MH Feeding frenzy

While private investors accounted for 82 percent of the dollar value of nation-wide apartment acquisitions last year, institutions and REITS were among the nation's most active sellers, participating in nearly half of all dispositions over $5 million.

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“With their stocks battered over the past several years, REITs could sell a building for a lot less on a yield basis then what they could turn around and buy their own stock for. They could sell an older or under-performing asset for a 6.5 percent yield and, if their stock was yielding 7.5 or eight percent, turn around and buy it back. It was a bottom line financial play for them,” said Stanford Jones, executive VP of investments at Marcus & Millichap Real Estate Investment Services, who represented AvalonBay Communities and Equity Residential in two separate sales in the San Francisco metro in Q3 2009.

Equity Residential last October sold the 26-year-old, 492-unit Lakeville Resort at Petaluma for $52 million, or $105,691 per unit, to Abacus Capital Group, a New York City-based firm that owns about 23,000 apartment units across the U.S. for institutional investors. It was the largest sale in Sonoma County, Calif., last year. Abacus financed the transaction with a seven-year, fixed-rate loan with Freddie Mac, placed by Holiday Fenoglio Fowler Senior Managing Director Mona Carlton, and renamed the property Enclave at Adobe Creek.

Located in Petaluma approximately 33 miles north of San Francisco with convenient access to Redwood Highway, the community that was 94 percent leased at close of escrow consists of one-, two- and three-bedroom apartment homes averaging approximately 939 sq. ft.

AvalonBay Communities followed in November with the sale of the 192-unit Avalon at Parkside, a 19-year-old apartment community in the Silicon Valley’s Sunnyvale sub-market to locally based Acacia Capital Corp. for $43.8 million in a transaction that generated 35 offers.

Among the apartment REITs, however, AIMCO stands out as the disposition leader. Seven years ago, the company began an aggressive sales campaign to dispose of its weakest assets and has been a net seller to the tune of more than $1 billion a year. In 2008, the firm unloaded a whopping $2.6 billion of multifamily assets in deals that represented roughly seven percent of the entire national apartment transactions that year and generated $1 billion in net cash proceeds for the REIT.

As of the end of last year’s third quarter, AIMCO had disposed of $865 million in assets at cap rates averaging 7.6 percent with another $450 million of planned asset sales earmarked to repay maturing term debt, bringing total sales in 2009 to approximately $1.3 billion.

Another $350 million of property sales were in negotiations as of Q3 2009, but a number of them were pulled from the market during Q4.

AIMCO will continue to sell this year, but at a much more measured pace as term debt is repaid. “Since the end of the second quarter, we have repaid $140 million of our term debt, leaving us with a balance of $210 million today. Given the debt of our property sales pipeline, we currently expect that our term debt will be repaid in full during the first quarter of 2010, or one year ahead of its maturity date. We have made similar progress extending our property debt maturities,” said AIMCO President, Chief Investment Officer and CFO David Robertson during the REIT’s Q3 2009 earnings conference call.

Including planned sales, AIMCO reduced property debt in Q3 to $164 million comprised of two loans the REIT expects to refinance at maturity in 2011. AIMCO will continue to upgrade the quality of its portfolio by exiting non-target markets and selling off the bottom of its portfolio.

“For example, average rents for conventional properties sold during the third quarter were $753, nearly 30 percent less than average rent in the retained conventional portfolio,” said Robertson. Sales also have helped to raise the REIT’s property portfolio to an average Class B+ from an average Class B.

According to Fitch, multifamily REITs will continue to be negatively affected by an unemployment rate that is above 10 percent, but the ratings agency still maintains a stable outlook for apartment REITs this year due to limited supply of apartments and continued access to low-cost financing from Fannie Mae and Freddie Mac. With their renewed liquidity, if the market begins to recover in 2011, as many real estate research experts expect, apartment REITS could post the strongest effective rent gains in history, according to REITWrecks.

REITs poised to buy
Last year, institutional players accounted for a mere four percent of apartment purchases, compared with 36 percent in 2007, but they are cautiously retesting the waters.

Most of the buyers of AIMCO’s assets during the early part of 2009 were local and regional players, but, as the year progressed, the REIT began to see an upswing in the number of institutional bidders at the buying table, said Robertson, during a panel at the BMO Capital Markets conference last September.

That certainly was the case in the San Francisco Metro area, where only 14 apartment assets with more than 100 units sold last year. “REITs and other institutional buyers were completely absent from the acquisitions arena for the most of 2009 and didn’t make an appearance until the end of the year. They didn’t close on anything, but started coming into the fold and getting fairly aggressive and we think this quarter they will get involved and close a few transactions,” said Jones.

Cap rates on Class A properties in Metro San Francisco went up to somewhere in the 6.5 range on a stabilized year-one basis and peaked probably in the second quarter of 2009. Since then, they have been driven down to around six or slightly under six percent, said Jones.

“The underlying story here is that there was a definite bottom reached in the market about eight or nine months ago and the most recent transactions have demonstrated that the most recent values have stabilized and gone back up on a yield basis and there is very little inventory out there and there is probably the least amount of buying opportunities that have been around in the last 20 years. In 2008, there were 28 sales, twice as many as last year, and in 2007, there were 56, twice as many again, so 2009 was a very slow year,” he said After spending the past several years pruning assets in less promising markets and propping up balance sheets, apartment REITs are leveraged at around 47 percent, compared with the 70 percent average leverage of private real estate companies, said Harvey Green, president and CEO of Encino, Calif.-based Marcus & Millichap.

The REITs with the strongest balance sheets and access to capital will be in the best position to capitalize on undervalued real estate opportunities, although those deals still are few and far between.

“REITs have made a significant recovery in the value of their stock and their cost of money is cheaper, therefore they can aggressively buy,” said Jones.

Equity Residential closed last October in an all-cash transaction on the 326-unit Metropolitan at Pentagon Row in Arlington, Va., from joint venture partners Cornerstone Real Estate Advisers and Kettler for $100 million, or approximately $306,748 per unit. The six-year-old, 15-story high-rise in the Pentagon City/Crystal City sub-market of northern Virginia consists of studios, ones and twos averaging 870 sq. ft. and was 95 percent leased at close of escrow.

The nation’s second largest apartment REIT beat out about 40 bidders for the asset that was on the market for 60 days and generated interest from a mix of institutional, private and foreign investors.

Although not a distressed deal, Equity Residential CEO David Neithercut believes the sale price represents a 30 percent discount to what the property would have traded for several years ago. “To replace that asset today would require 10 percent low to moderate income set asides, and all of the units we have under contract in this particular asset are all market-rate,” he told analysts in Q3, right as the transaction was closing.

The REIT expects a 6.1 percent yield in the first year, seven percent in the short term and a double-digit, 10-year unleveraged IRR. As of the third quarter, Equity Residential had another $50 million of acquisitions under contract.

Jones believes both institutional and private buyers will be active this year, but any activity will be driven by what happens with debt cost. “If debt costs go up, cap rates will mirror those movements in cost. Interest rates today are in the neighborhood of 5.75 percent, plus or minus, for good borrowers, and those costs could escalate because of either a recovery or some other component like bad liquidity,” he said.