. “In this case, we're loading up on multifamily.”
Given the availability of debt, shortage of new supply, and demand from echo boomers, baby boomers, and immigrants, multifamily was the obvious growth choice. Plus, other asset classes were seeing growing problems. “Multifamily is fairly stable and predictable,” says William M. Thompson, vice president of asset management for Northland. “We may not see rents rising like the last few years, but at least there's some predictability to it.”
It wasn't always like that, though. Northland's roots, for one, took hold in the ruins of the last real estate crash. In 1991, Gottesdiener started Essex Partners, a multifamily investment firm that bought properties from the Resolution Trust Corp. Six years later, he bought Northland and merged Essex into the company, keeping the Northland name.
By early 2007, Northland had a 50/50 split in its portfolio between multifamily and commercial. Instead of specializing in one market or one product type, the investments are located in various cities across the country—some of them with seemingly nothing in common. Today, the firm can develop, do value-add upgrades, or just buy and hold without performing renovations. It even has a $1.5 billion development pipeline with four different mixed-use projects to its name.
“Their approach to diversification is different,” says Gil Menna, a partner at Goodwin and Procter, a corporate and real estate law firm with offices around the country, who also chairs the firm's REITs and Real Estate Capital Markets Group. “Most of our clients specialize on certain asset classes.”
Today, the strategy is different, although the buying rate wasn't as accelerated—Northland bought 22 properties between 2004 and 2007 when cap rates fell to crazy numbers. That was part discipline, part the doing of the market. “In '05 and '06, when every single institutional buyer was competing for the same property, it was hard to buy unless you were a REIT, a big pension fund advisor, or you just didn't care about money,” says Andrew Gnazzo, vice president with CW Capital in New York. “Maybe out of necessity they were forced to take a backseat a little bit.”
There was one advantage to sitting on the sidelines. Gottesdiener says the company has only two maturities totaling $85 million next year (the larger loan has a one-year extension), though it does have a couple in 2010. And when Northland did buy, it didn't overextend itself. It relied on insurance companies and conduits for financing, until moving to Fannie Mae in early 2007. It usually puts about 25 percent equity into deals and relies on 75 percent leverage (overall the firm is leveraged between 55 percent and 58 percent). “It's somewhat less than Wall Street was leveraging their equity at,” Gottesdiener says.
BUYING LESSONS
The strategy had Northland sitting pretty, ready to take advantage of opportunities in late 2007 and throughout 2008. At the helm was Rosenthal. After all, the 21-year legal veteran didn't go to Northland to sit still. In October and November of 2007, just after he came aboard, Northland closed a few small transactions. Then, in December, Northland agreed to buy the debt under six conversions from troubled Tarragon Corp., a publicly traded apartment owner and condo builder based in New York.
Tarragon had bought the properties—five in Florida and one in South Carolina—for $300 million in 2005 and 2006. The deal included three broken condo properties (421 units in Florida and South Carolina) and three apartment communities (898 units in Florida). The plan was to convert them to condos. When the market turned, the builder found itself under water. That's when Northland swooped in, offering to buy the 1,319 units across the six-property portfolio for $160 million and return them to the rental pool. It used its Fund II, which had $100 million, to facilitate the deal. “Tarragon was troubled, and Northland got itself in position to take advantage of an opportunity,” Menna says.
Northland and Tarragon took the plan to Barclay's, which held the debt on the properties. The London-based retail and commercial banking firm agreed to the deal. “It was one of the first deals where someone was buying distressed assets financed by the seller,” says Robert Given, an executive vice president with CBRE in Miami who has worked with Northland on several deals in Florida. Given estimates that Tarragon got the properties at 75 percent of replacement costs and 55 percent of original costs. Unlike many companies coming into the Florida market, Northland was able to secure properties that were stabilized, so he sees the deal as a big win for the firm.
Others are more cautious. Jack McCabe, CEO of Deerfield Beach, Fla.-based McCabe Research & Consulting, a market research firm, believes that, in general, paying more than 50 cents on the dollar for assets in Florida might be too high right now.
While Rosenthal acknowledges that there's some softness in the portfolio, he sees it as a springboard to developing a platform in the Sunshine State. “The long-term fundamentals in Florida will be good,” he says. “In the near- to mid-term, we think it will continue to be soft, but we're very interested in Florida, especially the southwestern and southeastern coasts.”
The Barclay's debt transaction at the end of 2007 set the stage for Northland's second deal with Tarragon. In March 2008, the two firms agreed to set up a joint venture. Northland would transfer its 14,433 units from its portfolio to the deal, including the six properties it had just bought from Tarragon, and get a controlling 77.5 percent interest in the joint venture. Tarragon would contribute an additional 7,433 units to the deal, get a 22.5 percent interest in the new venture, and get a $50 million loan commitment from Northland. The proceeds of the loan, along with additional cash from Tarragon, would have been used to purchase part of Tarragon's subordinated debt at a discount.
Just as the deal was about to close, Tarragon says that GE Capital Corp., which held the debt on 23 Tarragon properties, wouldn't consent to the plan. In September, Northland sued for specific performance and damages. Shortly after, Tarragon countersued, claiming that Northland misrepresented the facts and harmed the joint venture's ability to claim the GE Capital debt. After the deal fell through, Tarragon entered into a deal to restructure $125 million of its debt with its lenders.
“The agreement was conditioned on getting GE's approval for the change in control of the Tarragon properties, which they financed,” says William Friedman, CEO of Tarragon in a statement to MULTIFAMILY EXECUTIVE. “The day after Northland failed to close on an apartment property they had agreed to purchase from us, they sued for a return of the $250,000 nonrefundable deposit. GE thought that kind of behavior from a would-be partner did not bode well for [their] future.”
Rosenthal believes the blame lies with Tarragon. “The breach of the joint venture agreement was an ill-fated attempt by Mr. Friedman and Mr. Rothenberg to advance their goal of collecting on personal loans to the company. The market has reacted accordingly, with Tarragon stock down over 95% since the breach occurred. Furthermore, their manipulation of the lender consent process has produced a default under the GE Loan and will cause their primary lender to recognize a major write down in the inevitable bankruptcy proceeding.”
GROWTH SPURT
Rosenthal, for one, is eager to move past the suit and says the botched venture did not handcuff Northland. The proof? Northland's August deal with REIT Equity Residential.
After two private equity firms bailed out of a deal to buy 2,985 apartment homes in Austin from Chicago-based Equity, Northland (which had bid on the deal originally) stepped up, paying $270 million for the nine Class A communities. Rosenthal says Northland got the properties at a $30 million discount. It pulled $65 million out of its $200 million Fund III, which closed in January 2008, to facilitate the deal.
“We got five years of interest only on a seven-year deal with debt in the mid-5 percents for the Austin deal,” says David M. Frieze, director of multifamily acquisitions for Northland. “We're excited about Austin, and the debt made it attractive.”
The acquisition not only upped Northland's unit count but also added quality to its portfolio. “These are core assets in infill locations,” says Ron Halpern, managing director for the Boston office of CBRE and Melody/Capital Markets, a Los Angeles-based lender that handled the deal's financing. “It was an opportunity to expand their portfolio in Austin.”
On August 25, 2008 (not quite a full year since Rosenthal had come on board), Northland announced the Equity deal, billed as the largest apartment deal in Austin's history. At the end of the statement, Northland announced that in the past 12 months, the company had completed 24 acquisitions totaling 5,906 units. The hefty growth has some concerned. “I think the only negative would be whether or not they can digest their growth,” Menna says.
A valid point, considering that those numbers are likely to grow. The cash-backed company still has about $10 million to $15 million left in its first fund; $130 million in its second fund; a $70 million unsecured revolving line of credit; and $276 million in its Northland Portfolio, a consolidation of past partnerships . Rosenthal says the high rate of expansion isn't a concern. “Integration fails when there isn't a focus on people,” he says. “Management function is only as good as the people you have. We care a lot about people and creating a culture that celebrates that.”
And don't forget that the acquisition strategy is a long-term one. As of November, Northland's 16,671-unit multifamily portfolio is 75 percent of the company's collective holdings.
While Northland executives say they don't really have a “magic number” as far as unit counts go, Gottesdiener admits that it would serve the company well to have more than 20,000 units. “We don't have any specific target, but we do find it beneficial to have certain scale,” he says. “Mainly, we just want to grow where we are, if we can. Some kind of scale of 20,000 units to 30,000 units will help us continue to provide the best training, the best software, and be able to amortize over our portfolio of scale.”
2009 AND BEYOND
There were many reasons for Northland's rapid growth in the past 12 months. For a company that considers itself opportunistic, the primary driver is, of course, opportunity—but only in a sector it likes. And that's not all. You can't discount Rosenthal's influence, the disappearance of many of its key competitors, or the firm's flexibility.
“Northland's funds don't have specific end time frames,” Gnazzo says. “For some of the public money or institutional money funds, you've got to get in there and buy something that has a quick pop to it. In 2007 and 2008, they're able to buy things because someone else may not see the appropriate return in three years. They can look at it in five to 10 years and sit and be patient. That will allow them to scoop up a lot of deals.”
Though the Wall Street meltdown and continuing capital crunch haven't helped bring buyers and sellers together, Rosenthal and Gottesdiener expect to see more deals come through the pipeline next year. And those deals could look a lot more like the Tarragon transaction than the Equity deals. If a buyer leveraged more than 25 percent of their deals and values fall an additional 15 percent to 25 percent, Gottesdiener expects to see lower B and C class products in second- and third-tier markets end up with the banks. “There is going to be a lot of lender-owned product,” Frieze says. “We're trying to look at buying notes and create relationships with the people who will own real estate before they end up in broker's hands.”
But Northland won't just go to lenders. It relies on a vast array of sources, including brokers, title companies, local contacts, and its own managers to find deals. “We're going to be very aggressive when there's an appropriate opportunity,” Rosenthal says. “There may be all kind of opportunities, not just buying notes. For instance, some of the smaller REITs have to sell property. Maybe there's an opportunity to take a small REIT private.”
As it continues to add units and grow, there are sure to be questions. Is Northland buying too soon? Is it paying too much? Rosenthal admits that no one really wants to venture into the field first to buy right now. Part of that is fear. “The buyers and sellers are not meeting in the marketplace,” Rosenthal says. “Sellers are in denial. They just hold on. Buyers don't want to overpay.” Gnazzo agrees, adding: “No one wants to catch the falling knife.”
McCabe is one of those who think some buyers will jump in too soon. “There will be false bottoms in this downturn,” McCabe says. “There will also be people that jumped in early in the game—the knife catchers. It may be the second or third ones in the game that realize the profitable workout opportunities.”
Northland insists it hasn't jumped in too soon. Peter Standish, the company's senior vice president of acquisitions and development, warns that anyone judging Northland's buys in Florida needs to realize that the company isn't just buying in hopes of cap rate compression. “We want to make sure we understand and are realistic about what we're buying,” Standish says. “We believe we haven't overpaid and have positioned [our assets] for long-term holds.”
If Northland sticks to its script and continues to get deals at a discount, Rosenthal thinks there's potential for a great reward. “Fortunes will be made during this time,” he says.
Underwriting Challenge
At Northland, property managers and acquisitions frequently get together.
WHEN NORTHLAND Investment Corp. in Newton, Mass, looks at purchases, it doesn't just call up the acquisitions people. Its management team plays a big role as well, doing lease audits and market surveys.
“We literally do up to a one-year budget from the property management folks, and we match it [with the budget from acquisitions] and see how far apart they are,” says William M. Thompson, vice president of asset management for Northland. “Typically, property management is more conservative, and acquisition folks are more optimistic. It's a good balance for what the pro formas are in the broker packages.”
It's not hard to understand why management is hesitant. “Sometimes, management will come back and say they can get $100; sometimes they're hesitant,” Thompson says. “They have to execute.”
At this point, Thompson pulls each team in to see which line items are causing the difference in opinion. “We'll discuss who's right and who's wrong, if it's a happy medium, and if it makes sense to still move forward,” he says.
Often the management team can help make a deal work, though. They've been able to execute a money-saving initiative to boost NOI at existing properties and can plug that into a potential buy. “They will add what they think they can do to better those operating expenses,” Thompson says.
Three To Watch
Northland names its favorite markets.
NORTHLAND INVESTMENT CORP. is watching three types of markets very carefully. They are widely different, but the company sees success in each one. Here's why.
- The Contrarian Play. Last year, most everyone was looking to get out of Florida. Northland decided to go back in. As prices fall, the company will seek more opportunity in the Sunshine State. “We think South Florida will eventually be a good place to be,” says David M. Frieze, director of multifamily acquisitions for Northland. “We want to get our toes wet and tread carefully, but there are indications that cap rates will get compelling.”
- High Barrier-to-Entry Markets. Northland likes being in markets where the permitting process or lack of land makes it hard to develop new competition. You can see that with the three infill developments it's planning in the Boston area and in New Haven, Conn. However, it isn't alone pursuing these sites. “The REITs are moving to high barrier-to-entry markets,” says Lawrence R. Gottesdiener, founder and chairman of Northland.
- The IT Markets. Although Northland doesn't play in the big West Coast tech markets such as San Francisco and Seattle, it loves tech hubs. “With places like Austin, Charlotte, or Raleigh, you see a real concentration of brain power,” says Steven P. Rosenthal, Northland's CEO. “You have a lot of smart people living in the same place. That will drive the economy.”
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NORTHLAND INVESTMENT CORP.
- Year Founded: 1970
- Headquarters: Newton, Mass.
- No. of Employees: 470
- 2007 Revenue: Declined to state
- 2008 Units Owned: 16,671 (as of Nov. 1; 100 percent self-managed)
- Most Recent Projects Completed: Hartford 21 (262 units); Endicott Green (258 units)
- Geographic Coverage: New England, Carolinas, Florida, Texas, Tennessee, Arizona
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- Title: CEO
- Age: 50
- Previous Gig: Co-Managing Partner at Mintz, Levin, Cohn, Ferris, Glovsky and Popeo, P.C.
- Favorite Quote: “It is all in the state of mind.”
- Best Business Decision: Joining Northland
- Greatest Challenge: Making sure my Little League team wins
- People You Most Admire: My three great kids
- Best Advice Ever Received: It is better to go 0-20 than 0-0.
- Leadership Philosophy: Do all your talking on the field.
- Last Book Read:Atlas Shrugged by Ayn Rand