Zell Buying Lehman Apartments Reverses REIT Slide: Mortgages
Their surprise $16 billion deal last week to acquire Archstone Inc. from Lehman Brothers Holdings Inc. ended a plan by the defunct investment bank for an initial public offering of its biggest asset and halted a 13 percent slide in apartment stocks since their July peak. The slump was driven by concern that rising homeownership and new construction would weaken landlords’ power to raise rents as a mammoth share sale flooded the market.
“The storm cloud has been lifted with the cancellation of the IPO,” said Dean Frankel, senior portfolio manager at Urdang Capital Management in Plymouth Meeting, Pennsylvania, a unit of Bank of New York Mellon Corp. (BK) that oversees about $6.3 billion of real estate securities globally.
Household formation is still increasing demand for rental housing and the tepid pace of U.S. job growth suggests homebuying remains out of reach for many people. Whether the apartment market gets overbuilt depends partly on lenders, said Gleb Nechayev, senior managing economist at CBRE Econometric Advisors, the Boston-based forecasting unit of commercial broker CBRE Group Inc.
“We do expect the rental market to remain strong and the big question on everyone’s mind right now is how aggressive will development get?” said Nechayev. “If new construction will remain disciplined, the market can ride this wave for a fairly long time.”
The largest sources of financing for apartments are the government-owned mortgage finance companies Fannie Mae and Freddie Mac, said Sam Chandan, president of Chandan Economics, a real estate research firm.
“Their books of business are performing very well,” Chandan said. “Even under conservatorship, Fannie and Freddie have taken the lead in supplying credit to the multifamily sector. The availability of credit has, in turn, supported property sales and prices.”
At banks, the default rate for multifamily mortgages was 2 percent of outstanding loan balances in the second quarter, down from a peak of 4.7 percent in 2010’s first quarter, Chandan said. He estimates the bank default rate will fall to 1.5 percent by year’s end. Before the global credit crisis, the default rate for banks’ multifamily loans was about 0.3 percent.
The Bloomberg Apartment REIT Index (BBREAPT) fell 0.2 percent in New York paring its gain to 0.9 percent since the Archstone announcement. The measure, led by Equity Residential (EQR) and AvalonBay, almost quadrupled from its March 2009 low to its July peak this year, before its decline wiped out the gains for 2012. With the foreclosure crisis forcing people into rentals, apartments had led the recovery in commercial real estate since the economy came out of recession in late 2009.
Equity Residential and AvalonBay drew investors with stock sales last week to help finance the Archstone purchase. Equity Residential sold 19 million shares at $54.75 each, almost 17 percent less than its July 17 high of $65.72.
“There’s a nice opportunity for the stocks to rebound,” said Kenneth Weinberg, senior portfolio manager at CBRE Clarion in Radnor, Pennsylvania, which manages about $20 billion of real estate-related assets.
“You might have a deceleration in rent growth but it’s still going to be very good,” Weinberg said. “The other issue that’s been weighing on the sector is the view that a recovery in housing means bad things for the apartment sector. Frankly, I believe they can coexist.”
Investors have flocked to apartment properties as well as stocks, driving investment yields on apartment purchases toward 4 percent, about the same level at which some prime New York office buildings changed hands during the market peak in 2007.
TIAA-CREF, with about $495 billion of assets under management, is spending about $300 million for three apartment complexes in Seattle this year and is partnering with a developer on a high-rise apartment tower in the city’s downtown, drawn by the Puget Sound region’s strong job growth.
TIAA-CREF owns about 8 million square feet (743,200 square meters) of office, industrial and retail properties in the Puget Sound region but until this year didn’t own any apartments in the area, said Christopher Burk, senior director of acquisitions for the Western U.S. for TIAA-CREF.
“Across the country we have increased our investment in the multifamily asset class,” Burk said. “We believe apartments are at a healthy pricing level and also believe there’s a possibility for continued rent growth.”
The apartment rally’s sustainability depends partly on how quickly developers build. A report by CBRE Econometric Advisors released today says apartment rent gains will shrink in 2013 for the first time in three years as the supply of new buildings increases and home purchases pick up.
Apartment construction, which accounted for all of the gain in U.S. housing starts in October, is now back to the average of the past two decades, said CBRE’s Nechayev. Multifamily home starts, which include rental and for-sale apartments, jumped 11.9 percent in October to an annual rate of 300,000 units, while single-family starts fell 0.2 percent to an annual rate of 594,000 homes, according to a Nov. 20 report from the Commerce Department.
From 1989 to 2008, developers built an average of 265,000 units a year in apartment buildings with five or more units, Nechayev said. Based on construction permits, apartment supply climbed an average of 300,000 units per year during the past two decades, he said. Apartment construction hit a 50-year low in 2009, according to the Census Bureau.
Nechayev estimates apartment rents, after adjusting for inflation, will increase about 2 percent on average next year, down from a projected 2.5 percent this year, as the national vacancy rate rises to 5.3 percent from 5 percent. Real rents climbed 1.5 percent in 2011 and 0.2 percent in 2010 after falling 6.1 percent in 2009, according to CBRE. The firm expects apartment vacancies to drop back to 5.2 percent in 2014.
In nominal terms, Nechayev estimates apartment rents will rise 2.7 percent next year, or close to the average during the past two decades of about 2.5 percent. That’s down from an estimated 4.6 percent this year and 4.9 percent in 2011. Rents rose 1.4 percent in 2010 as the economy came out of recession. In 2009, rents fell 4.7 percent.
Archstone would have been the third-biggest apartment REIT had it gone public again. The company on Nov. 19 had filed amended plans to raise about $3.45 billion in an IPO. Equity Residential and AvalonBay are buying Archstone for about $16 billion, including about $9.5 billion of assumed debt, of which about $8.6 billion is held by Fannie Mae and Freddie Mac.
The sale of Archstone to its larger rivals gives the country’s No. 1 and 2 apartment REITs well-located properties in large coastal cities where job growth is relatively robust, expanding their revenue and assets. Equity Residential said it plans to fund part of the purchase by selling properties in markets including Atlanta, Phoenix and Jacksonville, Florida, by the end of 2013.
“The value proposition today looks a lot better than nine months ago,” Frankel of Urdang Capital said.
Even with signs of a slowdown in rent growth, the apartment market remains strong by historical standards, said Nechayev. “The reason new supply is coming in is precisely because the market has done so well.”
Archstone has been an emblematic real estate deal, being the last big leveraged buyout before the credit crisis shut off lending. Tishman Speyer Properties LP and Lehman, with financing from Barclays Plc and Bank of America Corp., bought Archstone for about $22 billion in October 2007 at the tail end of the commercial property boom.
Lehman and the other two lenders, which became shareholders through a subsequent reorganization, fought over how to sell Archstone, with Bank of America and Barclays eager to unload their stakes and striking a deal to sell shares to Equity Residential. That prompted Lehman to exercise its rights to counterbid and ultimately gain 100 percent of Archstone.
In exchange for Archstone, Lehman’s estate will receive about $2.69 billion of cash and about $3.8 billion of Equity Residential and AvalonBay stock that it’s required to hold until April 26, 2013. Lehman will get about 34.47 million shares of Equity Residential and about 14.89 million shares of AvalonBay, making it the companies’ largest shareholder.
Archstone’s owners forfeited the chance to take the company public while investors were most bullish on apartment REITs, said James Corl, managing director of Siguler Guff & Co. overseeing distressed real estate investments for the firm, which manages more than $10 billion.
“In missing the IPO window, they missed the opportunity to have the stock market competing with the real estate private equity market to pay top dollar for the portfolio,” Corl said. “Only time will tell whether taking a huge share position in a pair of stocks whose fundamentals have clearly peaked will pay off or not.”
Kimberly Macleod, a spokeswoman for Lehman, John Yiannacopoulos, a spokesman for Bank of America, and Brandon Ashcraft, of Barclays, declined to comment. Spokesmen Marty McKenna for Equity Residential and Richard Wolff for AvalonBay also declined to comment.
Lehman didn’t get full ownership of Archstone until May. Once Archstone filed plans Aug. 10 for an IPO, investors expected the company would go public again. Archstone had been moving to reduce its debt burden from the buyout by selling assets. As of the sale, its ratio of debt to net assets still exceeded the industry average.
The rallies in Equity Residential and AvalonBay following the sale suggest the buyers bought at attractive prices from the Lehman estate, Frankel said. “The buyers got a good deal, and the seller got the best price available and more certain liquidity,” he said.
“This is the best execution for Lehman today,” said Laurel Durkay, an analyst at Cohen & Steers Inc. (CNS), a New York- based manager of about $44.9 billion of real estate-related securities. “While sentiment on the apartment sector was more positive earlier in the year, the Archstone portfolio was not in a position to be brought to market at that time, given leverage levels.”
To contact the reporter on this story: Hui-yong Yu in Seattle at email@example.com