“We’ve gone from a lender’s market back to a neutral market,” says Mark Wilsmann, managing director for New York-based MetLife. “But for core trophy assets in places like Washington, D.C., and New York, the market is very much a borrower’s market again—and very frothy.”
Trickling Down
The acquisition market’s recovery started at the top: Institutional buyers, including REITs such as Equity Residential and Behringer Harvard, looked to core properties with certainty of cash flow. But as those assets were bid up, a trickle-down started to occur as investors searched for higher returns elsewhere in late 2010.
Loosen Up the reins
Finding capital for a value-add/acquisition-rehab deal has been a tough task this year.
Many multifamily lenders are still shell-shocked from the acq-rehab boom seen at the height of the last upturn. Many of their balance sheets are weighed down by ambitious value-add plays that never delivered the expected results.
But as fundamentals continue to improve in many markets, more lenders are growing comfortable with the idea of underwriting rent growth. “More people are talking about it now because there is finally some debt available for it,” says Bill Hughes, managing director of Encino, Calif.-based Marcus & Millichap Capital Corp. “Six months ago, no one had enough confidence in the marketplace to take the risk of a property stabilizing. Now there are a number of different financial institutions, typically private funds, that will provide that kind of financing.”
While the GSEs clearly dominate the debt market, they’ve shied away from the repositioning market. The GSEs’ acquisition-rehab programs have basically been put on the shelf as they continue to furiously process deals for stabilized assets. This means that most of the acq-rehab business being discussed now is on a small scale—bringing a B-plus asset up to an A-minus, for instance. The rehabs that change the nature of a property—bringing a Class C to a Class B, for instance—have a much more difficult time finding financing.
“We won’t make that loan; we’re not going to speculate on that type of transformation,” says Mike May, senior vice president at McLean, Va.-based Freddie Mac. “In fact, some of our largest problem assets are exactly that.”
Yet, many private-sector lenders are growing more confident with the ability to get a pop in rents through rehab, particularly as bridge loans become more available. Active providers today include Ladder Capital, BB&T Real Estate Funding, Starwood Capital, GE Capital, Canyon Johnson, and A10 Capital—and all of them have seen a shift in their focus heading into 2011. “Bridge programs have been around, but now we’re seeing bridge product move into the arena of value-add,” Hughes says.
“The market wants a little more yield than those trophy buildings allow, so it’s migrating to deals with a trickier rent roll, or buildings that aren’t as nice,” says Mike Kavanau, a senior managing director for Holliday Fenoglio Fowler’s (HFF) Chicago office. “And then it migrates further down, until you get people going full bore on B and C properties.”
Like most trends, the story started on the coasts. Cap rate compression was soon after being felt in secondary markets such as Nashville, Tenn., and Chapel Hill, N.C., where Class A deals traded in the sub-6 percent range in 2010. But the compression that characterized 2010 isn’t expected to continue. Industry watchers say the suddenly rising interest rate environment of the fourth quarter of 2010, combined with the availability of more product in most markets, will put upward pressure on cap rates in 2011.
“Debt really does, in a lot of circumstances, control pricing on the cap rate side,” Kavanau says. “If you have sustained upward moving interest rates for a period of time, cap rates follow as a general rule.”
What’s more, for much of 2010, there was a scarcity premium baked into many cap rates. An abundance of equity looking to invest, combined with a lack of quality assets in the marketplace, made buyers willing to pay a premium for the best assets. But as more deals come to market, the more likely that premium is to go away. In fact, there will likely be no scarcity premium in 2011. “Cap rate compression has pretty much run its course,” Wilsmann says. “Values will be higher in 2011 because of improvements in NOI and not because cap rates are tighter.”
