APARTMENT NEWS

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Multifamily REIT CEOs Upbeat On Apt. Prospects Despite Bleak Fundamentals
With Demographics On Their Side, Multifamily Firms Say a Tough Recovery Is Underway - 02/10/10
By Randyl Drummer

Even as apartment rents continue to erode, vacancies remain at historic highs and prospects for recovery unlikely until next year, executives for the nation's largest publicly traded apartment companies sounded a note of optimism during the latest round of earnings conference calls, believing that the worst of the pain has already passed.

Most predicted slow and steady, if unspectacular, improvement in fundamentals over the course of 2010, though the path to recovery will be bumpy.

"Management teams are sporting a new cloak of optimism, although it is heavily footnoted," said Citi REIT analyst Michael Bilerman in a research note.

Some companies, such as AvalonBay Communities (NYSE: AVB) and Equity Residential (NYSE: EQR) based their optimism on capital raising, acquisition, development and other growth plans. Others, such as Camden Property Trust (NYSE: CPT) are holding back, shelving their 2010 development plans while deleveraging and charging off losses and impairments to their land and portfolios.

Most companies said they are trying to boost occupancy by lowering rents, trading lower net operating income (NOI) in hopes of holding the line on vacancies during the current wave of job losses that has thinned the ranks of renters, especially among "echo boomers" in their 20s and 30s who are opting to double up with roommates or live with their parents. Just as their office and retail counterparts are doing, apartment companies are giving renters the upper hand.

Meanwhile, the long-expected flood of distressed property sales hasn't yet materialized, with deals held back by limited financing availability and low interest rates that have mostly allowed borrowers to continue to service their loan debt, even though many of those loans are under water.

For now, apartment executives are hanging their hopes on the unprecedented slowdown in housing construction, and the sheer numbers of the echo-boom generation, second in size only to the baby boomers, which they say point to strong expected rent growth starting in 2011, according to Marcus & Millichap's 2010 National Apartment Report.

"It is simply a matter of time before an expanding economy releases this powerfully favorable demographic into the renter pool," said Marcus & Millichap President Harvey E. Green and Managing Director Hessam Nadji, authors of the report.

Acquisitions: Back On the Radar Screen For Some

After dropping about 70% from the peak, confidence and investment activity began to stir modestly in the second half of 2009 and into 2010. Private local buyers account for most of the activity, but REITs and institutions that have built-up capital are expected to continue targeting large properties in major markets this year.

The largest apartment REIT, Equity Residential, has been first out of the gate. EQR earlier this month acquired two luxury apartment complexes in Manhattan from Macklowe Properties, River Tower and 777 Sixth Street, and signed a contract for a third, the Longacre House, for more than 900 units in deals totaling $475 million.

EQR, headed by billionaire Sam Zell, also in the fourth quarter closed its purchase of Metropolitan at Pentagon Row, a 326-unit apartment complex in Arlington, VA, from joint venture partners Cornerstone Real Estate Advisers and Kettler for $100 million, according to CoStar information. The company has also acquired two other high-rises in Arlington and mid-rises in Seattle and Del Mar, CA, according to EQR President and CEO David Neithercut.

"This is all good news for the apartment business," Neithercut told investors earlier this month. "I'm not suggesting that we're experiencing any kind of sharp inflection here. I would rather say we think we are at the beginning of a period of slowly, and I do mean slowly, improving fundamentals. But … if you add job growth to that picture, we believe that will quickly turn into one of the best operating periods in our history."

The cautious return of large investors may signal a shift in strategies from wait-and-see to bargain-hunting. Some believe values have dropped sufficiently to encourage investors to resume acquisitions in stronger metros and submarkets rather than risk missed opportunities by attempting to time the absolute bottom of the market.

"Visions of quality assets coming to market at fire-sale prices will continue to fade, and buyers and sellers will move closer to redefining fair value based on true assessments of quality and risk," Green and Nadji said in their report. "More distress is sure to come to market, but the quality will be highly mixed as lenders avert further losses by avoiding foreclosure on performing assets and those with reasonable prospects for stabilization."

REITs aren't the only buyers gearing up for future investments. Private local investors who liquidated their holdings at a tidy profit in the mid-2000s are coming back as buyers, Marcus & Millichap said.

In what may be "the clearest signal yet that prices have adjusted to levels that can be sustained," such smaller investors recently have accounted for 82% of the dollar value in the current acquisitions pool, compared with 37% at the peak four years ago.

New Development On Hold

The majority of apartment companies have chosen to either cancel or scale back their 2010 development plans, according to a survey of company earnings statements and conference calls. Developers delivered just 94,000 units in 2009, according to Marcus & Millichap, a number expected to drop even lower this year, a level expected to be the lowest level since 1995. New construction starts have fallen to a 15-year low, with new development constituting just 0.5% of existing inventory.

Fitch Ratings recently maintained a stable outlook for multifamily REITs in 2010 due to this limited supply, along with continued access to low-cost financing from government-sponsored entities Fannie Mae and Freddie Mac.

The construction pause, along with a population surge among renters forming new households over the next three years, is expected to drive down vacancies and offer the opportunity to raise rents. With these numbers in mind, AvalonBay, unlike some of its rivals, said it remains committed to delivering new product.

"Given greater visibility now for both the economy and capital markets and our positive outlook regarding the fundamentals in late 2011 and 2012, we will be increasing our acquisition, free development and development volumes this year to position us for the projected improvement in fundamentals," said AVB Chairman and CEO Bryce Blair.

"We do intend to start some new developments in 2010 although the amount should be modest by historical standards upon the order of $400 million," added President Tim Naughton. "Most of the activity is likely to occur in the northeastern suburban markets where market conditions are more stable and wood frame communities offer better projected returns. In addition we are beginning to look at new land opportunities as some land owners and lenders are starting to consider disposing of their holdings and many of our competitors remain on the sidelines."

The prospects for a recovery come as apartment vacancies hit a 30-year high in the fourth quarter, and rents fell 3% last year as landlords scrambled to retain existing tenants and attract new ones.

Rising unemployment contributed to a more than 3% decline in asking rents in 2009, while effective rents fell nearly 6% and concessions rose. Landlords quickly cut rent in the first half of 2009 and concessions have become commonplace in formerly torrid housing markets, such as Fort Lauderdale, Las Vegas, Miami, Orlando, Phoenix, the Inland Empire, Sacramento and Tampa-St. Petersburg possibly reflecting increased competition from the single-family and condo "shadow" market.

GSEs To The Rescue

At the end of last year, 4.9% of CMBS were delinquent, a five-fold increase over the year before, Moody’s Investors Service said last month. The Moody's “delinquency tracker” found that more than 8% of the bonds for apartment loans and more than 9% of bonds for hotel mortgages were delinquent.

In another black-eye for the industry, multifamily is at the center of one of the biggest commercial real estate deals to come undone so far, the default on the debt used to finance the $5.4 billion purchase in 2006 of the massive Peter Cooper and Stuyvesant Town apartment community in Manhattan. The 11,000-unit property is now valued at less than half its purchase price.

However, agency funding has likely helped stave off even higher multifamily delinquency rates. Fannie Mae and Freddie Mac dominated multifamily financing last year. Financing 81% of all multifamily activity based on Freddie Mac's accounting for a combined $36.4 billion. See related story in Watch List: "Fannie, Freddie Grabbing Ever-Higher Share of Multifamily Debt Financings"

The agencies’ commercial loans have been among the best performing assets in their portfolios, and GSEs should remain the primary sources of financing for apartment investors, according to Marcus & Millichap. Beyond that, the lending climate for apartments will remain constrained and underwriting standards will be conservative in 2010: investors should expect loan to values to stay within the 55-75% range, M&M said.