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Well, if you didn't give a little money back in the last few years you probably weren't really in the business. And we did. Revaluations of assets have harmed most equity positions. We reamin invested in a Hotel property with an upscale Restaurant and the results are about as one would expect. Occupancy isn't so bad in the Hotel but rates have significantly declined so ADR is well below proforma. The volume at the Restaurant has been healthy but again margins have shrunk. Two asset classes we wish we had avoided. New development intown is still too costly to build, but perhaps if we are successful in obtaining approvals a market for the site will develop and another development entity may choose to proceed.

We will be devoting some effort to sourcing affordable multifamily assets which require improvement in current operations by acquiring either the asset or the controlling partner position. A judicious investment of equity in conjunction with a large owner/operator with a large presence in the affordable housing space should extend the investment horizon until better times are back.

Two years on and we have three additional ventures committed, and we're getting really close to final approval on our initial 20 acre site. "If development in the Boston area was easy everybody would be doing it." Along the way we have partnered up with a terrific institutional player and now have two properties we are jointly invested in. The first is a 190 room hotel in a great location which has just closed for renovation and which should reopen this summer under a new flag; additional development opportunities adjacent to the site make for an intriguing future. The other is an intown location with great visibility in an emerging area; definitely a mixed use site with an extended planning and approval process.

Last summer we became a passive limited partner in a venture sponsored by an old friend in the mortgage banking industry. The business is an advisory and investment management company focused on Indian real estate, providing services to Indian developers and global institutional investors. Eight full time employees are on the ground closing deals and providing a mix of capital; equity, debt and even mezzanine financing. It's a tremendously fast growing market.

No shortage of attendees, even if many were brokers selling deals. Cap rates are rumored to be very low; routinely people talk about 7% (and not just for high growth, California markets). Best Quote: "There is no premium for risk as buyer.... maybe I should buy A+ assets since value added/core plus deals are commanding similar cap rates, already assuming some rehab or repositioning". Peter Linneman from Wharton gave an interesting talk where he pointed out; 1) we are in a typical recovery and recovery means that you still feel some pain but you are getting healthier, 2) all recoveries have a no/slow job growth phase and this is no different, 3) the apartment industry hasn't yet stopped building (unlike most other commercial property types) and we really need to slow the pace of construction before occupancies will improve, and 4) we are NOT Japan since we do impose capital market discipline and allow enterprises to fail, banks call loans, executives who make big mistakes lose their job, etc, and therefore we will not suffer the fate of the Japanese stagnant economy (and plunging stock market) of the last  decade.  Lots of graphs which track historical dips and recoveries and we seem to be on track with the past; yet the possibilty exists that history may not hold true in the short run. Leanne Lachman's demographics presentation pointed to strong demand in the future but emphasized the need to segment the markets by age and ethnicity. Also very good graphics especially the age/gender cohort group analyses over time.

It's a week later and we have all returned home and the stock market just gave up almost all of the 2003 rally. Everyone talks about the need to Slow Development (even Ron Terwilliger ot TCR in January Multifamily Executive), yet starts continue unabated. 2002 was the highest construction level of homes and apartments in 14 years; and in December apartments starts were up again to an annual pace of 321,000. Some Capital Sources opine that the only chance to buy at better cap rates than 7% is with new construction joint ventures and then at least you get to target your submarkets and product type (and hopefully prove up your actual rent roll).  Of course Fidelity investing wizard Peter Lynch forcefully told us that "it is futile to predict the economy, interest rates and the stock market" so don't waste your time; you only need a couple of great investing ideas per decade to be successful.... funny, he never mentioned any specifics or anything in real estate.

Two months later and the story is unchanged; it is an active sellers market for existing apartments
and operating results are still a problem with real NOI down from a year ago. Thanks to the REIT analyst community which is able to document operating results quite accurately. Surprisingly, apartment starts continue in excess of 300,000 units annually. The larger market participants as represented in the ULI Multifamily Councils swear that they have cut starts dramatically and mostinstitutional investors say the same thing, yet the starts continue. Even after assuming that condo for-sale units account for 40,000 units and assuming affordable tax credit units including bond financed projects total 70,000, there are still 190,000 umits being built and financed by someone.

A possible explanation for the low cap rates in the buy/sell market today. If today's underwritten NOI reflects actual rent levels (reduced from a year ago), concessions, and higher vacancy; then the NOI is lower than two years ago. To generate the same absolute price (e.g. price per unit) it requires a lower cap rate since the NOI is less. Sellers care more about absolute proceeds received, and some buyers feel that they are receiving a bargain if they can buy for the same absolute dollars as they would have paid 2 years ago (given time value of money). Mathematically, a drop in NOI of 17.5% is offset if cap rates move from 8.5% to 7%. Should this equation hold, when will the institutional advisors join the selling bandwagon for their 4-5 year old properties that experienced strong NOI growth up until this year? Advisors are evaluated on IRR, and a shorter holding period = a higher IRR. Sell the existing assets, buy new ones and restart the IRR clock. It worked fabulously well for the LBO funds and the early Real Estate Opportunity Funds.   
 
 

It's Good to be a Borrower...... and Good to be a Seller
Not so Good to be a Leasing Agent...... or a Developer/Builder

Operating fundamentals STINK. Operating expenses still go up; revenues computed as rents (falling) less vacancies (rising) adjusted by concessions (one month, or two; even three months) are declining and offer little predictability and uncertain increases (not so good to be a leasing agent). While one of the most successful Developer/Builders points out "it's a great time to be building.... it's just not so good to be leasing"... at some point you've got to prove those proforma rents and revenue stream. Even experienced Affordable LIHTC developers are thinking twice about new developments since maximum allowable rents aren't easily obtained and as a result the development costs just don't pencil out.

It's a time to sell your apartments; cap rates are the lowest in memory... and acquirers (institutional advisors who, after all, earn fees for investing) are flooded with funds from sponsors who see apartments as attractive relative investments. Of course, once the apartments are sold the reinvestment problem arises for anyone not wishing to exit real estate ownership. But if your owner partners are financial investors first and real estate investors second, selling now is pretty compelling. How about $455,000 per unit in LA? Or selling a well bought ten year old asset for enough dollars to fund this year's entire development pipeline.... not bad. If Pension Funds are over allocated to real estate equities because common stock values are way down (S&P, Nasdaq), i.e., the "denominator effect" will Pension Funds be forced to sell? Not necessarily, if they simply borrow a 50% LTV mortgage against previously unleveraged real estate equities (remember it's a good time to be a Borrower with rates at near historic lows), then the Fund has cash to invest elsewhere and re-weight its assets by investment class.

Even a different Seller scenario has arisen... Condominiums. Whether converting a ten year old property in California, or developing a high rise in Atlanta on phase two land, profit opportunities exist. If low home mortgage interest rates are enticing your higher income renters out of your apartments, why not share in the opportunity and profit yourself from the effect of low interest rates? After all, for-sale purchasers recognize it's a good time to be a Borrower.
 
 

Once again the national economic outlook diverges from the near term prospects for multifamily properties. While acknowledging a recession, most economists feel that the bottom has been already reached and that a modest recovery is underway. Perhaps, but it is clear that the recovery will come at the expense of a tremendous number of  jobs lost and that has significant negative impacts on the apartment markets. Ron Witten's U S Apartment Market Update painted a sobering picture of the recent 4Q01 data with all indicators down; occupancies @ 93%, rent growth reflecting concessions is negative for 4Q01 and 1Q02 while completions of units begun months ago continue to have very slow absorption. Ironically, record home sales boosted by very low home mortgage interest rates, which has been one of the factors which has helped the national recovery, has predictably been a negative for Class A apartment occupancies. It is curious to be in a room of developers who wax poetic about the positive effects of an interest rate increase on the business (but only a percentage point or two).... be careful for what you wish for. Unlike four months ago, everyone admitted to much lower occupancy rates within their own portfolios and many of the merchant builder developers have reduced this years starts and even given back development sites to land sellers. Clearly it is a time for proformas built on actual rent rolls, no revenue growth until 1Q04 (remember occupancy may still go lower and concessions remain prevalent), stabilized vacancy of at least 7% (not the ever popular 5%) and well documented increases in insurance expense and probably local real estate taxes. So will sellers (of existing property and/or to-be built projects) lower prices sufficiently to entice buyers? There is lots of equity capital in the hands of institutional advisors looking for a home in the apartment sector but yields will not be as high as initially promised. Job formation is the cure from a national perspective; severe cutbacks in completions are the key in specific local markets. No one mentioned that the LIHTC tax credit allocations have been increased (and will almost certainly be fully utilized) and that many LIHTC developers are increasing their use of tax-exempt bond financing to build more new units, many of which show proformas at market rates which will compete with units in all but a few "supply constrained" markets. LIHTC and tax-exempt bond driven starts could increase by 30,000 units which would necessitate even larger cutbacks in conventional starts than most commentators were discussing. As for humor, the best line of the meeting might have been from a Southeastern based developer who self-deprecatingly remarked that "his problem was that he operated only in demand constrained markets".
 
 

While attending the January, 2002 NMHC Annual Meeting in Naples, FL much of the discussion focused on the effects of the current recession on apartment rental markets. While no one would confess to serious problems within their own portfolios, it is clear that certain markets such as Atlanta and Austin are unlikely to have positive NOI growth this year, primarily due to an abundance of units in the new Class A category. REIT activity is much more subdued and REIT acquisition executives would be well served to be patient and cautious in pursuing new business ventures which are tangential to their primary business of managing focused portfolios for optimum cashflow.