What’s happened to the distressed multifamily market?

As the great recession peaked, and portfolios were reassessed, we anticipated a vast sell-off of distressed multifamily communities or their notes. But a funny thing happened on the way to the fire sale: Many properties didn't show up.

It’s no surprise that the recession forced many multifamily property owners to reassess their portfolios. One would have expected that the market would have a goodly proportion of foreclosed multifamily properties, or their notes, to be disposed of and available to savvy investors, and in some cases that is exactly what has happened.

“It’s not so much about a property being bad, but just that many were over-leveraged,” observes Dave Hendrickson, managing director, real estate investment banking, Jones Lang LaSalle. Hendrickson says that when a property’s worth is almost matched by its loan, and then is hit by falling rents and rising concessions, something’s got to give.

“It may not be a bad property, and may even be fairly well-occupied,” he says. “But the combination of many things, plus bad timing,” will attract a market for either the note or the property itself.

But a question remains: If the recession treated so many single-family homeowners so roughly, with presumably similar economic pressures being brought to bear on multifamily communities, what’s happened to the market for distressed properties?

Observers are saying that, except for some of the hardest-hit areas, like Nevada, Arizona and Florida, there’s only been a trickle of distressed properties coming on the block.

“Overall, people were expecting a tremendous amount of distress, but that didn’t really come to fruition,” says Kitty Wallace, executive vice president with Colliers International. “As the cap rate started coming down last year, there was a softer landing.”

Wallace notes that lenders seem more willing to add debt into under-performing assets, rather than just dump them. Unlike the single-family home situation in many parts of the country, with large numbers of foreclosed or abandoned houses lingering in weedy lots, banks have seemed to be willing to work with multifamily owners to restructure deals. Sure, there are negotiations aplenty, but in many cases, observers say, lenders seem willing to continue the ride, in particular if the asset is decent and well-run.

Peter Donovan, senior managing director with CB Richard Ellis’ Boston office, agrees that, while there are distressed multifamily properties available to interested investors, there has not been a flood of deals.

“Many people have been surprised, and maybe disappointed,” Donovan says. “We haven’t seen the better-quality multifamily deals being brought to the market.” He observes that many fixed loans are at relatively low rates, and floating rates are even lower. As a result, “lenders are willing to give the owners a little cushion.

“Even if the asset is underwater, they won’t close on you,” he adds. “If the owner seems to be doing a reasonable job, we’re seeing lenders willing to restructure.”

History doesn’t repeat

This recession differs significantly from the economic conditions that hit the multifamily housing market in the early 1990s. A large proportion of financing at that time had been put in place by savings and loan associations, many of which didn’t have the inclination or the staffing to ride out the storm.

Today, however, most loans are held by bigger banks, as well as by Fannie Mae and Freddie Mac, which were taken over by the federal government in September 2008. Because of the bank bailouts, and the greater ability for Fannie and Freddie to execute longer-term strategies, they’re not terribly interested in selling the better-quality product into the market. However, many observers point to a “day of reckoning” in the not-too-distant future, when multifamily loans mature.

“We have lots of loans maturing in 2011, 2012 and 2013,” Donovan says. “So, even with low rates, with loans clearly underwater, something will have to be done. We do hear some lenders talking about note sales in anticipation of loans coming due, and if they feel they can get out close to whole, some may sell notes into the market.”

Meanwhile, there seems to be plenty of funds available, ready and willing to be invested.

“There is financing available, and some bridge lenders are coming back into the market,” says Wallace. She adds that there is significant interest from buyers willing to pay cash, too. A recent Colliers deal in a tertiary market attracted “north of 20 offers,” with the ultimate sale in cash.

Donovan agrees that money is available.

“Institutional players, pension funds, REITS, private individuals, foreign capital and even owner-operators—we’ve seen as much equity money waiting to get into multifamily as we’ve ever seen,” he says. “Across the board, I’ve never seen such interest in multifamily.”

As for bargains, Wallace says they certainly exist. But buyers looking for deals have to be realistic; a recent Colliers project valued at $9 million attracted offers ranging from $4.5 million to $9.4 million.

“Some people think distressed and foreclosed properties offer a big bargain, but others are more realistic,” she says. “Sometimes I’m selling properties for more than the loan balance. It just depends on the asset.”

Going, going, gone

While there hasn’t been a flood of distressed multifamily properties coming on the market, there definitely are some portfolios that are being “reassessed.” Here, some lenders are turning to auctions.

Auctions, says Kenneth Rudy, president and chief operating officer of Jones Lang LaSalle’s capital markets practice, can “maximize the value of assets in a timely manner without risk or upfront fees. In a stagnant market where there are limited interested investor parties, using an auction opens up a viable buyer marketplace.” JLL, in fact, launched an online auction venture last fall that is attracting a lot of interest from investors and owner-operators (see sidebar).

“Both brokered sales and auctions have been successful,” says Wallace. “Sometimes the threat of putting a property up for auction will get a buyer to pay more.”

Donovan, however, says auctions play a narrow role in handling distressed properties. “Mainly they’re being done for smaller assets, under $5 million, for example,” Donovan says. “I don’t see auctions as the best way to maximize the value for larger assets.”

So what’s the bottom line with multifamily distressed properties? Some are calling the situation “suspended animation.” Except for C or C-minus properties in badly hit areas, there’s not much available for sale. Interest rates are still low, lenders are willing to work with borrowers, and the market is anticipating an upswing in rental rates. This all may change when loans hit their maturing dates. Only time will tell.

To comment on this story, e-mail Diana Mosher at dmosher@multi-housingnews.com.