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Falling Apartment Values Add to Construction Losses
MBA Newslink
Published: November 5, 2009
By Michael Murray
Apartment construction lenders will face nearly $22 billion in losses--17 percent of total loan balances--after a nearly 25 percent year-over-year decline in property values, said Caldera Asset Management, Greenwood Village, Colo.
Mike Kelly, president and co-founder of Caldera, said lower rental rates and higher vacancy rates caused value declines, and most apartment construction loans face a three-year term with two, one-year built-in extensions. While terms for obtaining extensions vary widely between asset type and lender, as each month passes the number of loans going into extension periods also increases. Kelly said loans originated in 2005 already expired on the original term and the developer is "living off the extension(s)."
Moody's/Real Commercial Property Index for October said apartment property values dropped 24.4 percent in the past year and 32.1 percent from October 2007.
"Even the loans with the most conservatively stress-tested cap rates are probably underwater by 50 basis points to the current sales market," Kelly said. "Rental rates, occupancy and absorption rates are generally below pro forma. Most construction loans were indexed off LIBOR with spreads ranging between 150 and 300 bps. LIBOR has dropped from approximately 3 percent in 2005 to 0.20 percent today, helping borrowers to offset the lower effective NOI with lower borrowing costs. This has also helped the built-in 'interest reserve' to last much longer than anticipated."
On Bloomberg Television last month, Kelly said multifamily properties parallel residential loans in falling values and delinquencies. Between 2005 to 2007 in multifamily, Kelly said nearly $90 billion in transactions took place each year combined with $60 billion annually in equity. With falling values and tight credit, Caldera estimated $20 billion to $25 billion losses from that equity.
“That is going to filter through banks, life insurance companies and pension funds,” Kelly said.
Multifamily property loans declined 40 percent during the third quarter this year, the Mortgage Bankers Association said in its Quarterly Survey of Commercial/Multifamily Mortgage Bankers Originations.
Kelly said lenders continue to extend apartment assets because most major maturity schedules do not hit until 2012 to 2014.
“A lot of lenders are doing a phrase, which is 'extend and pretend,'” Kelly said. “[Lenders] will extend any loan out there and pretend there is not a problem. But it is putting [the property] into the teeth of the maturity schedule, which is going to cause more problems. We think that in some markets the end will be much quicker--2010 or 2011 in some markets--and in other markets it is going to be 2012 and on, just because the rent rolls have declined to such a level that it falls a lot quicker than it ever recovers."
Multifamily construction--including condominium properties--fell 18 percent in October from September, said Robert Murray, vice president of economic affairs at McGraw Hill Construction, New York, in his monthly Forecasts & Trends report.
Two large multifamily projects reached groundbreaking in September, including a $106 million condominium tower in Chicago and a $61 million apartment complex in New York City, "but in general the number of large multifamily projects continues to be down considerably from prior years," Murray said.
During the first six months of 2008, 18 such projects reached groundbreaking, and 21 projects of $100 million or higher reached groundbreaking during the first six months of 2007. During the first eight months of this year, Murray said six multifamily projects valued at $75 million or more reached groundbreaking compared to 33 projects $75 million or higher during the first eight months last year and 57 such projects for the same period in 2007.
“A lot of lenders are doing a phrase, which is 'extend and pretend,'” Kelly said. “[Lenders] will extend any loan out there and pretend there is not a problem. But it is putting [the property] into the teeth of the maturity schedule, which is going to cause more problems. We think that in some markets the end will be much quicker--2010 or 2011 in some markets--and in other markets it is going to be 2012 and on, just because the rent rolls have declined to such a level that it falls a lot quicker than it ever recovers."
According to Kelly, original equity investors put in 10 percent on average of total construction costs, they already lost all their equity and if original developers refinanced completed assets at 65 percent loan-to-value--based on new values--they still need to raise $36 billion more for equity alone.
"Considering that the entire apartment real estate investment trust universe had a total market value of only $28 billion on September 1, this is a significant amount of capital to raise," Kelly said. "Although there will be considerable pain for banks on all asset types, they will most likely fare better on apartments solely due to the existence of GSE’s including Fannie Mae and Freddie Mac. Unlike other assets, GSEs are still active and continuing to provide new permanent debt at 65 percent LTV [on average]. In certain situations, they are even providing more dollars for developers to refinance as if they were funding a new acquisition."
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