Caldera Asset Management

back to August 2010 issue

The New Debt Environment

By Mike Kelly President
Caldera Asset Management, Denver
mkelly@calderaassetmanagement.com

As we roll into the second half of 2010, apartment owners are trying to fully understand the changing dynamics of sales and debt markets. Due to our reorganization efforts nationwide, we have been able to observe some details and trends on a large swath of apartment assets.

Looking Back at the First Half of 2010

•	There was a low supply of quality assets in any of the primary markets. Institutional assets in urban markets achieved cap rates similar to the ones seen in 2007.
•	Occupancy rebounded quicker than most apartment analysts predicted. Most high quality assets picked up 200 to 400 basis points in occupancy during the first half of 2010.
•	The federal housing agencies were the dominant lender in the market. Freddie Mac gained the most market share as Delegated Underwriting and Servicing (“DUS”) lenders slowed down. Life companies slowly come out of hibernation, but the absolute number of new loans originated was still low.
•	Concessions flattened, and even shrunk, in several markets.
•	CMBS servicers extended more loans and took back the assets with either poor financial records, or fundamentals, or both. The time taken to solve CMBS issues was long but is beginning to improve.

Anticipated Second Half of 2010

•	More assets will hit the market with attempts to close by year end. Investment funds, which originated between 2004 and 2007, are going to use this window to pare down their portfolios. With strengthening rent rolls and competitive debt markets, many deals which were under water at the end of 2009 suddenly look better.
•	A sale in the second half of 2010 also demonstrates fund “manager expertise” in not selling when the market hit the bottom in 2009. They hope it will resonate for new investors in newly raised funds.
•	Occupancy should remain strong across the country. The real test of the apartment market will be seen in the fourth quarter as the comparisons to prior years and prior quarters will become more difficult.
•	Effective rents should remain strong in the fourth quarter. However, the important issue will be if the owners are able to translate this into an increase in rental rates or they will cave into the slightest hints of market slowdown and start offering concessions.

Debt markets

•	In the first half of 2010, many of the Fannie Mae DUS lenders were more conservative as they were trying to understand the risks and balance sheet impacts of adding new deals to their existing platform. Freddie Mac took advantage of this and appears to have captured a bigger share of the market. Furthermore, Freddie Mac’s new CME product has become the staple in many of the new acquisitions. Fannie Mae and their DUS lenders will become more aggressive in the second half of 2010.
•	Freddie Mac has announced a new “Mezz” program that is providing the refinance bridge to many existing assets. The new mezz will piggy back off the Freddie CME and go up to 90% loan-to-value (“LTV”) based upon a 1.05 times the combined debt service coverage (“DSC”). Currently, there are four groups in the program that will bid on and be the end provider of the mezz debt. Additionally, the four groups are able to negotiate current and accrued pay rates on their loans which will offer additional options to borrowers. This is an excellent program for the market which we are in, and it should work better for refinances than for new acquisitions due to the low current cap rates.
•	CMBS lenders will gradually enter the apartment market. However, since competing against the agencies will be an uphill battle, they will end up lending mostly to high quality office, retail, and industrial assets.
•	Life companies will provide debt on a few high quality assets, but they will also find greener pastures in other type of assets.
•	The flow of new deals, which is expected to be significant based on our conversations with major brokers nationwide, will test the origination platforms as many have reduced their staffs.

Conclusion

The long awaited flow of properties is finally thawing. Many equity providers and sponsors will take advantage of the current uptick in fundamentals to sell some of their non-core holdings. Servicers are starting to get back better assets and they have spent 2010 making their sales processes more efficient. Since debt markets appear to be plentiful and competitive, the real question facing apartment investors will be “how long will this tight cap rate last,” and whether this will ultimately affect the supply of products to force cap rates back up.

About the Author
Mike Kelly is the president and co-founder of Caldera Asset Management, a turnaround consulting and restructuring services firm specializing in multifamily assets. Caldera’s team has experience working with lenders, equity investors, lawyers and other consultants to solve complex problems associated with distressed multifamily assets including turnaround, refinancing, stabilization, restructuring, dispositions and property management. For more about Caldera, please visit www.calderaassetmanagement.com.