Thursday, May 20, 2010

US mid-size Reits struggle to clinch apartment deals

Lack of quality real estate, large pool of competing bidders worsen competition

(BANGALORE) Mid-sized apartment Reits have led the US multi-family sector in snapping up properties, but they could soon get squeezed out of the deal market due to increased competition and lack of quality real estate.

Industry experts expect multi-family Reits to cash in on real estate deals in 2010, but pricing has turned out to be an issue, with demand for the higher-rated properties outstripping supply.

In the last three months, Essex Property Trust, Home Properties Inc and BRE Properties have been front-runners in this spike in merger-related activity.

In March, Essex Property, through a joint venture, purchased an apartment complex in California for US$128 million, while Home Properties also acquired two apartment communities in Maryland.

Mid-America Apartment Communities Inc chief financial officer Albert Campbell said the Memphis-based Reit had participated in more than 40 bids in the first quarter but had succeeded in winning only one.

'We are definitely bidding a lot,' Mr Campbell said, 'We are underwriting, on average, 15 deals a month...There's a lot of activity, but we are not winning as much as we would like to.'

Even larger players are entering the fray, making it difficult for mid-sized Reits to cut deals.

In April, apartment landlord Equity Residential acquired a luxury Washington DC apartment property for US$167 million, following deals in Manhattan earlier this year.

Also, the rate of return on properties, known as cap rates in industry parlance, is a concern. Cap rates are a measure of calculating how fast an investment will pay for itself.

'We are definitely seeing more deals right now. The problem is that the cap rates in the space are very low at this point,' said RBC Capital Markets analyst Michael Salinsky.

With its dependence on the job market and also due to its short-term leases, the apartment sector was among the first to be crippled by a combination of eroding rents, rising vacancies and declining values.

However, led by the mid-cap apartment Reits, it has also been among the first of the commercial real estate sectors to bounce back as the markets improved. Along with intensifying competition, the lack of high-quality real estate currently on offer is a source of worry, and could push back any consolidation in the space.

Mid-America's Mr Campbell said the number of properties put on the market was lower than expected, and those were not of the highest grade.

Top-rated properties are those that are 10 years old or less, in a good location and with the capability to charge rents above current street rates.

Houston-based Camden Property Trust chief executive Richard Campo said he was looking for deals but the current environment was 'difficult.' 'We have a very limited supply of high-quality real estate today in the market, and a very big supply of capital that is looking to acquire those properties,' he said.

Earlier in March, Camden Property announced a US$250 million share offering, the proceeds of which were to be used partly to fund development activities and finance acquisitions.

Faced with this difficult environment, mid-sized apartment Reits are looking at other avenues to pick up property.

'What we are doing is to try to acquire properties that are more complicated, or we are trying to buy the debt on the properties, or we are trying to get some off-market transactions so we don't have to bid it up,' Camden's CEO said.

In the aftermath of the US housing market collapse, lenders have severely minimised their exposure to the commercial real estate market and are only willing to back deals concerning properties of the highest rating.

But the biggest advantage that the apartment sector Reits have over other commercial Reits is their access to Fannie Mae and Freddie Mac capital.

Macquarie Equities Research analyst Michael Levy said agency-issued multi-family loans continued to outperform single-family agency loans and commercial mortgage-backed securities debt.

Dean Frankel, a senior portfolio manager at Urdang, a BNY Mellon asset management company that invests in Reits, said apartment Reits would turn to the unsecured market for financing.

'Today, the cost of unsecured debt is comparable to secured but there is an added flexibility that comes with utilising bonds over mortgages,' he said.

However, scepticism about future ventures remains.

'There isn't much value addition created when you stand around with 50 different people and try to be a winning bidder,' Mr Campo said. 'It's hard to do, and we haven't been very successful so far in buying properties.' - Reuters

Source: Business Times, 20 May 2010

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