Midwest exodus

If leaving the Heartland were a board game, Equity Residential (EQR) moved ahead some 200 squares with the nearly $1.1 billion sale of its Lexford Housing Division to privately-held New Jersey-based Empire Group Holdings last October.

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The REIT still has around 20 squares to go before crossing the finish line. The Lexford sale that included mostly single-story garden-style communities with almost no amenities, totaling 27,115 apartments in 289 assets in 10 states and the property management business that oversees them, resulted in EQR’s exit from Indiana, Ohio, Kentucky, Pennsylvania and most of Michigan.

Camden Property Trust, United Dominion Realty Trust and Archstone- Smith also have been playing the Midwest exodus game and, while the apartment REIT exit from the Midwest comes as no surprise, it does raise the question, who is taking their place? The answer is regional players and institutional investors, pension fund advisors and patient private money from all over the country, looking to the Midwest for stable properties that promise slow, but steady growth going forward. Brokers report that buyers from as far away as both coasts are scouring the Heartland for good deals.

EQR’s planned exodus from Chicago is bound to raise some eyebrows. It’s hard for some to accept that the REIT intends to exit the market where its headquarters is located. “Equity Residential is not leaving. Equity Residential loves Chicago!” more than one expert on the Midwest has exclaimed recently. Similar protests likely would have been the response to the suggestion a year or so ago that real estate legend Sam Zell might sell Equity Office Properties.

But, he did, and for the same reasons the apartment REIT he founded plans to sail out of the Windy City and the rest of the Midwest — he wants to put his money elsewhere. EQR CEO David Neithercut made that clear during a Bank of America conference last fall when he displayed three maps during a presentation that focused mainly on the REIT’s ongoing portfolio transformation. “We’ve gone to great lengths over the past few years to reallocate about $6.5 billion worth of capital in 93,000 units,” he explained, introducing the first slide that highlighted the 54 markets where EQR’s 227,000 units were located seven years ago, when the REIT’s top 20 markets contributed 65 percent of the company’s NOI. Only a dozen states on that map showed no EQR presence.

“We had grown dramatically since our IPO in August of 1993 and found ourselves with a highly diversified portfolio across many primary markets across the country, but we found that not all those markets were created equal — not all those markets were offering the same opportunities for return on our invested capital and we have started a process to narrow our focus, reducing the number of markets in which we operate,” Neithercut said.

“Today, in 2006, you can see significantly fewer markets,” he said, showing a second map. “And we continue to desire to reduce our concentrations in some of those markets to get ourselves along the coasts,” he continued, displaying a map pinpointing 35 markets, with 92 percent of NOI coming from the top 20, none of which are in the middle of the country.

The third map, depicting EQR’s portfolio dream for the future, told the tale of its plan to completely exit the Midwest, including Chicago. “The portfolio of the future will be the coasts, Atlanta, Dallas, Phoenix and Denver,” he said of the map on which 32 states are empty of EQR communities.

Neithercut predicted the company would complete the exit of half a dozen or so markets in 2007, including Minneapolis, Detroit, San Antonio, Kansas City, St. Louis and Chicago, while pouring the sales profits into markets the company has targeted over the past half- dozen years or so, nearly doubling its invested capital in Boston, New York, Washington, South Florida and Southern California.

Four years ago, the REIT owned eight properties in Chicago, 19 in Minnea-polis/St. Paul, nine in Kansas City, and four in Milwaukee. As of mid-March this year, the REIT’s asset pool in the Midwest was down to four in Chicago, one downtown and three in western suburbs; two in Minneapolis/St. Paul, one in Missouri and three in Milwaukee.

Last June, EQR sold three of its Minneapolis assets to Henderson Global Investors, which has been a buyer of the REIT’s properties for years. In 2003, when EQR was just getting its Midwest exit underway, Henderson bought its 216-unit Woodlane Place Townhomes in Woodbury, a Minneapolis suburb. In late 2005 and early 2006, EQR sold four assets in the Twin Cities area to RREEF North America and INVESCO Real Estate.

In early March, the REIT sold another four of its Minneapolis/St. Paul properties to privately owned, Minneapolis-based Stuart Management Corporation, which was founded in 1970 and owns and manages more than 50 apartment communities in Minnesota, Wisconsin and Nebraska. Stuart bought the 72-unit Summer Creek, the 154-unit Coachman Trails and the 72-unit Fernbrook Townhomes in Plymouth and the 200-unit Woodridge in Eagan. A Holliday Fenoglio Fowler (HFF) team that included senior managing director Matthew Lawton and directors Sean Fogarty and Marty O’Connell of the firm’s Chicago office and Dave Nachison of the HFF Washington, D.C., office, represented EQR in the deal.

Tom Moran of Moran & Company’s Chicago office, who arranged the REIT’s Twin Cities sales to Henderson Global last summer and several of its recent sales in the Chicago suburbs, is seeing pension fund and institutional money pour into those two markets, as rents begin to rise after five years of tough times. Between 1982 and 2000, rents rose an average of four percent annually, but, from 2000 to 2005, remained flat to down and concessions flooded the markets. All that changed in the past 12 months, when the two biggest markets in the Midwest saw occupancies rise to between 94 and 96 percent, as concessions burned off and net rent increases ranged from four to
eight percent, Moran said.

“Institutions are happy to see the REITs sell and go coastal, because now they’ve got the market to themselves,” he said last month. And, in Chicago, almost everything Moran sells is going to pension funds. “The pension fund advisors are very aggressive because they can buy at a meaningful discount to reproduction costs with virtually no pipeline of new deals. They’re bidding five percent cap rates on projections for Class A properties because they anticipate rent increases in excess of four percent over the next several years,” said the veteran broker.

By the end of the year, EQR already had unloaded its last two assets in Detroit at an average cap rate of 7.4 percent, identical to the cap rate on the Lexford deal.

Archstone-Smith also has been selling off some of its Midwestern assets lately. Since mid-December, the REIT sold two Minneapolis properties — the 24-year-old, 250-unit Symphony Place to Waterton Residential, an affiliate of Chicago-based Waterton Associates LLC, in a buy that marks Waterton’s entry into the Twin Cities market, and the 121-unit LaSalle Apartments that sold for $12 million to TE Miller Development, a four-year-old private owner, manager and developer of apartments and office space based in Edina, Minn.

Waterton also bought Archstone’s 36-story One East Delaware Place in Chicago’s Gold Coast neighborhood in January and the REIT’s 399-unit River North Park Apartments last May. Archstone now owns just one community — the 809-unit, 52-story One Superior Place — in the city.

Camden Property Trust’s three remaining Midwest assets in Missouri and Kentucky are expected to be under contract soon with closings by mid-year. The REIT currently has no plans to increase holdings in those markets, Camden VP of Investor Relations Kim Callahan said last month.

Last September, Camden contributed nine assets totaling 3,237 units in the company’s Missouri portfolio to a $239 million joint venture agreement with institutional investor DRA Advisors. Camden retained 15 percent ownership in the properties and will continue to manage them. HFF’s Chicago-based team is marketing the 304-unit Camden Taravue in South St. Louis County for an asking price of $16.4 million and the 372-unit Camden Trace in West St. Louis County for $31 million.

Debbie Corson of Apartment Realty Advisors’ office in Dayton, Ohio, is marketing the 32-year-old, 254-unit Camden Downs in Louisville, Ky., at a list price of $13.25 million. Corson also represented AMLI Residential in last October’s sale of the company’s last asset in Indianapolis to Core Realty Holdings LLC, which is based in Newport Beach, Calif. The acquisition represents Core’s first buy in the Midwest. Core and its owner affiliates, Saunders Property Company and Optima Asset Management Services, Inc., seek out both core and value- added middle-market office, industrial, retail and multifamily assets for its own account and for TIC investors.

AMLI, which sold to Morgan Stanley’s Prime Property Fund in February 2006 and became a private REIT, exited Indianapolis with the sale of the 996-unit AMLI at Riverbend. At the end of September 2005, the then public REIT owned 2,428 units in the city that last month was listed as the most affordable major housing market in the country on the National Association of Homebuilders/Wells Fargo Housing Opportunity Index, with the median sales price for a single-family home in Q4 at $113,000, down from $122,000 the previous quarter.

Other buyers of AMLI’s Indy properties included Louisville-based NTS Realty Holdings LP, Boston-based institutional investor Meridian Realty Investments and New York-based private investor Sterling American Property, Inc. Late last year, Sterling bought the 352-unit Windscape Village in Naperville, Ill., just 30 miles southwest of Chicago, for $33.5 million and AvalonBay Communities bought the 256- unit Covington Apartments for $32.25 million in nearby Lombard for the REIT’s value-added fund.

“On a regular basis, now, we’re seeing people coming in from everywhere, not just the West Coast, but the East Coast and the middle of the country. We’ve got people from Texas. Literally, they’re coming in from all over the place and making offers on deals,” Corson said.

Those buyers are having a hard time finding deals that make sense in high-growth areas, so they’re looking to the Midwest, where cap rates are a bit higher than on the coasts and in the Sunbelt states, she said. According to Corson, cap rates in the Ohio, Indiana and Kentucky markets that are her focus range from around six percent for Class A assets to between 6.5 and seven percent for Class B properties, which look pretty good compared to the four percent cap rates for well-located coastal California assets and the three percent caps on some Manhattan deals lately.

Eric Taylor of Hendricks & Partners’ Detroit office, who represented United Dominion Realty Trust when the REIT exited Michigan with its sale of an eight property, 1,970-unit portfolio in Detroit and Lansing three years ago, believes it’s the more regional, opportunistic firms, like Mishawaka, Ind.,-based Sterling Group and the New Jersey-based Lightstone Group that are stepping into the REITs’ shoes there. Sterling paid $87 million for seven of the eight Michigan assets United Dominion sold in early 2004 and Lightstone bought Home Properties’ nearly 5,046-unit, 19-property Michigan portfolio last year for $230 million at a 7.6 percent cap rate.

“There’s really no institutional investment in Michigan at all right now. It’s primarily opportunistic, regional-type syndicators who are pretty much the major players. And we’re seeing a lot of TICs looking in the market because they can’t find the yields that they need out West and along the seaboards. They need initial yields in the seven percent range and they’re not finding those as readily as they had in years past. We haven’t closed any deals with them, yet, but they’re starting to knock on the door,” he said, adding that he expects to see a lot of TIC buyers entering the Michigan market for the first time.

In mid-February, Taylor closed the $32 million sale of the 740-unit Crossings at Canton by the Boston-based Dolben Companies to the Ann Arbor, Mich.,-based Madison Group, which has been fairly active in the area. The Crossings was the only Detroit asset Dolben Companies ever owned and the investor held it for more than 20 years. The community traded at a cap rate of around 7.75 percent.

Taylor’s office also arranged Archon Group’s $49 million sale last December of the 1,145-unit Harbor Club in Belleville, about 10 miles southeast of Ann Arbor, to GFE Capital, an opportunity fund, value- add player based in New York.

He’s not seeing much REIT action either on the buy or sell side in Ohio, which represents United Dominion’s only Midwest market. The REIT, which owns 2,530 units in six assets in Columbus and another 444 units in two Dayton properties and one in Toledo, hasn’t bought anything there since the 1990s.

“Columbus, Ohio, is interesting,” United Dominion CEO Tom Toomey said in December. “It’s the state capital and has a large university, so it has good, steady job growth. But, it has housing affordability problems because a significant number of homebuilders are able to build very cheaply in that market, so it has had some struggles over time and probably will be one of those markets we will use as a trading market and, when we get to the right price for the assets, it probably would be a market that we would consider selling,” he said.