Apartments Driving Commercial-Property Recovery

When Arenda Capital Management LLC bought an Atlanta apartment complex whose owners defaulted on a $26 million loan, they did something distressed investors rarely do: They paid full price, deciding not to wait for lender LNR Partners to foreclose and face competition from other acquirers.

“If I don’t buy the deal, then it may be 12 to 24 months before I’d have another chance to buy it, and they still may not be selling unless I make them whole,” said Ryan Millsap, managing principal at Los Angeles-based Arenda, which bought the 592-unit property in October.

Demand for U.S. apartment buildings is surging as the homeownership rate hovers near the lowest level since 1998 and government-supported mortgage companies provide record levels of financing for apartment properties. That’s fueling a rush by investors to buy buildings and helping lenders recover 75 percent of the value of defaulted mortgages tied to multifamily housing, the highest recovery rate on all commercial property.

Sales of U.S. apartment properties totaled $3.8 billion in January, a 53 percent increase from the same month a year earlier, the strongest start to the year compared with offices, and shopping centers, according to Real Capital Analytics Inc., a New York-based commercial property data firm.

Fannie, Freddie Loans

The dollar volume of multifamily loan originations by Fannie Mae and Freddie Mac hit an all-time high in the fourth quarter, according to a Mortgage Bankers Association index that has tracked the data for 11 years. The government-supported entities increased lending by selling $33.9 billion of bonds tied to apartment buildings last year, from $21.6 billion in 2010, according to data compiled by Bloomberg.

For Millsap, paying full price to acquire Atlanta’s Arbors at Winters Chapel before foreclosure seemed like a pretty safe bet, he said.

“Multifamily was not hit hard from a capitalization standpoint,’ Millsap said. “Everybody overpaid -- but there was nothing wrong with the actual properties and today’s market recognizes that. The property itself doesn’t know the difference -- it just keeps operating.”

When the complex was appraised in March, 2006, it was valued at $39 million. The original loan matured last May and went into default because the borrower was unable to refinance, according to data compiled by Bloomberg.

Little Capital Risk

Millsap’s firm got a loan from Freddie Mac at a 4.5 percent interest rate. The capitalization rate, a measure of investment yield on the property, is about 7.8 percent, by Millsap’s estimates. “That puts me in a position where I don’t feel like I have a lot of capital risk,” Millsap said.

“Freddie Mac and Fannie Mae originate a huge portion of the loans out there for apartments,” said Ben Carlos Thypin, director of market analysis for Real Capital Analytics Inc. “If a buyer can secure cheap financing, whether from a government sponsored entity or elsewhere, that allows them to be able to pay more for a property.”

The interest rate for a 10-year fixed multifamily loan designated for purchase by Fannie and Freddie was 4.1 percent, as of March 2, according to New York real estate investment banking firm Cushman & Wakefield Sonnenblick Goldman. The rate is for a loan that covers up to 80 percent of the asset value.

‘Aggressive Lending’

Life insurance companies and commercial banks are also competing to lend in the relatively stable apartment market, offering mortgages for shorter durations and for “transitional” properties that are not fully occupied, said Bert Crouch, director of acquisitions for structured investments at Dallas-based Invesco Real Estate.

“You’re seeing interest rates fall and a very stable and aggressive lending environment, and you’ve got a supply constrained world,” Crouch said.

Rents in the U.S. climbed 4.1 percent in the 12 months through December, according to Axiometrics Inc. Apartment owners are projected to see their rental revenue increase by 6.7 percent this year, as little new supply comes to market.

For all of 2011, 37,678 new apartment units were completed, the lowest annual total in 31 years of data compiled by New York-based Reis Inc.

While Invesco’s real estate holdings are “overweight” on multifamily properties, the firm hasn’t found the kinds of deals it had hoped for when dealing with lenders disposing of troubled apartment loans.

Retail properties recovered 61 percent of their debt, and office properties mustered 68 percent, Real Capital said. Industrials recovered 73 percent.

Apartment vacancy rates, now at a decade-low of 5.2 percent, never fell below 8 percent, even during the lowest point of the commercial property rout, according to data from Reis Inc. The office vacancy rate was 17.3 percent in the fourth quarter, while vacancies at shopping centers average 11 percent in the fourth quarter, unchanged from the previous three quarters.

“It’s a lot easier to hang your hat on something that’s experiencing good fundamentals where values are being supported than if somebody handed you a retail building that sits 60 or 70 percent occupied,” said Ryan Severino, senior economist at Reis.

Excerpt from the article written by Oshrat Carmiel for Bloomberg.com. To read the original article in its entirety, click here.