Despite Current Uncertainty, Well-Located Multi-family Assets Poised for Long-Term Gains

Uncertainty in the global financial system has exacerbated the credit crunch, further limiting the availability of credit to private and institutional apartment investors. But despite the roller coaster ride on Wall Street that sent global stock market indices on a downward spiral, the Federal Reserve’s announcement that it would infuse $250 billion into the nation’s largest financial institutions, coupled with its decision to bail out government-sponsored entities Fannie Mae and Freddie Mac, could spur a recovery by as early as late 2009. Tighter lending standards will prevail in the foreseeable future, and spreads are expected to remain volatile through the next several quarters. After the Lehman Brothers and Merrill Lynch & Co. announcements, portfolio lender spreads for apartment properties increased 30 to 40 basis points, then rose another 20 to 25 basis points when the initial Emergency Economic Stabilization Act failed to pass a vote in the House of Representatives; they currently range from 275 to 300 basis points over the 10-year Treasury. Apartments are a bright spot in Fannie Mae’s and Freddie Mac’s portfolios, and the agencies continue to lend on quality deals. Agency fixed-rate spreads have also risen since the Lehman and Merrill Lynch announcements, to 275 to 300 basis points over the 10-year Treasury.The credit crunch and expanding buyer/seller expectations gap are hindering apartment transaction velocity, especially for institutional-grade assets, which will place further downward pressure on already discounted prices over the short term. While cap rates for Class A, B and C assets have increased, Class A cap rates have remained the most stable–rising only between 35 and 75 basis points–a trend that is expected to continue over the short term. Investors can secure acquisition financing for Class A assets in prime locations, especially if these properties are priced below $10 million and the buyer has plenty of equity in the deal and ample experience as an apartment owner/operator. Life insurance companies and regional banks are still providing financing for these “safe” assets, while financing for institutional properties has all but subsided. Opportunistic investors should target Class B urban infill product because of lower land costs and shifting demographic trends. Whereas new, ground-up product may cost as much as $200,000 per unit to build, depending on market location, developers building Class B urban infill product can redevelop units at a lower cost of between $90,000 and $120,000 per unit. As Baby Boomers and Echo Boomers continue to flee the suburbs for smaller residences in urban cores across the United States, these Class B urban assets will only increase in value over the long term.Current woes on Wall Street, the CMBS crisis and the housing market slump have tainted otherwise healthy apartment market fundamentals, which has prompted lenders to increase equity requirements over the short term. As the global financial markets recover, expect apartment fundamentals to improve by the end of 2009, although values will remain discounted on a historical basis, depending upon asset type and location. We remain bullish on the national apartment sector and expect property values to return to their inherent value by 2013.Linwood Thompson is senior vice president & managing director of the national multi housing group at Marcus & Millichap Real Estate Investment Services.