Bid-Ask Spread Surfaces in Market

A lot of the reason behind the strength of the multifamily segment is the financing available to it. While Wall Street and other capital sources have pulled back from the market, government agencies like Freddie Mac and Fannie Mae upped their business, more than doubled their financing of apartment acquisitions in the last half of 2007. In fact, they remain the primary source of debt capital in the market today. Still, Real Capital's team concludes, they are not able to fill the gap left by CMBS lenders.

Wall Street loan totals fell 85% during 2007 while and national and international banks, which typically securitize paper, also decreased their activity. Regional and local banks, the firm says, tended to favor other sectors, particularly because many of them were burned by failed condominium conversions and have a high exposure to residential and multifamily. Insurance companies, another large group of portfolio lenders, also slowed their financing of apartment acquisitions in the second half in favor of office. International banks such as HSH Norbank, Barclays, Westdeutche, Anglo-Irish and Heleba capitalized on these conditions, upping their lending in the last half of 2007.

Still, Real Capital concludes that volume could be higher were it not for the gap between seller expectations and what buyers are willing to pay. The average sales price as a percentage of the original asking price fell to 94% compared to slightly more than 95% right before the credit crunch hit at the end of last summer. Cap rates too have changed only slightly, particularly for high-quality assets.

In fact, researchers say many sellers seem to have reconsidered asset dispositions altogether in this market. New offerings slowed to $4.3 billion in February, $3 billion less than the prior month, but 35% more than last year. There's a wide gap between closings and offerings--$8.5 billion versus $11.8 billion, respectively--and the dynamic is most present in such markets as the Maryland suburbs of Washington, DC, Los Angeles, Las Vegas, most areas in Florida and tertiary markets in the Midwest and Southwest.

The firm believes ongoing liquidity problems will exert pressure on sellers to mark down their price tags, but for now, it's status quo because owners are reluctant to accept discounts on assets that are performing well. "This stalemate could last for awhile, especially if occupancies gain from the dislocation caused by the deteriorating housing market," Real Capital researchers maintain. "In fact, buyers may blink first. Increasingly apartments are drawing interest from investors that are shunning the other property types and are anxious to invest before conditions improve further."

Still, apartments are among the most sought-after product types in today's market. While volume in the sector dipped a bit over the past year, total sales in the office and retail sector, by comparison, plummeted 95% and 88%, respectively, from February 2007.

When sellers do decide to shed their properties, some will feel more pressure than others. Institutions, for instance, which tend to hold assets long term and not use as much leverage, are in a better position to sell in a weak market.

"Institutions have significant exposure in the apartment sector and their stable ownership should help support prices," Real Capital's team explains, adding there is a slight risk that these players could be forced to sell if the "denominator effect" leaves them over-allocated to real estate.

A large amount of dispositions by foreign investors and REITs, which have accounted for much of the sales activity in the past year, is not expected. What is anticipated, however, is a sell-off by private firms, particularly equity funds, which feel the credit crunch the most. These players usually have short investment horizons and oftentimes used short-term debt or bridge loans from Wall Street. However, private equity funds have relatively little exposure to apartments--unlike individual private investors that are highly leveraged.

"Some developers may run into trouble as construction loans mature and refinancing or sales options are poor. Other investors may face difficulties in meeting debt service as reserve funds are depleted before leasing goals are met," according to the report.

Yet the most motivated sellers are those involved in failed condo conversions. Since the end of the condominium boom about 10% of the properties bought with the intention of conversion, representing 31,500 units, have been re-traded as rental communities. Because this phenomenon has been occurring for two years, researchers say it's unlikely that many more such deals will take place.

For many investors, the one subsector of the multifamily market that appears to be as close to a sure bet as possible is student housing. With college enrollments at an all-time high and the wave of Echo Boomers reaching college age, the demand for student housing has never been greater, according to the firm.

More than $1.5 billion of student housing properties changed hands from February 2007 until February 2008. And recently, American Campus Communities announced its intention to buy GMH Communities' student housing portfolio in one of the largest deals to be announced so far this year.

Foreign players also have gotten in the game--the Association for Foreign Investors in Real Estate reported that 30% of those recently polled were exploring niches including student housing. GIC, the investment arm of the Government of Singapore, formed a $1-billion joint venture with Campus Apartments. Also good news is that capital sources, particularly Fannie Mae and Freddie Mac, have a favorable view of the sector.

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