For assuming that risk, hedge funds are often rewarded with a significant premium over yields on the 10-year U.S. Treasury bond, a benchmark for investment returns on Wall Street. As Real Capital’s Fasulo points out, hedge funds’ willingness to invest in those kinds of properties has opened up a much wider range of capital sources for development. “It’s made the distribution of the different pieces of the market much more efficient,” Fasulo says. “That’s a great thing.”
None of this is to say that hedge funds are only interested in investing in multifamily debt. As the stocks of apartment REITs have broken out of their traditionally hum-drum trading ranges, those equity shares have attracted hedge funds’ attention as well.
This is especially true with the fallout from the sub-prime lending market for single-family homebuyers becoming more widespread. As defaults on the easy-to-get mortgages of the last five years have increased, hedge funds have actively been looking for areas where they can profit from the trend. One place they see that kind of opportunity is the possibility that once-and-former home owners will now need places to rent.
“To the extent that the sub-prime market is melting down, and people can’t afford to own their homes any more, apartment REITs may benefit from a rental perspective,” says Malcolm Sheih, an analyst at Palmyra Capital Advisors, a $200 million hedge fund based in Los Angeles. “Apartment REITs have not always been on the radar for hedge funds,” Sheih says. “They’re not necessarily new, but they are just more prominent today, because of the potential catalysts for the rental market.”
That’s a school of thought to which Simon Wadsworth, chief financial officer at Mid-America Apartment Communities, a Memphis, Tenn.-based REIT that operates 40,000 units throughout the Sunbelt, also subscribes. “We know that 25 percent of the people who leave us each year do so to buy a home,” Wadsworth says. “Well, if those people find that it is not as easy to borrow money to buy a house, they may stay in their apartments a little longer. I believe that is going to be a factor going forward.”
Wadsworth says there are three areas where he’s seen hedge funds take interest within the apartment sector: investing in CDOs and convertible debt; providing capital for public firms to go private, such as the high-profile privatizations of Gables Residential Trust in 2005 and AMLI Residential Property Trust last year; and, more recently, looking for derivative plays from the fallout of the single-family, sub-prime lending market.
Wadsworth also notes that some hedge funds are looking at the flip side of the sub-prime scenario, staking their bets on the flurry of condominium development and conversions that took place during the boom. Namely, if now hard-pressed homeowners default on those units, and banks put them back on the rental market, it could have the opposite impact on apartment REITs.
“One argument may be that a lot of those condos and houses are going to go back to lenders, and that those lenders will put them back on the rental market,” Wadsworth says. “There are some hedge funds that are looking at that, and thinking you’ll have increased inventory.” Those hedge funds likely would sell apartment REITs short, he notes.
One thing’s for sure: Good or bad, hedge funds’ presence in the world of multifamily finance is becoming more widespread. They’ve been drawn in by higher yields on the debt side, and the increased potential on both the long—and short—side of stocks. For REIT owners, hedge funds’ penchant for shorting stocks is probably a negative. On the other hand, many see the increased liquidity that hedge funds provide to apartment financing on the debt side as a positive. Whatever your view, though, there’s one piece of investing wisdom to keep in mind in any market: Neither trees, nor apartment towers, grow all the way to the sky.
“Liquidity can be a sometimes thing,” says Moody’s Kriz. “While there has been significant interest in this sector—and money available to put to work—one should not assume that this goes on forever. You always need to be thinking a few moves ahead. Investors often want to move on to the next new thing.”
Joe Bousquin is a freelance writer in Auburn, Calif.
