And herein lies the quagmire. Most investors in the distress arena are seeking high-quality assets at discounts, and they don't seem to mind waiting for those opportunities to arise. Meanwhile, lenders and servicers are putting only lower-grade product on the sales block. Add to that the issue of financing-the main sources of capital in the multifamily market, Fannie Mae and Freddie Mac, have set lending criteria that would by default negate class B or C product and one can see why deal activity has been lacking.

A major factor behind the dearth of class A assets for sale is the propensity of lenders and servicers to do workouts with borrowers. In March, for instance, the apartment market saw $963 million in new distress, as per RCA. The real figure, however, was much lower, since $957 million of the total was resolved or restructured. It should be noted, though, that 64% of those workouts consisted of two deals-the refinancing of River house in Manhattan and Essex Property Trust's purchase of a 349- unit asset from iStar Financial that was left over from its 2007 acquisition of Fremont Investment & Loan's commercial loan business.

Distress, says Kelly, can be broken down into two categories: situations that are truly distressed financially and those with looming maturities. While lenders and servicers will look to quickly shed nonperforming or lower-quality product, typically those with underwater loans, he explains, in the latter case, "you have good borrowers, good business operators with good business plans, but they're staring a maturity default in the face."

In those scenarios, he says, if the properties are performing and are in good markets, an extension is the most logical solution. "The markets are getting tighter across the country, occupancies and rents are going to increase-it's just a matter of when," he explains. "Foreclosing for a simple maturity default doesn't make a lot of sense. The most successful approach we're seeing is if you have a good operator with a good business plan, give it time to ride the wave for the next 24 months. That would also benefit your trust holders because it minimizes your transaction costs. Generally, the person that's already in the deal has the best vested interest in getting you through whole, rather than someone you'd bring in later."

Lenders and servicers are more likely to sell if it is profitable and, in some cases, the sales appetite isn't high enough that the workout won't be the more profitable solution, says Debbie Corson, a Chicago-based principal with Apartment Realty Advisors and head of the firm's Distressed Asset Solution Group.

It's actually a Catch-22. On one hand, there is so much capital seeking multifamily deals, and particularly, distressed multifamily deals, that there's a scarcity premium. "You're seeing cap rates at ridiculously low levels to acquire 'nice' properties," she says. "Even on the distress side of the business, we're seeing a lot more activity for projects that don't have any net operating income or have value-add components, just because there are so many groups that have put funds together to go after that type of product."

On the other hand, the buyers out there aren't aggressive enough to convince asset holders that selling would be the best option. "The frenzy is not high enough for investors to bid 100 cents on the dollar, there is still some discount going on to where these people are on their notes," explains Corson. "The question becomes, if someone will pay 70 cents on the dollar for the property or note, will the borrower do that? So even if the borrower is going to pay a little less than what the frenzied market would, it may be more worth while for them to work something out with the borrower than it is to go through the year or two of a foreclosure process."

Of course, she adds, it's market specific, since all states have different foreclosure and bankruptcy laws. For instance, Corson says that Texas, which has some of the most relaxed foreclosure laws in the country, is also seeing the most activity in terms of distress transactions.

Another factor keeping deal activity at a minimum is that lenders and servicers are being inundated with product, and are too busy trying to get their arms around the assets they have, let alone come up with a plan to dispose of them. "A lot of the special servicers are so bogged down with product coming in the door that they may be working on four assets and trying to put together a plan for those properties and, in the meantime, four more come in," says Corson. "What I see is a bottleneck. All of us are working very hard to force something through that bottleneck, but not much is happening." If it's any indication, that bottleneck will worsen as time goes on. In a recent study, Fitch Ratings reported that investors are sending CMBS loans into special servicing at an increasingly rapid pace. The volume of securitized loans in special servicing grew to $81.7 billion at the end of the first quarter, and servicers are responding to the onslaught by adding additional staff and new technologies, or restructuring their organizations to better handle the growing load.

That's not to say, however, that Corson and her counterparts are sitting idle. There is in fact a significant amount of activity, but "it's just not anything that's resulting in transactions at the moment," she says. "We're doing a ton of broker opinions of value for special servicers and lenders all across the country. The special servicers are getting BOV s as well as appraisals and reviewing that information" to put together the appropriate game plans for the assets they hold.

Most observers agree that unclogging this bottleneck will be a long term process. For now, the best way for investors to get their hands on distressed multifamily assets is to enter the deal on the debt side-an approach that many players have embraced. The significant amounts of overleveraging have made outright property sales prohibitive, so oftentimes investors' best option to ultimately own an asset is to buy the debt it secures-the classic loan-to-own scenario.

Right now, there are two classes of property, says J. Kingsley Greenland, president and CEO of DebtX in Boston. The product with performance issues-that is, those in which borrowers can't meet their debt obligations because the income from the property is too low-constitutes only 10% to 15% of the current market, Greenland points out. That's also the group of properties that has, for the most part, worked its way through the system.

The remaining majority of assets, however, are performing properties with large loans that will likely not obtain refinancing. When there's structural overleveraging, "a del evering of that asset has to occur," says Greenland. "In many respects, a loan sale is the optimal way to handle a delevering, since it's difficult to foreclose on a performing property, and simply forgiving the debt has its own issues." This trend will intensify over the next couple of years, he adds.

Yet investors may be disappointed with the pickings here, too, since the majority of deals these days have involved class Band C assets. In recent weeks, DebtX, in a partnership with KEMA Advisors dubbed KDX Ventures, auctioned off $306 million in nonperforming loans on behalf of the Department of Housing and Urban Development. That sale garnered 67 bidders and more than 200 individual and pool bids for the package, which consisted of paper backed by 25 multifamily assets and one health care property. Proceeds from the 12 winning bids accounted for more than 48% of the debt's unpaid principal balance.

Though the debt side is where the deals are, Caldera's Kelly points out that investors should be careful, since "the debt side is a quirky business. People have to understand what they're doing to buy loans, and there are a lot of people who are trying to buy loans right now who aren't really prepared for all that's necessary to be the buyer of a loan that has different terms and extensions. In that situation, you are a lender, not a buyer of real estate. It's tough for a lot of people to see the distinction."

Generally, however, most observers believe the opportunities for distress multifamily investment will grow over the second half of the year and especially in 2011 as the market finds its bearings. Lower-grade product will certainly dominate, and some investors will eventually opt to reach for the low-hanging fruit. Interestingly, the Federal Deposit Insurance Corp. isn't seen to be a major source of distressed deals, be

it on the real estate side or debt. "I can probably count on one hand the number of deals that have been FDIC driven," says Kelly. And although the agency can certainly take over more failed banks-the FDIC put 73 new banks on its "problem list," bringing the total roster to 775 banks as of the first quarter-it's anyone's guess as to whether that would bring more distressed multifamily to market.

It's likely that we'll see more offerings from HUD, by virtue of the size of their portfolio, says Greenland (KDX Ventures is the agency's exclusive loan sale advisor). But, he adds, while HUD will be "a significant player, it won't be dominant since the market is so fragmented." Lenders and servicers will still make up the bulk of sellers. At press time, ARA had more than 50 distressed apartment listings, primarily REO properties, and the majority were either unpriced or priced below $10 million. But Kelly points out that he wouldn't be surprised to see some developers on the scene as more loans reach maturity. "If you look back, there were a staggering amount of development deals that were started in 2005 through the middle of 2007," he says. "The developer is probably already riding a construction extension now, and the banks aren't going to do much better. If they sold a year ago, they would have lost a lot of money. But if they sold today, they'd probably break even and live to fight another day."

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