COVER STORY, JUNE 2008

MULTIFAMILY FINANCE: OPPOSITION AND OPPORTUNITIES

Katz

Dashed hopes from the once-rampant condo-conversion market are coming back to haunt many over-leveraged multifamily owners in Southern California. It’s easy to see why: refinancing or restructuring loans on properties that were originally targeted for condo conversion has become tougher to do during the past few months.

The root of the problem lies in a deepening housing slump and credit crunch. After paying lofty sums to acquire their properties during the peak years of the property boom, many multifamily owners now fail to meet their monthly debt costs with the market rental income generated by these assets. Even fully-occupied buildings are challenged: with the in-place rents already priced at or above the market rate, there is little additional upside to the property’s value without selling off units individually. This climate isn’t about to change, either. Seasoned industry professionals estimate that the current crisis will continue to affect the local condo market for at least another 18 months as the market correction continues unabated.

But this unsettled market also presents opportunity. For example, there is tremendous opportunity right now in the multifamily sector, which is perhaps the only commercial property type that is fundamentally benefiting from the subprime meltdown. The foreclosures of single-family homes, combined with stalling economic growth, have boosted occupancy rates among many Southern California apartment communities.

The end results are rent and net operating income (NOI) growth. This primary improvement, compounded by the Federal Reserve’s aggressive campaign to lower interest rates, has spurred a favorable environment in which to refinance. During first quarter 2008, for instance, there’s been a tremendous influx of loan applications from borrowers wishing to take advantage of various portfolio lender and agency programs in which interest rates may now be fixed as low as 4.89 percent. Given that the average life of a commercial loan extends roughly 7 years, lenders can expect to sustain and improve their current volume levels well into the near future.

Obstacles still remain. One example is the significant disconnect between buyers and sellers when it comes to local property valuation. Not too long ago, the capital markets were frothy and debt was distributed hand over fist. That overly-ambitious lending atmosphere contributed substantially to cap rate compression in Southern California. But many liquid buyers are scratching their heads as they sit on the sidelines.

These buyers are awaiting unique opportunities while sellers slowly re-think their valuation assumptions. Hopefully, the availability of attractive debt terms for the right deals will help bring both parties back to the bargaining table. As of late March, portfolio lenders and the agencies such as Fannie Mae and Freddie Mac have found themselves inundated with loan requests. By many accounts, they have filled the huge void left behind by the unavailability of affordable commercial mortgage-backed securities (CMBS) instruments.

Volatility in the capital markets has even curtailed demand to finance properties that were once deemed safe bets. Nor does history offer many parallels: the current liquidity crunch can easily be distinguished from the pain experienced by many owners in the early 1990s since property fundamentals generally remain strong. This distinction, however, must be accompanied by the following qualification: in this rapidly evolving market, it is anyone’s guess whether or not even the stalwart multifamily sector can withstand volatile commodity prices and the early stages of a global recession.

Against such turbulence, borrowers value assistance from the professional community to navigate the treacherous waters. Individuals who possess the knowledge, experience and persistence required to turn lemons into lemonade will meet today’s challenges head on.

Alex J. Katz is managing director at Meridian Capital Group LLC’s Los Angeles office.

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